Fed should step aside on real-time payments
Beyond its monetary policy and bank supervisory functions, many would be surprised to learn the Federal Reserve has a third role: operating, oddly enough, revenue-generating payments services that compete with private-sector systems.
Whatever justification led Congress to authorize the Fed to establish a national check clearing system in 1913 no longer makes sense today, with the private sector, including financial utilities, card networks and fintechs, already delivering significant results in modernizing the country’s payments infrastructure. Indeed, the Fed is an outlier among most other central banks in industrialized countries, as only two others — Germany and Belgium — run check and retail electronic payment clearing systems.
The Federal Reserve’s entire role in payments was initially justified on the grounds that it could achieve economies of scale in the relatively cumbersome process of clearing checks through multiple banks and across long distances. Whether or not that was true in the early 20th century, there’s been a drastic decline in revenue at the Fed from check clearing activities as the economy moves toward card and electronic payments. From 2005 to 2014, Fed revenue from check clearing, taken into consideration along with ACH and wire services, fell by 54%, according to the Government Accountability Office.
As such, the initial justification no longer holds.
What’s more, private-sector operators also run far more efficiently than the Fed, operating check, ACH and wire clearing at 16-29% of the cost of the comparable payment system services provided by the Fed. This is the predictable result of competition between public and private providers of similar goods, as the private sector has inherent incentives to be more efficient. Managers and staff are accountable to the market and to their stakeholders for meeting earnings targets.
Government operators, by contrast, enjoy both direct and implicit subsidies, including through the government’s preferred use of their service over the private sector, which has the effect of limiting pressures to reduce cost. The Federal Reserve’s Fedwire system also obtains preferential treatment from the federal government, as the U.S. Treasury predominantly uses reserve bank payments services to make and receive government payments. (Compare that to the perennially underwater U.S. Postal Service and its private-sector competitors, FedEx and UPS.)
One reason the Federal Reserve has held onto its payments systems business is that this work supports large numbers of personnel — in operations, technology, marketing and sales, for instance — not to mention that the regional reserve banks now function as semi-autonomous economics research departments. It is not difficult to see why the Fed would deem it important to modernize its payments infrastructure.
But we need to ask ourselves whether this motivation is worth the costs to the country as a whole, as the U.S. works to catch up with the many other economies around the world operating modern payments systems built for the digital age. These considerations are crucial as the Fed contemplates developing its own real-time payment system — a significant investment.
There is also substantial evidence to suggest that the Fed doesn’t compete on a level playing field, but instead leverages its independent quasi-governmental status to its advantage. A number of competitors have raised issues with Fed pricing practices in the operation of its payments systems, which they feel involve unfair bundling or other anticompetitive practices. The fact that the Federal Reserve is not subject to federal antitrust law, while competitor payments systems are, further suggests the central bank should get out of the payments system business.
Another long-term cost is one we cannot yet see. The Federal Reserve has little incentive to innovate, as its managers are not residual beneficiaries of future profits. The Federal Reserve’s presence in payments crowds out private-sector competitors from making the initial investments needed to test out more efficient and effective systems. Further, one can easily make the case that, due to these variables, the Fed’s role in payments over the previous decades has stifled innovation in payments — something that we as a country are only now remedying through private-sector initiatives.
The political will may not be there for the Congress to entirely eliminate the Federal Reserve’s role in payment systems, but at the very least, the Fed can keep from making the problem worse. The central bank should halt its effort to create a real-time payments system and instead concentrate solely on elements in the existing system that are hindering or delaying the widespread adoption of competing private-sector real-time payments capabilities.
The Fed is already delaying the arrival of real-time payments in the U.S., as some institutions are waiting for a decision from the Fed on whether it will launch a real-time payments system of its own. Far more seriously, the Fed risks impeding innovations across the U.S. payments system, thereby further exacerbating the conflicts of interest that it has created over time.