Digitalization / Cashless Society / Instant Payments
1. General information.
Consumers are demanding more speed in every aspect of their lives, and payments are already lagging behind to meet the expectations. Some countries managed to close the gap, while most of them are still working hard to do so. This article will give you a deeper understanding of what Instant Payments are, what is their role in the payments ecosystem, as well as barriers of adoption, possible threats and solutions.
1. What are Instant Payments?
Instant Payments is an Electronic retail payment solution available 24/7/365 and resulting in the immediate or close-to-immediate interbank clearing of the transaction and crediting of the payee”s account with confirmation to the payer (within seconds of payment initiation). It is often referred to as SEPA Instant Payments Scheme. The idea was proposed by The European Payments Council (EPC) to the Euro Retail Payments Board (ERPB) in November 2015.
2. What are the characteristics of Instant Payments?
In a true real-time system, posting, clearing and settlements are performed in real-time. However, there exist many different hybrids in the market. For example, UK and Singapore systems have deferred net settlement, while SIX in Switzerland has actual real-time settlement.
|Desirable Features||Advanced Features|
|Account to account||Universal access||Alternate identifier|
|< 1 min end-to-end||ISO standards (20022)||Individual payments|
3. What are the drivers of Instant Payments?
- Regulators who aim to increase the velocity of money through the economy
- A history of hyperinflation in countries like Brazil resulted in the urge to develop payment systems with fast settlements
- Threats from providers outside the traditional banking sphere (FinTechs)
- Increased use of transfer funds with mobile technology in the last decade
- Consumers and merchants are used to immediacy and they expect digital payments to keep up at the same pace
4. Which countries will participate?
The SEPA Instant Credit Transfers scheme applies for 34 SEPA Countries and will go live in November 2017
1. Austria, 2. Belgium, 3. Bulgaria, 4. Croatia, 5. Cyprus, 6. Czech Republic, 7. Denmark, 8. Estonia, 9. Finland, 101. France, 11. Germany, 12. Greece, 13. Hungary, 14. Iceland, 15. Ireland, 16. Italy, 17. Latvia, 18. Liechtenstein, 19. Lithuania, 20. Luxembourg, 21. Malta, 22. Monaco, 23. Netherlands, 24. Norway, 25. Poland, 26. Portugal, 27. Romania, 28. San Marino, 29. Slovakia, 30. Slovenia, 31. Spain, 32. Sweden, 33, Switzerland, 34. United Kingdom
2. How it works.
Intermediated payments have two parts. The first is messaging – the instruction that states who is to be paid, by whom and in what amount. The other part is the settlement, which is the event that finishes a payment. It is the actual transfer of funds, reflecting the transfer of ownership of value from payer to payee.
According to the European Central Bank (ECB), in order to preserve the ecosystem from fragmentation and assure harmonization and integration with previous initiatives, the Instant Payment ecosystem should be divided in three main layers; the scheme layer, the clearing layer and the settlement layer.
- The scheme layer
The Scheme Layer covers the subset of services, standards, rules and regulations put in place in order to assure a uniform service and product across all the customers using Instant Payments. The Scheme can be divided into two different parts: the end-user scheme, used by the Customer, and the Banking scheme, used by the financial institution.
- End-user Scheme
The end-user scheme is the Instant Payment “product” offered to the end consumer. Here is where the main competition will appear. Being consumer-orientated, Instant Payments is no longer can be seen as a commodity, but rather as a simple and secure experience for all stakeholders (consumers, merchants and banks) – this is the space in which banks have more to win.
- Banking Scheme
This is the level on which the future of Instant Payments is going to be decided. Regulators, banks and financial institutions need to decide on a common foundation to provide their services. This could be a very complex situation, such as with the initiative of enhancing the SEPA Credit Transfers (SCT) scheme for Instant Payments, at the same time that all stakeholders are indirectly supporting the choice of ISO20022 as inter-banking message standard. The ISO20022 allows carrying more data mostly orientated to achieve a simpler reconciliation and enrich remittances. In Europe, implementation for SEPA was not uniform and rose due to this complexity. Each country needs to meet specific rules, regulations or even needs issued from deeply rooted management policies.
- The Clearing and Settlement Layers
Clearing is seen as the validation of the payment details occurred from a credit or debit accounts, while settlement is the actual irrevocable exchange of funds – in line with definitions provided by SWIFT. Depending on the way clearing, posting and settlement take place, they can be considered a single process, therefore they are evaluated in the same section.
