Senior Tutor, Transaction Banking Academy
Open a financial services publication or attend a payments conference and you are confronted with “instant”,“ immediate”, “real-time”, or “faster” payments. What is this all about?
For decades, making a payment took time … and often quite a lot of time. Whether a payment arrived at its beneficiary the next day, or after three days, or a week depended on the country, whether it was a domestic payment or had to travel across borders, and how many banks were involved in the middle. In some countries payments moved faster than in others. The consumer had no say in the matter. Short of choosing a large-value RTGS system with immediate finality, the consumer was dependent on his country´s ACH system and its clearing cycle.
Over the last few years, major innovation initiatives emerged, among them the notion of making payments “faster”. The reasons are manifold: with the increased usage of internet activities, consumers are requesting that their payments are executed faster. New technologies enable payment providers to meet these demands. New non-bank players have entered the market and are offering innovative payment methods. And last but not least, regulators have pushed the industry towards “faster”. For example, in the UK where the Bacs systems is based on a three-day clearing cycle the regulator mandated in 2008 that the UK payments industry speed things up. The “Faster Payments” project for Sterling payments was initiated.
Around the globe, a number of countries have gone live with real-time payment systems. Some had outdated payments platforms in need of repair. Rather than renewing them, some opted for building brand new infrastructures and introducing real-time payments right from the start. Others are planning this step, considering cost, impacts, governance and technology. Examples of already existing or planned real-time payment systems are Australia, Canada, Denmark, Finland, Mexico, the Netherlands, Norway, Poland, Sweden, Singapore, South Africa and the United States. In Europe, the “Instant Payments” project has started and keeping the payments industry on its toes.
Are Real-Time Payments Happening in Real Time?
But are all these initiatives the same? There is agreement that real-time payments must be electronic payments, available 24/7/365. But that´s where the agreement stops. Fact is that we find multiple variations. To understand the reasons for the variations it is useful to consider the process which a payment goes through. Simplistically put, a payment from the payor’s account at bank A to the beneficiary’s account at bank B passes through three stages: (a) initiation by the payor, authorisation and approval of the payment by bank A; (b) transfer of funds from bank A to bank B via clearing and settlement at the payment system; and (c) bank B’s posting the funds to the beneficiary’s account at bank B and making the funds available to the beneficiary.
Do all of these functions happen instantly in real time? Ideally they would. However, the currently existing real-time infrastructures differ. Common to all is instant confirmation that a payment has been initiated, and a drive for a richer data standard, such as ISO 20022. But there are differences as well: for example, the UK´s Faster Payments System is a multilateral deferred net settlement system. There are several interbank clearing cycles each working day at which settling occurs. Transactions take between 15 minutes and two hours. This may be “fast”, but neither “instant“ nor ”real time“. Amount limits are another differentiator: some systems have set ceilings on the amount which can be sent/received. Other differentiators involve the role of the national regulator, and of course pricing.
Potential Users of Instant Payments
Proponents of instant payments point to four principal use cases:
- Person-to-Person (P2P): e.g. instant money transfer of funds between consumers, to substitute for cash and checks;
- Person-to-Business (P2B): e.g. instant internet/online purchases, payments for electricity, gas, rent, payments for plumber, electrician, cleaner, etc;
- Business-to-Person (B2P): e.g. instant payout of salaries, pensions, insurance claims, etc.;
- Business-to-Business (B2B): e.g. instant payment of tax, fines or penalties, intercompany payments.
However, critics of instant payments projects stress that these use cases will vary by country and their payment habits. For example, immediate funds availability and confirmation may not be needed in countries where B2P salaries and pension are paid on defined dates and with a defined frequency, or where P2B bill payments are made via direct debits.
The proponents of instant payments point to multiple potential benefits: cash and checks can be replaced thereby reducing the costs involved with those. “Real-time” functionality can promote usage of e-and m-commerce payments. In Europe, banks have invested significantly into the development of SEPA (Single Euro Payments Area) products. Banks` infrastructures could thus be used as a springboard for additional 24/7/365 financial services. This could help banks combat the threat of non-bank providers such as Google and PayPal. Corporates would be able to improve their cash-flow management and optimise their liquidity management.
Who´s Who in Instant Payments in Europe
In Europe, the active debate around instant payments accelerated last year. The Euro Retail Payments Board and the European Central Bank are leading the effort1, supported by the European Payments Council. EBA Clearing started an instant payment task force and published a blueprint and roadmap 2015–2018 for a pan-European solution. And of course central banks and the banking industry itself are hard at work.
Instant payments are defined by the Euro Retail Payments Board as “electronic retail payment solutions available 24/7/365 and resulting in the immediate or close-to-immediate interbank clearing of the transaction and crediting of the payee’s account with confirmation to the payer (within seconds of payment initiation). This is irrespective of the underlying payment instrument used (credit transfer, direct debit or payment card) and of the underlying arrangements for clearing (whether bilateral interbank clearing or clearing via infrastructures) and settlement (e.g. with guarantees or in real time) that make this possible.” (ERPB/2014/018 of 1st December 2014).
The efforts around instant payments should not be underestimated: SEPA was achieved in August 2014, after about 12 years of tremendous effort and cost. Since then, same-day and next-day euro payments are available – yet this is still a far cry from “instant” payment execution. But the cost of moving to instant payments will be significant: as with SEPA, banks face both one-off investment costs and ongoing maintenance costs. How will they handle AML and KYC in an instant environment? And let us not forget the business case: depending on customer willingness to move to instant payments and pay a premium for the service, the business case may be negative.
Challenges for Instant Payments
It is clear that we are faced with another complex and massive project. Quite a number of challenges exist. While the EBA blueprint sets as an objective that the scope of instant payments will be limited to euro credit transfers with SEPA as the geographical scope, some stakeholders aim for a wider scope, including e-money and payment cards. Time-to-market is considered crucial for the launch of instant payments; thus the EBA promotes starting a pilot in 2017, with a live date of 2018. If not all requirements can be met, a two-phased approach is envisaged. But how does one deal with different countries and their expectations around the time frame? Some payments markets within the Eurozone have already developed community solutions. Thus the existence of several instant payment infrastructures with differing functionality raises the question of interoperability. Other challenges involve regulatory questions: how much should central banks become involved? Should the regulators step in and demand implementation by a certain date? Certainly the SEPA experience has shown that the 2012 SEPA Regulation functioned as a motor speeding things up.
Work on instant payments is in progress and it is likely that European banks will offer them in the near future. But how quickly will they be accepted by consumers? What role will pricing play? Will consumers and businesses be willing to pay extra for instant payments, and under which circumstances? Perhaps they will be happy with instant payment confirmation, knowing that the payment will be made by the end of the business day. Will they really need instant availability of funds? Will merchants adopt instant payments? What expectations do corporates operating in multiple countries have regarding instant payments, instant confirmation and instant reconciliation? How much risk is inherent in instant clearing and settlement? Will intense competition between providers ensue? And last but not least: to what extent will privacy and security concerns among customers determine the fate of instant payments?
As with SEPA, much communication and understanding amongst industry stakeholders will be necessary, with regard to approach, content, timelines, and migration strategies. We can look forward to interesting times.
This article was first published in International Payments Framework Association, July 2015