The Evolution of Real-Time Payments: Part 2 - What's Next?

Sonia (00:01): Hello everyone and welcome back to PCBB's podcast Banking Out Loud, I'm Sonia Portwood your host for today's episode. Recently we sat down with Allen Sztukowski our SVP of operations here at PCBB for a two part series on payments. In part one we discussed the payment rails and the history of payments where they started compared to where they are now, as well as some of the online payment systems like Venmo, Zelle, and PayPal. I just wanted to let you know that it's not essential that you have already listened to part one of our payments episode to enjoy this episode, though I do recommend you check it out when you have time. Sonia (00:51): Because the topic of payments is so broad and because we only have so much time on one episode we thought we needed to bring Allen back to talk more on the subject. Today in part two we'd like to shift and talk more about what the future holds, what bankers can expect as far as changes in payment rails, technology, and functionality, and also how you all, our listeners, and your colleagues can prepare for some of the changes headed your way. Allen, thank you for agreeing to come back, how are you? Allen (01:25): I'm doing very well Sonia, thank you very much. And I appreciate the opportunity to come back and speak with you again. Sonia (01:30): Thank you. Well, we're excited to get going. Umm… Allen, would you please remind the audience how long you've been involved with the modernization of payments? Allen (01:40): Absolutely. Our efforts here at PCBB and my personal efforts have been probably I would say around five years at this point when the Fed started the Faster Payments Task Force initially and it's just been an evolution since then and it's definitely one that's not going to stop anytime in the near future, that's for sure. Sonia (1:59): No, it doesn't appear there's a dull moment. And all of this is on top of your 20 plus years in the financial industry so a veteran for sure. it's probably safe to say that you have some unique insights that you can share with us on the speed of payments and the systems going forward. Allen (02:14): that's a great topic to start with Sonia. Where payments are going in the future it's pretty clear that the concept is fast, everyone wants things immediate. I think we're very used to that already using the payment systems that are out there, they're much quicker than they were several years ago and it's only going to continue. But I also think it's going to continue not just from the concept of domestic payments, I think it's going to also carry over for international payments as well. It's interesting to note that if you're in the United States right now it's actually easier to make real-time international payments than it is to make real-time domestic payments to folks. Allen (02:51): The evolution is that a lot of other countries set up their own real-time payment systems and they're pretty mature at this point. And it's really the US is a little bit behind but I think we're behind a little bit and part because of our banking system. What we have are so many banks and credit unions that are out there as opposed to a lot of the other regions of the world tend to have a much smaller number of institutions and so it's easier to get adoption and to move forward with things. Sonia (03:15): Yeah. I believe we mentioned last time we spoke that especially Europe are pretty far advanced compared to the United States in real-time payments. Allen (03:24): Absolutely. Yeah. There it's real-time is the standard amongst participants that are in the European Union at this point and there's quite a few other regions as well. A lot of where things are going internationally are the concept of connecting the various real-time payment systems. So, if you have a real-time payment system, let's say that it's in the UK and one that's in the EU as well, what's taking place is a lot of the effort there is to connect the two together, that way folks in one region can make payments to folks in a different region still in real-time. Allen (03:53): In America we're a few years behind so we have a little bit of little ways to go to get to that point and I think right now America is in the phase of building out the domestic real-time payment rails. And honestly, I think we're on the verge of having some really impactful things come to market with RTP getting traction and FedNow set to launch next year. And so, I think we're at a very exciting time in payment modernization here in America and it should be a very exciting next several years for all of us in the financial industry. Sonia (04:24): So we're really just looking in the next couple to five years out. But before we move to beyond those could you step back and give our audience just a really quick overview of the FedNow program and what that means to us as bankers? Allen (04:41): So, the FedNow program is the Fed's real-time payment product that they've created. The idea is that customers of one financial institution can send real-time payments to a customer of another financial institution and it stays inside the banking system. So, it actually uses existing banking rails, the funds go from one institution's master account of the Fed to another institution's master account of the Fed in real-time and the debits and credits post to the parties making and receiving the payments in real-time as well. This has been a multi-year effort on their part and it started