By Patti Murphy
This month, both established payments enterprises and upstarts jockeying for position in the burgeoning sphere are gathering in Las Vegas for Money 20/20. This yearly gathering has become a seminal event in the payments space, offering a look into what the future holds for electronic payments. In the lead up to Money 20/20, we thought it would be helpful to examine how payments have evolved over the past 100-plus years.
The first electronic payments date back to the late 19th century, when Western Union Co. introduced the concept of wiring money, which leveraged the infrastructure used for its core business at the time, transmitting telegrams. These electronic fund transfers predated by 34 years the Federal Reserve's introduction of a government-backed wire transfer system.
The Federal Reserve Board and the Federal Reserve Bank System were created by Congress in 1913 as the nation's central bank in the wake of the Financial Panic of 1907. By 1915 the Reserve Banks had begun moving funds electronically, and in 1918 they built a proprietary telecommunications system to process fund transfers, known today as Fedwire. Previously, settlement of interbank payments was typically done with the physical exchange of cash and gold.
The Federal Reserve Act also paved the way for a national clearing house for check payments. Before that, interbank check clearing was handled exclusively through bank-owned clearing houses. The most well-known of these was the New York Clearing House (today known as The Clearing House, or TCH). Banks would dispatch clerks with file boxes full of paper checks and cash to a local clearing house each day where they literally exchanged cash for checks drawn on their respective banks.
The check payment system got its first technology upgrade in the late 1950s with the introduction of machine-readable magnetic ink character recognition (MICR). The American Bankers Association published standards for adding MICR lines to checks in 1958, based on technology developed by the Stanford Research Institute and General Electric Computer Laboratory.
Scanning devices read MICR lines to ascertain bank and customer account information for check clearing and posting. Even with this automation, however, banks continued exchanging paper checks, typically shuttling sacks of paper to and from clearing houses or Federal Reserve Banks for clearing and settlement Image capture and processing technologies, introduced in the 1990s, eliminated the need to physically transport checks for clearing between banks, and the Check Clearing for the 21st Century Act (or Check 21 Act) effectively transformed the check payment system into a mostly electronic mechanism. Check 21, which took effect in 2004, authorized banks to truncate paper checks and exchange electronic images of those check deposits in lieu of the paper items.
Before long, the technology evolved and banks realized customers could capture check images using available check scanning equipment (in the case of business customers) and desktop scanners (available to consumers). Eventually smartphone-based scanning became an option, giving birth to mobile remote deposit capture.
Today, better than 99 percent of all checks clear between banks as electronic images, according to the Fed. Mercator Advisory Group estimates 25 percent of consumers use mobile deposit. John Leekley, founder and CEO of RemoteDepositCapture.com, believes mobile check deposit is even more entrenched. "Some of our own research indicates many financial institutions are now seeing 50 percent or more of their consumer deposits coming from mobile deposit," he said.
In the 1970s, faced with the prospect that mounting numbers of check payments could soon overwhelm the banking system, the Fed and banking industry set about to create the automated clearing house (ACH) as an electronic alternative to check payments.
"It was also seen as a cheap way to move money outside of Fedwire," said Bill Moroney. Moroney was the first president and CEO of NACHA, the ACH rules group, a position he held from 1984 to 1988. "In the mid-1980s, we were really focused on getting everyone on the bandwagon with direct deposit," he noted, adding that using the ACH for automated payments then "kicked off."
The ACH in the early years was a semi-electronic payment system. Banks would truck magnetic tapes and computer disks containing instructions for ACH payments to local Federal Reserve Bank offices or correspondent banks, which would process the transactions; final settlement generally lagged initiation by one to three days. The move to a fully electronic ACH began in the 1990s, with a Fed edict that all financial institutions have online connections with their Reserve Banks. In recent years, same-day ACH has helped to further compress the clearing cycle.
Charge cards, the predecessors to bankcards, began with Western Union. What Western Union introduced in 1914 weren't exactly cards; they were paper documents identifying customers who had accounts with the company, which billed them monthly for charges accumulated for telegrams and fund transfers. Department stores soon started offering customers charge accounts, too.
