The fintech and payments sectors, like most other technology segments, are prone to jargon and confusing terms and phrases. That’s why in this latest episode of the FinTalk podcast we’re trying something new: taking one topic (in this case Faster Payments) and getting an expert to clear up questions like what exactly Vocalink is, what instant and faster payments are plus where this fits into what’s next for banking.
Who better to answer some of those questions than one of the lead architects who designed the central processing system for UK Faster Payments, which many of us now use every day?
Here we chat to Tom Hay, Head of Payments at Icon Solutions and try to clear up some of the confusing phrases and processes associated with bank and card payments. Tune in to our new FinTalk podcast episode or read the transcript of our conversation below.
In this episode:
- What is Vocalink?
- What’s the deal on its ownership?
- Why do payments take a long time?
- What are faster payments?
- How fast are they really?
- What are the barriers for banks transitioning to instant?
- What’s next for banking?
What is Vocalink?
Whenever you make a payment through internet banking or set up a direct debit, money has to go from your bank to the gas company for example. As you can imagine there are millions of these payments flying around each day. Rather than each bank paying directly to the other banks, which would mean lots of separate connections between banks, it is easier to have a central hub in middle. All bank payments go into that hub the hub then sorts them into the right order, sends them on their way and then settles with the Bank of England.
Vocalink is that hub. It sits between all the banks, transfers the payment messages and makes sure the money at the end of the day is settled at the Bank of England. They have been doing that for about 50 years so the tech has changed a lot but they now look after the Bacs (Bacs Payment Schemes, formerly known as Bankers’ Automated Clearing Services), Faster Payments and LINK (which is the domestic card payments ATM scheme).
And Vocalink is currently owned by the banks?
Yes but the regulator has fired a warning shot there. It is very likely MasterCard will take over Vocalink, which I am not sure is what the regulator had in mind but will definitely get rid of bank ownership.
What’s the problem with banks owning it?
It is perceived as a bit of a cartel and closed shop. The dozen or so bigger banks in the UK are all members of Bacs and Faster Payments but all the newer banks, the challengers – the Atoms and Starlings – find it quite difficult to connect in and become part of that club. It is also perceived that bank are operating a sort of monopoly so there no real competition. The idea is to open up access to the payments schemes and also to promote competition and therefore drive down prices.
Can you talk a bit about your work at Vocalink?
I’d been working in card processing for many years and in 2005 I moved into Vocalink – at that time that UK banks were considering a new way of doing payments, a faster way and that was partly in response to regulatory pressure. Various ideas were on the table, but the one that won out is the one that is now called Faster Payments. At its heart it was based on tech from the cards world because card payments are instant payments; if you take money out of an ATM, you get money three seconds after you put your pin in. The same thing was required in the account to account payments world.
LINK had put this idea on the table because they operate the card scheme. For Voca, who operated the Bacs scheme, it was all new but luckily I landed there and coming from cards and was able to explain. Working with LINK, Voca looked after the reporting and settlement or back office side, while LINK put in real-time switching: put the two systems together and that delivered Faster Payments. Because it was all so complementary the two companies ended up coming together to form Vocalink.
What do we actually mean by “faster”?
Bacs, the old fashioned payments scheme worked on a three day cycle. If I wanted to pay you for example I would make that payment instruction on one day, then that night it would be sent to your bank, they would have a day to think about it and then on the third day the money would appear in your account. It would be three working days before you go the money and if it was over a weekend it could take an awfully long time before it got to you.
Why so long?
It was a legacy from the initial days of Bacs when there wasn’t online communication between banks, it was all handled by magnetic tapes. At the end of the day the banks would transfer the information onto magnetic tape, give it to a motorbike courier who would zoom over to Bacs HQ then they would collect together all the mag tapes and push them in through the main frame. It was a very physical and manual process, but as things became electronic the tech moved on the process did not – so it was still taking three days even though in principal it could have been flipped onto next day or whatever. So that is why it did and still does take three days.
At the time faster payments was being debated – one option on the table was making payments ‘faster’ but just next day. One of the schemes was called ELLE – ‘early for late, late for early’, so if I submitted early it would get to you early and vice versa. But the other option was why not make it absolutely instant, so the payment happens in seconds, like it does in the card world.
That was the option that the industry went for – driven by one or two vocal proponents saying let’s build something useful in 10 years’ time and look to the future rather than build something that works for the next couple of years.
What’s the difference between Instant, Real-Time, Faster and Immediate Payments?
Fundamentally there is no difference, it is simply semantics. The UK scheme is called Faster Payments, while in Singapore the scheme is called G3 which they describe as ‘Immediate Payments’. They all refer to the same thing – and that’s moving from an off-line, batch based payments processing system, to an on-line system which processes payments as they are received.
The terms are used interchangeably depending on where you are in the world and who you’re talking to. Instant Payments is the term that seems to be used the most widely in the market.
When it comes to transitioning to Instant Payments, how much is cost a barrier for banks?
Most banks process payments in batches at set times. By contrast, Instant Payments is an online system that requires continual input, process and output of data. Put simply payments must be processed as they are received.
This transition has major associated demands and challenges. Banks need to both change their internal infrastructure to handle real-time as well as connect to the relevant national payment scheme or schemes. Critically the implications aren’t purely technical – there are major operation requirements to ensure governance, not to mention business considerations around how the core system will power forward-looking products and services. Sophisticated routing decisions have to be instantly taken, fraud and anti-money laundering checks now need to be handled instantly, and exception-handling processes require automation.
The problem for mid-sized and smaller banks is they only have a sledge hammer to crack a nut.
For example, large global banks may already have a payment hub that they can use in their core markets, but such systems are difficult to customise and costly to deploy in smaller, subsidiary markets. They are expensive to license, inefficient at lower transaction volumes, and often hide additional professional services fees. The price tag increases further when middleware and database licenses and the requirement for heavyweight infrastructure are factored in.
So yes, cost is one of the biggest barriers, and it is particularly acute for smaller banks asking for a lower cost way to provide the speed of execution their customers need today, and the digital services they expect tomorrow.
What is the risk if the banks don’t embrace this?
When we started talking to banks in Europe maybe a year or so ago they were not sure about instant payments, asking what the business case was for it. That has changed completely in the past 12-18 months. There is a pan-European payments scheme in the pipeline at the moment and all the banks are saying forget about the business case, we have to get on board with this because if we do not offer instant payment and all our competitors are we are out of business. So instead of being a differentiator or a value-add it has become part of the table stakes. If you are a bank you’d better be offering instant payments or else you’ll get left tin the dust.
It’s a time of big change – how do you see the banking sector changing?
One area I think is very exciting is the convergence of different technologies. Amazon has something called Echo in the US, which combines its voice recognition system Alexa with artificial intelligence with internet search and can be connected to control devices in the home. I see that kind of integration as being really interesting. Imagine I’m watching TV and I like the tie that the newscaster is reading so I ask Alexa to find and buy it for me. That embedding of payments so that it’s not a case of getting my phone out and make a payment, but rather just becomes part of something I want to achieve: in this case buying that polka dot tie.
What’s the most useful piece of advice you’ve been given?
A long time ago someone gave me a phrase from a US aircraft designer called William Bushnell Stout, who said: ‘Simplicate and add more lightness’. It was taken up by Colin Chapman, who founded Lotus. He explained it as: if you add more power and give a car a bigger engine, it will go faster on the straight. If you take things out and make it lighter it will go faster everywhere. I think that applies to tech design, deign for business processes and user experience – simplicity is everything.
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