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Brian Knight
Associate Director, Financial Policy, Center for Financial Markets
Banking and Business and Capital Access and Capital Markets and Finance and Financial Innovations and FinTech and Global Economy and Job Creation and Public Policy and Regulation and U.S. Economy
Brian Knight is an attorney with significant experience in new sources of capital, financial technology, and entrepreneurial issues. He is interested in the interplay between technological, regulatory, and market innovation and how best to improve access to capital for businesses of all sizes.
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Faster Payments—It Won’t Be All Wine and Roses

By: Brian Knight
September 24, 2015
   
   

After reading Milken Institute Center for Financial Markets former intern (*slow, single tear*) Will Council’s explanation of the high cost of slow payments, you would have to be a dour stick-in-the-mud killjoy to have any doubt that faster payments are the path to a golden future. Well, my friends don’t call me Brian “the Party-Killer” Knight for nothing*. It isn’t that a faster payments system could be a potentially hugely beneficial service – it is – but there is no such thing as a free lunch, and there are real potential costs that we should consider before we develop a new, transformative, and expensive system.

First, we should be worried about fraud, and how a faster system may make it harder to prevent fraudsters from stealing innocent people’s money. To understand why this might be the case, you have to remember that under the current system there are (generally) two stages to a transaction: first you have the assignment of rights and responsibilities (X promises to pay Y $5; this obligation is recorded as a debit in X’s account and a credit in Y’s), then you have the settlement ($5 is actually transferred from X’s account to Y’s). With ACH (the system used to transfer money between bank accounts used by almost all U.S. banks), and the systems that run on it, settlement generally takes at least a couple of days, which means that if fraudulent activity is detected before the actual transfer happens, the transfer of funds can be stopped, and Y never will not get his ill-gotten payment. This would not be possible in a real time system because the transfer of money would occur nearly instantly.

What’s more, as people like Lauren Saunders of the National Consumer Law Center point out, any new system will likely make the payment irrevocable, which means that there is no systemic ability to reverse a payment. Instead the business rules of the system will have to require the bank or other recipient to send the payment back. While irrevocability makes sense overall and is probably essential to the system’s functioning, and while the business rules should work fine for legitimate banks and recipients who meet their obligations, a fraudster won’t comply with the rules.

Secondly, there is the issue of cost. While it is possible that a new system could be sufficiently more efficient than the current one so that costs are comparable, this isn’t likely in the short term, at least. The increased cost of a real-time system presents different but related issues, whether the system is mandatory or optional. To analogize: let’s say you want to mail a letter. If you want it to arrive very quickly you can pay the premium for priority mail, but if there is no rush you can just use the less expensive regular mail. As it stands, regular mail is very cheap, while priority is much more expensive, due to lower volume and greater specialization in service delivery. If you are ok with regular mail the timing is usually fine, but if you need the speed (e.g., when your credit card bill is due tomorrow) you would have to pay a relatively high premium. Now let’s say that the Post Office decrees that all mail must become priority mail. Sure, the mail would be delivered more quickly, and with the increased volume and efficiency from specialization the price may come down a bit, but not to the level of regular mail. While this benefits people who need priority mail it also results in people who were fine with the speed of regular mail having to pay a higher price for the service (extra speed) they didn’t need.

The payments system may well work out the same way. The current ACH system is relatively slow, but also very cheap, so if you are ok with the speed (and according to Fed research, 78 percent of transactions are fast enough), life is good. Of course, if you need faster speed then there isn’t really another good option. Moving to a new system and making it mandatory will (until it can be run at the same or lower cost per transaction) tax the majority of people who don’t need the enhanced speed. Conversely, making the service optional may make it less efficient, making it even more expensive for those who do need it.

Finally, we should remember that “the float” (the time between when a check is written and when the money actually leaves an account), and the commercial expectations that the float has created, are a double-edged sword for the poor. Will mentioned how the delay in getting money transferred to the poor can lead to liquidity issues and encourage the use of services like check cashers that are more expensive, and that makes sense. The other side of the argument, however, is that the float can also be used as a form of unauthorized short term credit. While we are not recommending that anyone “play the float,” it is naïve to say it doesn’t happen. Real time payments would eliminate the float as creditors insist on real time payments rather than waiting for checks to clear. This will disproportionately harm the poor who are more likely to lack reserves.

None of this is to say that a faster payments system isn’t a good thing. It almost assuredly is, and the technological and commercial realities are driving us in that direction. While a faster payments system will solve a lot of problems it may create others, and we should be looking for ways to mitigate these as we move forward.

*This is a lie; I am the life of the party.