Starting the Journey

Is the Fed Just Going to Do It by Itself?

A common question is repeatedly asked when discussions about the payment system project arise: Will the Fed simply create its own protocols and services?

The 2015 strategies paper summed up the long-standing criteria that must be met for the Fed to offer new financial services: "These criteria include the need to fully recover costs over the long term, the expectation that the new services will yield clear public benefit and the belief that other providers alone cannot be expected to provide the service with reasonable effectiveness, scope and equity."

However, the Fed does play an integral operations role within the payment system through the services it currently provides. As part of the payment system improvement project, the Fed reviewed these offerings for potential improvements that would support the overall goal of enhancing the U.S. payment system.

Enhance the National Settlement Service

The Fed will engage in a three-phase process of improving its National Settlement Service to make it more attractive as a settlement vehicle for private-sector arrangements.

• Phase 1: Extend the service hours to 7:30 a.m. ET to 5:30 p.m. ET. This phase is already complete.
• Phase 2: By the end of 2015, move the opening time to coincide with the 9 p.m. ET opening of the Fedwire Funds Service (on the prior calendar date).
• Phase 3: Explore what it would take to support weekend and/or 24/7 operating hours.

While most of the 87 million payments per day flowing through ACH do not require real-time authorization and clearing, some may benefit from same-day ACH processing cycles by reducing counterparty risk and/or improving speed.

Expand Risk-Management Services

The Fed will look for enhanced risk-management products to provide to users of Federal Reserve Financial Services to complement its services.

Provide the Reserve Banks' Financial Institution Customers Access to Interoperable, Secure Directory Tools

Tools offered to Federal Reserve Financial Services customers will support legacy and future payment types, such as access to an industry directory for various payments.

Starting the Journey

In 2012, the Fed initiated a gap and opportunity analysis to study improving the speed and efficiency of the U.S. payment system from end to end, while maintaining a high level of safety and accessibility, with "end to end" meaning the point of payment origination to the point of receipt, including payment reconciliation and notification. This was a significant shift from the way the Fed previously examined the payment system, which was usually limited to the interbank processing space. This analysis resulted in the "Payment System Improvement – Public Consultation Paper," which was released on Sept. 10, 2013.

Following the paper's release, the Fed gathered reactions to its content. The Fed received more than 200 responses to the paper and a general consensus that the desired outcomes captured in the paper were indeed the right ones to receive attention.

Opportunities within the System

Inefficient Payments

It's not news that check writing has been declining for many years. However, despite seemingly falling out of favor, more than 18 billion checks were still written in the United States in 2012.¹ Checks remain a preferred—or at least regular—option for many individuals and businesses. Part of this stems from checks having the important attributes of ubiquity (as they are accepted as a form of payment in many, if not most, cases) and convenience.

Payment Speed and Security

There is currently no ubiquitous, convenient and cost-effective way for U.S. consumers and businesses to make real-time or even near-real-time payments from one bank account to another. While payment system speed has become faster as a result of private-sector innovation, the U.S. still lags behind many other countries in terms of real-time payments.

In addition, payment security challenges—such as data breaches, phishing attacks, spoofed websites, payment card skimming, fraudulent ATM withdrawals, computer malware and infiltration of retail point-of-sale systems—are becoming more prevalent and costly. An estimated 31.1 million fraudulent transactions occurred in 2012, with a value of $6.1 billion.²

Legacy vs. Limited Systems

In the past several years, new payment methods have been introduced that offer promising improvements, such as faster transaction speeds. However, these are mostly still private systems that require the transacting parties to both be part of the system. With a few exceptions, nonmembers receive no benefit and are unable to take part.

On the other hand, legacy systems—such as check writing or ACH—are more ubiquitous, but lack the features of new systems that customers are increasingly demanding: real-time validation, timely notifications, assurance of payments going through and masked account details.

The Efficiency of International Payments

Typically, cross-border consumer and business payments involve much higher transaction fees and longer processing times than domestic payments. Several innovators have emerged recently with products and services that partially address these challenges, but not in a comprehensive way.

The 2013 paper "Payment System Improvement – Public Consultation Paper" summed up the gaps and opportunities in the U.S. payment system this way:

"End users of payment services are increasingly demanding real-time transactional and informational features with global commerce capabilities. Legacy payment systems provide a solid foundation for payment services; however, some of these systems (e.g., check and ACH) rely on paper-based and/or batch processes, which are not universally fast or efficient from an end-user perspective by today's standards. The challenge for the industry is to provide a payment system for the future that combines the valued attributes of legacy payment methods—convenience, safety, and universal reach at low cost to the end user—with new technology that enables faster processing, enhanced convenience, and the extraction and use of valuable information that accompanies payments."