The US Payments System from a Europeans PoV

Welcome back to Bitesize Payments where we look at their history, how they work and who does what. 

When we look at the payment systems of another region, they often seem impenetrable due to different brand names, terminologies, use cases, and cultural nuances.

You might be thinking, aren’t payments just payments around the world? Well, yes and no. While there are common elements like high-value payments, ACHs, and cards, you need to peel back a few layers to find the similarities.

There are several aspects that might trip you up, and not just while you’re on holiday.

In the next two episodes, we will examine the USA payment systems from a European perspective, and then the European systems from an American point of view.

Joining me for this discussion is my good friend, Eric Grover. Eric is a keen observer of both European and American payment activities, making this an exciting and insightful conversation.

So, let's dive into part 1 and understand how US payments work. This is going to be fun…. Here we go….

Payments Industry Insights

History of Payments

Payment System Explained

Corporate Payments Strategy

Payment Regulations Impact

ISO20022 Standard

Digital Payments Evolution

CBDC Advancements

Cryptocurrency in Payments

Financial Technology Education

Transcript

SPEAKER_00: 0:01

Welcome back to Bite Size Payments, where we discuss the history, how they work, and of course, who does what. In this episode, it's going to be part one of a two-part series, which is really looking at things from different points of view. So, for instance, today we're going to look at the USA and its payment system through European eyes. And Part two, if you will, will be looking at European payments through USAIs. Well, hold on a second. You're probably saying, well, aren't payments just payments around the world? Well, you know, kind of the answer to that is yes and no. To some degree, yes, we have high value payments, we have ACH payments, cards, etc. But we have very different views, terminology, operations, and adoptions, and frankly, even cultures. There's quite a few things that might just trip you up. And I don't mean while you're on holiday. So here we go. Let's have a look at it. And in this episode, as I say, we're going to look at US payments, how they work from a European point of view. Hang on to your hats. Here we go. Today, I'm joined by my good friend, Eric, to come and look at this. And of course, in part two, it'll be the reverse. Eric, you're a keen watcher of Europe as well as all the activities in the US. You know, it's great to have you here.

SPEAKER_01: 1:38

Thank you. I'm looking forward to this.

SPEAKER_00: 1:40

Yep. I have to say that I am too. Look, before we get started, I have to say that there are more similarities than there are differences. And as ever, we have a huge problem, which we have different brand names, which actually do very similar things. We have different adoptions and to a degree, a slightly different culture. But underneath it all, the payment processes and the types of payment processes, of course, are very similar. But to get us where we're going, we have to recognize that the U.S. is big. And it's, you know, it's the world's biggest payments platform. And, you It has three of the four global payment systems, Visa, MasterCard, of course, the dollar, and the other one being Swift. That's crazy, though.

SPEAKER_01: 2:36

Well, crazy, and I would even add, in terms of Swift, Swift is based in Belgium, and it's a cooperative. But even there, the U.S. has an outsized impact because the New York clearing banks... are perhaps first among equals among SWIFT membership. And a hugely disproportionate number of cross-border settlements ultimately go through those banks. But you're right. Of the genuinely global retail payment networks, period, they're U.S.-centric.

SPEAKER_00: 3:12

But the sheer numbers are phenomenal. I think some people might be surprised when we say that the dollar is a world currency, right? And we chatted about this before, but that is true.

SPEAKER_01: 3:27

Well, it's true in spades and it's been true for a long time. And notwithstanding a lot of bad behavior, perhaps by the U.S. government, but the U.S. dollar is overwhelmingly the primary reserve company worldwide. That's been true since World War II. It's declined a little bit, but the euro is a hugely distant number two. The U.S. dollar is the most foreign trade outside of Europe is denominated in dollars. The overwhelming majority of foreign currency denominated debt is denominated in dollars. And there's no really viable alternative option. fiat currency network. If you think about currencies, they are a payment network and King dollar is global. The Chinese one is marginal and it's almost inconceivable that that would be viable. Euro is small and not growing in terms of share. If the Swiss economy was the size of the US economy, okay, maybe the Swiss bank would be interesting. But I think for the foreseeable future, notwithstanding the U.S. debasing the dollar and being sometimes pretty aggressive, employing the dollar as a tool of foreign policy, the dollar is here as a global network for the foreseeable future. If you're in the Hindu Kush or you're in the Kalahari Desert and you give a$100 bill to a tribesman, or to a Bushman in the Calahari. They know what to do with it. They'll accept. You think about acceptance, they will accept it. A majority of U.S. dollars circulate outside of the United States.

