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Real-time payments: a near-future reality?

October 20, 2014
Consumers, small and medium businesses, and corporations are becoming more and more impatient thanks to the digital and mobile revolutions. Despite this, our nation’s payment systems are either very slow, or costly: paying via check takes one to three days but is “cheap”, while making a wire transfer is practically instantaneous but is expensive. Why is it that we write checks to pay for our rent when, for over 20 years, we’ve been sending e-mails that reach their destination instantaneously?

By Paul Maia, MBA W’15

Have we stayed behind on this specific topic because our payment systems or not relevant? Certainly not, this is an extremely important topic. Within the USA, on average, 330 million non-cash consumer payments with a total value of $220 billion are processed on a daily basis. That’s $80 trillion that are transacted over our payments systems throughout a whole year, or 5x of our nominal GDP!

Created by Paul Maia - public domain at http://www.philadelphiafed.org/consumer-credit-and-payments/statistics/

As a user of payments systems, you might have never thought about this. I don’t blame you, what happens between when you swipe your credit card at a cash register and when the merchant receives his money is invisible and complex. Payments processors even call it “the plumbing”. However, it typically takes 1-3 days for your money to reach the merchant after he submits the authorization that you signed. This delay is also true for transactions between customers and their suppliers, for salary payments, for money transfers, etc.

Because of this delay, merchants, suppliers and other users are exposed to unnecessary credit and fraud risk, and have a much harder time managing their cash flows and working capital, among other costs. For example, users are exposed to credit and fraud risk because this makes it easier for customers to purposefully or accidentally default on their commitment to pay for something between the moment a transaction begins and the moment the transaction is actually accomplished. Additionally, working capital is harder to manage because of the uncertainty of when a user will receive funds from a transaction. Imagine having to take a loan to replenish your inventory because a payment is delayed.

To make matters worse, at a systemic level, these risks are aggravated. For example, during a financial crisis, if multiple insolvencies are occurring simultaneously, many of the transactions that are pending may suddenly become insolvent. Remember, with a three-day processing time, at any moment, on average, there is $0.6 trillion dollars being processed throughout the whole country! If transactions were close to instantaneous, there would be almost no payments pending and the systemic credit risk associated with payments would be practically cancelled. The result of this is a mix of increased prices experienced by end-consumers, lower margins for our companies, and higher costs when exporting from or importing to our nation.

Motivated by similar reasons, multiple countries and international bodies have decided to implement lower cost real-time or near-real-time systems throughout the world. These systems process payments in just a few minutes. Among many other examples, the UK successfully launched its Faster Payments Service, which is fully dedicated to small value payments, and Sweden’s main banking association has continuously improved its Bankgirot payments system. The latter supports different speeds for processing transactions, mobile and e-money transaction processing, automatic e-invoice processing, etc. It’s even fully integrated with the online income tax system. As a plus, the UK’s system was implemented by the private sector with minimal government intervention, and Bankgirot is fully driven by the private sector. Other countries that have opted to implement such a system include Switzerland, Japan, the Eurozone, Brazil, Mexico, South Africa, India, etc.

Within our nation, some private sector initiatives to increase our payment speed are already being developed by the private sector, such as PayPal and Venmo’s P2P transaction systems. However, such systems only ensure real-time payments when transacting funds between two user accounts of the same system. This is clearly insufficient to resolve this problem and does not put us on par with other developed countries where real-time payments are possible between any two bank accounts.

Many questions remain though. What would be the actual economic benefit of implementing a real-time system in the USA for smaller transactions? What would be the total cost of implementing this (including both developing the platform and updating all payment interfaces to use the new platform)? If this is a worthwhile endeavor, who should drive it? Should it be public-private effort kick-started by the Federal Reserve or the government? How can the administration help the various stakeholders discuss this topic, make a decision, and implement it?

Multiple agencies are collaborating to find answers to these questions. As an example, the Federal Reserve has already launched a process to explore potential options and is engaging with both national and foreign stakeholders that can help shed light on what direction we should take on this matter. You can read about this on innumerous Papers and reports launched by the Federal Reserve Banks.

These are tough questions about a critical topic for our economy. It’ll take the collaboration of multiple agencies to find the direction that best fits our nation’s needs.


Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.


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