Real-time payments are immediate transfers of funds from a payor to a payee. The topic is trending and for good reason. The promise of immediate settlements and instant access to funds is compelling, especially for merchants frustrated by their bank’s policy of holds and reserves.
The term “real-time payments” can describe a range of rapid money transfers. The true meaning includes:
- The transfer of funds from a payor to a payee within seconds — not minutes, not hours, and certainly not days. It’s called an “immediate settlement.”
- Unrestricted access by the recipient to the full amount of the transfer with no reserves, holds, or limitations on the use.
- Irrevocable transfers. Once received, the funds transferred via a real-time payment cannot be called back or rescinded by the sender.
Use Cases
There are five popular uses cases for real-time payments.
Real-time settlements for merchants, who would benefit greatly if they could immediately use the funds in their merchant account for, say, purchasing inventory, paying employees, and covering expenses. Most accounts require a hold period, ranging from one to 14 days, depending on the size of the reserve, the amount of funds, the merchant’s account status, and the type of business.
Traditionally, merchant accounts are not settled in real-time because acquiring banks (i.e., merchant account providers) must request and receive authorizations from issuers and other participants in the payments ecosystem. Acquirers also prevent immediate access to funds to protect against chargebacks.
A handful of merchant account providers now offer some form of real-time settlements to help smaller, independent businesses amid the pandemic. The most prominent is Square’s Instant Payments feature, which allows merchants to fund payroll with their Square account balance. However, a lot more could be done. The technology exists, and the potential is enormous, but the implementation has been slow.
Real-time payments for employees, contractors, and freelancers. Merchants are not the only ones harmed by slow, cumbersome settlements. Employees, contractors, and freelancers often struggle because of delayed payments. Real-time payments can speed up the process. For example, for a small fee, a Lyft driver could use Lyft’s Express Pay to cash out his earnings before the usual weekly deposit.
Replacing paper checks. Insurance companies, governments, and other organizations realize significant cost savings and improved customer satisfaction with real-time payments instead of the much-maligned paper checks, which are expensive to produce, distribute, and process. Fraudsters target paper checks. They are easy to lose and slow to receive.
Cross-border payments. Sending and receiving money across international borders is inconvenient. It’s common for an international money transfer to take two weeks or more to settle — an unconscionable timeframe given the maturity of the internet. Real-time payments can expedite international money transfers without compromising security. Indeed, both MoneyGram and Western Union have announced efforts to use Visa Direct (the company’s platform for real-time payments) for certain cross-border money transfers.
Peer-to-peer payments are popular as a simple, safe, and cost-effective way to transfer funds from one person to another without handling checks or cash. P2P payments are sometimes (but not always) a type of real-time payment. Again, a valid real-time payment facilitates instant transfers and immediate and unfettered access to all of the funds. Most P2P apps do transfer instantly, but not all allow immediate access to the money.
Real-time Networks
Several systems have been developed to provide real-time payment capabilities, and many more are on the way. Here is an overview of the most recognizable real-time payment mechanisms.
Visa Direct and Mastercard Send use OCTs (“original credit transactions”) in their real-time payment networks. OCTs credit funds from a payor’s credit or debit card to a payee’s card. They are similar in concept to a refund wherein a company puts money back into a customer’s credit card account. OCTs can be pushed only to a Visa or Mastercard account, never to a bank account.
Corporations, governments, and technology providers are migrating to Visa Direct and Mastercard Send to disburse payments in real-time. Funds are transferred to the cardholder within seconds, and the recipient can use those funds immediately.
The RTP Network allows U.S. banks and their customers to transfer funds to and from accounts in real-time. The RTP Network was created by The Clearing House Payments Company, a for-profit joint venture of large banks and financial institutions. All participating banks support real-time money transfers with immediate settlement.
The RTP Network is mainly used for B2B payments. Not all banks are members as it involves maintaining large reserves at a Federal Reserve Bank and investing in employees and technology to support and grow the service. Approximately 56 percent of U.S. checking-account holders are eligible for real-time payments via the RTP Network. Smaller financial institutions have been reluctant to join because of the cost and the desire to remain independent from the gigantic competitors that control the network.
FedNow Service. The Federal Reserve recognizes that real-time transfers are essential for a healthy payments ecosystem. Further, the Fed also understands that smaller institutions are hesitant to join the RTP Network, thereby preventing many accounts from participating. The result is FedNow Service, the Fed’s own real-time payments network, which will operate like the RTP Network. Unfortunately, FedNow will not launch until at least 2024.
Challenges
Real-time payments have great potential to help merchants. However, there are challenges to overcome before such payments are ubiquitous.
- Security and privacy protection. As more people access real-time payment networks, the threat of security breaches, hacks, and account takeovers (from phishing and social engineering attacks) will become more prevalent.
- Fraud. Because real-time payments are immediate and irrevocable (i.e., they cannot be called back), the networks will have to invent processes and technologies that counteract fraudsters.
- Seamless integrations. Real-time payment platforms will have to integrate with other business-critical systems such as accounting and cloud-based management platforms. It’s not good enough to facilitate real-time payments alone.
- Regulations. Laws and regulations that prevent money laundering and the illegal use of funds — drug and weapon sales, for example — will need to be updated to include real-time payments.
- Fees. It’s difficult to say if real-time payment fees will rise, fall, or remain constant. However, one can be sure that there will be costs to maintain these systems, and end-users will ultimately pay.