SPEAKER_00: 5:25

Talk to me a little bit more, because that just sounds absolute, especially when we think about the sheer size of the U.S., to think that there are more dollars outside of the U.S. than are actually in the U.S. It's difficult to get you... mind around how big it must be in the first place, let alone who these other players are.

SPEAKER_01: 5:45

Well, and again, when we think about in terms of money as a store of value, a unit of account, means of exchange, and the dollar is universally accepted. It is the de facto currency in many countries outside the United States. It operates in parallel in many countries outside the United States. It operates as a store of value. So folks who are legitimately or illegitimately want to store value and dollars are a viable choice. And there's no sign that that's going to change anytime soon. Crypto is not going to displace the dollar. There's no fiat currency that is likely to displace the dollar. And imagine, and we don't know this is going to happen, but imagine if we started to have stable coins, fiat currency-backed stable coins at scale. So imagine I could have a dollar Citi stable coin, a dollar Chase stable coin, Well, assuming they could circulate worldwide, that would, if anything, amplify this. You know, I'm a Venezuelan. I can have dollars in my mobile phone instead of boulevards. Or I'm in Zimbabwe. I can have dollars in my mobile phone. I think the weak to base national currencies would be wiped out.

SPEAKER_00: 7:18

Yeah, it's interesting you say that because I'm not sure that I know any stable coins that aren't denominated or backed by the dollar. Very few. Very few. Yeah.

SPEAKER_01: 7:28

Yeah. And for the reason, because you think about, again, the network effect. So the dollar is global. And anybody, even where it's prohibited by law, people will accept dollars. People are willing to spend with dollars. And so if I want to build a stable coin, The Swiss franc might be nice, but it doesn't have the same network effect. You know, most of the currencies, you wouldn't even contemplate that. I'm building my better mousetrap. I'm Tether, I'm Circle, I'm Binance, whoever I am. If I want to get people to have my stable coin in their digital wallet for whatever purposes, my chances are much better with dollars.

SPEAKER_00: 8:16

Yeah.

UNKNOWN: 8:17

Yeah.

SPEAKER_00: 8:17

I think that's true. So, I mean, it's the sheer scale of this is it's overwhelming, as you say, compared to the euro. I mean, obviously, I'm based out of the UK, but I spend a lot of time in Europe. And, you know, obviously, we think of the euro as being, you know, large. And I think it's the number two currency. But as you say, the scale isn't. It's

SPEAKER_01: 8:37

number two, but it's not a close number two. The dollar is three or four. It's a very distant number two. And then number three. which I'm not sure whether it's the yen, I think it's the yen, I'm not 100%, is also, I mean, it's also almost irrelevant.

SPEAKER_00: 8:57

Yeah, yeah. And I think there's a couple of things here. that we have to say, and we'll get more into this when we do it the other way around when we're talking about Europe. But the fact is that Europe has been moving, obviously, into the single currency, the separate zone, and they have multiple currencies, multiple languages, excuse me, processes, multiple supervisors, et cetera, et cetera. And we'll go into that more in the second part of this. But the U.S. is a single playing field. It is a single language. It has a single regulator, or Maybe you'll tell me more about that in a

SPEAKER_01: 9:32

minute. I'm not sure if I wish that was the case, but it has a set of regulators at the federal level for many things. And then it also has, for many things, a set of regulators in 50 states,

SPEAKER_00: 9:48

which

SPEAKER_01: 9:48

introduces its own set of complexities. I mean, there are opportunities for jurisdictional arbitrage which aren't always bad. But there's no shortage. Sometimes when I'm on your side of the pond, I hear Europeans all over the place talk about how wonderful or what a dastardly free market the U.S. is. And would that that was the case? I mean, we have plenty of regulation.

