Instant Payments: A Critical Assessment

SEPA has long dominated the financial industry, but Europe’s next major payment project is just around the corner: instant payments. Leading the field here are the European Central Bank (ECB) and the European Retail Payments Board (ERPB), who are driving the development of a real-time payment system. Payments within Europe will, in future, be performed in real time, while money transfers will take just seconds. Achieving this aim, however, will be no easy matter, and we are still at the very beginning. Another, similarly rewarding objective would be faster and cheaper to achieve, while still providing decent protection against Apple, Google and their like.

Keywords: Regulation, SEPA, E-money

Money in your account instantly? Whether you ask private customers or companies, it’s a great concept. We’ve become accustomed to simply calling up live data on our smartphones, shopping at all hours, and communicating with the entire world in real time. Music and videos are streamed instantly on mobile devices and, if we have to wait, it’s only for an Amazon Prime delivery which will reach us tomorrow, if not before. Nowadays, therefore, payments which take several days to reach the recipient are no longer acceptable. It’s time for a paradigm shift in payment processing. SEPA and the first Payments Services Directive (PSD1) have already reduced money transfer times (at least within the European economic area) to one business day, but that’s still a long way from real time. Indeed, many customers still perceive it as too slow. The reason is that transfers are currently forwarded to the central banks, where a daily cut-off point is used to reconcile payments between the various institutions. The differences are settled and payments are then credited to customers’ accounts. Instant payments are set to change that. Instead of being performed once a day, payments are performed in real time. Whether through money transfers, direct debits or card payments, funds are not only instantly debited from one side, but are also instantly credited to the other. The ECB likes to refer to this as “cashless cash”. Theoretically, a money transfer should be as direct and immediate as a cash payment—without, however, banknotes actually changing hands.

Real-Time Payments Are Still In their Infancy

Real-time payments in themselves are nothing new. Around twenty countries are either already experimenting in this field or are moving towards doing so. In the UK, for example, the UK Faster Payments Service[1], an accelerated posting system for Britain’s banks, processes a billion transactions annually, each of which normally takes between 15 minutes and two hours. Although this is fast, it’s not instant. Instant payments require immediate reconciliation, something which will require extensive modernisation of the banks’ IT systems and will cost a tremendous amount of money. The banks’ core IT systems, as well as the linked gateways and control systems which validate transaction data, would be affected. In addition, all other players in the market would have to invest, including, for example, linked payment service providers (PSP). Precisely how much a European real-time payment system would cost, no-one currently knows. This is, however, not due to a lack of research—it’s simply that any such project is still in its infancy. But we do have a rough idea: in Denmark, a real-time payment system was implemented as part of a larger payment project. The infrastructure alone cost around 33.5 million euros. Although UK Faster Payments isn’t quite real-time, the banking IT still cost around 275 million euros. The 12 linked PSPs invested around 60-70 million euros each.

Retailers Require Payment Guarantees

One major group for whom instant payments should prove advantageous are the retailers. While some would certainly appreciate this concept, online shopping requires only that the customer’s payment is immediately confirmed and guaranteed to the retailer, not that the money is immediately paid into the account. These guarantees are particularly important for digital goods, which are instantly released to customers, as well as for fast shipping services, as they enable goods to be dispatched the moment payment is confirmed. The effect for the retailer is therefore similar, except that real-time guarantees do not incur the enormous additional costs involved with instant payments. This becomes even clearer when you consider that retailers nowadays often work with payment targets of between 30 and 90 days. In such cases, payment services with real-time guarantees, like the German giropay or Dutch iDEAL, represent a dramatic advancement. Retailers leveraging these services receive instant payment guarantees and their accounts are credited just a day or two later. For many retailers, receiving real-time credits to their accounts could even be counterproductive, as daily auditing and consolidation take time and effort. Many find weekly or monthly reconciliation perfectly adequate.

