To assist Congress in that endeavor, I wish to draw your Committee's attention to some dangers posed by the Federal Reserve decision to proceed with FedNow — a real-time retail payments service that will compete directly with private-sector retail payments services. Specifically, I wish to discuss four ways in which the Fed's plan might hinder rather than facilitate the achievement of an equitable, efficient, and safe U.S. fast payments system, and to suggest steps Congress should take to guard against this outcome.
The Federal Reserve as a Payment Service Competitor
As a rule, competition is an effective — if not the most effective — means for encouraging providers of services to price those services equitably, to produce them efficiently, and to improve their quality over time. However, these outcomes depend on the presence of a level playing field on which all providers compete — that is, they depend on the various providers having roughly equal legal privileges and obligations. In the absence of a level playing field, the presence of multiple providers alone does not guarantee good outcomes. Instead, special care must be taken to guard against bad ones.
The Federal Reserve banks enjoy many legal advantages over private suppliers of payment services. They command a monopoly of bank reserves that serve as means of final payment; they are empowered to regulate commercial banks and some other private-sector payment service providers; and they are exempt from antitrust laws. Finally, although the 1980 Monetary Control Act requires that the Fed charge prices for its services that recover those services' capital and operating expenses, it only needs to do so over a "long run" of unspecified length, and then only according to accounting methods of its own choosing that are not subject to external review.
These and other Fed privileges mean that, when it enters into direct competition with private-sector payment service providers, it does so on a playing field that it can easily slant in its favor. It is owing to this that the Fed itself has established strict criteria it must meet before offering any new payment service, including the requirement that the service in question "be one that other providers alone cannot be expected to provide with reasonable effectiveness, scope, and equity."2
In responding to the Fed's request for comment regarding "Potential Federal Reserve Actions to Support Interbank Settlement of Faster Payments," I argued against the Fed's then-proposed retail RTGS ("Real Time Gross Settlement") payment service partly on the grounds that it did not meet the Fed's own criteria for providing new payments services.3 I also argued that the new service would delay progress toward a ubiquitous U.S. fast payments system. I continue to hold these views.
I also fear that, instead of preventing private-sector payment service providers from engaging in anticompetitive behavior, the Fed will itself engage in such behavior. In my testimony today, I wish to draw attention to four particular anticompetitive dangers that the Fed's entry into the fast payments business poses, and to recommend steps Congress should take to guard against each.
Postponed Fed Settlement System Reform
The first danger is that the Fed will treat FedNow as a substitute for a 24x7x365 expansion of the operating hours of Fedwire, its wholesale RTGS service, and NSS (the National Settlement Service), a separate multilateral settlement service that is also owned and operated by the Federal Reserve banks.4 The availability of 24x7x365 Fed settlements is essential to achieving faster (though not necessarily real-time) and safer payments on other payment services. But instead of hastening to offer that service, the Fed may delay doing so to limit private payment services' ability to compete with it.
The danger here stems from the Fed's monopoly of final means of payment, including bank reserves. Because of that monopoly, most private noncash payments, including most check, card, and ACH ("Automated Clearing House") payments, can only be completed with the help of either Fedwire or the NSS or both. Only once settlement takes place can recipient banks credit funds to a payee's account without assuming some credit risk. Because Fedwire and the NSS operate only on weekdays, excluding holidays, and then with limited hours, retail payment services that rely on them are correspondingly limited in their ability to complete payments both quickly and safely at all times.5
Although it would also enhance the efficiency of private real-time payments services, the main benefit of 24x7x365 Fed settlement services would consist of a substantial reduction in delays on "legacy" payment networks.6 For example, today's Fedwire and NSS operating hours currently stand in the way of National Automated Clearing House Association's (NACHA) long-standing effort to enhance ACH's same day payment services by providing for a third ACH "processing window." Although NACHA had hoped to make this third window available by September 2020, and the change required only a minor extension of Fedwire and NSS operating hours, the Fed failed to prepare for the change on time, forcing NACHA to postpone its planned reform until March 2021.7
When the Fed requested public comment on whether it should establish its own fast payments network, it also asked whether it should either arrange to have Fedwire and the NSS operate 24x7x365 or establish a new "Liquidity Management Tool" for the purpose of allowing 24x7x365 transfers among commercial banks' Federal Reserve accounts. Almost every response to this question favored having the Fed pursue one of these proposed reforms (most respondents did not care which), making the proposal much less controversial than the Fed's plan to establish its own retail RTGS service. Yet despite this, and the relative easiness and great potential benefits of the asked-for reform, the Fed ultimately chose to do no more than continue to "explore" the possibility of offering 24x7x365 settlement services, and to perhaps seek comment upon the proposal yet again!8
Why is the Fed dragging its feet on an almost universally favored reform that could alone suffice to eliminate most of the more notorious payment delays in this country?9 The Fed's actions seem at odds with its overarching public mission. But they are what one would expect from a firm endeavoring to compete successfully with rival payment service providers. For example, when NACHA was first endeavoring to make same-day ACH payments possible, its efforts were opposed by several large banks. It was widely suspected, according to a contemporary report, that this opposition stemmed from those banks' intent "to build their own proprietary electronic payment systems, which could give them a leg up on smaller banks."10 The Fed's hesitation to make 24x7x365 Fed settlements available to private payment service providers may likewise reflect its own desire to give FedNow "a leg up" on other payment networks.11
Whatever the Fed's motives, Congress should not allow it to delay a badly-needed enhancement of its settlement services any longer. Instead, it should give the Fed two years within which to either place its Fedwire and NSS services on a 24x7x365 operating basis, or establish an alternative 24x7x365 Liquidity Management Tool. If Congress does not do this, I fear that Congress will overlook the most important of all steps it might take to dramatically and rapidly enhance the speed of U.S. retail payments.
Volume-Based Pricing Favoring Large Banks
A second danger the Fed's entry into the fast payments business poses is that, by resorting to volume-based pricing, the Fed will ultimately put small banks that wish to offer fast payment services to their customers at a disadvantage.
Because many are counting on the Fed to guard against rather than introduce volume-based fast payment fees, some background is required to understand why that expectation exists, and why just the opposite might happen.
The only potentially ubiquitous real-time payments service that exists at present, the RTP system established by TCH (The Clearing House) in 2017, presently operates on a contractually-binding flat-rate basis, with no minimum volume requirements.12 But TCH's flat-fee commitment isn't absolute: instead, it allows RTP to alter its pricing policy in the event that the Fed enters into competition with it. Noting this, Fed officials and others have argued that RTP cannot be trusted to make certain that small banks continue to receive equitable treatment, instead of finding themselves placed at a disadvantage relative to their large competitors. That TCH is itself owned by 25 of the nation's largest banks makes the risk to smaller banks seem all the more obvious. Consequently, the Fed and others argue, having FedNow directly compete with RTP is the surest way to keep RTP from reneging on its flat-fee commitment.
But closer consideration of TCH's general pricing practices, along with some history, suggest that the Fed's entry is more likely to have just the opposite consequence. Regarding TCH's practices, in seeking a statement from the Justice Department's Antitrust Division "of its present intention not to seek any enforcement action against" the RTP system it was then developing, TCH explained that it