SPEAKER_00: 10:21

Let's get into that in a minute because I think that's going to be a big surprise to people. When we talk about that, but, you know, so while the rest of the world was building out its history with early payment systems, two of the biggest payment networks were actually created in the US, namely wires, which one way or another, you know, is now everywhere not necessarily the name or the brand but the type and of course cards network and you know we discussed many times if you really think about it a lot of the things that happened in the other parts of the world are really interesting but wires and cards are really important and you know we could also add to that things like apple pay on google pay etc but the u.s market sheer scale does lend itself to build out large-scale adoptive payment methods. However, I'm going to tease you now and say it still uses checks and there's a lot of paper money. We've just been discussing beforehand how I was wrong. And in fact, the In Europe, we use more dollars.

SPEAKER_01: 11:36

Not more, much, much, much more. I

SPEAKER_00: 11:40

will consider myself told off. Because I thought it was the opposite way around. So let's get into the culture and the environment a little. Because from our point of view, the card system seems a little old-fashioned when you're over in the U.S. You still often get asked to sign and get one of those silly little pens or use your finger and everything. Credit is much more prevalent now. in the US versus, you know, debit cards, which is about everywhere over here in Europe. And, you know, I made the comment about checks, but checks are ubiquitous. And the process of checks is just the most extraordinarily efficient story. I'm right in thinking that they're the cheapest form of payment processing. It's, you know,

SPEAKER_01: 12:30

the cost accounting here. So there are, so you're quite right. that checks use remains ubiquitous, it remains enormous, but it has declined dramatically. So peak check uses in the US was like 1995 when there were, if memory serves, on the order of 54 or 55 billion checks, commercial and personal written. And You know, check use, total check use now is still billions, but it's single digit billions. It's declined dramatically. Acceptance is close to ubiquitous. My nieces may never use a check, but if I give them a check, they know what to do with it. It is, you know, you don't need to be part of a formal acceptance network. You have an instrument that's legally binding. The system works. The infrastructure, the fixed cost infrastructure is now being shared over fewer and fewer checks. So you can argue that the real cost per check is starting to go up. But institutions are very reluctant, understandably, to penalize consumers and businesses for using checks. And people... and businesses are very much creatures of habit in terms of their payment use. So if you have a system that works, it has critical mass and it's habit, which the checking system fits all those criteria, it's hard to displace. And I think that the check use will very, very long tail, likely to continue to decline, but is it gonna go away in my lifetime? I don't think so. It works quite well. It does impose some costs. There's fraud. But you have those things with any payment system. And I suppose there are disadvantages. I mean, it takes a little longer. If you're at the point of sale, you see someone paying with the check. These days... 30 years ago, it might not have been annoying. These days, you can watch people in the queue and they are annoyed because it takes time. You see the same thing if someone is paying in cash and then change is being made. You can see palpable annoyance when people are expecting the payment is going to be instant and then the customer in front of them is going to move on. And it's becoming less common, but clearly, you know, it still happens.

SPEAKER_00: 15:10

But of course, we have, you know, the payment types are very similar, got different names, different brands, as we said. So, you know, we have the, you know, we have ACH and of course that's sort of natural. We have wires, high value systems. We have now FedNow, which is an immediate payment system. And, you know, a lot of these things have different names. And so we don't, in Europe, anywhere else, we don't call them ACHs, but in fact, they are ACH houses and so on. But when you look at the US, the sheer number and diversity of the financial institutions is genuinely mind-blowing. And the absolute, it's not just the number, it's the different types and the scale, literally from You know, commercial banks, credit unions, non-bank financial institutions, household names that, you know, JP Morgan, Bank of India, etc. They're all well known, but there are regional banks that are very, very small, maybe only have, you know, one branch, two branches. They all have different needs. And it's that sheer number and diversity that I think is really worth diving into a little bit. Okay, so let's have a little bit more chat about that diversity. I think it really is worth diving into a little bit more.

