Do We Need to Rethink Payments?
Whether a transaction is made using cash, credit, debit, points, or whatever new option becomes available, consumers expect payments to go through quickly and seamlessly.
Unbeknownst to most, automated clearing houses (ACHs) and settlement systems form part of a financial backbone that is absolutely vital for the functioning of our economies. The U.S. ACH Network processes nearly $39 trillion and 22 billion electronic financial transactions annually. In the UK, the Real Time Gross Settlement system (RTGS) settles roughly $700 billion between banks – almost a third of the UK’s annual gross domestic product (GDP) – each day. Without these networks and systems in place, the rate at which businesses operate would slow to a crippling crawl.
On October 2014, despite the marvels of modern technology, the RTGS suffered a catastrophic failure that resulted in an outage that lasted nine hours due to what was considered to be a routine configuration change, A report commissioned by the Bank of England, the UK central bank, found that 30 percent of all payment transactions related to residential real estate purchases on that day were not completed until the next day or later.
As the global mobile adoption and usage continues to rise, so does the number of financial transactions. Systems that were designed decades ago are no longer able to effectively keep pace with the increased volume from mobile users. The RTGS is marking its twentieth anniversary in 2016, and the ACH Network has already passed the 40 year mark.
Time for a Payment System Makeover
In a speech delivered at the end of January 2016, Minouche Shafik, Deputy Governor for Markets & Banking at the Bank of England, announced the plan to develop a new blueprint for RTGS and the central bank’s settlement system. This blueprint will address four key areas: policy objectives, functionality, accessibility, and the role of the Bank of England.
Shafik highlighted developments such as the creation of the Faster Payments service in 2008 and the Payment Services Regulator in 2015 as clear examples of how the payments landscape has evolved. As a result of these changes and the system outage in 2014, the Bank recognizes the urgent need for a new system to handle large-value transactions like those managed by the RTGS.
Recent trends, like the tremendous growth in demand for real-time payment services that be accessed anywhere at any time using mobile devices, also play a major role in the Bank’s decision to redesign. In addition, application programming interfaces (APIs) have made it easy to integrate payment into websites and mobile apps.
Does Distributed Ledger Technology Hold the Key?
The section from Shafik’s address that seemed to draw the most attention from industry observers and the media touched on a concept that most central banks shy away from. Blockchain, or distributed ledger technology, is the bookkeeping system used by digital currencies like bitcoin.
“The emergence of various forms of Distributed Ledger Technology (DLT) poses much more profound challenges because it enables verification of payments to be decentralized, removing the need for a trusted third party,” said Shafik. “It may reshape the mechanisms for making secured payments.”
As groundbreaking as this may be, this is hardly the first time that the Bank has publicly discussed distributed ledgers and digital currencies. Going back as far as 2014, the Bank of England has studied at length the potential of using technology like the distributed ledger.
“As with money held as bank deposits, most financial assets today exist as purely digital records,” read a Quarterly Bulletin from the third quarter of 2014. “This opens up the possibility for distributed ledgers to transform the financial system more generally.”
There has been a lot of focus on the UK and its payment systems because of the country’s drive for innovation. That being said, many other countries could clearly benefit from adopting new technology.
The U.S. ACH Network, for example, currently lacks the ability to support real-time transaction settlement. A credit transaction takes one to two business days to settle, while a debit transaction takes a full business day.
As growing demand for real-time payments increases, central banks and financial regulators will be under pressure to mandate the overhaul of ageing payment settlement systems. Just as the world’s banks have moved away from using paper, bank notes, and checks as the primary means of carrying out financial transactions, the infrastructure that supports financial institutions needs to catch up and enter the real-time digital era.
Should the payments industry adopt distributed ledger technology?