Take On Payments, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Take on Payments and look forward to collaborating with you.
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May 16, 2022
The Cost of "Free"
When I began my banking career in the early 1970s, we essentially had only three consumer payment methods: cash, check, and credit (or charge) card. My checking account had a monthly service charge, and the account permitted me to write 15 checks a month—any more than that cost me 15 cents each. The overdraft/nonsufficient fee was $15 per check. My credit card had an annual fee of $25.
Today, I pay no fees for my checking account, debit card, online banking services, mobile banking services, electronic bill payments, or electronic wallet. I pay no annual fees for my credit cards unless a card is a premium card that bundles other products such as product protection or roadside assistance. (Of course, my statement about free checking is slightly exaggerated—most banks impose some sort of monthly maintenance fee, which you can often avoid by keeping a minimum balance or having a recurring direct deposit.)
The banking and payments industry has invested billions of dollars in these free channels and products. But is there really such a thing as a free lunch? Have financial institutions (FI) adopted a benevolent social policy giving everyone the right to free banking services?
It’s more complicated than that. Publicly traded FIs answer to their stockholders, and even nonprofit credit unions must generate sufficient revenue to maintain their financial health. So how can they offer all these free services and products? I believe there are four primary reasons that FIs are willing to forego explicit pricing for their services. The first is competition. Banks must compete in their market with the pricing of their products and services along with other factors such as quality of service and convenience of location. Second, debit card usage creates significant interchange revenue for the issuing FIs. Third, core deposits are the lifeblood of an FI's ability to fund its credit-related, revenue-generating products. Fourth, the bundling of services like bill payment and direct deposit have been shown to create a level of "stickiness"—in other words, the bundling increases the level of dissatisfaction a consumer must experience to believe it is worthwhile to move their account.
Will the bundling of these free services continue, or will the evolutionary cycle return to more explicit fees? Many FIs have been announcing of late that they are eliminating or reducing their overdraft/nonsufficient fund (OD/NSF) fees. The Consumer Financial Protection Bureau estimates that FIs collected almost $15.5 billion in OD/NSF fees in 2019, which was about two-thirds of their fee income. You have to wonder if fees in other products and services will increase to replace this lost revenue. What do you think?
May 9, 2022
Managing Liquidity and Settlement Risk the Fed Way
Today's post features a guest blogger from Credit and Risk within our Supervision, Regulation, and Credit Division.
When we talk about funds flowing through the financial system, it isn't a stretch to compare it to plumbing. For example, plumbing is largely invisible: open the tap, water comes out. Likewise, the smooth-flowing payments system is often invisible. Open your bank app, enter some information, a payment leaves your bank account, and your water bill is paid.
One of the roles the Federal Reserve plays is to keep the payments and settlement system flowing smoothly, and to do so, it has to manage some risks. Let's talk about liquidity risk, which is the risk that a bank may struggle to meet obligations. This can happen during a recession, for example. In normal times, institutions manage their liquidity risk through effective asset liability management, which is managing assets and cash flows to satisfy obligations.
The Federal Reserve manages liquidity risk by providing liquidity to the financial system. One tool Federal Reserve Banks use to do this is the discount window, which offers loans to financial institutions through three credit programs:
- Primary, for depository institutions (DIs) in generally sound financial condition: $47.5 billion in 2021, down 79.8 percent from $235.2 billion in 2020. DIs can request a primary loan on a no-questions-asked basis.
- Secondary, for depository institutions not eligible for primary credit: $10.0 million in 2021, up 809.1 percent from $1.1 million in 2020.
- Seasonal, for banks with deposits less than $500 million and a seasonal need: $138.8 million in 2021, down 50.1 percent from $278.0 million in 2020. Qualifying DIs experience fluctuations in deposits and loans due to servicing seasonal types of businesses such as construction, college, farming, resort, or municipal financing.
A quick two-minute same-day phone call to the discount window of a financial institution's local Reserve Bank is all it takes to have funds deposited by the close of Fedwire at 7 p.m. (ET).
As you can see in the chart below, COVID-19 significantly affected loans to financial institutions in the Federal Reserve System. Before COVID, primary credit lending was in the $74 million to $124 million range and skyrocketed to $89 billion in March 2020.
Another way the Federal Reserve manages payment system risk is to ensure the smooth operation of payment systems by allowing depository institutions to overdraft their Fed account. Known as intraday credit, daylight overdrafts minimize disruptions to payment and settlement systems and support the efficient movement of funds. Fed account holders can overdraft their account up to a specified limit without incurring an overdraft fee. While financially unhealthy institutions are not permitted to overdraft their account at all, qualifying institutions have a few creditworthiness-based options for daylight overdraft limits for their account. (These limits are known as net debit caps.)
Circling back to the plumbing analogy, it's easy to see how these short-term loans from the Federal Reserve help keep credit to households and businesses flowing—and the economy bubbling along.