originally with the Faster Payments Task Force that the Fed put together. And out of that the Fed came to the conclusion that it made sense for them to build this new payment rail in an effort to facilitate the more rapid adoption of real-time payments in America. Allen (05:31): By them participating in it as well it also is a good opportunity for the community financial institutions because a lot of the other payment platforms are a little bit more difficult for the community financial institutions to adopt. And so, the Fed has gathered groups of folks such as correspondents like our self, they've gathered large and small financial institutions, and they've gathered technology providers to collaborate to build some payment systems. And from what I'm seeing out there there's been tremendous progress that's been made and everyone really is embracing their part in this process. And it looks like everything is set to be on target for the FedNow product to launch which is in 2023 and for it to be in pilot towards the end of the year this year, and so. Sonia (06:13): That's exciting. Allen (06:14): Yeah. Sonia (06:14): That's sooner than I anticipated it would be here. Allen, do you see this as an easier entry point for competition with some of the FinTechs out there? Allen (06:26): I do see it as the easiest way for community banks to enter into the real-time payment market product and adopt one and have their customers do it. I honestly don't see this as competition, I think it's the natural evolution of what's taking place in this for the product development. And I think initially when the product first started getting created and when the Fed formed the Faster Payments Task Force there was more of an adversarial relationship I guess, as opposed to the collaborative nature that you need. And it was really the financial institutions wanted to have things, we're used to controlling how payments take place, right? We're used to controlling that experience and the FinTechs had a lot of the technology that was needed to be able to do these and they tend to be wired differently, they tend to think differently, they tend to have different longer-term objectives than financial institutions do. Allen (07:11): And so, you had a little bit less collaboration than I think you have now and I think right now that environment has evolved quite a bit where everyone realizes we need to learn to work with each other and everyone has embraced that. And I think that just by the discussions that I'm a part of and other folks are that I'm aware of everyone really has embraced that because we realized that to have this be successful we all have to work together to get there. And the products are going to be a lot better by having the collaboration amongst the various groups be it the technology companies or the banks and the financial institutions and the correspondents such as ourselves. Sonia (07:43): So before we move past that because it really sounds to me like that's one of the most exciting things in the near future that we have coming our way in the payment space for financial institutions. So you explained a little bit about how that would work between master accounts at the Fed, but how would the customer initiate that payment? Is this going to be something that the banks will have to work with their core system providers to set up? Or what would that look like? Could you walk us through from the customer's eyes as they initiate one of those payments? Allen (08:18): Absolutely. And we're all consumers in this world as well and so the first thing you think of when you think about making a payment to someone you think of your phone now, right? You don't think of, I'm going to sign on to my computer and go to online banking and initiate a payment to Sonia, it's second nature right now, you pick up your phone, you open your app and you're there. And so really financial institutions need to partner with someone, it could be their core and it could be a technology provider. And really, I think that the financial institutions should be agnostic as to who it is as long as it's whatever is the better experience out there and whatever is coming quickest to the market. The thought process initially was you had to have your core do this because your core needs to have this real-time ability to post the debits and credits, the real-time ability to do sanctions monitoring and those types of things and it's integrated with the banks online and mobile platforms. Allen (809:09): But I think what we're seeing is that the core vendors at this point are tending to focus on the core platforms and banking systems that are used by the much larger banks. And you can't blame them because that's what the economics are for, right? I mean, if you're a core you're going to look and say, okay, who has the most accounts and what core supports the most accounts? You're going to go after that and most likely it's going to be a core system that the regional and larger banks are on. And you're going to focus your energy on the cores that the community banks are using probably a couple of years from now, right? Because you're going to try and get the biggest bang for your buck because you're launching your new product. Allen (09:46): And so, I think because of that organically there's become this opportunity for FinTech providers that have developed mobile applications and online banking platforms. And that have spent the time and effort to be able to post the debits and credits to the core and have