From the September Special Report issue of Treasury & Risk magazine

The Next Evolution of the US Payments System

Cooperation Key to Future of Payments

The U.S. payments system is facing a defining moment. New technologies and industry participants are changing users’ perceptions of payments while regulatory initiatives designed to improve safety and to address expectations around speed and convenience have been introduced. Evolution is essential but the absence of appropriate dialog—between merchants, banks, payment processors and technology providers—in the development of new payments models means that meaningful advances in U.S. payments have been limited.

Incongruous efforts to improve payments have mostly thus far produced only niche benefits or, worse, caused new problems. If the U.S. is to create the payment system it needs for the 21st century, a new approach based on a simultaneous dialogue involving all parties is critical. To produce a smart system that meets the needs of all, stakeholders must accept that the challenges of the U.S. payment system cannot be solved by disparate efforts driven by the interests of any one group: a broader perspective is needed if true innovation is to prosper.

Payment Fundamentals Remain Unchanged

To lay the foundations for meaningful improvements in U.S. payments, stakeholders first need to recognize two incontrovertible truths. Firstly, there remain only five main ways in the U.S.—cash, check, card (debit or credit), ACH and wires—to settle any consumer or business transaction. Each of these has a unique set of infrastructure, rules, protocols, participants, and economics.

Secondly, there are only five basic payment flows or reasons to make a payment: a person needs to pay a bill; a person needs to make a purchase; a person needs to pay another person; a business needs to process a payable (such as an invoice); or a business needs to move money.

All payment innovations to date rely on the five core settlement systems to complete a transaction and are prompted by one of the five basic reasons for transferring value from one party to another. Some of the innovations have focused on how payment occurs, such as paying with a cell phone via the cloud or using contactless near field communication, or on expanding the acceptance of cards using dongles or tablet point of sale (POS) devices. Other innovations have aimed to improve customer experience or to electronify paper processes.

The Players

When considering how U.S. payments might be improved, it is important to outline the roles and responsibilities—both distinct and often overlapping—of the myriad players that enable online or physical commerce.

Banks are at the heart of the payment system, acting as sources of funding for business and consumer transactions through the provision of demand deposit accounts, hold accounts, lines of credit and the issuance of credit and debit cards. Most importantly, banks are protectors of the payments system; they are subject to stringent regulations and are held accountable globally for know-your-customer and anti-money laundering (AML) legislation. In addition, banks own the NACHA and SWIFT payment infrastructures, and are key stakeholders at many clearing houses. Banks also play an important role in merchant acquiring.

Networks provide the complex many-to-many endpoint connections that are the means for payments to occur. Electronic funds transfer enables seemingly real-time movement of funds (debits and credits) between bank accounts while card networks, such as Visa, MasterCard, Amex and Discover, connect merchants to central processing hubs globally to facilitate acceptance of card-based transactions. Other networks include the PIN/ATM networks (e.g. NYCE, STAR, etc), clearing entities, such as the Federal Reserve, NACHA, and The Clearing House, which provide infrastructure for the clearing and settlement of ACH and wire or real time gross settlement transactions. SWIFT and other entities route instructions for money movement in a common standardized format worldwide. Networks have driven useful standards that have helped increase payment safety, accuracy, convenience and speed. Networks also provide analytical and practical support to reduce fraud.

Other parties integral to the payment process include payment processors, which help make sure that merchants get the funds from their sales by managing the highly complex routing, rules, and protocols established by networks and issuing banks. These services—both front-end (such as authorization) and back-end (such as end-of-day settlement and clearing)—are the lifeline for commercial entities looking to accept card payments. At the point of sale (POS), acquirers work with hardware manufacturers and related vendors to provide integrated POS devices with industry specific software packages or installation and maintenance of POS equipment. Innovation in this space has been rapid with the recent entrance of tablets, smart phones, and other IP enabled POS devices.

Silicon Valley and other innovation hotspots around the globe have also made a significant and important contribution to payments. These new non-traditional entrants, including peer-to-peer payment providers, alternative merchant acquirers, and providers of reloadable prepaid cards have produced innovations that have benefited both consumers and companies. The rapid uptake in the use of online and mobile payments means that the innovative entrants have drawn the spotlight in recent years by providing end-to-end payment experiences that consumers have adopted at a rapid pace. Consumers have found such affinity with some of these innovations that they have even been willing to share their sensitive personal financial information and bank log-ins to these new entrants. While the new entrants’ ability to innovate is helped by the fact that they can leverage existing infrastructures and networks (which have taken many years and significant investment to build) their speed of technical and business development, razor sharp focus on the customer, and the high level of competition by their non-traditional peers has provided the payments industry a view into what is possible in the future of payments.

This is a constant reminder, that it is important to recognize that the payments system should be driven by its users, both businesses and consumers. Ultimately, it must be addressing users’ needs, not protecting traditional silos, which should spur innovation in payments.

