"It's Just a Fascinating Space": A Conversation about the Payments System
Lali Shaffer: Hello, and welcome to the Economy Matters podcast for the Federal Reserve Bank of Atlanta. I'm Lali Shaffer, representing our Supervision, Regulation, and Credit Division. My focus is on fintech and payments, and I'm also your host for today. This episode is the second in a series spotlighting our strategic priority of promoting safer payments innovation. The Atlanta Fed has payment expertise gained from our roles as a network operator, supervisor and researcher. Our goal is to share what we learn to educate the industry, which we hope leads to better payments solutions—and thus a positive impact to all of us as consumers. Today, I'm joined by Doug King, payments risk expert here at the Atlanta Fed. Welcome, Doug—thank you so much for joining me.
Doug King: Lali, thank you so much for having me. I'm really looking forward to today's discussion with you.
Lali Shaffer and Douglas King, both of the Atlanta Fed
Shaffer: Well, I'm excited to have you here. Before we begin, I should share that the thoughts expressed here are of the presenters and may not reflect the views of the Federal Reserve Bank of Atlanta, or System. In preparing for this, we had some really great discussion and we discovered that between the two of us we are bearish on some things and bullish on others, so I wanted to play with that a little bit today since we both have unique views due to the nature of our work. Doug, can you share a little about yourself—both personally, and your role here at the Fed?
King: Absolutely. I sit within a group called the Retail Payments Risk Forum. We are really a research and outreach group, all about understanding risk and ways to mitigate risk and fraud across multiple payment platforms. I've been with the Fed going on 11 years now, and I've been in the payments industry for approximately 15 years. As far as my direct role, I am responsible for managing the Take On Payments blog, which is a weekly blog that the Federal Reserve Bank of Atlanta produces around all things payments, risk and fraud-related. I'm also the co-chair of the Federal Reserve's "innovation payments" roundtable.
Now for a fun fact, before we dive into today's conversation: I am a long-suffering New York Mets fan. People might be wondering, "What's so unique or interesting about that?" Well, for any baseball fans listening to this podcast, they will know that the month of August just continued that long suffering that I have often experienced as a New York Mets fan.
Shaffer: All right—well, I'm hoping you're not going to suffer on this podcast today, but I appreciate you sharing a little bit about yourself. And I wanted to say that you and I are going to take a ride today, Doug. We're going to take a ride in our imaginary "Fed mobile," since we are still virtual, and we're going to explore the hotspots around the financial world. But first I wanted to talk about what's in front of us, and then we'll talk about where we are going—so let's talk about the payments landscape. The Fed conducts a consumer payments survey. Can you share the background of the survey, who the population is, and anything that was surprising to you?
King: Absolutely. Let me get my McLaren gassed up, though, before we get started...that's just a nod to my son—it's his favorite car out there and his favorite Formula One team. But there's some great research that has come out of the Atlanta Fed which really highlights consumers' payment choices, and we have undertaken what is called the Survey of Consumer Payment Choice as well as the Diary of Consumer Payment Choice. I just want to highlight a few interesting shifts that we saw prepandemic, into the pandemic, and coming...I would like to say "coming out of the pandemic," but you know, here we are, still really in the throes of it. But from 2019 to 2020, Lali, the share of mobile payments for purchase and person-to-person transactions increased from 2.8 percent to 5.4 percent. That's still a relatively small number of transactions, just north of 5 percent of all payments, but that is also a dramatic increase—nearly doubled in a single one-year period.
Also, anecdotally, we know a lot of people stayed at home or are still choosing to stay at home, just given the environment that we're in, so we saw the share of remote purchases increase from 9 percent in 2019 all the way to 20 percent in 2020. Again, another pretty dramatic shift that has taken place from 2019 to 2020. And then cash has been a hot topic during this time, and what these two surveys found is that cash's share of in-person purchases and for P2P payments—and again, "P2P" being person-to-person payments—fell from 35 percent in 2019 to 28 percent in 2020. So a pretty significant shift there in people's cash usage, but I will say that when you talk person-to-person payments—and this might go against anecdotes, because I don't know how you are when making person-to-person payments, Lali, but I know personally I use electronic payments for that almost exclusively now—but in that segment paper remains king, is what these surveys found, with still seven in ten person-to-person payments being made with either cash or checks in 2020.
