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Take On Payments, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Take on Payments and look forward to collaborating with you.

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November 24, 2014

What’s Unsettled in Faster Payments?

When I started at the Federal Reserve Bank 27 years ago, the phrase "faster payments" was rarely spoken. Indeed, if people talking of payments were musing on speed (or the lack thereof), two things were a safe bet: first, the conversation was likely among bankers and, second, the talk revolved around check float and the tools for reducing it—check sort patterns, airplanes, or optimized ground routes. Those tools are not part of today's "faster payments" conversations, and the universe of discussants is much broader; it's not just bankers anymore.

Payments essentially comprise two components. The first is messaging—the instruction that delineates who is to be paid, by whom, and in what amount. The second component is settlement. Settlement is the event that finishes a payment. It is also commonly the slowest aspect within any given payment scheme. Settlement is the actual transfer of funds, the account adjustments directed by the messaging components.

For many payments, settlement takes much longer than appears to be the case, particularly from the perspective of the end user. For example, in a typical payment card transaction between a consumer and a retailer, once the card is swiped and "approved," the consumer is considered to have paid and can generally leave with the goods. But the merchant has received only the promise of payment. Settlement between card issuers and acquiring banks must occur before the merchant is paid. This can take more than a day and illustrates one issue with settlement lags: consequential strains on liquidity that merchants experience when they need to replace goods but may not have received payment to fund the resupply.

So will a faster payment solution resolve the liquidity issues currently experienced in many of the extant payment schemes? At this point, the answer is not a simple one. In town hall-style meetings and other updates, Fed speakers have noted that "real-time settlement is not required for real-time availability." This suggests that at least at the outset, a faster payments scheme here may not include immediate settlement. And if settlement does not occur simultaneously with messaging, certain parties in the transaction remain exposed to liquidity as well as other settlement risks. This doesn't mean that a new scheme will be plagued with settlement risk. The UK has successfully offered real-time clearing and availability without real-time settlement. However, other countries have built real-time settlement into their new systems because it does indeed reduce systemic risk. If a new system here is to be built from scratch, it seems important to probe fully the range of design issues and options and consider solving all of the longstanding payment risks that can be feasibly solved.

By Julius Weyman, vice president, Retail Payments Risk Forum at the Atlanta Fed


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