that connection with the core for them to be very successful with the community of financial institution market. Realistically I think for banks that are under $20 billion in asset size most likely if you want to be a FedNow participant in the first couple of years you're probably going to have to partner with someone other than your core to be able to do that because the core is going to have their efforts focused on the higher volume larger bank cores. Sonia (10:26): And that's important for us to know. if they were interested in finding out which FinTech companies had that type of relationship with the cores would their core be able to provide that and would they be willing to do that? Or do they need to go somewhere else to find out who those technology companies are? Allen (10:44): Yeah. There's a couple of ways to go about doing that, one is, yeah, they could always ask their core. I'm not necessarily sure what response their core is going to give them because their core at some point they want to build out a product for these community financial institutions just not right now, a couple of years in the future though, and so they might not want to refer someone off to a different solution that would make it so the core would be less in the future. The FedNow has created an online portal where folks can go to and on there they've created this virtual city and there's a regulatory section, there's a third-party section, there's a section where you can go to find technology providers and correspondents, even us we're listed there as well. Allen (11:26): And the thought process with that is, if a financial institution is interested in learning who could do what they kind of select, hey, I'm looking for a technology provider that can provide a customer facing front-end to integrate with my core. There's probably 10 or so entities right there in that virtual community that the institution can read about what they do, who they are, what their product looks like, what their FedNow rollout plan is, what do they plan on doing on day one as far as the FedNow beta test launch? What do they plan on doing a year from now once it gets more mature? So, there are different places for institutions to get that information they just have to look at it a little bit and kind of dig through it to find the information of value and we can provide folks a link to the FedNow community as part of this podcast as well. Sonia (12:10): Yeah. That's great. We'll post that below for all of you. Thank you Allen, that's a good reference. Okay. Is there anything else you'd think that they would be interested in knowing about FedNow that we've not already covered? Because that's coming pretty soon and it's probably not too early to be looking at your provider for the front-end piece for your customers, wouldn't you say? If the beta is starting later this year. Allen (12:37): I would say institutions they need to start looking kind of at a holistic solution because as a community financial institution there's really the two pieces that you need, you need that customer facing front-end that integrates to some degree with the core but then that institution also needs to sit back and think, do I want to manage my liquidity and settlement and posting transactions and cash management 24/7 now? Because this is the fundamental part of real-time payments that are 24/7, you have payments you have to process 24/7. Allen (13:04): And so, I would say, talk to your correspondent as well, I mean, such as us, that's one of our core competencies that we do is provide settlement services. And it's not just the tech provider that need to line up, because if they don't line up someone such as us then by default that financial institution now has become a 24/7 shop. And they might be a five branch community bank that's in one state and they might not necessarily have the infrastructure to support that. So, the idea is to, educate yourself what's out there, figure out what role you want to play and then find the partners that can work with you to help build out what you're looking for. Sonia (13:36): Thank you. I think that's important and I'm glad we brought that up. I wanted to ask you, with these accounts being at the Fed for these real-time payments will they be setting up some type of overdraft mechanism? Allen (13:48): Absolutely. And the way FedNow would work would be that everything is a credit push so the party that's making the payment to someone else they would initiate that through that bank or that financial institution's master account at the Fed. A lot of smaller institutions, two things, maybe they don't have an account at the Fed, and maybe they don't keep anything in that account at the Fed because they work with a correspondent. And so, for institutions in that situation you have to rely upon a correspondent such as us or form a partnership with a correspondent such as us because you need to have someone's master account at the Fed for those things to pass through. And so, by working with a correspondent the smaller financial institutions are able to benefit from FedNow and participate in there as if they were a multi-billion-dollar bank with the exact same functionality without having to wake up Saturday morning to wonder if there's enough money in their master account at the Fed. Sonia (14:44): So, let's say that some that they do have a master account at the Fed, with these real-time payments where they have to push payments out when they're initiated by the client what