Shaffer: The pandemic propelled the use of digital mechanisms, both for getting loans to small businesses and transacting personal payments. I think most people are familiar with sending money to friends and family, but Doug—what other opportunities do you see for digital payments?
King: So that one you just mentioned, sending money to friends and family, Lali, is still a huge opportunity. If you'll remember from our previous section that seven in ten P2P payments were made with a paper-based instrument, either cash or checks—so that still remains a huge opportunity for these digital payments. But the other interesting thing we're seeing with the digital payment apps is that they're not only being used now for person-to-person payments, but they're also being enabled with merchants, where an individual can pay a merchant through one of these digital apps. Beyond the specific digital apps, I think there's still a big opportunity—and we're seeing that in small ticket item purchases. Items that are under $10 have traditionally been heavily paper-based purchases. But with contactless payments—both on a credit or debit card, or within that mobile phone functionality—I think there's a big, continued opportunity to see card-based payments continue to chip away at cash-based transactions for those small-dollar transactions.
And then when you talk about these apps, I think there is ultimately an opportunity here in the US for this notion of a "super app" to really take off. And we've seen that in other markets, but I think it might make sense first to talk a little about what I mean by "super app." Literally, if you think of all the applications on your mobile phone, it is a single application that can serve a multitude of purposes. Think of a super app that when you wake up in the morning, you're able to order your coffee with the app, perhaps read your local news or global news stories, send a message to a friend to say, "Hey, I'm headed to grab coffee...you want to join me?" When you grab that coffee, you actually use the app to pay for the coffee. Perhaps you use the app to catch a ride home from the coffee shop, or to order something to be delivered to your house so it's there for you when you get home. So this whole notion of rather than having a whole bunch of different apps on your phone, that we use one app for many different functions. And we've seen that take place in other markets. Really where it has exploded and taken off is in China, where there are two apps that—I would consider these super apps. And interestingly enough, they really started as a messaging app.
Shaffer: OK, let's stay on this digital path, and something else that the Bank should be aware of: the concept of "buy now, pay later." This is the opposite of a layaway plan. I remember my mom loved putting things on layaway. I can still envision the store clerk in a tiny room filled with junk from floor to ceiling. But fast forward to now, and you get your item today with the promise to pay later. What's cool here is at the point of sale, you can typically get instant approval via a fintech platform. Doug, can you expound on that? And why should banks take note?
King: Absolutely. And this BNPL, or buy now, pay later, phenomenon is growing massively, Lali, and it's really the younger generation of shoppers—namely, younger millennials and older Gen Z-ers. So, say, your 20-year-olds to early 30-year-olds—that are gravitating towards this notion of BNPL, or buy now, pay later. And the growth rate in this segment has simply been phenomenal. Would you care to take a guess, Lali, on what that growth rate might look like?
Shaffer: Sure. I'm going to be safe here and say somewhere in the double digits.
King: So double digits, you're right. But I don't know if the "safe" part hurt you there, because what I'm seeing out there is approximately 40 percent growth on an annual basis for buy now, pay later platforms.
Shaffer: Wow, that's definitely a strong growth.
King: When you look globally, that number is actually even growing at a higher clip. Banks should definitely take notice, given the growth. And the space, while we read a lot about it—I've spent some time diving into it—it is a little bit more complicated in the fact that there are multiple business models in the BNPL space. While someone might be familiar with one particular BNPL platform, another platform could have a very different model—both in how the payments are flowing, as well as an economic model, with how it impacts a consumer, and how it impacts the merchant accepting that BNPL payment. So would you like to dive into a couple of these models—to not get too deep in the weeds, but just to provide some high-level information for our listeners today?
Shaffer: Yes, let me know what you think are some of the more interesting models out there.
