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Take On Payments, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Take on Payments and look forward to collaborating with you.

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May 23, 2022

Vulnerable Populations and the Case for Cash

We recently wrote a post about communities not being able to access cash Adobe PDF file format because of natural or man-made disasters. Severe weather and war, for example, may leave a bank branch inoperable. But even in "normal" times, access to cash Adobe PDF file format remains an important consideration, especially for consumers who use it as their only or preferred means of payment. With this post, we look at how cash remains an important payment option and how accessing it may be becoming more difficult for certain vulnerable populations. These vulnerable populations—who tend to be low- to moderate-income households, rural communities, and recent immigrants—are more likely to be un- or underbanked (underserved) and often rely on cash to buy groceries and pay utility bills.

Even with an uptick in digital payment usage Adobe PDF file format, cash remains a critical payment choice for many Americans. Some may be unable to use digital payment options because they lack access to broadband or a smartphone, for example. Others may not be able to access these options because they are unbanked. Data from the Federal Deposit Insurance Corporation's 2019 report How America Banks reveal that approximately 5.4 percent of households Adobe PDF file formatOff-site link (7.1 million) were unbanked in 2019. Almost 14 percent of Black households are unbanked and presumably rely on cash or alternative payment options.

There are many reasons why cash can be a person's default method of acquiring goods and services, according to a forthcoming paper titled "Cash Is Alive: How Economists Explain Holding and Use of CashOff-site link" by Oz Shy, a senior policy adviser at the Atlanta Fed.

Unfortunately, recent data suggest that challenges to accessing cash existed prepandemic and accelerated during the pandemic. It may be especially difficult for the underserved, cash-reliant consumer, according to a report by the National Community Reinvestment CoalitionOff-site link:

  • The number of banking institutions declined from approximately 18,000 in 1984 to fewer than 5,000 in 2021.
  • The rate of bank branch closures doubled during the pandemic.

Rural areas tend to see the most bank branch closures, and those closures have contributed to a decline in ATMs as well. Adding to this, banks have been more cautious in providing accounts to independent ATM operators in part because of anti-money-laundering concernsOff-site link. So some banks are adopting policies that prohibit business relationships with independent ATM operators or are charging much higher fees for their services—which means some ATM accounts with banks are closing and fewer ATMs are being established.

These closures matter, even to the unbanked consumer, who may need bank branches and ATMs, for example, to obtain cash from a prepaid benefits card for unemployment or social security payments, get a cash advance on a credit card, or cash a check at a bank where the check writer has an account.

As the digital economy expands, people in underserved communities and those who are cash reliant, whether by choice or lack of other options, are at risk for being further marginalized in the financial system. To help ensure that everyone, regardless of payments preferences, is included in this system, cash access and preservation in underserved communities across the nation remain important to maintain.

May 16, 2022

The Cost of "Free"

When I began my banking career in the early 1970s, we essentially had only three consumer payment methods: cash, check, and credit (or charge) card. My checking account had a monthly service charge, and the account permitted me to write 15 checks a month—any more than that cost me 15 cents each. The overdraft/nonsufficient fee was $15 per check. My credit card had an annual fee of $25.

Today, I pay no fees for my checking account, debit card, online banking services, mobile banking services, electronic bill payments, or electronic wallet. I pay no annual fees for my credit cards unless a card is a premium card that bundles other products such as product protection or roadside assistance. (Of course, my statement about free checking is slightly exaggerated—most banks impose some sort of monthly maintenance fee, which you can often avoid by keeping a minimum balance or having a recurring direct deposit.)

The banking and payments industry has invested billions of dollars in these free channels and products. But is there really such a thing as a free lunch? Have financial institutions (FI) adopted a benevolent social policy giving everyone the right to free banking services?

It’s more complicated than that. Publicly traded FIs answer to their stockholders, and even nonprofit credit unions must generate sufficient revenue to maintain their financial health. So how can they offer all these free services and products? I believe there are four primary reasons that FIs are willing to forego explicit pricing for their services. The first is competition. Banks must compete in their market with the pricing of their products and services along with other factors such as quality of service and convenience of location. Second, debit card usage creates significant interchange revenue for the issuing FIs. Third, core deposits are the lifeblood of an FI's ability to fund its credit-related, revenue-generating products. Fourth, the bundling of services like bill payment and direct deposit have been shown to create a level of "stickiness"—in other words, the bundling increases the level of dissatisfaction a consumer must experience to believe it is worthwhile to move their account.

Will the bundling of these free services continue, or will the evolutionary cycle return to more explicit fees? Many FIs have been announcing of late that they are eliminating or reducing their overdraft/nonsufficient fund (OD/NSF) fees. The Consumer Financial Protection Bureau estimates that FIs collected almost $15.5 billion in OD/NSF fees in 2019Off-site link, which was about two-thirds of their fee income. You have to wonder if fees in other products and services will increase to replace this lost revenue. What do you think?

May 9, 2022

Managing Liquidity and Settlement Risk the Fed Way

Today's post features a guest blogger from Credit and Risk within our Supervision, Regulation, and Credit Division.

When we talk about funds flowing through the financial system, it isn't a stretch to compare it to plumbing. For example, plumbing is largely invisible: open the tap, water comes out. Likewise, the smooth-flowing payments system is often invisible. Open your bank app, enter some information, a payment leaves your bank account, and your water bill is paid.

