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Senate Banking Committee Hearing on Facilitating Faster Payments in the U.S.

Senate Banking Committee

“Facilitating Faster Payments in the U.S.”

Wednesday, September 25, 2019

 Key Topics & Takeaways

  • Competition: Republican members questioned the need for the Federal Reserve to build a separate payments system that would compete with The Clearing House’s RTP Network, while Democrats focused on the benefits of competition for consumers in promoting innovation.
  • Large Banks: Ranking Member Sherrod Brown (D-Ohio) noted that The Clearing House is owned by the largest banks, adding that many of these firms needed to be rescued with taxpayer money during the financial crisis. He commented that allowing these same banks to run a monopoly “just doesn’t seem wise.”
  • Interoperability: Hunter stated that he is not optimistic that the FedNow system and the RTP Network would be interoperable, explaining that real time payments are fundamentally different in how they work compared to wire transfer or ACH systems because with real time payments, clearing and settlement happen together instantaneously and the two processes cannot be bifurcated.

Witnesses

Opening Statements

Chairman Mike Crapo (R-Idaho)

In his opening statement, Crapo stated that faster payments are important for consumers and businesses as they provide the flexibility to manage money and to access time-sensitive payments, and help to avoid fees. He added that the Federal Reserve’s (Fed) establishment of a task force on this issue in 2015 has been critical. Crapo noted that the task force finalized a report in 2017 that highlighted the need for a 24-7-365 real-time gross settlement system and interoperable system. He noted that Fed Vice Chairman for Supervision Randall Quarles dissented to the Fed vote on faster payments due to his belief that there has not been evidence of private sector failure in this area, and due to the potential that the Fed could crowd out innovation.

Ranking Member Sherrod Brown (D-Ohio)

In his opening statement, Brown said large corporations could not be trusted to take over critical public infrastructure, as he believes they would work to squeeze out more profit from working families. He stated that the Fed developing a real-time payment system is “great” news and that the Fed would create a system that provides access for everyone.

Testimony

Esther L. George, President and CEO, Federal Reserve Bank of Kansas City

In her testimony, George said the Fed has developed a modernized payments system, called the FedNow Service, to further promote efficient, safe, and ubiquitous access to payment and settlement services. She stated that the Fed considered three key criteria before developing FedNow: 1) the inability of other providers to reasonably achieve a system with effectiveness, scope, and equity; 2) the need for a system that promotes integrity and reduces payment risks; and 3) the Fed’s ability to recover its costs over the long run. George added that the Fed’s ability to connect to over 10,000 financial institutions and to provide liquidity and operational continuity help serve the needs of Americans. She referenced a 2016 Government Accountability Office (GAO) study that found that the Fed has been long judged as effective in promoting accessibility, safety and efficiency for payment services. She added that all Fed services to date have met the requirements of the Depository Institutions Deregulation and Monetary Control Act of 1980, and stated that she fully expects the FedNow Service to maintain this standard.

Robert Hunter, Executive Managing Director, and Deputy General Counsel, The Clearing House

In his testimony, Hunter said that The Clearing House RTP Network started operating in 2017 and is effective and fully functioning. He explained that The Clearing House reaches over 50 percent of financial transaction accounts across the U.S. and its RTP system delivers faster, efficient and more secure benefits to consumers. He noted that the organization clears and settles roughly $2 trillion each day over its wire, automated clearing house and check-clearing networks, and that 80 percent of check clearing transactions occur for institutions with under $10 billion in assets and that The Clearing House prices its service on a cost recovery basis.

Hunter stated that The Clearing House has a “remarkable” history of operational resiliency, clearing payments without fail. He referenced that the Fed rated the RTP Network as the highest submitted proposal for a solution to faster payments and that the network was recognized for accessibility and nationwide reach. He expressed that a Fed run system would hinder RTP’s ability to operate because of the competitive advantage the Fed has over the private sector.