King: The big one that is out there is truly—you talked about layaway, this is almost the direct reverse of the layaway—where a consumer using a BNPL platform purchases something from a merchant, the merchant hands over either that service or that good, and it is the BNPL platform that advances that payment to the merchant. The consumer, on the other hand, makes a down payment at the time of the purchase and then subsequently three more payments—is the usual case, over a six-week period, so they're making a payment every two weeks after that down payment. That payment that the consumer is making is being paid to that BNPL platform, and that payment is coming from a debit card, a credit card, or it could be an ACH transaction directly from the consumer's bank account or savings account.
Shaffer: OK, so would you say you're bullish on this, or bearish?
King: I'm extremely bullish on this, and I think as a whole the payments industry, the fintech space, is bullish. And I think banks are bullish. What you have seen with other models are banks saying, "Well, we have consumers who hold our credit card. Can we create a platform where they can, rather than go out with a fintech platform but use our card, and we set them up on an installment plan to pay off that transaction?" So you're seeing some of your larger banks get into this, either building it in house or outsourcing it and partnering with a fintech player in this space. But those capabilities are being performed inside those banks' walls. So while fintech is a major player in this, banks are highly involved—either directly, through offering this to their customers, or by being the payment mechanism that ultimately settles that BNPL transaction.
Shaffer: All right. Well, I will say that I am also bullish on this—of course, if implemented in a safe fashion with consumer protection in mind. The interesting thing I saw about this was that it's highly customer driven with, as you said, the increasing demand. So this is an opportunity where banks can meet the customer where they are—actually, quite literally. I was shopping on my phone and right next to the "add to my cart" button was the tagline for a buy now, pay later option, and the payments were automatically calculated there. All I had to do was click the link and go forth, so it's definitely an opportunity there that we can see coming down the road.
King: And you touched on how the options were laid out before you, and I think that's one of the things that consumers really like about the BNPL option is it's very transparent on the front end with what the interest will be, what is the term of this, what are the payments going to be? Another BNPL product out there is truly an installment loan at the time of purchase, where there's an underwriter behind that purchase who, that underwriter again is fronting the full purchase price to the merchant and then feasibly, the consumer has entered into an installment loan agreement with a bank underwriting. So that is another area where banks can play in this BNPL space, by being an underwriter of these installment loans at the point of sale or when a consumer checks out online.
Shaffer: Excellent. Well, I'm going to keep us driving down the road here, and I want to hit our next hot topic—which could be a giant bridge in front of us here, but I want to talk cryptocurrency. We've all heard of this in the news, and usually it has some combination of terms like "coin" or "bit." However, I wanted to share the definition from the Financial Stability Board for the listeners out there. A "crypto asset" is broadly defined as a type of digital asset that depends primarily on cryptography and distributed ledger or similar technology. Doug, what are your thoughts on cryptocurrency?
King: Can my thoughts be all over the board? [laughter] It's just a fascinating space, and there's so much happening in this space, and I loved how when you were defining cryptocurrency, you brought in the notion of a crypto asset. There are even different names that we can apply to these that I think people generally use to refer to the same thing, but some folks might want to get into the weeds and say, "Oh, there is a difference here and there." But I think what I see when we talk cryptocurrencies are that there are so many different cryptocurrencies and functions for these cryptocurrencies in the marketplace today. There's a website—there are multiple websites—where you can track crypto pricing—so, what is a crypto equal to, its price in US dollars. Last time I checked, there were over 6,000 cryptocurrencies being tracked by one particular website, so trying to bucket, or say, "what are your thoughts on cryptocurrencies?"—there's so much variety within cryptocurrencies that it's really hard to have that just single opinion. Each of these cryptocurrencies are unique, and they serve different purposes, really, based on what their blockchain is trying to accomplish.
And I know I'm driving my fancy McLaren down this road today, but I don't want to get us into blockchains and different purposes, and how different blockchains are structured. But I am comfortable with saying that many of these 6,000 cryptos serve really no purpose whatsoever. And there's been such an explosion, and such an interest for people to invest in these, that a whole lot of cryptos have been created solely for the purpose of—I'll say speculation, and there are no real use cases for many of these cryptos. I think when you talk about this bridge—and based on previous conversations, I'm definitely a little more bearish than you on cryptos, as I really struggle to see cryptos gaining a large share of the consumer payments pie, Lali.