Losing Sight of Users’ Needs

The goal of regulators in introducing new payment rules is usually to improve the quality and security of service to users. However, some regulatory initiatives have failed to deliver results for users.

For example, in recent years a new message format was introduced with the objective of supporting extended-character business remittance information, prompting a shift from paper to electronic and improving the ability of companies to reconcile receivables. Unfortunately, it has suffered from limited uptake and offered minimal opportunities for banks to monetize their significant investments.

Missteps can occur in retail ventures as well; consider the expensive, but generally failed efforts to gain broad-based adoption of a digital wallet. Myriad players have, or are attempting to find, one universally accepted technology that both consumers and merchants would embrace to allow users to pay for purchases online and in stores with their phones. Universal acceptance has mostly proven to be elusive due in no small part to decisions by many players to go it alone without key industry participants, or by others to not engage in the dialogue. This along with the general slow adoption of near field communication technology (NFC) serve as additional examples that payments are at a minimum a two-sided market that take participation by both the payer and the payee to realize benefits before there can be any meaningful adoption.

There are similar concerns about current considerations to accelerate the settlement of ACH transactions. In an open network such as ACH, speed for its own sake may result in a poor experience for users if other factors are not considered and addressed. These factors can include fraud protection for all participants, operational readiness on the part of both banks and customers to support accelerated settlement, and the economic value of an incremental improvement. Additionally, there needs to be an understanding of user expectations on how quickly payments should settle. For example, if there is a desire for near real-time settlement, then the batch environment of ACH may not be an effective basis upon which to build.

Numerous online and mobile payments innovations in recent years have failed to gain critical mass because alternative payment providers generally have not considered the full payments ecosystem. Too many products seem to offer a truncated value proposition that, for example, puts the onus on customers to transfer money to a digital wallet or wait days to withdraw funds, limiting the utility of the product.

It is unhelpful to blame any single group involved in U.S. payments for the general failure to work together: many stakeholders operate in silos and have mostly failed to consider the potential benefits of working appropriately with others. Instead, banks, networks, non-bank providers, hardware manufacturers and others need to recognize that their individual successes—and ultimately their ability to deliver payment innovations to their end customers (many of whom are customers of more than one party)—are dependent on appropriate and effective cooperation.

Innovation Through Dialogue

While there are examples of ineffective payments initiatives in recent years, there are also inspiring examples of true innovation offering sustainable economics for payment participants and demonstrating the potential promise of working together. For example, Hong Kong’s Octopus contactless stored value card was initially launched as a travel card but through initiatives involving regulators, businesses and financial institutions, it rapidly become ubiquitous and is now accepted by thousands of retailers and restaurants.

Brazil’s Boleto is an automated collections and reconciliation instrument that unlike other similar initiatives does not require invoice information to be appended to it. Instead, a Boleto has a barcode that allows the electronic reconcilement of the payment with the outstanding client receivable.

Similarly, India’s Immediate Payment Service (IMPS) shows how huge challenges can be overcome through joint dialog. More than 230 million of India’s 1.2 billion people are unbanked and over 90% of personal expenditure is in cash. Faced with an existing payment system that could not reach all potential users, regulators, government-owned and private banks worked with mobile companies to set up IMPS as a mobile payment system offering instant, 24/7, interbank electronic fund transfer service through mobile phones.1 This has subsequently been extended to Internet Banking and ATM. IMPS now processes approximately 500,000+ transactions a month.

Cooperating for the Future

Regulators in many countries want banks, alternative payment providers, hardware companies and other payment ecosystem players to own the dialogue to shape future payment solutions. All payment parties should welcome regulators’ preference to let the industry determine its future. Change driven by a broad base within the payment industry can help create ownership by all and thus help direct efforts down a smart path to desirable outcomes.

There is a role for every rail and the evolution of the payments system must not be a zero sum game with the benefits accruing disproportionately to one party. By talking to each other (obviously within the parameters of U.S. and international antitrust laws), industry participants can share knowledge and help make sure that the correct emphasis is placed on priorities such as speed of settlement and transaction authorization, provision of information, and use of robust security features, so that users’ expectations are effectively and profitably met. Moreover, greater cooperation will enable the industry to discover additional challenges and opportunities, including new ways to monetize data or tolls for access that represent the value delivered.

Bank of America Merrill Lynch believes the time to have industry-wide discussions is now. We are optimistic that payments providers and payment users are willing to come together to solve the new challenges. For our part, we are going to begin stepped up efforts to appropriately discuss and share ideas across the payments ecosystem through trade associations and other appropriate venues.

1. Source: National Payments Corporation of India (NPCI) presentation dated Nov. 6, 2012

Ather Williams, III, Bank of America Merrill Lynch

Ather Williams, III
Head of Global Payments and Global Strategy, Global Treasury Solutions
Bank of America Merrill Lynch


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