What the big banks left out when they slammed Fed over real-time payments

The Federal Reserve may be poised soon to announce plans to build a next-generation payment system — an idea that many community banks embrace, but the nation’s biggest banks strongly oppose.

This divide within the industry is nothing new. Big banks have long played a major role in the nation’s payment systems. And small banks have resisted the big banks’ dominance out of fear that they will be disadvantaged unless the Fed offers a counterbalance.

Back in 2017, The Clearing House, a payments company that is owned by 25 of the world’s largest banks, launched a real-time payment system. But so far, many smaller banks and credit unions have chosen not to participate, holding out hope that the central bank will build a competing service.

In a Politico article last week, Greg Baer, president and CEO of the Bank Policy Institute, a lobbying group that represents big banks, suggested that the Fed is now preparing to backtrack on a past promise to defer to the private sector.

“In 2015, the Federal Reserve called on the private sector to build a real-time payments system,” Baer said. “The Clearing House, and only The Clearing House, responded by building the most advanced payments system in the world.”

He added that “the Federal Reserve may pull a bait and switch and build its own system — certainly delaying and perhaps completing undermining the goal of a ubiquitous system where any U.S. consumer or business can pay any other.”

But that summary of the recent past glosses over a lot of relevant information. The fuller history shows that the Fed can be criticized for dragging its feet — in an ultimately futile effort to avoid antagonizing either big banks or small banks — but the bait-and-switch charge appears unfounded.

Before they built their own real-time payment system, the nation’s big banks were skeptics of faster payments. In 2012, they torpedoed a plan to enable speedier payments on the automated clearing house network, though a revised version of it was later enacted.

In 2013, the big banks released a white paper that described a long series of criteria that would have to be met before they would support a real-time system. The following year, the big banks got religion on faster payments. The Clearing House announced plans in October 2014 to build what would become the RTP Network.

By this time, the Fed had launched a collaborative process between the public and private sectors that was meant to encourage the development of real-time payments in the U.S. From the start, the Fed was cagey about its own potential role.

But the central bank was clearer about what a future payments system should look like. A paper published by the Federal Reserve banks in 2013 stated that payment networks best serve the public interest when they reach every bank or credit union, are broadly interoperable, or both.

Fifteen months later, The Clearing House endorsed that same broad vision.

“Ubiquity through interoperability is a way to optimize the benefits of both network effects and competition,” The Clearing House stated in a December 2013 paper.

“In a market of proprietary, closed networks, the most likely way to maximize network effects is for one provider to achieve a monopoly. A monopoly, however, eliminates competition, and competition is necessary to drive customer value and innovation.”

After The Clearing House launched the RTP Network, however, it backed away from concerns about the dangers of a monopoly.

The Clearing House has recently argued that the Fed should remain on the sidelines in part because technical challenges in achieving interoperability would slow the adoption of real-time payments. Interoperability would enable a payment to be initiated on one of two systems and completed on the other.

For its part, the Fed has been consistent about the value of competition, though it long seemed to be waiting for the emergence of multiple private-sector offerings that would appeal to banks and credit unions, which would eliminate the need for a public-sector option.

In January 2015, the Fed did express reluctance with respect to the possibility of becoming a provider of real-time payment services.

Specifically, the Fed said that it "would not consider expanding its service provider role unless it determines that doing so is necessary to bring about significant improvements to the payment system and that actions of the private sector alone will likely not achieve the desired outcomes for speed, efficiency and safety in a timely manner."

These are the comments that Baer was referencing when he accused the Fed of a bait-and-switch. But the Fed's statement contained important caveats, putting the central bank in an indecisive posture that it has maintained for several years now.

Since the RTP Network launched nearly two years ago, no private-sector competitors have gained significant traction with U.S. financial institutions. Meanwhile, it is unclear whether thousands of small banks and credit unions across the country will sign on to a system that is controlled by the nation’s largest banks.

The RTP Network boasts that it currently reaches more than 50% of U.S. demand deposit accounts, but that is largely because the country’s biggest banks have such large market share.

The irony in Baer’s recent comments is that if anyone can be accused of engaging in a bait-and-switch with respect to real-time payments, it is the big banks.

Shortly before the launch of the RTP Network, The Clearing House asked the Department of Justice to conduct an antitrust review. The Clearing House was marketing its faster payment system to smaller financial institutions, and a thumbs-up from antitrust officials might have offered a helpful selling point.

During the antitrust review, The Clearing House told the DOJ that it would charge all depository institutions the same price, regardless of their size. Nearly a year later, the Justice Department cited that assurance when it gave The Clearing House its blessing, saying that it had no intention to take an antitrust action against the RTP Network.

But then in April 2019, The Clearing House added a large caveat to its earlier pledge: Its commitment to charge the same prices to banks of all sizes will apply only as long as it is the sole U.S. operator of a real-time payment system.

Bankshot is American Banker's column for real-time analysis.