One problem in the payment network system is that it involves a really complicated series of transactions that need to be authorized, authenticated, clear, and settle in a process that at least in current iterations is not at all in real time. Let's think about what happens when you use your credit card as a means of transacting. So you go to the local grocery store and you give the grocer your credit card to purchase a $100 of groceries. The merchant then has to send those credit card details to the merchants acquiring bank. The merchants acquiring bank is responsible for getting the funds from the card holders issuing bank back to the merchant. So the acquiring bank, the merchant's bank then forwards those credit card details to the credit card network let's say MasterCard in this setting, and then MasterCard goes to the customer's bank, the issuing bank and then request payment authorization for that transaction. Next the issuing bank, the customer's bank has to verify the card information that it receives from the credit card network. If customer funds are available for that transaction it has to send an approval code to the merchant via the same series of channels. Through the initial card network MasterCard in this case back to the acquiring bank the merchant's bank, then back through the acquirer to the merchant, and then the merchants payment terminal collects all the approvals from this complicated process and approves the transaction providing the customer with the sales slip to complete this purchase. At this point the transaction has been approved by the customer, but no funds have actually exchanged hands. Now the merchant is going to have to send the batch of approved transactions back to his bank, the acquiring bank. The acquiring bank then has to forward that approval back to the credit card network, MasterCard for settlement. The credit card network has to send every approved transaction to the appropriate issuing bank, the customer's bank. Then the customer's bank is going to have to transfer the funds back to the acquiring bank routing it through the credit card network through a series of complex transactions, each of which has a fee for the participating institution. At this point the transaction has been approved but no funds have actually been transferred between the cardholder and the merchant. So now the merchant is going to send notice of the approved transaction to his bank, the acquiring bank. The acquiring bank is then going to send that approval along to the card network MasterCard for settlement in this case. The card network sends every approved transaction to the customers issuing bank, and then the issuing bank transfers funds through the card network to the acquiring bank, and the acquiring bank, the merchant's bank provides the merchant those funds to complete this particular transaction. Know how many different participating institutions are required just to get an exchange from the card holder to the merchant, for purchase of a retail good in this setting. Compare this complexity with the simple cash transaction where the card holder has a $100 bill, and provides it to the merchant in order to pay for the groceries set she requires. Perhaps unsurprising given this incredibly complicated chain of transactions, but in the United States today we are far from a real time payment system. This means that every piece of this transaction chain takes significant time in order to settle or clear. So it takes time for merchants to be able to get the funds that they are owed when consumers make transactions. It also is unclear from the consumer's perspective, for the merchant's perspective, even the bank's perspective whether the funds are actually available to be dispersed at the time when the transaction is made. This is a noted, this is a problem that exists in the United States more so than interestingly in countries with better real-time payment systems like China, and one that the Federal Reserve is quite attuned to and paying attention to. Recently, Lael Brainard governor on the Federal Reserve Board noted that consumers and businesses expect to be able to send and immediately receive payments at anytime of the day, on any day of the year. Given that our economy is a 24/7 one, it is important for the payment structure to be as well. This is why she advocates that the Federal Reserve in the private sector come together to try and make investments in real-time payments to create a more secure and more efficient payment structure for the future. Most existing real-time payment systems around the world offer instantaneous 24/7, interbank electronic transfer fund services that can be initiated through a variety of channels like on your smartphone, or through a digital wallet, or through the web. In such a scheme, low value real-time payment requests can be initiated that enables instantaneous payment fund transfer, and a secure transaction that can be done with much less complexity than in our current scheme.