Shaffer: Got it. What about financial institutions?
King: Great question. There are some use cases—some intriguing use cases—out there, whether it's cross-border or business-to-business (B2B) payments. But I think FIs [financial institutions]—just because I might be bearish, you might be bullish—I think FIs still need to follow and pay attention to this space because they are an important player, whether they think they are or not. And what I mean by that, no doubt people are holding their fiat dollars in exchanges and are trading in these cryptocurrencies. So whether they're using them for a store of value, for an investment vehicle—what kind of future impact will that have on consumers holding deposits with financial institutions? It's kind of a far-out-there thought right now, but I have to think that some banks are losing deposits to parties that are playing in this crypto space, where people are saying, "Wow, there's a real opportunity to increase my savings with a crypto asset rather than in a savings account with a traditional bank that right now is struggling to pay much interest on those deposits."
And then the other area that banks play a role in: if you and I want to invest or put money into these cryptocurrencies, we've got to have a vehicle for getting the money into those exchanges. And so it's using generally those traditional banking rails, whether it be debit cards or ACH transactions. Some credit issuers allow credit card transactions, but there are some who are not doing that because of the speculative purposes. Banks are serving that purpose of being the on and off ramps for individuals to get their funds into the cryptocurrency space, as well as then pull the funds back out of the cryptocurrency space.
Shaffer: That's right. I know you are a little bearish, but I'm going to say that I'm bullish on crypto, mostly because it's already happening—and as you said, there are thousands of them out there already. From the banking perspective, we are seeing banks either strategizing or already dipping their toe in the water. And in fact, I would say this is probably one of the hottest topics right now because nobody wants to be left out, including the government agencies. As we speak the pending infrastructure bill has cryptocurrency oversight embedded within its 2,000 pages, and the Treasury may very well be deciding on the path forward over the next couple of years—and also, the SEC chief has stated that they, too, may need more jurisdiction. Also, the fact that the infrastructure bill contains broad language on tax reporting requirements for crypto transactions says to me that legislators are seeing crypto as something to be taken seriously. Just a little bit of technical stuff: cryptocurrency typically happens on a decentralized exchange, or a term we call "DeFi," which stands for "decentralized finance." Basically, these transactions happen outside of the banking system.
So, I will say for those bankers out there to keep an eye on this, as it is moving very rapidly. And speaking of those banks out there, there's something called "open banking." This is not just when the lobby of your local bank is open for you to visit, but it's actually a technical reference to application programming interfaces—which is basically the plumbing behind how your typical budgeting or investment app connects to all of your financial accounts. And there are a growing number of use cases and benefits to open banking. Doug, what benefits do you see on the payments side?
King: There are several benefits, and I will say that there are other areas of the globe that are much further along in the open banking world than we are here in the US. For our listeners who are very interested in this—and from a regulatory perspective, standards perspective—I think looking to the European Union region, there's been a whole lot of movement in this space from a regulatory arena. And it is very important because open banking, Lali, I think ultimately puts the consumer in charge of their data and who has access to that data, which in my opinion is a very good thing and a very powerful thing for the consumer. And when you think about it for payments, I think there are advantages for the consumer as well as financial institutions because this whole open—and as you mentioned, the plumbing, it opens the possibility for consumers to port their banking data and credentials across the payments spectrum. So any fintech that is involved in payments, it could allow them to easily port that banking data to that fintech provider, to a payment option that maybe their current bank is not providing them.
I think that also creates very good opportunity for the banks, because we know core banking—and then, as you touched on...I love that word when you talk about payments: "plumbing." Changing your plumbing is a very big undertaking, and a challenging task. So banks now, in this open banking model, are able to give their consumers a multitude of options, potentially, without investing in all new types of plumbing. So I really see this as a win-win. The challenge, I think, Lali—and I don't know if you'll agree or disagree with me—is really formulating the rules behind this, and also standards for how this data can be openly shared with the consumer in control of that data.
Shaffer: That's right, I agree with that, definitely. We'll talk a little bit about some of the regulation later on. Let's see—did you have any other comments on open banking?