SPEAKER_01: 16:42

Well, a banking system, so it is interesting. The U.S. certainly has more banks, for the last two centuries, has had more banks than any other country on the planet. And the number of banks, I think, what did it peak? Let's see. The number of banks in the US peaked 1921 at slightly under 31,000 commercial banks. Wow. And today, or as of the end of 2023, there were 4,470 FDIC commercial banks in the United States. So that's a dramatic decline. And on top of that... there are slightly over 4,000 credit unions in the United States. So you add that up, we're close to 9,000 regulated banks. The number of credit unions has also been declining. Interestingly, in 2023, for the first time in a long time, the number of commercial banks in the United States increased, increased by over 300. I think... Part of that may have to do with the wave of fintechs, the notion that there's more... And I think it's a good thing. I'm encouraged by it. But nonetheless, I was surprised by it because the regulatory hostility to the banking industry is as great in the United States as it's been a long time. And you can argue... that there are too many banks, it's inefficient. And there's a very, there's a plausible, there's a credible argument there. But the fact that you have lots of small institutions willing to, many of them are willing to be flexible in engaging in the business model. So even though their unit cost economics can't compete with say a Chase or a V of A, their ability to accommodate a new non-traditional business model product can be much greater. I would also note, while the U.S. has more banks per capita than Europe, Europe has quite a few banks. I mean, the European Union 2020, there were 5,441 banks in the European Union. So yes, the U.S., if you throw in credit unions, has more. If we just look at commercial banks, The European Union has about as many commercial banks as the U.S. does. Now, there's variation, like countries, and enormous variation.

SPEAKER_00: 19:36

Yeah, I think that's right. But one of the things that's slightly different, and we'll talk more about this, is where Europe has come from with its now different countries and all that. But I think what people might be surprised about is to talk about TCH, where it came from. And its role compared to, you know, why was it set up? And, you know, it's like simplistically put, TCH is for the big banks and everyone else uses the Fed.

SPEAKER_01: 20:10

Is

SPEAKER_00: 20:10

that harsh?

SPEAKER_01: 20:11

Well, it's hard. It's too harsh. But there's certainly this within that there is a significant kernel of truth. So the clearinghouse was set up in back in 1853. Among law. So it's been in the world. There were a range of clearinghouses set up in the 19th century. And 19th century banks, U.S. banks issued bank notes. There were two central banks, but by the mid 19th century, there were none. So we had banks issuing bank notes. Money was private. Clearinghouses were set up to clear money. The clearinghouse was set up by a bunch of very large, principally New York banks. banks. And the Fed was not set up until 1913, much, much later. And the system, you know, there are certainly critics and you can call out the people who cry the age of wildcat banking. But the system, by and large, is pretty stable. These clearinghouses, there were registers and they evaluated the value of all the currencies issued. The Clearinghouse has evolved since then, you know, it's certainly, but it serves as a payment clearing processor and does some advocacy. Today, the Clearinghouse runs one of the two national ACH processors. It runs one of the two traditional, and I underscore traditional, real-time interbank payment systems, RTP, which was launched back in 2017. And it runs chips. The Fed competes in ACH. And ACH, Wells Fargo and B of A for a brief period ran their own ACH system, but that didn't last. The Fed runs an ACH system, competes head-to-head with the clearinghouse. The Fed runs Fedwire, which competes with chips. And the Fed launched in 2023... FedNow, which is its real-time interbank payment system. So the clearinghouse provides behind the scenes, and it's invisible to the average consumer in most businesses, very important payments infrastructure. And it competes with the public sector player, the Fed, which is also, I have to note, the Paramount regulator, of the owners, the banks that own the clearinghouse. And so the clearinghouse has to be delicate in how it behaves because it's competing with its regulator, or its owner's regulator, I should say.

SPEAKER_00: 23:02

So I want to talk about that in a second, but I think one of the things that... Maybe we'll talk about this in the second episode, but we have, because the US is so large, it doesn't have the same IBAN. It basically has a routing number because it's all inside of the same country. But maybe we should expose that because it's probably more of a European issue or international issue than is an American one. But let's just tiptoe into this into this bit which I think is going to be quite fun and switch gears into the political stroke regulatory process which we were just touching on then because as we've been on lots of sessions where we talked and joked about the differences here but let's just get into the basics of this as I see it the Fed is both a poacher And it's a gamekeeper. And that's quite unusual. Well, I

SPEAKER_01: 24:16

wish it was more unusual. The Fed is a gamekeeper and poacher. I would suggest the ECB is exactly the same thing because the ECB regulates the banks, regulates the EBA clearing, and it competes with them. And in some other markets, it's even more stark. The Central Bank of Brazil is the paramount regulator. It competes directly with the banks. It competes with the payment networks. It competes with processors. You know, there are markets. The Bank of Russia now runs the primary payment card network. But you're right. So the Fed... The Fed is the regulator. The Fed competes with some of the entities it regulates. It has to be somewhat more restrained than the Brazilian central bank. By statute, it can't provide services directly to businesses or consumers. It can only provide services to banks.

