March 18, 2016
Instant payments have long been a dream and some companies are putting in significant efforts to make that dream come true. As consumers, we can already enjoy the convenience of instant payments with Google Wallet that recently enabled instant payments using a phone number. However, we are still not at a stage when instant payments are a habitual every-day practice. While consumers have extremely high expectations from payments providers, it is actually quite a complex task. One set of important points to consider is the clearing and settlement of instant payments.
At this point, all transactions performed by account holders need to be cleared (the payment information is validated), and then settled (the funds are transferred between accounts). Usually, high-value payments between banks are cleared on an individual basis for security matters, while a mass of low-value transactions goes in batches (RTGS) in order to optimize the process. The entities dedicated to performing those operations are automated clearing houses (ACH), which are either operated by central banks or third-party service providers.
However, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) believes that the clear-cut line between RTGS and ACH is blurring. ACHs are moving away from single, end-of-day batch processing towards more frequent settlement cycles. As the organization states, as technology becomes cheaper and more accessible, transaction-by-transaction settlement, in central bank money, is becoming more realistic for a larger number of important retail payments. With the possible shift towards RTGS, instant payments have a chance of a fasted introduction as the time between batch clearing is decreasing along with increasing frequency. However, there are important considerations to make in order to speed the pace of introducing instant payments.
Due to the fact that instant payments are supposed to be actually almost instant, clearing and settlement need to be optimized to work 24/7/365. Unfortunately, traditional clearing and settlement are not ready to operate under such conditions. Constant operational availability of the payment infrastructure requires time and resource investment to reduce the potential downtime. As global safety science company UL believes, current clearing and settlement systems are mostly limited to capabilities to continuous clearing and windowed settlement.
As we have mentioned before, an important point to consider is batch settlement versus an individual depending on the value. Traditional systems settle high-value payments individually and batch low-value payments. The system is aimed to diminish the credit and liquidity risks when moving large amounts of funds between banks or governments. Distribution to the batch and individual settlement has a high associated cost and time to process. For instant payments, the system will have to move away from individual approvals and use RTGS for large amounts of transactions.
A single standardization approach (methodology, process, repository) to be used by all financial standards initiatives – ISO 20022 – will lead to the necessity for clearing and settlement mechanisms to support larger amounts of data that are to be treated together with the original transaction. In the case of instant payments, the primary goal of ISO 20022 messaging is seen to be for providing a complete set of data accompanying the typical transaction information.
Risk and fraud opportunities are a strengthening headache when it comes to instant payments. Due to the time taken to clear and settle the transactions, risk and fraud management is in a better position now than it will be with instant payments where no validation will be needed to clear and settle transactions. Security professionals will need to pay extra attention to possible fraud issues with instant payments as the funds will be made available instantly, hence, allowing criminals to perform illegal actions with more freedom and at a higher speed.
In order to mitigate the risks, the European Central Bank suggests that financial institutions implement an infrastructure with appropriate and enforceable measures such as pre-funding, cash guarantee funds and/or securities guarantee funds. In the ideal scenario, such risk mitigation measures should be harmonized across infrastructures to facilitate cross-border interoperability.