Real-Time Payments Already Exist

The retailer’s perspective is, however, not the only one. What about the consumer? When private individuals are on the receiving end, there is certainly a great need for real-time payments, as these allow funds to be accessed immediately. Instant payments, however, are not the only way to provide this service. Some e-money providers, including PPRO Group, already offer real-time payments. When a VIABUY prepaid credit card is loaded using InstantTransfer, for example, the money is immediately available for spending or withdrawal. In such cases, the e-money provider—in this case, PPRO Group—bears the risk that the transfer may not go through the next day, as well as the costs of making the credit available early. Theoretically, banks could handle this similarly amongst themselves. Whether each bank would then bear the risk for its own customers or whether the institutions involved would share the risk has yet to be decided: a number of different models are possible. A great deal could, therefore, be achieved simply by guaranteeing payments—and the high infrastructure investment required to implement instant payments could, for the time being, be saved.

Rapid, Long-Term Solutions

The question here is not, however, whether or not real-time payments will actually be part of our future. As has been shown above, they are, firstly, already partly possible, and secondly, they are a logical step in our fast-paced world. Instead, we need to determine the specific form the “big picture” payment solution should take, what it will cost, and how long it will take to launch real-time payments. These hot topics are precisely those currently under discussion. The EPC (European Payment Council) has recently published a status report containing several different ideas. If you consider payments as a multilayered model, various different options for implementing instant payments are conceivable. By far the most expensive option is implementation at what is known as “settlement level”. If banks are really going to reconcile their transactions in real time, they need completely new, much more comprehensive IT systems. In addition to the costs involved, this approach would also be by far the most time-consuming. Another, often forgotten, point is that real-time systems aren’t just fast: they should also function around the clock. In addition, they should also function independently of the payment instrument. In other words, regardless of whether people pay by direct debit or card, everything should run in real time. If we consider the multilayer model further, schemes like SEPA or payment services like giropay could also form the basis for implementing real-time payments. One benefit of implementing a higher-level solution is that it could be launched more quickly and cheaply. This type of service would, however, only give customers the impression of real-time payments; in reality, they would receive only a payment guarantee. The problem with this approach is that the service provider must bear the risk of non-payment. It would be conceivable to take a two-pronged approach and to allow such real-time guarantees to bridge the gap until real-time payments are fully implemented in the requisite IT systems. Banks could then equip themselves for the future in the background, while still using practical solutions to compete in the market with Apple, Google and the like.

A Single European Solution – Or Multiple Ones?

Current discussions of real-time payments are focusing on a unified European system. This could, theoretically, be achieved in one of two ways: either by creating a unified system for the SEPA area, or by having each individual country focus on their own real-time solutions, which could then be linked via standardised interfaces. The major advantage of the SEPA-wide solution would, of course, be its range. In addition, payment service providers, as well as all the other institutions involved, would have a clear overview of the solution’s interfaces and standards. The biggest disadvantages of this system are the scale of the project and the competition with the national standards already in place. If we focus only on national standards, we will see measurable results more quickly. The fear is, however, that doing so will once again fragment the payment market and thus work against SEPA unity.

Next Steps

So what happens next? The ERPB has established a working group to address the topic of real-time payments. This, in turn, has tasked the EPC with working on approaches to solutions. The EPC has already successfully developed the SEPA standard, so has a great deal of experience in this matter. Their first task is to identify customer and company expectations and to make recommendations on how these can best be fulfilled. The key question is: should there be a single, SEPA-wide solution, or do people want to link national real-time projects together? Answers to this question, as well as a possible rollout plan, should be presented by mid-2016. In all probability, a solution for instant payments will be created first for credit transfers, with card and direct debit payments coming later.

Conclusion:

There are no two ways about it: real-time payments are the future. The fact is, however, that in many cases (as with retailers), all that is needed is a payment guarantee. Nowadays there are a range of services which provide precisely that. Banks which are prepared to assume the inherent risks can offer their customers several of the benefits of real-time payments using real-time guarantees. Whether instant payments are implemented as part of a massive, SEPA-wide project or as a network of national real-time payment systems, they are still some time away and will cost a great deal. In the meantime, banks could use real-time guarantees to resist the market pressure exerted by Apple, Google, and similar companies.

[1] http://www.fasterpayments.org.uk/