SPEAKER_00: 25:31

Lazily, I think in Europe, we say the Fed, and we say it as a singular term. But in fact, the Fed has several roles, and we also have the Office of the Comptroller of the Currency, which I can't remember anybody ever talking about outside of the U.S.

SPEAKER_01: 25:52

So the Fed is the instrument of monetary policy, right? So it's the central bank, classic function. The Fed is the primary regulator of the financial system. And the Fed is a payments operator. So those are, I would broadly say, those are the three functions. And those are all provided for by statute. So the Fed is not, and people like to talk about the central bank, our central bank, the U.S. central bank being independent, right? It has some distance, but it's not independent. Its mandate is from Congress, and it's quite explicit. The Fed and the OCC regulate banks. The FDIC is a regulatory institution regulating FDIC banks. The CFPB, the Consumer Financial Protection Bureau, which is notionally part of the Fed. I say notionally, it's funded by the Fed. So it's part of that, but it operates by and large independently, has taken some regulation of payments unto itself. The FTC... The Federal Trade Commission has some regulatory purview and will bring cases against merchant processors, for example, that are doing bad stuff, perhaps supporting fraudulent operators. And the DOJ has some purview overpayments for antitrust. So the DOJ blocked Visa, for example, from acquiring Platte. And they argued that Visa was going to crush a competitor and that that would be bad for the payments market. The DOJ is, we don't know, but there are certainly speculation that the DOJ might try and block Capital One acquiring the Discover Network. So at the federal level, I think that is, those are the regulators that have some role in payments. And then at the state level, almost every state regulates money transmission companies. So a company like PayPal has to be licensed in almost every state at the state level. A company like Western Union, clearly. A bank doesn't, but a non-bank payments provider is subject to this patchwork of state level regulatory supervision. It's one of the issues that the stable coins have had that they're often being characterized in crypto operators as needing money transfer compliance. And therefore, that's a federal issue and a state issue. So on the one hand, the U.S. market, as you said, is enormous. And as a market, you know, in terms of what consumers and businesses want and language and culture, it's certainly much more homogenous than than Europe, which is a patchwork of historically different countries. And the regulatory, you know, the, the, the federal versus state the, well, a hundred years ago, the, they might've been comparable today. The federal level is, it tends to be more important in most functions. It the, there is some aspect in which competition at the state level is healthy. So, for example, because banks, credit card issuers, for example, can export the practices of the home state in which they're domiciled, a credit card issuer can set up, they're not going to set themselves up in a state that has a low usury limit, has nasty regulation. They'll set themselves up in South Dakota or Delaware, a state that is relatively friendly, and they will compete nationally. And that's been good for the market, I would argue, that states that had anti-industry laws and regulation, companies have not located there. And the ability to compete at a national level from a more friendly platform has meant those products are available nationwide. Now, the regulatory climate, I fear that the US is becoming more European rather than the reverse. Regulators are becoming more prescriptive, more willing to assert their policy views in regulation. The CFPB may be the most vivid example of that. But we've seen the FDIC aggressively shutting down, going after small banks that partnered with fintechs. The CFPB extending its remit to technology companies where payments are embedded. The Fed has been, as regulators go, relatively less inclined to to try and push its policy views into the regulation. The Fed has a number of cases where Congress has said the Fed's the implementer. The Fed has been, I think, relatively neutral, even charitable in how it's implemented administrative regulation. But I think overall, the trend has been somewhat negative.

SPEAKER_00: 32:08

Is it too simple to say now or certainly recently that the U.S. is a market compliance-based, focused regulator, whereas the EU certainly is much more interventionist, directing FIs what they can and can't do? As you were just touching on there, the Fed doesn't tend to do that. It tends to say... Well, you perhaps explain it because I think it's... I

