The Future of Payments

Should Non-Bank Payment Firms Be Eligible to Open Federal Reserve Bank Accounts? 88 BANKING PERSPECTIVES QUARTER 4 2018 This article discusses this growth in demand among non-banks for direct access to U.S. settlement systems, with a focus on Federal Reserve master accounts, and evaluates the key considerations that inform possible responses from U.S. policymakers and the banking industry. One set of responses includes options for expanding eligibility for master accounts. Any of these options would require creation of new federal-level regulatory mechanisms to address policy concerns about the integrity of the payment system. Such parallel mechanisms, while feasible, carry risks of unnecessary duplication, competitive inequity, and both under- and over-regulation. Other responses, however, would target the underlying drivers of non-bank demand for direct access – particularly the restricted availability of U.S. bank charters and licenses. Expanding opportunities for suitable firms to obtain federally supervised banking charters or licenses would ensure that such firms are subject to comparable supervisory and regulatory standards as incumbent participants, without the need to create parallel regimes. At the same time, non-bank firms that do not want to (or simply cannot) become banks could continue to operate under their current models. THE PAYMENT LANDSCAPE: CHANGE AND STABILITY The U.S. payment landscape is evolving rapidly as new products, participants, and technologies emerge. Non- bank firms have taken on an important and highly visible role in providing payment-related services as the volume of electronic and online transactions has increased. These firms provide front-end access to retail payments for consumers and businesses, perform back-end operational and technical processing for depository institutions, and facilitate a growing variety of cross-border and cross- currency transactions, among other services. Some non-bank payment firms operate without direct licensing or regulation. Others are subject to various financial services licensing and regulatory regimes, including those governing money-services businesses or trust companies. Some also operate banks outside of the U.S. For purposes of this article, any such firm is a “non- bank” provided it does not operate pursuant to a U.S. charter or license that could make it eligible to open a Federal Reserve master account. “Banks” that do qualify for master accounts include: • Federal Reserve member banks • Depository institutions, as defined in Section 19(b)(1)(A) of the Federal Reserve Act, including banks, thrifts, and credit unions that are insured by the Federal Deposit Insurance Corp. or eligible to apply for FDIC insurance • U.S. branches or agencies of foreign banks • Edge or agreement corporations Opening a master account – or, in certain cases, simply being eligible to open one – is key to the ability to settle U.S. payments without a depository institution intermediary. Settling directly through such Federal Reserve Bank Services as Fedwire requires a master account, for instance. Similarly, major private payment systems’ various membership criteria effectively limit direct participation to institutions that hold or are eligible to open a master account. Non-bank firms that lack a master account must work with institutions that hold one in order to provide or facilitate U.S. payment services. GROWING DEMAND FOR DIRECT ACCESS For many non-bank firms, settling through a depository institution is unproblematic. One might reasonably ask whether there is even a need to consider extending master account access to non-bank firms, which already have established a viable economic niche for themselves. After all, in the last decade, non-bank firms have achieved notable success in areas such as cross-border payments, merchant processing, and prepaid cards. Non-bank payment firms have greatly increased in number and variety due to marketplace changes, including growth in the scope and penetration