One of the roles the Federal Reserve plays is to keep the payments and settlement system flowing smoothly, and to do so, it has to manage some risks. Let's talk about liquidity risk, which is the risk that a bank may struggle to meet obligations. This can happen during a recession, for example. In normal times, institutions manage their liquidity risk through effective asset liability management, which is managing assets and cash flows to satisfy obligations.

The Federal Reserve manages liquidity risk by providing liquidity to the financial system. One tool Federal Reserve Banks use to do this is the discount window, which offers loans to financial institutions through three credit programs:

  • Primary, for depository institutions (DIs) in generally sound financial condition: $47.5 billion in 2021, down 79.8 percent from $235.2 billion in 2020. DIs can request a primary loan on a no-questions-asked basis.
  • Secondary, for depository institutions not eligible for primary credit: $10.0 million in 2021, up 809.1 percent from $1.1 million in 2020.
  • Seasonal, for banks with deposits less than $500 million and a seasonal need: $138.8 million in 2021, down 50.1 percent from $278.0 million in 2020. Qualifying DIs experience fluctuations in deposits and loans due to servicing seasonal types of businesses such as construction, college, farming, resort, or municipal financing.

A quick two-minute same-day phone call to the discount window of a financial institution's local Reserve Bank is all it takes to have funds deposited by the close of Fedwire at 7 p.m. (ET).

As you can see in the chart below, COVID-19 significantly affected loans to financial institutions in the Federal Reserve System. Before COVID, primary credit lending was in the $74 million to $124 million range and skyrocketed to $89 billion in March 2020.

chart 01 of 01: Federal Reserve System Primary Credit Lending Volume

Another way the Federal Reserve manages payment system risk is to ensure the smooth operation of payment systems by allowing depository institutions to overdraft their Fed account. Known as intraday credit, daylight overdrafts minimize disruptions to payment and settlement systems and support the efficient movement of funds. Fed account holders can overdraft their account up to a specified limit without incurring an overdraft fee. While financially unhealthy institutions are not permitted to overdraft their account at all, qualifying institutions have a few creditworthiness-based options for daylight overdraft limits for their account. (These limits are known as net debit caps.)

Circling back to the plumbing analogy, it's easy to see how these short-term loans from the Federal Reserve help keep credit to households and businesses flowing—and the economy bubbling along.

You can find more information about Federal Reserve discount window liquidity options on the Fed's discount window web pageOff-site link. You can read about the Fed's policy on payment system risk and intraday credit on the Board of Governors websiteOff-site link.

May 2, 2022

Taking the Long View: A Visit with Retail Payments Risk Forum Founder Rich Oliver

Rich Oliver, the founder of our Retail Payments Risk Forum (RPRF), paid a visit to our team recently and shared his vision when creating the forum, the challenges facing the payments industry, and the future direction our team could consider as the payments landscape continues to evolve.

In addition to founding our RPRF, Rich's payments expertise goes back to the 1970s when he led the effort to utilize the fledgling US Automated Clearing House (ACH) system to electronically deliver the first government payrolls and social security payments.

Drawing on his expertise, Rich wrote a book with George Warfel Jr. about the payments industry, The Story of Payments: How The Industrialization of Trust Created the Modern Payments SystemOff-site link, that "tells the story of how payments—between people, merchants, employers, and governments—emerged from the ancient system of barter and grew, through various technological implementations ranging from coins and paper money to checks, wire transfers, and credit cards, to today's entirely electronic local and international payment systems."

In a wide-ranging conversation about the history of payments and Rich's role in many areas with the Fed, each of us in the RPRF took away some highlights to share with you.

Scarlett Heinbuch: Rich reminded us of the need to be bold in our thinking about the future of payments. We discussed advances in biometrics and how these initiatives could address identity and security concerns and make payments easier for all while also presenting other risks and challenges.

Nancy Donahue: One comment that made me go "hmm" was: "Do we have too many retail payments products that are trying to solve the same problem? Do they all make money? Do they all need to?"

Catherine Thaliath: What resonated with me was when Rich talked about potential risks of Buy Now Pay Later (BNPL). While viewed as a credit offering, it is nevertheless using a payment instrument in ways not previously done.

Claire Greene: "When it comes to product design, you can't assume you know what someone wants without doing the work." This was a humble statement from an innovator that applied in the 1970s and remains relevant today.

Dave Lott: Rich discussed the evolution of the current consumer banking product market where many of the explicit services (on-us ATMs, online banking, mobile banking, pay wallets, etc.) are provided free of charge.

Sally Martin: It resounded with me how much collaboration went on with the payments players in the industry. Also, the amount of time spent brainstorming on what the needs were and how to fill them, and in moving toward new offerings rather than replays of existing products. Rich's talk focused on moving into new territory—he was "agile" before it was cool.

Jessica Washington: We still need to collaborate on fraud mitigation at the strategic level. In the United States, we implemented chip credit cards but not so much chip-and-pin, plus we still have the magstripe, which is a major source of weakness, and we still have much work to do on card-not-present transactions.

As the RPRF founder, Rich challenged each of us to remember its mission: to be a source for non-biased thought leadership, to do original research, challenge norms, and push the envelope to move the payment system forward. Sometimes looking back at history can bring the future into sharper focus, which is what our chat with Rich did for us. As you look to the future of payments and payments risk, what stands out to you?

By the Retail Payments Risk Forum Team: Jessica Washington, Dave Lott, Scarlett Heinbuch, Claire Greene, Nancy Donahue, Catherine Thaliath, and Sally Martin.