As we continue into the 21st century, it’s important that our businesses keep up with the ever-changing technological advances. One of these advances is real-time payments. What are they? How do they work? And what does the future hold for them?
We’ll answer all of those questions and more. We’ll also discuss the two main competing networks in the U.S., and how they differ from each other.
Real-time payments (RTP) are just what they sound like: electronic payments that are processed and settled instantly. This is in contrast to traditional payment methods like wire transfers, which can take days to process.
Admittedly, faster payments have been in operation for years now in many countries around the world. About 40 countries have some system in place to transfer money in real-time, and some of these counties have had these systems for decades.
It’s true that the US has lagged behind these other countries in this area, but that’s about to change. That’s because the Federal Reserve is poised to launch its own faster payments system by 2023 or 2024.
The Clearing House Systems
Real-time payments in the US are not exactly advanced all that yet. But that only means that there will be a lot of development in the future, and that can lead to more competition and more choices. That should benefit business owners, and even consumers as well.
Currently, real-time payments and even same-day payments make up a very small fraction of the many millions of financial transactions that occur in the US each day. But that may soon change.
These changes began back in 2017 when The Clearing House’s RTP network started operating. According to TCH, more than half of all US bank accounts can now access this system.
It’s true that a large number of people still do not have access to this RTP network. This is especially true for people who bank with credit unions and other smaller institutions. But TCH projections are confident that this will change soon. It helps that TCH also offers a flat pricing model that sets various institutions of different sizes on an equal footing.
And once real-time payments trend, it could become ubiquitous. That has happened before, such as with large LED TVs and smartphones.
The Federal Reserve Systems
Still, back in August of 2019, the Federal Reserve announced that it would launch its own faster payment system, and that’s now set to start by 2024 or so. This announcement followed a public comment period and a lot of speculation, and those speculations have now been largely put to rest.
With the opening of the Federal Reserve System, businesses and consumers will now have another option to transfer funds in seconds, and this capability will be on hand 24/7.
What’s so different with this new system? Was it even necessary? The key difference here is that while these 2 networks do have the same purpose, the ownership is different.
The Federal Reserve system is run by the country’s central bank and is therefore part of the public sector. Theoretically, this means that service to the people is the main focus.
Meanwhile, the current RTP network is operated by The Clearing House (TCH), that’s owned by a group of large, private banks. As part of the private sector, generating profits is its main focus.
According to the Federal Reserve, its upcoming faster payments system should offer a level of competition to the TCH’s RTP network, and that should drive down the costs for businesses and consumers.
In addition, businesses and consumers can pick the option that best serves their needs and circumstances.
How Does RTP Work?
Here’s an example of RTP in action:
- Let’s say that there’s a patient, who wants to pay the hospital where they recently had surgery.
- The patient uses their bank app or website to authenticate their identity and then initiates the payment using that app or website.
- The patient’s bank sends a message about this to the RTP network.
- The Clearing House (which runs the RTP network) validates this message and then forwards it to the receiving financial institution. In this case, the message is forwarded to the hospital’s bank.
- If everything goes right, then the hospital’s bank accepts the message. Of course, it is also possible that the message can be rejected for various reasons. The patient may have entered the wrong bank account number, it may be listed as a closed account, or the account may not even be listed in the bank’s system.
- If the hospital’s bank accepts the message, then it immediately sends a message back to the patient’s bank, stating that the payment has been accepted.
As this process occurs, TCH settles the transaction in real-time. TCH uses a joint account at the Federal Reserve in New York. The participating banks have to refund this account and maintain the account to a certain level. Every credit transfer in real-time costs the sending institution (in this case, the patient’s bank) 4.5¢. There are no monthly minimums and no volume discounts.
The process requires the sender to initiate the transaction via the RTP network. But the receiving institution may encourage the start of the transaction by issuing a request for payment. The hospital’s bank can send a request for payment to the patient’s bank, with a link to the bill in the request. This will cost the hospital’s bank 1¢.
The patient’s bank can then send this request for payment to the patient, who can then start the transaction. Keep in mind that this request for payment is not the same as a debit, as the hospital’s bank cannot automatically pull the fee from the patient’s account. It’s still a request, and in theory, the patient can ignore the bill. The payer is always in control, and it’s up to them whether or not they wish to pay.
This control is an additional layer of security, as it helps to reduce errors and fraud. The request for payment is attached to a particular invoice and receiving bank account, and the transaction goes through a secure channel.
What does this all mean for businesses and consumers? When real-time payments become more accepted and common, both businesses and consumers can only benefit as they meet their current financial challenges.
With real-time payments, benefits include certainty of payments. The receiving institution gets its money, while the payer is sure that they’ve discharged their financial obligation and have paid properly.
This system also improves cash flow, makes managing finances easier, and makes transactions faster, which is always a good thing. A larger economic boost awaits both parties. The emergence of the Federal Reserve’s faster payment systems should add to the benefits.