The Faster Payments Challenge
APACS, the UK payments association, recently announced that a new Faster Payments clearing and settlement system will be introduced in the UK market to facilitate same day real-time clearing of Internet and telephone banking transactions by UK bank account customers. This sets the UK clearing banks a new set of operational and technical challenges. Sterling will be cleared faster, but this will not be without risk and cost to the UK clearing banks. And it will all happen in less than two years, which is approaching with the speed of light in terms of payment system change.
In May 2005, the Payment Task Force of the Office of Fair Trading set out its expectations and intentions for mandatory changes in the UK market. With the authority of the UK Treasury behind it, this Task Force is progressively reviewing the different payment instruments offered by banks to the UK market. The government has long been critical of the way that payment services work within the UK (see the 2002 Cruikshank report) and the OFT is the vehicle being used for reform – representing the customer’s interests.
In the past, central banks have operated as the regulators of the payment sector, and banking associations (APACS in the UK) have represented the banks. Risk management has been the real concern. But in today’s regulatory world, the politicians have stepped in to change the way that banks offer payment services – so that the European Commission, with its new legal framework for the Single Euro Payment Area (SEPA) and the OFT in the UK are demanding change in the way that banks operate payment services for customers. The objectives are quite simple – to reduce the cost to the economy and the consumer, to standardise and make transparent cost and service levels and to improve service levels offered. The customer now has a powerful voice and these issues have replaced risk management as the key driver of change.
As UK consumers, we may have wondered why it takes three days to give value to another account holder electronically. The methods of moving money within the same day have always been expensive. A single CHAPS transaction for a retail consumer is charged at more than £30, and a banker’s draft at £10 to £20 is really not a payments vehicle for the 21st century. If you had just arrived from Mars, your first question might be: “Why, with all the computing power at a bank’s disposal, does it take so long?”
The OFT have set two requirements: UK bank account holders, using an Internet or telephone banking service, must have the facility to make and receive payments in real time, or as near real time, as banking technology and operational concerns permit. This means, for example, that a customer must be able to see that a credit transfer instructed through an Internet-based banking service results in the funds instructed leaving the account at the time of the request and that those funds have arrived in the account of the beneficiary in an acceptable time. This is assumed to be while the user is sat at his or her terminal.
Banks must also give same-day value for standing order payment instructions from their customers. (Standing orders are the last of the electronic instruments, which take three days to clear, and thus banks are losing the value of the float on these.) The value contained in a standing order must leave the payer’s account on the due date. The value received in the beneficiary’s account must be given on the settlement day of the payment. The key requirement for standing order payments is, therefore, same-day settlement.
The Task Force has stipulated a date by which this must all happen – by the end of 2007, for a scheme to handle a peak day volume of in excess of 10 million transactions. This is a demanding timescale in which to develop a new scheme and system, as it involves building the system, agreeing the details of the scheme, separate projects for each member bank to build its interface into the system, as well as the establishment of new settlement arrangements, which must be compliant with the famous ’10 principles’.
The banks’ reaction to this has been interesting. The initial grumbling at a regulatory imposition on their systems and budgets has been replaced by the realisation that this presents an opportunity, both to do something which should be done anyway and to change UK clearing in a positive way. This has much to do with the fact that the cost per transaction is likely to come out at 10 per cent or less of the current CHAPS transaction cost – and the more the volume increases the less the costs will be. There is a real opportunity for the bank product managers to develop new services.
So, with real speed, 11 banks have gathered together under the APACS banner, agreed the requirements, selected the technology vendor and are setting about building this groundbreaking initiative.
In November 2005, the APACS banks selected the vendor to build the scheme. In a sense, the selection was surprising, since it was a joint venture company formed between Link (the ATM people) and Voca, (formerly Bacs). This is an interesting combination, in which the real time switching capability of Link is teamed with the clearing and settlement expertise from Voca. This provides a high-volume real-time clearing facility, which is already used to dispense cash from most ATMs in the UK and debit the account at the account-holder’s bank in real time, and the settlement management capabilities of Voca, whose investment in new clearing and settlement technology has been much commented on in the banking press.
The introduction of new electronic payment services, which offer straight-through processing, has been of great value to customers and to banks, but the possibility of fraud is substantially increased. Security in electronic banking is a continuing concern, as evidenced by tales of phishing and of hackers inhabiting untraceable areas of the Internet who seem to be able to introduce themselves into the systems of unwary users.
Faster Payments will increase the risk of fraud by its very nature. A delayed clearing and settlement cycle (whether it is one, two or three days) gives banks time to authenticate the validity of the source and destination of a payment, and also to detect patterns of payments which may indicate criminal activity – before the money can leave the banking system. A real-time service removes this time and increases the attractiveness of the banking system as a whole to perpetrators of electronic fraud.
The actual time for a payment to be declared final will be several hours during the early days of the scheme. Payments will actually be processed in seconds, settlement of the banks’ indebtedness to one another will happen periodically (probably hourly) within the settlement hours operated by the Bank of England, but a payment will only become final once it has passed through the fraud processing facilities of a bank. In some banks’ cases, this may take two hours during the early use of the scheme. This will be expected to speed up, as banks’ facilities are improved. However, the real onus will be on the payer bank to guarantee the validity of the transaction, by ensuring that the means of transaction capture is safe and secure.
The safety of the UK banking system has to be protected by the banks, and in particular by the robustness and security of their accounting and payment systems. Re-engineering these massive systems to provide the ability to offer real-time value to both the payer and the beneficiary of a payment transaction has to be undertaken with care, and will be costly to each member, especially if a completely new technical interface is required. And this may not be so easy.
The first challenge presented by Faster Payments is the real-time nature of the initiative itself. The near real-time service presumes that value can be deducted from the payer’s account and given to the payee’s account in near real time. Where banks do not all have a real-time updating facility for their customer accounting systems, and more particularly, where the updating of the account could be to customer systems in more than one database, the management of Faster Payment processing within a bank will need much more than a technical interface to manage the transaction formats and messaging between the bank and the service.
The second challenge is presented by the nature of settlement risk management and settlement within the new scheme. The system will operate around the clock with relatively high volumes of transactions, so the new service will combine the service characteristics of a high-volume/bulk payment system with the settlement and regulatory oversight characteristics of a high-value payment system. Each member will have to operate within a settlement limit, which will be enforced by the central system. Settlement itself will happen several times a day, thus the member bank’s liquidity allocated to the service will need to be accurately managed by the member and enforced by the central system. The reconciliation of transactions settled in multiple cycles over several days will require close attention within the member bank’s back office.
This mandates the use of a payment system, not just a messaging system, rather in the style of the bank-specific systems, which were originally deployed for Chaps. The system must manage liquidity and also handle the relationship between several applications and accounting systems that need to integrate the use of the Faster Payments service.
The key challenge, however, is one of time. The service and the interface to the service are not yet fully specified. The technology build required cannot be finalised until that sign-off is completed. And working backwards from the end, which is the project manager’s lot today, banks will have 12 months to define and build their own systems and system changes in order to be ready for member testing and certification. All of the members will go live on day one in December 2007. So the challenge is set, and banks and their technology suppliers must supply the right solution for market need.
The initial view of Faster Payments taken by the banks, that the new service would be supplied as a quick fix to appease the regulators, seems to have been overtaken by a more positive view within the banking community that Faster Payments is the first step in the UK market place to real-time clearing.