if there is an overdraft situation? Allen (14:56): That's a very good point. So the answer to that would be, part of the FedNow product it checks to make sure you have the money there and so if you don't have the money in your master account to cover a payment your customer wants to make they're not going to be able to make a payment. And so really, it's either an all or none for the smaller finance institutions in the sense that either they partner with the correspondent and the correspondent takes on that settlement and liquidity functionality where we always make sure there's sufficient funds to cover these transactions and post the debits and credits to your account or by default you have to manage that 24/7. Allen (15:30): And doing so could make the cost of implementing something like FedNow... it could make the technology piece of it really the insignificant piece if they have to start staffing for 24/7. And so that's why I think for the smaller financial institutions it's really prudent for them to look at the tech piece as well as the correspondent piece and look at it as a holistic package, right? Because the community financial institution, the tech provider, and the correspondent altogether make it so the ecosystem works efficiently. at least on day one it's going to make sense for the smaller institutions to do that and at some point, they might decide they want to be 24/7 on their own but then that's an economic decision for them to kind of work through. Sonia (16:04): Thank you. Is FedNow really the first and only real-time option available? Allen (16:12): So there are quite a few other real-time payment systems already out there, an example you've got Zelle, Venmo, PayPal, paying through Facebook, and things of that nature. Most of those are either writing existing payment rails or they're outside the existing banking system. As far as real-time payment systems that settle through the Fed as its own unique scheme there's really two of them that are out there, one is The Clearing House's RTP product and one is the FedNow product. The RTP product is different from FedNow in the sense that for RTP payments there is a single master account at the Fed that every participating bank participates in is a partial owner of the funds that are on deposit in that account based upon how much they've put in that account. And so, the way those settle is that the RTP platform debits, the paying bank's sub account and that one account at the Fed and credits another sub account. Allen (17:12): And so, the funds technically stay in the same actual account at the Fed but The Clearing House's ledgers track it on a different sub account and that's how they manage their settlement with that. And so with that those funds aren't necessarily available for a bank to use in real-time as well, right? If someone were or if the bank were to receive a big huge credit payment through there that's going to sit in that joint account at the Fed until that financial institution decides to take their money out of that account and in that time, it would go to their own master account they have access to. And so the RTP product is primarily different in the sense that it's a singular joint account with all the participants at the Fed where all the money is kept in that one account and the banks don't necessarily have use to it until they pull it out. Allen (17:53): Whereas FedNow is structured different in the sense that instead of a singular account for funds to settle through every financial institution can have settlement flow, their own master account. And so in real-time they receive the debits and credits to their master account or through a correspondence such as us to their account at that correspondent and so they in real-time have access to those funds as well. And so it's not as if it's co-mingled in this other third party account that's managed, each financial institution has immediate real-time access to it 24/7. And so, I think that's the key distinction between the two real-time products that are centered on Fed settlement as opposed to a lot of the other ones that are out there that are more focused on creating their own wallets and using existing rails like debit and ACH for payments with banks. Sonia (18:44): What about different functionality you anticipate seeing coming if not in the next five years maybe even beyond that? And of those which ones do you really think have a chance of gaining traction? Allen (18:57): Yeah. I think there's a zillion use cases out there, right? I think a lot of these have to develop and I think there's going to be a series of them that are live on day one I think and those are basically a credit push where I want to pay Sonia some money and I pay her and it ends up in her account, your P2P type of applications that are out there, right? It's kind of mirroring what's already out there but it's making it so it's kind of more focused on flowing through the Fed as opposed to through a third party. Sonia (19:24): And just to put a fine point on that talking about the third party, I know between me and my friends and my family we send money very quickly through Venmo and while that's great it's not hitting your bank account, the money that you receive stays in Venmo unless you take another step and have that sent to your bank account. So you're allowing the platform to have use of your funds while it's sitting with them instead of basically sitting in your bank. Do you think that FedNow will start competing with these