In the age of COVID-19, America’s outdated payment system is making it more expensive to be poor. How can real-time payments fix this problem?
On March 27, Congress passed the CARES Act that provides $2 trillion in direct payments to Americans, but it took as much as three months for households to get the money in their accounts. Needless to say, this is a serious problem for the 78 percent of Americans living paycheck to paycheck. In a recent survey, almost half of lower-income households said that they were unable to fully cover at least one basic expense due to COVID, with many resorting to credit cards or payday loans to fill the gap.
Sadly, this is just another example of how our slow payment system disproportionately affect the financially vulnerable — and it has nothing to do with financial literacy. In this economy, managing your money requires knowing how much money you have available and at what time it will become available. But a slow and unpredictable payment system makes those questions much harder to answer for lower-income people. When stimulus checks or paychecks don’t hit people’s bank account in time, some are forced to rely on risky loans and check cashers to pay the bills — or face onerous overdraft fees.
The increased prevalence of these fees has become a source of revenues (and harmful incentives) for banks to benefit from working class Americans. Every year, the overdraft industry is estimated to generate $24 billion in fees — a sizable profit that led one bank CEO to name his boat “The Overdraft”. Similarly, the payday loans and check cashing industry together makes another $9 billion from exploiting workers’ vulnerabilities.
That’s why Aaron Klein, the Director for the Center on Regulation and Markets at Brookings, argued that “Implementing real-time payment will be the single most important policy lever that the Federal Reserve can directly utilize to reduce income inequality in America.” Real-time or instant payments would enable businesses and consumers — especially those with savings constraints — to make and receive payments in real time, providing convenience, speed, and faster availability of funds. Klein estimates that by eliminating just a tenth of overdraft fees, payday loans, and check cashing, real-time payments would restore around $3.5 billion a year to working families.
The technology has been around for a long time, and dozens of developed countries including Sweden, Poland, United Kingdom, and Singapore are already operating their own real-time payment infrastructures for years. Even developing countries like Mexico and Brazil implemented this technology in 2002 and 2004. The United States, however, lags far behind in adopting instant payments.
Currently, the biggest banks in the U.S. have been implementing real-time payments through its own system called The Clearing House (TCH), but this only covers about half of all transactions in the U.S. financial system. One can also imagine a scenario where a private monopoly having sole control over the U.S. real-time payment system can suppress fair competition. This would further alienate small businesses and consumers alike by subjecting them to higher fees.
The Federal Reserve, to its credit, announced last year that it is developing its own real-time payment systems called FedNow, which would serve as a cheaper, government-backed alternative to TCH. Although this has been praised as an essential step toward ensuring equal access, implementation remains slow, and its expected launch date isn’t until 2023 or 2024. In the meantime, critics say that the Fed program might actually delay national adoption of the technology — especially if smaller banks are willing (or even nudged by the Fed) to wait a few years for the FedNow system to be rolled out.
There is one other solution that the Fed has been reluctant to exercise: a regulatory mandate requiring all financial institutions to adopt real-time payments today. This legal authority comes from the Expedited Funds Availability Act, which gives the Federal Reserve Board the power to reduce the waiting period for depositing checks to “as short a time as possible”. Carrying this out will have its challenges, however, since it’s not so clear how the Fed can dictate TCH to offer its services to all financial institutions in the United States. This is not to mention the likely pushback from the private sector against what it considers to be unnecessary government intervention. Nonetheless, some believe that this regulatory push is necessary to accelerate the adoption rates of real-time payments.
No matter what approach the Federal Reserve takes, one thing is clear: the benefits of real-time payments will by far outweigh the costs. Unlike traditional redistribution policies, this technology can give back billions of dollars to working-class Americans without raising any taxes or welfare. It is the hidden solution to reducing inequality for the bottom-half without affecting those at the top. For a country wracked with social and economic divides, this is extraordinary — and we must do everything we can to make this a reality.