You can find more information about Federal Reserve discount window liquidity options on the Fed's discount window web page. You can read about the Fed's policy on payment system risk and intraday credit on the Board of Governors website.
May 2, 2022
Taking the Long View: A Visit with Retail Payments Risk Forum Founder Rich Oliver
Rich Oliver, the founder of our Retail Payments Risk Forum (RPRF), paid a visit to our team recently and shared his vision when creating the forum, the challenges facing the payments industry, and the future direction our team could consider as the payments landscape continues to evolve.
In addition to founding our RPRF, Rich's payments expertise goes back to the 1970s when he led the effort to utilize the fledgling US Automated Clearing House (ACH) system to electronically deliver the first government payrolls and social security payments.
Drawing on his expertise, Rich wrote a book with George Warfel Jr. about the payments industry, The Story of Payments: How The Industrialization of Trust Created the Modern Payments System, that "tells the story of how payments—between people, merchants, employers, and governments—emerged from the ancient system of barter and grew, through various technological implementations ranging from coins and paper money to checks, wire transfers, and credit cards, to today's entirely electronic local and international payment systems."
In a wide-ranging conversation about the history of payments and Rich's role in many areas with the Fed, each of us in the RPRF took away some highlights to share with you.
Scarlett Heinbuch: Rich reminded us of the need to be bold in our thinking about the future of payments. We discussed advances in biometrics and how these initiatives could address identity and security concerns and make payments easier for all while also presenting other risks and challenges.
Nancy Donahue: One comment that made me go "hmm" was: "Do we have too many retail payments products that are trying to solve the same problem? Do they all make money? Do they all need to?"
Catherine Thaliath: What resonated with me was when Rich talked about potential risks of Buy Now Pay Later (BNPL). While viewed as a credit offering, it is nevertheless using a payment instrument in ways not previously done.
Claire Greene: "When it comes to product design, you can't assume you know what someone wants without doing the work." This was a humble statement from an innovator that applied in the 1970s and remains relevant today.
Dave Lott: Rich discussed the evolution of the current consumer banking product market where many of the explicit services (on-us ATMs, online banking, mobile banking, pay wallets, etc.) are provided free of charge.
Sally Martin: It resounded with me how much collaboration went on with the payments players in the industry. Also, the amount of time spent brainstorming on what the needs were and how to fill them, and in moving toward new offerings rather than replays of existing products. Rich's talk focused on moving into new territory—he was "agile" before it was cool.
Jessica Washington: We still need to collaborate on fraud mitigation at the strategic level. In the United States, we implemented chip credit cards but not so much chip-and-pin, plus we still have the magstripe, which is a major source of weakness, and we still have much work to do on card-not-present transactions.
As the RPRF founder, Rich challenged each of us to remember its mission: to be a source for non-biased thought leadership, to do original research, challenge norms, and push the envelope to move the payment system forward. Sometimes looking back at history can bring the future into sharper focus, which is what our chat with Rich did for us. As you look to the future of payments and payments risk, what stands out to you?
By the Retail Payments Risk Forum Team: Jessica Washington, Dave Lott, Scarlett Heinbuch, Claire Greene, Nancy Donahue, Catherine Thaliath, and Sally Martin.
April 25, 2022
Leaders Discuss CBDC Research Project
Please note that because of a scheduling conflict with one of our guest presenters, we’ve rescheduled the webinar and updated this post. The webinar is taking place on June 9.
What might a central bank digital currency (CBDC) look like? And how would it work? While the Federal Reserve Board of Governors has not expressed any intention to launch a CBDC, it issued a white paper in January this year to kick off a discussion about it with payment stakeholders. The Board is asking for input by May 20.
Last August, before the release of the white paper, the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology's Digital Currency Initiative announced they were partnering to study the implications of a CBDC. Calling their collaborative effort "Project Hamilton," they describe it as a "multiyear research project to explore the CBDC design space and gain a hands-on understanding of a CBDC's technical challenges and opportunities." They issued a Phase I report this past February.
In the next episode of our Talk About Payments webinar series on June 9, two Boston Fed senior leaders on the Project Hamilton team will provide a detailed overview and current status of the project. Jim Cunha is executive vice president and interim chief operating officer leading the Boston Fed's research effort in central bank digital currency technology. Bob Bench is an assistant vice president in the Boston Fed's payment strategies group. Dave Lott, Atlanta Fed payments risk expert, will moderate the discussion.
We encourage financial institutions, retailers, payments processors, law enforcement officials, academics, and other payments system stakeholders to participate. As always, we're allotting time for participant questions. Please pass this invitation along to any colleagues you believe will be interested in attending.
So, please join us for our webinar on June 9 from 1 to 2 p.m. (ET). The webinar is free and open to the public. However, you must register. We'll send you login information after you register. If you cannot attend the live event, a recording of the webinar will be posted the week after the event.
If you'd like to view previous webinars, go to our Talk About Payments webinars page.
We hope to see you on June 9!