Thursday, February 12, 2015
Slow greenbacks, fast loonies
Canada trails the U.S. is a common refrain, but not when it comes to payments. Courtesy of the Interac e-transfer service, Canadians have been able to make person-to-person (P2P) payments in real-time as early as 2002. By person-to-person, think email or mobile phone payments to friends, family, or your landlord, and by real-time, the receiver of a payment can immediately turn around and use those funds to buy something. By contrast, most Americans are still stuck in the nebula of three day delays when it comes to P2P.
Why this incredible lag? I think it's for the same reason why the U.S. banking system is so much more unstable than the Canadian banking system. Whereas Canada has a small number of strong national banks, the U.S. has a large population of weak undiversified regional. This lack of size and strength renders U.S. banks prone to failure while simultaneously making it difficult for them to coordinate together in order to create shared-use systems.
Part of the problem in providing a real time P2P solution to consumers is that U.S. banks can't use the Federal Reserve's existing small payment network, ACH, to do the job. ACH is a forty year old system that transfers funds with delays sometimes lasting as long as 3-4 days. That being said, the Canadian equivalent small payment system, the ACSS (run by the Canadian Payments Association) isn't much better, with settlement occurring the next business day. Yet somehow we Canadians enjoy real time P2P.
Over a decade ago, Canadian banks decided to avoid ACSS altogether and set up their own proprietary network to provide real time P2P capability. Run by Interac, a bank-governed non-profit, the network processes P2P payments, nets them out across all banks, and provides instant communications among participants. At the end of the day, the banks settle balances owing and owed by trading Bank of Canada clearing deposits via the CPA's Large Value Transfer System (LVTS). Even before the banks settle among each other, Canadians will have instant access to funds they have received either via email or their smart phone (or, if they have been debited, lose access to these funds). Heck, Royal Bank even has real-time payments via Facebook. 
As anyone who has read the free banking literature knows, the U.S. has an awful history of bank regulation. Until recently, law makers forbade banks from setting up national branch systems, with unit banking being the norm. (Here is George Selgin on the topic). As a result, the U.S. is characterized by a patchwork quilt of banks, 6,891 in fact, with the top five banks accounting for only 56% of all deposits. Canadian law, on the other hand, never discouraged national branch banking. As a result, Canada has five dominant banks with broad exposure to all provinces and maybe two dozen smaller banks, the "big 5" accounting for at least 80% of Canadian deposits.
You can understand now why it would be difficult for U.S banks to set up their own real-time payments system. In Canada, only a handful of bankers needed to be convinced that the time and effort to build a mutually beneficial system was worthwhile before the remaining minority followed. A much larger expense must be incurred in herding U.S. banks towards that same equilibrium. It's sort of like fax machine adoption. A single fax machine is useless, but the value of every fax machine increases as the installed base of fax machines grows, since the total number of people with whom each user can send/receive faxes rises. Ideally, everyone just agrees ahead of time to get a fax, or in the case of P2P, all bank decide to jointly build a shared network. Tough to do when you're a thousand squabbling voices. Enlightened cooperation among a few large banks, the Canadian solution, gets you there quicker.
The result is that in the U.S. most of the P2P solutions haven't been developed by banks, but by technology companies. Finance tech giants Fiserv and Fidelity National Information Services have developed their own networks; Popmoney and People Pay. Upstart Dwolla is trying to convince financial institutions to adopt its FiSync real-time service. This plethora of competing networks reminds me of what I've read about the early days of electrical utilities in the U.S., with multiple competing wire systems running down the streets. To avoid this sort of redundancy, some might say that the best option is to have a regulated monopoly like the Fed take the baton, say by upgrading ACH to real time. And with so many different competing systems, I can't help but wonder how they 'talk' to each other. If there were three or four brands of fax machines, and each brand could only receive its own faxes, how much less useful is the fax network?
So we Canadians have ubiquitous real time P2P and the Americans don't. However, the dark side to the Canadian system is that cooperation among the few needn't always be so enlightened. Just as the chiefs of the big 5 banks can get together in a back room and cobble together a mutually beneficial shared network, it's just as easy for them to set up a mutually beneficial pricing scheme—at the expense of consumers. It costs $1.50 to do an Interac e-transfer. Sounds suspiciously high to me.
 My source for information on the Interac e-payments system is the CD Howe's Mati Dubrovinsky, who briefly describes how the system works here.