platforms? Because that's really who it's going to be competing with right off the bat, don't you think? Allen (20:03): I think it is, yes. I think that on day one there's going to be some cannibalization from existing platforms. And I think that's just a natural evolution for it because those existing platforms do the easiest types of payments, I want to pay you or you want to pay someone in your family. And I think as it matures there's going to be a lot more use cases that come on that are going to be a lot more unique based upon that. Sonia (20:25): Have you actually seen some of the technology companies and the functionality that they offer for these real-time payments through their financial institution? Allen (20:34): Absolutely. And I'm very impressed by what will be coming down the pike and I think in the next couple years as this matures. And some of the use cases of it might be, let's say as an example you have a car loan through an institution, instead of that institution mailing you a bill at this point they could really just send you a text to your phone or through your online banking app that you have with them and really they could say, hey, your car payment is due, click here to see your bill and click here to pay it. And it could be that straightforward Allen (21:04): And so I think that's really a common use case that's going to come out here. I think loan servicing is a huge thing because really you solve a couple of things for the financial institution, you solve no longer having to mail things out to folks and it's immediate and when that person who owes the institution the money clicks the button to pay it's automatically reconciled in that institution's loan servicing or accounts receivable platform. I think that's where a lot of the use cases are going to come up is that, how do we automate processes that are currently very manual? And examples where folks have to send manual payments back and institutions have to reconcile those to their receivables that's the prime opportunity for this because it can completely automate that 100% and in real-time and so I think that's a big efficiency pickup for them. Sonia (21:53): And there has to be integration with the core of course. Allen (21:58): Yes, either the core or the loan servicing platform. In some degree there needs to be integration with a source of data or a system that's able to post transactions as well. Absolutely. I think you're going to start to see a lot of more use cases. an example, if you're a driver for Uber I think you could get paid after every single ride if you wanted to, right? Allen (22:19): And so, RTP they're already there, and it's in your bank account real-time, it's not in your PayPal account that you have to find a way to get it to your bank account at some point or pay an extra fee for that. And so these little by little these use cases are going to start to sneak into our lives and I think before we know it a couple of years from now it's going to be so second nature for anyone that it is just the way things are going to work, right? You're not going to think about cutting that check anymore or I have to go to my online banking platform now and sign on to do that. Those things go away and the idea is make it as easy for the person who needs to pay money for them to pay money and make it as easy for the person who's supposed to be receiving money to reconcile it and get that money. Allen (23:02): And I think the combination of those really is going to lead the adoption for this. And you look at some of the large builders, an example, a cable company, I mean, they're just dying to be able to send your monthly cable bill out to you through a real-time payment system be it FedNow or RTP because it saves them so much in costs. And it's a lot of small dollar transactions they have to reconcile too, right? It's not like they have 10,000 home loans they have to service, it's millions and millions of $50 payments they have to reconcile at some point. Sonia (23:35): They have the ability now to send out the text to let you know about your bill but in order to get the money it's you've either got to set up a draft or go onto your online bill pay or send the check of course. But to be able to automate that in real-time, it's right at our doorstep so it's pretty exciting, it's exciting times and things are moving very fast. Allen (23:55): Absolutely. And it's not going to slow down for probably the next 20 years, that's for sure. Sonia (24:00): Well, talk about something that's on everybody's mind or at least they keep hearing about and that's digital currencies. How do they factor into the future of the payments landscape? And I know we are in our infancy stage here, I know it's too soon to tell but it's in the news every day. So, from your vantage point, what are you seeing and anticipating next from digital currencies? Allen (24:27): It's an interesting topic and it's a difficult one to kind of figure out because most digital currencies you have up to this point really are designed for speculative. And so digital currencies right now really aren't being used in a way that could replace actual currency transactions. The Fed recently sent out a request for a comment on a proposal about how the Federal Reserve might issue a central bank digital currency. Allen (24:53): Those that are from the existing digital currency world, the Bitcoins and those kinds of things are against it because you lose all the ability to hide behind something else and be anonymous. It's