The democratization of something is often used too loosely and in many industries and business practices. The democratization of shopping, renting, buying, traveling, and particularly finance. The over usage of this term does not apply to payments transfer over the past decade. With the advent of smartphones, better internet, and peer-to-peer payments are virtually real-time within the U.S. and many developed countries worldwide.
The Past, Present, and Future
Western Union first started to issue employee salaries via non-cash payment with a metal plate card in 1914. Throughout the ’50s and ’60s, payments networks such as American Express, Mastercard, and Visa emerged as payment networks that began facilitating trade. This paved the way for the magnetic-stripe POS system in the ’70s and ’80s, which went wireless in the ’90s.
Today, non-cash transactions make up more than 80% of in-store sales. Non-cash is the preferred method of payment for a growing number of transactions. Payment networks continuously look for ways to capture a larger piece of the payment’s universe, particularly the tail-end of the payment ecosystem, such as small ticket items such as candy bars and large ticket items like cars.
However, there still are key barriers to overcome. Payment settlements are not quick. In many cases, nor is it cheap. Even with automated clearing house (ACH) transactions, which has reduced the cost of payments and processing time down to a matter of one day, instead of the average three days, merchants would still prefer to have the funds for the goods sold right now, as is the case with cash.
Enter Real-Time Payments (RTP)?
That is what Real-Time Payments (RTP) accomplishes. Although RTP is not a new technology, it has been adopted only recently in the U.S. In the ’70s, Japan introduced the first RTP, and today it is estimated that over 50 countries have an active RTP system implemented.
RTP allows payments and data to flow extremely fast, settling payments instantaneously. The Clearing House (THC) unveiled the U.S. iteration of the RTP in 2017 and now processes payroll, B2B, P2P, and RFP transactions, among others, in real-time.
How does RTP work?
The closest to RTP so far has been Next Day Payment and ACH Same Day Payment. They are usually traditional payments processed very fast. They have a specific cutoff time for transactions to be assigned to particular dates and then processed.
ACH Same-day funding and Next day funding utilize batch submission that happens faster via the ACH network and, depending on the cutoff times of the day, has the payments transferred to sellers in a matter of hours or overnight.
Real-time payments are different. RTP is the collection of financial information and verification of user identity between the seller and the buyer that is settled, and funds transferred at that very moment, effectively in real-time, like cash. The following steps are involved in this exchange:
- The seller submits a Request for Payment (RFP).
- The buyer submits payment details.
- The payment is settled once the seller receives payment details and confirms authenticity.
- The buyer confirms the finality of the transaction.
These steps happen in a matter of seconds, if not microseconds.
Even with the fastest existing payment rails, merchants must wait overnight to access their funds if the processing is done by a specific cutoff time. The system is available 24 hours a day, 365 days a year, even on weekends and holidays with RTP.
There are numerous benefits for all types of users using RTP. First, Merchants can get their funds immediately. If there are issues in processing a certain payment, the merchant will know of it in real-time.
Another benefit is that the RFP is available 24/7/365, including holidays. So anyone can transact at any time, and the payment is cleared, and funds settled immediately.
This system can translate into actual dollars for firms. Any business processing payroll will not need appropriate funds and processing fund transfers out of their bank accounts a day or two before the paycheck date. Businesses can process payroll and have the funds withdrawn at that date.
As with any innovation, there still are cracks in the system. The biggest hurdle will be adoption. As the system gains traction, many financial institutions will be late adopters, which will not be able to accept RTP payments. Until there is mass adoption as banks and financial intermediaries ramp up their technology infrastructure and security, it will not be easy to gauge the impact of a new payment system.
Furthermore, although there will be a heightened level of security surrounding the new payment rails, any fraudulent transactions that slip through the system will also be processed just as quickly as any other real-time transaction. This will create more hurdles in monitoring and tracing transactions involved in theft or other criminal activity.
Federal Reserve’s FedNow
The U.S. Federal Reserve Board is also expected to enter the fray. The central bank announced in late-2019 that it was developing an RTP rail called FedNow and will launch in 2023. As of early-2021, over 200 financial institutions were participating in the FedNow pilot program, supporting the rail’s development, testing, and implementation. These financial institutions also included several payment processors that are part of developing the technological integration requirements to sync with FedNow to adopt the RTP.
The payments industry has experienced many changes, with a history ripe with ingenious innovation. More and more firms enter the market to take advantage of the latest technology to facilitate trade and transactions at breakneck speeds. Now, thanks to real-time payments, merchants and consumers alike can benefit from a payment system that is both cheaper and settled instantaneously.