Fed governor Waller delivers speech on payments at the Clearing House Annual Conference

I hold the view that it generally is the private sector that can most reliably and efficiently provide goods and services to the economy, and I apply this view to the payment system as well. It is that perspective that underlies a question I often ask when forming my positions on the appropriate role of the Federal Reserve in a variety of initiatives: What is the fundamental market inefficiency that would be solved by government intervention, and can only be solved by government intervention? If there isn't a satisfactory answer, then I believe government shouldn't intervene in private markets. Does this mean I believe the Federal Reserve should not be involved in payments? And the answer is no. While I generally believe that government shouldn't directly compete with the private sector, there are situations where government involvement is needed to solve for market inefficiencies that may arise because of things like incomplete markets, coordination problems, and a lack of resilience. As a policymaker, I have applied that same question to issues ranging from bank regulation to monetary policy. For an example in the payments area, three years ago there was an increase in public discussion about creating a new payment instrument called a central bank digital currency, or CBDC. The Federal Reserve Board was compiling a report and seeking public comment on the potential benefits and risk of the idea. In a speech I gave in August 2021, I asked what problem would a CBDC solve? In other words, what market failure or inefficiency demands this specific intervention? In more than three years, I have yet to hear a satisfactory answer to that question. Given today's audience and my position serving as the chair of the board's payments committee, I want to focus on the important roles the private sector and the Federal Reserve play in our ever-evolving payment system. To set the stage for that discussion, I think it would be helpful to recap some history around payments and clearing in the United States. In the early decades following the country's founding, banks generally had state charters, while state bank notes and checks circulated locally as payment instruments. There were difficulties clearing and settling checks across states. One way of describing this is to say that the early US payment system suffered from incomplete markets. The Second Bank of the United States was created in 1816, and due to its federal charter, it was able to create a national system for clearing checks and bank notes. This in turn led to a more complete national clearing and settlement process. When the charter for the Second Bank lapsed, clearing and settlement of bank notes and checks fell back to state-chartered banks. Many of the earlier inefficiencies simply resurfaced. For example, porters in New York City would deliver checks and exchange them for gold and other coins, and then transport that specie to the payee. Hauling these money bags around New York posed obvious risk, and these risks multiplied by the mid-19th century when the number of banks in the New York area grew rapidly. As this audience is well aware, the New York Clearing House Association was founded in 1853 and served as a central location for the clearing process, which soon evolved with certificates replacing coins. Furthermore, by being part of a common infrastructure, all members had a reasonably good idea of the quality of each other's balance sheets. In modern economic language, the New York Clearing House became a coordination mechanism that improved clearing by getting banks to clear and settle payments in a well-organized manner. It also reduced asymmetric information about the quality of member balance sheets. By performing this function for New York banks, which constituted a relatively large share of the US financial system, the clearing and settling of payments improved nationally. In this sense, the New York Clearing House was the closest thing the United States had at that time to a central bank. While this was an improvement, not all important financial intermediaries were members of the New York Clearing House or other such private arrangements. That is, there were gaps in the payment system, and financial panics, sometimes driven by these gaps and problems in check clearing, were a regular feature of the 19th and early 20th century. The Panic of 1907 was a classic example of that. Depositors and investors lost confidence in certain New York banks that had been combined into large, complex, and opaque trust companies that were not members of the New York Clearing House. This resulted in runs on those trusts, which led to broader liquidity problems. Although the New York Clearing House had the ability to provide liquidity to those trusts, the provision of that liquidity was delayed. It appears that at the time, the New York Clearing House was reasonably observing some form of Bagehot dictum when deciding whether to provide liquidity. Under that dictum, you want to know that the institution to which you're providing liquidity is solvent. If it isn't, then liquidity extension could be akin to throwing good money after bad. But because the trust companies at the time weren't member institutions, the Clearing House didn't have a good enough understanding of their balance sheets to know whether they were solvent or not. Some banks refused to clear checks from other institutions, which led to an erosion of depositor confidence and more failures. This historical example points to another aspect of a payment system for the country that is important: resiliency of that system. These problems highlighted by the 1907 Panic—coordination failures and a lack of resilience—could have been mitigated with the help of a central bank. Paul Warburg, an influential banker at the time, argued that such a central bank could establish and maintain a perfect system of credit, enabling the general banks to transform cash credits into actual cash with such absolute ease and certainty that the use of cash credit instead of actual cash will not cease, no matter what may happen. In 1913, Congress agreed and created the Federal Reserve. It positioned the Federal Reserve at the center of the banking system by establishing a nationwide check clearing system and a telegraph wire transfer service that is now known as Fedwire. We still use the wire. The Fed was also intended to function as a lender of last resort so that suspension of payments would no longer be necessary. In the 1970s, the Fed promoted more efficient check clearing by adding the Automated Clearing House service. Our job in providing these services and carrying out our responsibilities was, and continues to be, to make sure the payment systems function efficiently and resiliently, promoting the kind of confidence that is vital for a modern economy. All right, I'm done with the history. The lesson from this history, as relevant now as ever, is that the payment system has been one of those areas in which the best efforts of the private sector have sometimes fallen short. The decentralized and diverse nature of banks in the United States is a feature that goes back to the 1800s and has the merits of promoting competition and a vibrant economy. However, when engaging in clearing and settling of payments, coordination problems, information asymmetries across banks can be, and were, destabilizing. While the private sector made advances in resolving those issues, the Panic of 1907 showed that those steps were not sufficient. As successful as the New York Clearing House was for its members, it could not protect its members and the economy from risk in the growing share of finance occurring outside its walls. This contributed to the motivation