SPEAKER_01: 32:42

think you're right. So I think historically... So first of all, I would say that the abiding assumption, and this has been more or less bipartisan until recently, has been regulators' job is to implement and enforce what Congress instructs them to do. Regulators' job, whether it's the Fed, the Congress, FDIC, the OCC, is not to make policy, it's to enforce. And the general policy view of Congress and therefore of regulators has been that their job is to enforce the rules of the road. It is not to prescribe how the competitors are supposed to operate. And the few interventions have been, I think there have been some very discreet interventions which have been designed to fix what were perceived as market failings. So for example, and this is Democrat or Republican administration, the Clinton administration brought an antitrust suit against Visa and MasterCard back in 1998. And Visa and MasterCard at the time which were both not-for-profit associations at the time, had rules that prohibited banks that participated in Visa and MasterCard from also participating in Amex and Discover. And the DOJ contended, and they also, the DOJ challenged two things. They said that the dual participation banks shouldn't be able to participate in both Visa and MasterCard and that these banks rules prohibiting banks from participating in Visa and MasterCard dynamics and Discover at the same time were anti-competitive. The DOJ lost its antitrust case against banks participating in both Visa and MasterCard, which I think is fine. And the DOJ prevailed. And in 2004, finally, the decision was rendered that banks could participate. Visa and MasterCard could not ban banks from using Amex and Discover. And on the face of it, that's pro-competitive. Somebody said, okay, let's make it easier for Amex and Discover to work with banks, work with merchant acquirers, which they've done. And, you know, it hasn't really moved the needle for Discover, Amex you can argue about, but it was aimed to be pro-competitive, but it wasn't prescriptive. And I think generally speaking, U.S. regulators and U.S. lawmakers have not seen their role to design how the market should function. It's been simply if there's an impediment, you know, try and address that, see if there's a remedy. In Brussels, the Brussels mandarins clearly are quite comfortable with being highly prescriptive. And their view openly, shamelessly, is that the enlightened regulator in Brussels is knows better than the market players in the industry what is needed, which is a classic central planning view. And it's usually wrapped up in something about they're pro-Europe and therefore this is how you have to do payments. I think ultimately the most enlightened, brightest central planning engineer is not smarter than a market of billions of consumers or hundreds of millions They're making the decisions that, you know, the distributed knowledge of all of the market players ultimately produces better outcomes, even though it seems messy. And, you know, you look at companies fail, they launch, you know, quixotic, crazy products. But, you know, the market can be a ruthless regulator. And when things don't work and when companies deliver products that aren't satisfying, capital gets taken away from those operators quite quickly. And so, you know, the system, a system where there is at least some deference, healthy deference to the market participants is more dynamic. And I think over time is more innovative, delivers more value. And a system that, you know, is subject to prescriptive diktats on how the products should be structured, how they can be priced, you know, It may seem appealing because it's clear. It seems easy. Everyone can be forced to participate. But ultimately, it has to be less dynamic. It has to be less innovative. And products that aren't satisfying, they may not go away because they're mandated.

SPEAKER_00: 37:31

And I think there's a lot in there, and we'll pick up some of this when we talk about it from the European point of view, why they're doing the things that they're doing. But the truth of the matter is, it is a very different regulatory culture. Yes. And I don't want to be defensive on one or what have you, but the truth of the matter is, the way that they go about their operation is, is very different. And I think that's partially from the history of Europe, frankly, being many countries trying to act as one and therefore trying to get that

SPEAKER_01: 38:12

alignment. And there may be several flavors of Europe. I mean,

SPEAKER_00: 38:16

the

SPEAKER_01: 38:17

Dutch and the English flavors of Europe have been historically more enterprise market friendly than the dirigist French version of Europe. which has been much more comfortable with prescriptions from Versailles.

SPEAKER_00: 38:34

I think that's remarkably true. But look, we're getting into the next... We're getting into part two now. And I thought we skated through that without... crashing into any lifeboats there. But as ever, Eric, thank you for this. I really do look forward to the other way around when we're talking about it, from Europe, from a US point of view. But for today, thank you very much. Oh, as ever, your insights are amazing. I look forward to the next one.

SPEAKER_01: 39:11

It was fun. Thanks.

SPEAKER_00: 39:13

All right, mate. Take care. Well, there we go. That's the end of part one, trying to look at US payments and their ecosystem, how they work, the regulatory bodies and all of that, but perhaps from a European's point of view. The next time round, we're going to have a conversation around Europe, but from an American point of view, which should be fun. Eric, always entertaining. Thank you so very much. Look forward to it. Take care, guys.