It’s not the topic of virtual get-togethers, but there’s certainly a lot of buzz about mobile apps revolutionizing the ways we can pay for goods and services. Terms like "fast," "faster," "real-time," and "instant" are descriptors for some of the newer payment options being offered. This article unpacks those terms and provides a framework for thinking about the differences among the various arrangements.
Almost no one would describe a check payment as fast. It might be quick for a payer to give a check to the payee, but the payee likely will not have access to the funds for a day or more. And while some might describe traditional card payments as fast, in the sense that the payer and payee can execute the payment in seconds, even these payment options don’t fit the evolving understanding of what a faster payment is. A "faster payment" is generally accepted to be "… a payment in which the transmission of the payment message and the availability of 'final' funds to the payee occur in real time or near-real time on or as near to a 24-hour and seven-day (24/7) basis as possible." Footnote 1
To be classified as a faster payment, the payment option must 1) enable both payer and payee to see the transaction reflected in their respective account balances immediately and 2) provide funds that the payee can use right after the payer initiates the payment. And because of this, the payment is, by its nature, also irrevocable, meaning it cannot be reversed by the payer or the payer’s financial institution (FI) after it is sent.
A simple enough definition from the payer’s and payee’s perspectives, but things get more complicated behind the scenes. Faster payment options can differ in several ways, including whether they are closed or open loop and whether they settle on an instantaneous (immediate) or deferred basis.
"Closed Loop" systems refer to payment options offered by a single central provider in which both the payer and the payee must maintain an account with that provider to transact. Examples include PayPal, Venmo and Square’s Cash App. In such systems, it is relatively straightforward to transfer funds from payer to payee more or less simultaneously. However, the payee's ability to then use the funds received for payments outside the closed loop network typically requires a transfer to an account at another FI, which can take a day or more.
"Open Loop," in contrast, refers to systems that enable payers to pay much wider groups of payees, even those who have an account with a different FI. In these systems, payments must be routed and settled among the various FIs, typically through a shared network, such as what happens with VisaDirect, MasterCard Send, the RTP network, and Zelle (and in the future, the FedNowSM Service).
A second differentiating factor is how the payments that flow through the shared network settle, meaning how the payee's FI receives final funds from the payer's FI. Settlement in these systems can be either on a deferred or instantaneous (or real-time) basis. Deferred settlement, as the name implies, means that the transfer of final funds between the payer's and the payee's FIs occurs after the payee’s FI has made the payment available to the payee. For some systems this may be only a few minutes, but for others, it might be a day or longer. In such systems, this is akin to the payee's FI extending short-term credit to its customer (and taking on that risk) until it receives final funds from the payer’s FI.
Instant/real-time settlement means that the transfer of final funds between the payer’s and payee's FIs occurs with the transmission of the payment message and just seconds before the payee's FI makes the payment available to the payee. Because it receives final funds from the payer immediately, the payee's FI does not incur any credit risk the way it does in deferred systems.
Faster payment systems that rely on such immediate settlement arrangements, such as the RTP network and eventually the FedNow Service, are often referred to as instant or real-time, as a shorthand way of distinguishing them from faster payment options that meet the definition of faster, but entail the payee's FI taking on short-term credit risk.
1 Committee on Payment and Settlement Systems (2016) – Fast payments: Enhancing the speed and availability of retail payments, Bank for International Settlements, November.