The Present and Future Payments Ecosystem

By Tyler Mondres

The payments ecosystem has grown more diverse as technology has improved and new ways to pay have been introduced to the market. A combination of emerging technologies and rising customer expectations are driving these changes. Financial institutions are leveraging technology to make payments faster, easier and safer.

This article identifies some of the key areas in the evolving payments landscape that bankers should be monitoring, and in some cases implementing, as we move into 2018. The common theme in all of these categories is that they result in an improved customer experience by meeting customer demands.

Beyond the Faster Payments Task Force

In 2015, the Federal Reserve organized the Faster Payments Task Force to encourage the industry to improve the payment system by making it faster and safer. This was a unique effort because elsewhere in the world, governments had directed the process for how payments would be made faster. Only in America was it left to the market participants to create the marketplace. The task force of 330 individuals from all sectors of the payments industry—including banks, merchants, regulators, solution providers and more—issued its final report in July 2017.

The task force didn’t endorse any specific payments solutions, but it helped coordinate consensus on the characteristics (effectiveness criteria) that a faster payment product should have. It also offered a platform for these providers to exhibit their products and have them evaluated against the effectiveness criteria. The final report contained a list of 10 recommendations for accelerating real-time payments in the U.S. with a goal of real-time payment ubiquity by 2020. The 10 recommendations cover governance issues, payments infrastructure and the sustainability and evolution of the payments system.

The task force has been dissolved, but the recommendations will be addressed by a new organization, the Governance Framework Formation Team. This group of 27 industry stakeholders is creating a model to facilitate interoperability across the different faster payments solutions to enable seamless transactions for users regardless of their provider. The GFFT will release a draft framework for comment in the second quarter of 2018.

Same-day ACH

The first wave of same-day ACH came ashore in September 2016, when credit transactions started flowing. The new SDA process increases the number of ACH windows where transactions can be initiated to include morning and afternoon openings, in addition to the regular overnight batching of transactions. It is now possible to originate an ACH transaction and have it arrive at the payee the same day. This provides an excellent solution for businesses that submit late payroll files or consumers that need to make a last minute payment.

The second wave hit in September 2017 with the introduction of SDA debit transactions. For example, a utility may contact a customer to let it know that its bill is due that day and if it approves a same-day debit, its account will remain in good standing.

The benefits of SDA are that every financial institution that receives ACH transactions is already connected to the system and understands the rules. This means that no new infrastructure or governance issues exist and there is immediate ubiquity of banks and customers. On the downside, while faster, this is not a real-time solution, and it still doesn’t address the issue of making payments on weekends or holidays. SDA is a clear step in the right direction for faster payments, but it is just as clear that it is not the final step.

Digital wallets

Digital wallets broadly refer to applications that let users make payments online or at the point of sale with a mobile device. They also often enable peer-to-peer payments, which are payments sent directly from one end user to another. Digital wallets are funded through a user’s bank account, credit card or debit card. They leverage tokenization—a process by which sensitive customer data, like a credit card number, is substituted with a non-sensitive token—to ensure the security of stored payment information. This reduces the risk of the true card number being compromised if a data breach occurs.

Digital wallets help reduce friction at online checkouts. Current systems require customers enter detailed payment information each time they make a purchase. While this may not seem particularly difficult, it can discourage customers from following through with the payment. Digital wallets, which store necessary payments details, improve this process by allowing customers to make purchases in one click. Digital wallets can also be used in-person at the POS if the merchant has enabled the technology.

According to a First Annapolis survey, consumers want the ability to consolidate payments in one digital wallet, and the majority say they want their bank to be the one that provides it. While adoption has plateaued in the past year, more than one in three consumers say they plan to use digital wallets in the future. Consumers may not be quite ready to make the full switch from physical wallets to digital wallets, but a lot of room for growth still exists in this space.

Peer-to-peer payments

While P2P payments are often included as a feature in digital wallets, they are also available via standalone applications. There are a number of ways to fund, initiate and complete a P2P payment. The bank-backed Zelle solution is just one example.

Zelle is a P2P payments solution that customers can access through participating banks’ mobile apps or through the standalone Zelle app. Users connect their checking accounts, savings accounts or debit cards to Zelle as a funding source. To initiate a payment, a user enters the recipient’s email address or mobile number. Zelle maintains a directory of addresses and mobile numbers that correspond to bank accounts registered in the network. If the recipient has never used Zelle before, he or she receives a notification explaining how to collect payment.

A great benefit of Zelle for customers is that transferred funds are immediately available in the recipient’s bank account—although the funds are actually settled by the banks later. With other digital wallets in the market, funds are often stored within the application. Customers have to go through an extra step to transfer the funds to their bank account. Banks can benefit by offering a product that customers want that also helps them retain deposits.

With the abundance of smart phones across the population and consumer desire for faster payments, virtually everyone will be able to access a P2P service, reducing the need for ATM withdrawals and putting another nail in the coffin of paper checks. It is important for banks to offer new and innovative ways for customers to pay to meet evolving expectations in the space.

Open API implications

Application programming interfaces will have significant implications for the payments ecosystem. APIs act as a universal adapter for data by creating a language that allows different software systems to communicate. They are often used to facilitate data sharing between companies or within an organization. Open APIs refer to APIs that are visible to developers outside the organization and are easier to access and build upon. Developers can code to specific criteria that can plug into any system that uses the API to create add-on services.

Open APIs have the potential to enable “open banking.” In an open banking ecosystem, customers are able to authorize third-parties to access their personal banking data for the purpose of providing services. In Europe, open banking has been hastened by Payment Services Directive Two, which, among other things, requires banks open their systems to third-party financial service firms. Third parties will only have access to customer data if the customer gives them explicit permission and if they meet established regulatory requirements in areas like capital reserves and data security.

In the U.S., regulators have taken a less prescriptive approach. The Consumer Financial Protection Bureau in 2017 issued nine guiding principles for protecting consumers who share data. While it affirmed that consumers should have the ability, it noted that they should not be required to share their banking credentials to do so. The principles establish that third parties should use shared data only to the extent necessary to provide services selected by the customer; that data should be accessed, stored and used securely; and that consumers should have the ability to review who has access to their data and have disputes resolved in a timely manner.

Open banking can provide new opportunities and enable new business models for banks, but it also presents some risks. The decision facing U.S. banks is finding the right balance in making customer data available in a way that doesn’t introduce any undue risk. A bank with very severe restrictions may risk losing customers entirely if they can’t use the nonbank tools they want to use. Alternatively, a bank with less restrictive data access policies runs a risk of increased fraud.

Blockchain

The blockchain allows multiple parties to trade assets directly without a trusted third party to clear transactions. The technology has yet to see mainstream adoption but could substantially reduce operational costs and increase transactional efficiency in payments. Virtual currencies have demonstrated the blockchain can facilitate payments reliably and securely without the need for payment networks or clearing houses.

Additionally, distributed ledger technology could be applied to any process in which an incorruptible system of records is needed. Some of the areas being considered include registering and trading of stocks and bonds without a clearing house. The same concept can be applied to deed registries.

Despite significant advancements in this space, few blockchain systems are currently deployed. Those that have been deployed have not yet reached ubiquity or scale. Banks should make sure they are engaging in internal education around blockchain opportunities and staying informed on blockchain developments in order to understand which problems blockchain can solve. For example, J.P. Morgan Chase announced in October the launch of the Interbank Information Network, which will leverage blockchain to reduce the number of participants needed to respond to compliance and other data-related inquiries that delay global payments.

About Tyler Mondres

Tyler Mondres
Tyler Mondres is a research associate in ABA's Center for Payments and Cybersecurity.
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