George Selgin, Senior Fellow and Director, CATO Institute

In his testimony, Selgin said the slow speed of payments in the U.S. is a “disgrace” and is taking a toll on working Americans. He said a Fed-run system could be beneficial if it competes on a level playing field with existing private-sector payment services. Selgin recommended Congress consider addressing two areas before the Fed launches a new system: 1) give the Fed two years to either place its Fedwire and NSS services on a 24-7-365 operating basis, or to establish an alternative 24-7-365 liquidity management tool; and 2) keeping the Fed from underpricing its payments services. He said the Fed has been “dragging its feet” to fix same-day fund releases and that the Fed can charge value discounts, noting that The Clearing House charges flat fees.

Bob Steen, President and CEO, Bridge Community Bank

In his testimony, Steen argued the operation of a real-time payment system is too important to be trusted with the largest banks. He stated his support for the FedNow service, saying the Fed is the only entity able to guarantee competition and choice for all customers and financial institutions. Steen said that the Fed would maintain fair and affordable pricing structures and that its services are easily accessible for community banks, even outside working hours.

The Honorable Sheila C. Bair, Former Chair, Federal Deposit Insurance Corporation

In her testimony, Bair expressed the need to consider whether it is the best approach to give control of infrastructure for the next generation of payments innovation to megabanks. She noted that the sector remains heavily concentrated and added that post-crisis reforms have been untested. Bair recommended that Congress apply “common sense” when considering if a single system monopoly owned by dominant banks would promote innovation, offer resiliency, reach ubiquity and provide access for all financial institutions. She stated that the Fed was deliberative in its approach and that The Clearing House RTP Network has not gained “significant” traction and stated that commenters “overwhelmingly” support the FedNow Service.

Question & Answer

Competition Between FedNow and RTP

Crapo asked about concerns that the Fed would have an unfair advantage in the development and implementation of a payment system. George argued that the Fed has a long history of operating payments services and that there has been no instance where it did not operate alongside the private sector and provide competitive and transparent pricing on transactions. Hunter stressed that The Clearing House is not opposed to competition, but that it wants to ensure a level playing field. He said The Clearing House is committed to a level pricing structure no matter the size of the institutions it works with, and that the Fed should engage in the same pricing structure. He added that the most important thing the Fed could do to encourage private competition would be to extend the operating hours for Fedwire and NSS.

Sen. Pat Toomey (R-Pa.) asked whether the possibility of a Fed alternative to RTP has been holding back the RTP Network from achieving ubiquity. Hunter stated that the uncertainty from the Fed has had an impact, and that the FedNow proposal is splitting the market and it remains to be seen how institutions will react.

Sen. Thom Tillis (R-N.C.) questioned the need for the Fed to build a new system when most of The Clearing House’s RTP system is working well and the Fed could simply engage with them to address any remaining concerns. George answered that the Fed Board of Governors did not feel it has adequate authority to drive changes to the RTP system and reiterated that the Fed has been effective in providing services as an operator. Hunter stated that both the Fed and the Federal Deposit Insurance Corporation (FDIC) have regulatory authority over The Clearing House, and he stressed that The Clearing House is subject to detailed anti-competition laws that would protect against any abuses.

Tillis commented that the Fed’s solution to build its own system seems like “a hundred dollar saddle on a ten dollar horse.”

Sen. John Kennedy (R-La.) similarly questioned the merits of the Fed building a new system, suggesting the Fed already “has enough to do” and that it may not make sense to spend taxpayer money for the Fed to build a system to compete with a working private sector solution.

Sen. Chris Van Hollen (D-Md.) stated that the fundamental question is about competition, and that while The Clearing House says it welcomes competition, its testimony has opposed the idea of a separate system.

Sen. Tina Smith (D-Minn.) asked the panel to explain the harm of more competition in the payments space. Bair said consumers would actually be helped by competition, which would result in innovation and better pricing for consumers and banks of all sizes. Selgin said he is not opposed to competition, but that it must be on a fair basis and that the Fed must take precautions to avoid competing unfairly. Hunter also questioned whether the Fed would compete on a level playing field.

Large Bank Ownership of The Clearing House

Brown noted that The Clearing House is owned by the largest banks, adding that many of these firms needed to be rescued with taxpayer money during the financial crisis. He commented that allowing these same banks to run a monopoly “just doesn’t seem wise.”

