Banks can't be counted on to lead faster payments

History has shown that banks cannot be trusted with exclusive rights to payments innovation. They have never done it in the past and likely never will in the future.

In 2015, Benjamin Lawsky, New York’s then-superintendent of financial institutions, referred to the U.S. as having a “disco-era payments system."

At the time, he was speaking in reference to New York being the first state to license digital currency. Looking back over the past four years, it seems we’ve made very little progress in modernizing payments in the U.S., while many other industrialized nations have embraced all sorts of faster and more convenient payments.

U.S. banks have a long history of sitting on their hands while others lead innovation. Like most people, you probably believe U.S. banks were the source of most of the financial services we use today, like checking accounts, consumer loans and credit cards. You’d be wrong.

Checking accounts were created by businesses in England. In the U.S., checks are said to have first been used in 1681 when cash-strapped businessmen in Boston mortgaged their land to a “fund,” against which they could write checks. Modern consumer loans were created by General Motors in 1919 because most car buyers couldn’t afford to buy their products with cash. Merchants advanced the use of “charge plates” to enable shoppers to buy more in 1935, long before the advent of today’s bank-centric card networks.

Speaking at The Wall Street Journal's Future of Finance Initiative in 2009, former Federal Reserve chairman Paul Volcker looked to finance's recent past and saw little to like, noting that he was yet to see any evidence that financial market innovations have provided any benefit to the economy.

Apparently, Volcker thought the industry reached a peak when it invented the ATM and, given what's happened over the last year or two, it's hard to disagree with that view.

More recently, Visa’s chief economist warned banks of potential disintermediation by fintech companies’ growing efforts to displace banks' open-end credit lines with their own products. Interest rates on business credit cards are typically much higher than commercial prime rates so it’s not surprising that opportunistic fintech firms would move in to undercut credit card rates.

Some big-bank proponents have condemned the Fed’s recent flirtation with taking an operational role in faster payments, citing the original activist role the Fed took in check clearing prior to the early 20th century. One thing those proponents decided to overlook was the fact that prior to the Fed’s creation of the Federal Reserve System and its insistence in clearing all checks at par, individual banks were surcharging customers who wished to deposit checks drawn on another bank. This was not only bad for their customers, but a disaster for the economy. The Fed in an activist role came to the rescue of both consumer and merchant bank customers, demanding Fed member banks clear checks at par and stop the practice of surcharging customers for depositing checks drawn on other banks.

Unfortunately for those of us who live in the U.S., merchants here pay the highest fees in the world to accept big banks' credit cards, ranging in price from 2%-4% of the purchase for most merchants, compared with fees that are limited to less than one-third of 1% for European merchants.

Just like every other operation cost from land and buildings to labor and benefits, these costs are passed along to U.S. consumers, who inevitably pay more for goods and services. While the U.S. market for payment cards is characterized by bank proponents as “open,” it is in fact completely broken.

The overwhelming majority of merchants have no opportunity to negotiate card acceptance fees with banks which hide behind their card scheme consortiums to set “default” fees at rates that guarantee no bank will venture out on its own to negotiate separately with merchants.

History has shown that banks cannot be trusted with exclusive rights to payments innovation. They have never done it in the past and likely never will in the future. Frankly, there is little incentive for them to innovate since they enjoy protected status and some of the highest profitability of banks anywhere in the world.

They seldom compete against one another in meaningful ways and do their best to avoid upsetting their cozy marketplace by setting up consortiums that discourage competition between them. Bank-owned consortiums, prominent in the U.S., typically provide lowest common denominator services that safeguard their owners by limiting their investment to replace badly outdated legacy technology.

Competition suffers and outside competitors are disadvantaged by having to go it alone against the bank consortiums. The Fed may be the only viable competitor to the bank consortiums capable of offering merchants and consumers protection against continuous price escalation typical of a market that lacks real competition.