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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 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.

April 4, 2022

The Fed Goes to School

A primary mission of the Retail Payments Risk Forum (RPRF) is to educate the payments industry on the financial, operational, compliance, and reputational risks of payment methods and channels. We seek to accomplish this outreach mission not only through this weekly blog but also through webinars, papers, and presentations at payments conferences and industry group meetings. But as Fox Mulder of the X Files always said, "We are not alone out there." The Atlanta Fed and other Federal Reserve Banks as well as the system-wide Federal Reserve Education (FRE) group make many efforts to improve financial literacy.

The Education Outreach group within the Atlanta Fed's Public Affairs Department offers a vast number of educational outreach programs including:

  • Professional development training and credentialing for K-12 grade teachers in the Sixth District on financial literacy
  • Development and updates for a personal finance curriculum with supplemental infographic posters and lesson/activity books
  • Delivery of career-day programs for high school students as well as teaching job interview skills and holding mock job interviews
  • Advice to state education departments of the states in the Sixth District on their personal finance standards
  • Partnering with the St. Louis Fed to conduct a Native American financial literacy initiative

The efforts don't go unnoticed. The Federal Reserve Banks of Atlanta and St. Louis received the Institute for Financial Literacy's 2021 EIFLE Award–Children's Education Program of the Year for their development of a personal finance curriculum and corresponding training program for more than 200 high school teachers in Mississippi as part of a collaboration with the Mississippi Council on Economic Education.

The Atlanta and St. Louis Feds are not the only Federal Reserve Banks in their education outreach efforts. The Richmond Fed recently developed and released an interactive training course video fileOff-site link called Payments 101 that covers the history of payments and the role of the Federal Reserve. Of course, financial literacy is more than just payments. The Federal Reserve offers many programs on personal finance training on the responsible use of credit, budgeting, and economic decision-making as well.

At the start, I mentioned the RPRF's various outreach efforts. But our education efforts go both ways. My colleagues and I are constantly reading industry publications and blogs from other payments geeks, attending conference sessions, meeting with vendors, and having one-on-one conversations with payments stakeholders to learn about the latest trends and tools. And, of course, we depend on your interaction to learn what's going on in the industry and always welcome your comments.

March 14, 2022

Thumbs Up: Smartphone Apps versus Websites

Sitting in front of my computer, I recently picked up my smartphone and unlocked my banking app with my thumbprint to see if a check I had written had cleared my account. Before going any further, let me acknowledge that, yes, this payment professional still writes checks every now and again! I learned the check had cleared, logged off the app, and resumed my day in front of my computer. This got me thinking about a change in my behavior that has occurred over time. Even when I am right in front of my computer, I find myself using my smartphone apps almost exclusively instead of visiting the full-function websites from my laptop or desk computer. Why?

The answer is simple: ease of access. I can get to my information through apps on my smartphone using just my thumbprint but accessing that same information from my computer through a website requires me to remember and type in my username and password. In fact, every app on my smartphone that requires a log-in allows me to authenticate using my thumbprint. Truthfully, I’m not so good at remembering my passwords even using the methods I teach others to use: create difficult yet supposedly easy-to-remember passwords. Perhaps this is why password managersOff-site link remain so popular. I continue to hold out from using a password manager with hopes that biometric authentication will become more common on websites and remembering passwords will be a thing of the past (except when biometric authentication fails). If smartphone apps authenticate me with my fingerprint or face, then why don’t websites do that when my laptop has a fingerprint reader and camera just as smartphones do?

While the same biometric functionality is currently available on my computer, the main barrier is that websites struggle to support and accept biometric validation due to different implementations across various web browsers and operating systems. Several organizations and standards bodies are considering this issue. The FIDO (Fast Identity Online) Alliance was formed in 2013 to produce stronger authentication standards and reduce password reliance. The FIDO2 Project, a joint effort between FIDO and the World Wide Web Consortium (W3C), released specifications in 2019 for W3C’s Web Authentication (WebAuthn) product that allows a website to use the FIDO authentication through a standard API implemented in a browser using public key cryptography and biometric authentication. Unfortunately, its uptake has been slow primarily because of the inconsistent user experience from website to website.

I should note that biometric authentication for apps on phones has not necessarily eliminated passwords, though it certainly feels like it, at least until the biometric authentication fails. Rather, biometrics serve as an alternative method of accessing the app’s username and password combination. The fingerprint and facial recognition is a template algorithm stored in a highly secure location on our phones. When an app requests my thumbprint and the stored algorithm confirms a match, the equivalent of a password manager opens on my phone and I am authenticated.

Is the end drawing any closer for manually entering online passwords, and are you looking forward to that day? Taking it further, will the day ever come when passwords are eliminated? Personally, I hope so and am very much looking forward to that day. If it doesn’t happen, then, based on my own habits, the days of visiting my financial institution’s website and others’ sites might be altogether forgotten.