Brown questioned whether the concentration of critical public infrastructure in the hands of big banks that had failed during the crisis might pose a risk to the economy and harm small banks and families. Bair  replied that the centralization of risk in a monopoly would create a single point of failure and present a serious operational risk. She stated that the RTP system is backed by joint accounts funded by the large banks, but it is unclear what would happen if one of the institutions could no longer fund the accounts.

Sen. Catherine Cortez Masto (D-Nev.) asked about the possibility of the Fed needing to bail out one of the large banks that own The Clearing House if the RTP system had a monopoly. George reiterated that a single point of failure would pose risks and said having the central bank as a provider during times of stress has served the country well. Bair warned that it is unclear what would happen to the customers of a large bank if it was unable to pay into the RTP joint account.

Tillis asked Hunter to explain whether any circumstances would necessitate a large bank bailout based on their role in the RTP Network. Hunter said there is no such circumstance because The Clearing House has detailed processes in place that it has worked on with the FDIC to use in the event of a bank going into resolution.

 Interoperability

Sen. Jerry Moran (R-Kan.) stated that interoperability between the Fed Now and RTP systems would be important and asked for assurances that there would be such interoperability. George said interoperability would be a desirable outcome, and that while the Fed is first focused on nationwide reach it could then look at interoperability. Hunter, meanwhile, stated that he is not optimistic that the systems would be interoperable, explaining that real time payments are fundamentally different in how they work compared to wire transfer or ACH systems because with real time payments, clearing and settlement happen together instantaneously, and the two processes cannot be bifurcated.

Toomey said he is concerned about interoperability and asked what would happen if an employer wanted to provide real time payment of wages to employees but the employees’ different banks did not all use the same system. Hunter replied that real time payment would be complicated, as the employer would have to work through two different banks and format payments through both systems.

Benefits of the RTP Network

Moran asked about the benefits of the RTP system for consumers and businesses. Hunter explained that RTP is a safer, more efficient way to make payments that provides senders with immediate confirmation that funds are received and lets people getting paid access their funds immediately.

Later in the hearing, Hunter added that the RTP involves a “credit push” rather than a “debit pull” system, meaning that funds would never be sent without authentication from a sender, and that the prefunding of accounts for the RTP Network means there is no credit risk in the system.

 Timeline for FedNow

Sen. Doug Jones (D-Ala.) asked George if there is a timeline or benchmarks to ensure the FedNow system is on track. George answered that the features of the system are now being designed, and this will guide delivery times. She said the Fed intends to be transparent about its intentions and will collect public comments in the future.

Pricing

Toomey noted that the RTP system has made an explicit commitment to provide flat fees on transactions regardless of size or volume, with the one caveat that this could change if the Fed offers a parallel system that offers a different pricing model. He asked whether the Fed has made any commitment to a flat fee, to which George replied that the Fed is in the process of designing the system and has not yet identified associated pricing. However, she noted that volume pricing has been common in the market.

Digital Currencies

Cortez Masto asked whether the Fed should explore the use of digital currencies. Bair said the technology is maturing rapidly and that she hopes the Fed will consider it. George said it is not currently being considered, but that the full range of digital currencies is under study by policymakers.

Crapo offered high level comments on digital currencies, commenting that their creation raises questions for the financial transaction space that central banks and all institutions should consider. George said it is hard to forecast where digital currencies are going, but that we need to be cautious so that the benefits of the technology are gaining without undermining safety, noting that the current banking system has been developed to include safety nets and consumer protections that do not exist yet with digital currencies. Bair added that digital currencies such as Libra might take payments completely out of the financial system where there is a lack of regulatory structure, and that the Committee should explore the issue. She said central banks need to get ahead of this technology so they are not disrupted by non-banking entities like Facebook.

Hunter commented that digital currencies are not fit for purpose to be used as a payments system because they require significant processing power and are comparatively slow. Selgin said digital currencies are part of competition and disruption, but we do not yet know their full potential benefits and they have not been useful so far for payments.

For more information on this hearing, please click here.