Diners Club took the concept to the next level in 1905, when it offered charge accounts for travel and entertainment expenses. This marked the first time a charge account could be used for purchases other than at the company holding the account. It also opened the door to what today is known as merchant acquiring. Merchants had to set up accounts with Diners Club and pay a fee for each transaction charged using a Diners Club account.
American Express entered the arena with a similar three-party charge account scheme in the late 1950s, and became the first to issue embossed plastic charge cards. At about the same time, Bank of America launched BankAmericard, with an initial drop of 60,000 cards to its best customers, and incentive pricing to entice merchants to accept the cards for payment.
Eventually, BofA franchised the program to other large banks around the country (there was no interstate banking at the time), and a separate group of banks formed a competing program, called MasterCharge. What eventually became known as the bank-owned companies Visa and Mastercard built sophisticated communications networks to support the authorization, processing and settlement of credit card payments. Mastercard shed its bank ownership, becoming a publicly traded company, in 2006; Visa followed in 2008.
The1980s were a turning point for electronic payments, as the card brands began actively migrating to electronic point-of-sale (POS) terminals that could help authorize and route card payments through their networks.
"To spur rapid terminal deployment, the card associations dramatically reduced interchange rates, explaining that on-line transactions were cheaper and faster to process," said Paul Martaus, a now retired industry consultant. They also began pricing interchange to account for the unique risks posed by different categories of merchants. "Thus was born the convoluted and incomprehensible pricing structure that persists today," he added.
The 1980s also marked the beginning of the rise of ATM networks and debit cards. This was driven largely by "an explosion in bandwidth," explained Moroney, who served as president and CEO of the ETF Association from 1981 to 1984.
ATMs had existed for about 10 years but were used primarily as branch extensions. Regional ATM networks allowed consumers to access cash from their bank accounts regardless of time or place. "Debit cards made a lot of sense," Moroney noted.
So did extending debit card usage to the POS, which became viable once regional ATM networks began merging, and Visa and Mastercard launched their own national ATM networks. By the turn of the century POS debit became the norm and soon surpassed POS credit card payments.
The Fed reported that in 2017 consumers made 82.6 billion debit card payments worth a combined value of $2.88 trillion, 13.1 billion prepaid debit card payments totaling $300 billion, and 37.7 billion general purpose credit card payments totaling $3.32 trillion.
The 21st century ushered in even more significant changes, including online payments to support ecommerce and mobile payments. Moroney isn't surprised. "Everyone who was in the business back then [in the 1980s] saw this absolutely happening," he said. "The only differences were between those with pie-in-the-sky visions and those who saw it happening as a result of technology [advances] and deliberate growth."
Omnichannel – the ability to make purchases with equal ease and the same look and feel across online, mobile and in-person environments – also has become a watchword of modern payments.
But perhaps the biggest change to unfold over the past several years has been in the direction of real-time payments. Research recently published by ACI Worldwide revealed that globally nearly half of all banks (47 percent) rank real-time payments as one of their top three priorities for product investments; 27 percent rank it as their number one priority.
"The most innovative banks recognize that investment in real-time payments infrastructure is a strong foundation for sustainable innovation," said Craig Ramsey, head of real-time payments at ACI.
"Real-time payments are a key building block for delivering continuous improvements in products and services for their customers."
While several payment initiatives emulate real-time transaction processing by posting payments near-instantaneously to recipients' bank accounts (for example, the bank-owned Zelle network and PayPal's Venmo) final settlement actually occurs later via the ACH. TCH, a bank-owned consortium that supports ACH, check and wire transfer services, built the first truly real-time payment system in the United States, called RTP, and designed for consumer and business payments.
At last count, 17 banks were clearing payments through RTP, primarily large banks, although TCH recently heralded the first community bank to join, Cross River Bank in Fort Lee, New Jersey. The Fed is also building out a real-time clearing and settlement infrastructure, which it expects any bank or credit union can access beginning in about five years. In addition, the Fed plans to support 24/7/365 inter-bank net settlement, a necessary component of any truly real-time payment offering. Today, the Fed's net settlement service is only available from 7:30 a.m. to 5:30 p.m. Eastern, and not on weekends or national holidays.
Experts agree that real-time settlement is key to ensuring minimal risks and maximum security, which are a bedrock of payment systems.
Patti Murphy is senior editor at The Green Sheet and president of ProScribes Inc. Follow her on Twitter @GS_PayMaven.
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