Settlement is the slowest aspect of any payment scheme, offering access to funds in one to three days. Even if the message of transferred funds is received instantly, it might take a couple of days for the user to get his money. Here is where Instant Payments will make a change – reducing the time from a few days to less than 5 seconds. However, there are certain considerations that have to be evaluated:
- 24/7/365 availability. Most of traditional clearing and settlement are not able, nor optimized to work under these conditions. An Instant Payment infrastructure needs to have permanent availability without any downtime that could harm any of the essential functionalities. Currently, only a few countries are able to perform up to these standards, with the most of them only offering continuous clearing and windowed settlement.
- Batch vs Individual payments. Large settlements divide payments between low and large value. The high value payments are cleared and settled individually (often by RTGS systems), while low value payments are grouped in batches and processed as a whole. This division reduces the credit and liquidity risks when moving large amounts of funds between banks or governments, which has an obvious impact on the related costs. In order to process Instant Payments, the clearing and settlement needs to prices individual low value payments in large volumes without losing performance, which makes an RTGS system needed for lesser cost and higher performance – opposite as it is now.
- Supplementary data. Due to the usage of new standards, the clearing and settlement mechanisms need to support larger amounts of data that are treated together with the original transaction. The goal of ISI20022 messaging is not anymore about providing an efficient way to process payments, but offers a complete set of data accompanying the typical transaction details.
- Fraud management. Instant Payments will make funds re-usable immediately, which requires the fraud management to speed up their actions. This topic addresses to the institutions taking part in the clearing and settlement mechanism. As with the raise of cyber-attacks, protective measures must be addressed to ensure safe clearing and settlement layers.
4. Clearing and Settlement Alternatives.
Traditionally there are three different clearing approaches that can be distinguished while fulfilling the Instant Payments requirements: the ACH approach, RTGS approach and Distributed approach.
- The Automatic Clearing House (ACH) approach is often referred as a hub approach where the Financial Institutions are all connected to a central hub that performs the clearing between all the entities. Later on the results are forwarded towards the Settlement house that uses a Real-Time Gross Settlement (RTGS) mechanism to complete the fund transfer. This is the most used mechanism for Instant Payments in countries like UK, Sweden, Poland, Singapore and others.
- The Real-Time Gross Settlement (RTGS) approach is able to settle transactions immediately (without validating transaction information) and return payments that failed to be completed. This mechanism is used in Switzerland, Mexico and Czech Republic amongst others.
- The distributed approach is based on a P2P clearing mechanism between all banks. Once this is completed, the settlement request is sent to the Central Bank to have it processed in real time. The actual movement of funds only occurs at the end of the day and this mechanism is used only in Australia.
5. Blockchain Technology.
Blockchain can play a significant role in enabling Instant Payments for international bank transfers due to its simplicity compared to the traditional transaction method. If we take a look on the current Electronic Fund Transfer (EFT) system, the process to make an international transfer requires banks to collaborate on multiple levels and each time money goes from one source to another, there is a transfer fee applied, which adds up to the final cost of transaction.
In comparison, a blockchain ecosystem will reduce the costs and increase the cash-flow speed by reducing the number of parties required for a transaction to take place. The following transaction framework for multi-currency is proposed by Ripple, a “distributed financial technology that enables banks to send real-time international payments across networks”.
The advantages of such a system, as stated by Ripple itself, are as following:
- There is no need of intermediate FX to other recognized currencies (i.e. when currencies used in one extreme are not internationally traded)
- It can be integrated in the existing banking systems and provide the same user experience to the end creditor or debtor
- Due to the quick settlement time, creditor’s and debtor’s bank can grant faster access to the funds and improve customer experience and cash-flow
- KYC/AML and other compliance requirements may remain largely the same due to the non-modified interaction between customers and their financial institutions.
In a world where expectations of instant access to everything and everywhere are growing, the payments industry still needs to catch up and answer to the demand of customers and merchants for a quicker way to perform payments. The Financial Institutions have two possibilities to tackle this challenge, either by providing the service that customers and merchants are willing to receive, or allow FinTechs and newcomers in the market to take their place and commoditize their existing banking services.
The opportunity of faster payments comes with threats for compliance to ensure innovative fraud-protection mechanisms that can operate at the speed of seconds. It is expected to see more FinTechs joining the battle of who can serve the highest value proposition for the end user and the traditional methods will not be enough to keep pace with the value of new players.
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