no longer a tool of speculation because it's priced at a stable price, right? And really from the financial institutions and other perspectives of other participants it's hard to see a use case where it's actually necessary. Allen (25:17): The general feedback that the financial industry is providing to the Federal reserve is it doesn't really solve any use cases that are out there that can't already be solved by a different solution. And if the idea is to facilitate instant payments, I mean, you have two Fed centric solutions that are already out there right now or one that already is which is RTP and then the second one coming out which is FedNow and so you can't say that Fed needs a digital currency in order to facilitate real-time payments because they already exist. Allen (25:44): I think it's going to evolve and I think they'll come up with some things that might make sense. And then the question is, it the most effective, most efficient, quickest way to solve it? And it's yet to be seen. Sonia (25:54): Yeah, it is yet to be seen. But then from the consumer's perspective for those that do have cryptocurrency they want to be able to spend it, right? Some of them don't have it just as investments, they'd like to be able to spend it on their everyday purchases. And we've already seen companies beginning to accept cryptocurrency as a form of payment. So, there's a lot that'll have to develop and only time and hindsight is going to tell us where this is going to end up. But it doesn't appear to be going away Allen (26:26): I absolutely agree with you completely; a lot is going to develop there I think over the next several years. Sonia (26:31): Okay Allen, this has been extremely informative and it's also very exciting to see all the positive changes coming down the pike. Let's step back just a minute if we can before we close and tell our listeners, what should they be doing right now? If you could just summarize what you would recommend they did right now to educate themselves or to be prepared what would you tell them? Allen (26:54): Yeah, I really think that there is a call to action right now for financial institutions that want to participate in faster payments and I think it really focuses on you need to start talking to your core provider about what their game plan is, is there a plan to support faster payments for the core that you happen to use five years from now or one year from now? Because I think that's a huge factor in making a decision that you need to contemplate here. If their answer is they're working on it right now then that's a great party to have discussions with. If it's going to be something that's going to be a lot in the future I think you might want take a step back and say, do we want to have a real-time payment product to the market prior to that? Allen (27:31): And if the answer to that is yes then I think the solution to that would be to start looking at what other technology providers are out there that are supporting the real-time payment systems. And a good way to do that is through the FedNow community that's been set up as well as reaching out to the folks at The Clearing House to talk about their RTP product. But also take a step back and say, okay, how do you really want to grow your business us with this? Do you really want to jump in head first and not only offer real-time payments to your customers but also manage your settlement and your liquidity and those types of things 24/7? Because I think what also we're going to realize as we walk through that discussion is we probably should talk to our correspondent as well or a correspondent that we know is going to support a faster and real-time and instant payments. Allen (28:15): Because I think the solution really for most financial institutions it's going to be dependent upon a partnership with a tech provider as well as partnership with their correspondent and collectively it's a wonderful product and very comprehensive and relatively easy for the institution to adopt. It's almost impossible to adopt without one of those other parties though, it's just very difficult for a small financial institution to find scalability by doing this all on their own. So takeaways to do, learn, educate yourself, find out who else is out there participating in this products that you want to participate in, find out what their timelines are and then do some soul searching to figure out as an institution what is it you really want to do, do you really just want to support the payments or do you really want to start going after a new vertical because you have this idea of use cases how this might work? And whatever it is talk to the technology providers about what they're able to do, talk to your core and talk to your correspondent. Sonia (29:05): Okay. Well thank you Allen, we really appreciate you joining us today. And I feel certain with all the changes going on in the payment space we'll probably be bringing you another podcast on payments in the not too distant future. I do want to encourage you to check out part one of this payments episode if you've not already done that. Again, we will be posting the link where you can access the resources on FedNow below so be sure to check that out. And if you like our episodes be sure to let us know or maybe if you have some additional ideas of a topic you'd like us to dig into more deeply. We're always looking for new ideas I'm Sonia Portwood and thank you again for tuning in and we'll see you next time on Banking Out Loud.