King: I do not have anything additional on open banking. I would love if you have anything to share, I would gladly listen in from your SRC side of the business.
Shaffer: That's right. From our side of the house, where open banking gives back by creating those efficiencies through increasing profits and on-boarding customers, it actually gives a little bit more work to the compliance side of the house by giving them more to monitor in the way of risk management and vendor relations. We call this "third-party risk management." Doug, as a contributor to the Atlanta Fed blog you talked about earlier called Take On Payments, you recently wrote about the request for comments that the three federal banking agencies released on third-party risk management. What were the main points that you saw in the proposal?
King: Prior to this guidance, each of the agencies had released their own guidance. Now that's not to say that the guidance was wildly different, but if you're a financial institution or somebody playing in this space—if you're a third-party service provider who wants to connect all the dots, cross your T's and dot your I's when you're partnering with a financial institution—it still was three different pieces of guidance. So I think having these three agencies come together to release joint guidance was very, very intriguing. And I think the banking industry, as well as these third-party service providers that you touched on, ultimately will think that is a good thing and beneficial to them. But the biggest thing I saw from that—and I probably didn't go through it with as big of an eye, given my role, that you did—was the encouragement that these financial institutions share information and data amongst themselves when they are able. Obviously, not all of their data should be shared or can be shared, but these institutions that are doing due diligence on these third-party service providers, any of that due diligence that they can share and take the burden off of another financial institution is a win-win, I think, for everybody in the industry.
But I will say that it still comes with a caveat that has been around for years when we've talked third-party service provider due diligence: no matter who a financial institution relies on—whether it's themselves, an outside party, another FI—for due diligence for these third-party service providers, the buck ultimately stops with the FI who is engaging with that third-party service provider. So while this guidance encourages sharing, it definitely does not let a financial institution off the hook should something go awry and they were relying on somebody else for that due diligence.
Shaffer: That's right, I agree. A huge part of third-party risk management is something we call "due diligence." This is essentially ensuring that your business partner or providers are legal and compliant. As Doug said, the buck stops with the institution. As a piece of late breaking news, the three federal banking agencies just released fintech guidance for community banks. This is focused on how community banks can strategically tackle the due diligence necessary to work with financial technology providers. Likewise, for you fintechs out there this guidance would be helpful to you as well so that you are prepared when your banks start asking for information such as this.
King: I was going to say, that's just so timely, Lali. You and I have talked—I mean, today we spent a lot of time talking fintech. Fintechs are really becoming interwoven, and such an important piece of this banking universe, whether it's a large financial institution or a small local credit union, and so I know from your side—coming from supervision and regulation—it has been a constant: What kind of due diligence do we perform on these, how do we know if this would be a good financial technology company to engage with? And then the fintechs were saying, "It would be really helpful to have guidance, so we know how to better incorporate in a banking environment." So, I think all around it is a huge piece of guidance that was out there, and it was great to hear your excitement when you reached out to me to say, "Wow, look what just came down the pipeline."
Shaffer: Yes. I will say that is our gift to the industry this year is the guidance that was issued by all three regulators at the same time. So hopefully you know that we are unified in that document and go out there to visit any three of those websites as well. They'll be posted. As a final topic today on our drive around town, Doug, we have a focus on payments inclusion here at the Atlanta Fed. We have a committee with big industry players that will tackle the idea of pulling more people into the financial system. How do you see technology playing a role here, and what options do consumers have, Doug?
King: It's no surprise—and you and I can both be in agreement—that technology is going to play a huge role. I mean, we've spent the last—I don't know how long we've gone, but basically talking technology and banking and payments. Technology just opens up a whole new swath of performing banking functions or making payments, or how we shop in commerce. I think a challenge of that is to ensure that this technology that you and I perhaps can harness, that it's made available to really everyone, and I think that's a big challenge.
Shaffer: So, Doug, we visited a lot of hot topics today driving our "Fed mobile." I wanted to thank you, and also the audience, for joining us today. This podcast will be archived on the Atlanta Fed's page under Economy Matters, and be sure to catch our upcoming payments podcast on financial inclusion. Have a great day.