Thursday, January 2, 2014

ACH is bad, but the banks are worse

So there’s been a lot of talk about BitCoin lately, and I particularly liked this piece by Guan - BitCoin’s real value is it's payment system. It doesn't necessarily work very well as a store of value or unit of account, but the very low transaction costs and ease of signup make it attractive as a payments system. The 1% cost of some bit coin transactions is very acceptable for small payments, and its fairly typical for small payments to cost more on a % basis than large ones. That vast majority of bitcoin payments cost far less than 1%, and thats very cheap for an international payments system. 

One of the reason’s that Bitcoin has become popular is because the US payment system sucks - ACH was originally designed in the early 70s, and its way out-dated compared to most of the national payment systems across the globe. Of course most of those systems were built and deployed 20+ years after ACH, but thats kind of the point: the US payments system is outdated and creaking under the demands of today's world. Unfortunately, the big banks that monopolize banking in the US have stymied all efforts at fixing the problem

So I agree with the thrust of Guan's post, but thought it might help to clarify some things - 
  1. ACH is actually a next business day system not unlike what Guan describes in Denmark. If your bank sends an ACH payment to the Federal Reserve by midnight, the Federal Reserve will send it to the receiving bank by 6 am of the next business day. In reality, the cut-off is 2.15 am ET, so really it takes less than 4 hours. However, almost 100% of banks in the US are on batch processing systems left over from the 70s, so each of the steps of making an ACH transfer: 1)debit sender’s account; 2) send to recipient bank via Fed; 3) recipient bank credits recipient account; ends up taking 1 day, and thats what leads to the 2-3 business day time for the end to end ACH payment.
  2. The Federal Reserve charges banks $0.0025 cents per ACH transaction. Thats right, less than 1/3rd of a cent. Think about that the next time your bank tries to charge you $10 for a “Next-day payment”. That’s essentially the bank sending an ACH transaction to the Fed tonight without holding your money for a couple of days first, and charging you for the privilege.
  3. FedWire costs banks $0.138 per transaction. Think about that the next time your bank charges you $35 for a wire transfer.
  4. So if back-end transaction costs are so low, why are retail costs so high? Some markup is to be expected, but these margins are insane, especially given the massive scale of US payments systems. ACH moved $37 trillion in 2012. Because NACHA, the standards body that sets ACH standards, is controlled by the big banks, not by Congress. So essentially, the banks write the rules, and the Federal Reserve implements them. 
  5. Not all customers in the US can get a bank account easily. There are 17 million unbanked adults in the US, and 10s of millions more are "underbanked". One of the main causes is that they ran afoul of a bank some day, and got their name added to debit bureau systems like ChexSystems/Qualifile. Most banks in the country will deny an account for anybody who has a ChexSystem entry.
As even Guan realizes in his post, the payment system is one part of the problem, but the outdated technology being used by banks is another big part. There are over 7000 banks in the US, plus 1000s of credit unions, so fixing the problem of outdated batch processing technology is a herculean task. Forcing banks to adopt new systems, which might allow them to automatically post a FedWire transaction intra-day without teller involvement for example, would bankrupt a lot of the smaller banks. The big banks are even worse off technology wise; CITI has spent billions of dollars to build a new BATCH processing transaction system which they are still rolling out globally; most of the others aren't even trying to fix their systems. Why should they, when they can just pass on the costs to customers, and the regulators aren't allowing any competition?

The Reserve Bank of Australia recently moved to same-day payments in Australia, and all the banks in Australia have a timetable to move to real-time payments within 5 years. The Federal Reserve in the US doesn't even have the authority to think of such a move. So yes, retail payments systems in the US are broadly fucked for consumers. But if you're wondering why, it's because Congress and the regulators have failed consumers in the US.