to establish the Federal Reserve and its role in payments. Now, fast forward to today, and we are once again in an era of rapid change and innovation in money and payments. I like to often joke, if you told somebody 20 years ago that payments would be the coolest tech job in the United States, they would have laughed you out of the room. Now, some of this innovation will not pan out. Some of this change is about delivering services readily available but doing so with new technologies. And some of it is leveraging new technology to rethink existing payment, clearing, and settlement structures. How will all of this come together, and what will be the respective roles of the private sector and the Federal Reserve? Well, let's break it down, keeping in mind my basic principle that the Federal Reserve should focus on addressing issues that the private sector cannot address alone, and in doing so, promote an efficient and resilient US payment system. I'll start by discussing the important roles that the private sector now plays in the payments system and in the evolution of payments underway. The private sector connects consumers and businesses to the payment system, with financial institutions competing to provide services to their customers. Such competition can lead to better products and services for consumers as profit-seeking competitors look for opportunities to win over customers, including through the adoption of new technologies. I have noted my concern that some see these new technologies as an opportunity for the public sector to play a bigger role in payments, which, in my view, may crowd out private investment. I believe this would be a policy mistake, and a better approach is one in which the private sector continues to have a significant footprint, with the role of government limited. One important reason for this is that the private sector, through competition, is typically best suited to sort out good ideas from bad ideas, rather than central bankers or other public sector institutions choosing winners and losers. At the early stages of innovation, the true value added of the application of new technologies is murky. Market competition helps sort that out and typically leads to a wider range of products that can be better suited to the needs of customers. But just as was the case in the time of Warburg, there remain problems in payments that can't be fully resolved by the private sector. And just as we have done throughout history, the Federal Reserve stands ready to support the evolution in payments and do so primarily through our operational role in the payment system by providing core clearing and settlement infrastructure on which the private sector can innovate. Notably, the Fed has the unique ability to provide the infrastructure to reliably settle interbank obligations using balances at the central bank, which enhances the stability of the banking system and the broader economy. Reflecting the lessons we learned in 1907, compared with many other countries where a small number of large banks dominate, the United States has thousands, thousands, thousands of banks and credit unions. Connecting those many organizations to a payment network requires a significant amount of coordination. That's a problem that is not faced by other countries, but we do. One recent example of an area in which we're playing such a coordination role, in my view, is in instant payments. The role we're playing with FedNow is to help that coordination problem using our existing connections to thousands of small institutions. And that approach is consistent with my overall view of the appropriate role of government to narrowly address problems like those of coordination that can't always be efficiently solved by the private sector alone. In doing so, we complement the private sector and promote responsible and efficient innovation in the broader market. With respect to new and emerging technologies in finance, I can think of two ways in which the private sector is uniquely positioned to develop and deploy them, while the government is not well suited to do that. First is the question of innovation risk. The investment in new payment technologies is large and comes with risk of failure. Private sector entities risking their own funds and seeking to turn a profit will have a greater incentive to accurately gauge demand for those technologies and bring those products to market faster. Second, despite the current fascination around the world with industrial policy, rarely can the government match the ability of the private sector to efficiently allocate resources and explore how well new technologies can address actual shortcomings in the current financial system. It is too early to tell whether some of the new technologies will relieve significant frictions in the payment system, but it's going to be the private sector, betting with its own money, that is best positioned to explore and answer that question. If problems emerge, as they did with check clearing in the 19th century, then the government can play a constructive role in overcoming them. Well before this point, however, it makes sense for the public and private sectors to look down the road together and engage in dialogue about potential issues and opportunities that might arise. For example, through the Bank for International Settlements, the Fed is currently engaged with the private sector to explore how tokenization technology might be used to facilitate cross-border payments in a faster and cheaper manner. This project brings together multiple central banks and private sector financial firms in collaboration to potentially facilitate a better-functioning monetary system. The process of working together to promote the efficiency and safety of the payment system, as the Federal Reserve has done for decades, can lead to outcomes that benefit households, businesses, and the overall economy. American entrepreneurship and technical prowess have generated exciting innovations in payments, and they will continue to do so. The role of the Federal Reserve is to support that initiative and engage with the private sector to promote innovation while guarding risk to financial stability. We've managed this balancing act before and will continue to do so. And together, we will ensure that the payments ecosystem continues to move forward for the benefit of households and businesses in the United States. Thank you very much.

Right, so there's a big initiative around the globe to have faster, cheaper payments, and safer payments. So I always like to say it's like air travel. I want cheaper airfare, I want non-stop flights everywhere, and I don't want the plane to fall out of the sky, right? And so that's kind of the idea with payments as well. We want faster payments, we want them to be cheaper, but we want them to be safe—safe from fraud, safe from money laundering, for illicit finance and terrorism. And that's where, as Raj was mentioning, that's where the tension comes in. To make them safer, sometimes you have to slow the process down. Certainly we know that with fraud, and then people on the other end say, 'I just want my money fast.' It's like, wait, slow down, we've got the safety part of it too. So that's what I've been trying to stress in my discussions with international counterparts. It's we want faster, cheaper, and safer—all three things, not just the first two. And that's where I want the discussion to go. We can't always think about just making them cheaper and faster and going away from safety. I mean, many of you stand in the security line in the airport, you're like, 'It would be so much faster if I could just walk to the gate and I didn't have to do all this.' And then you remember, I think there's good reasons. I have to spend some time and slow down my trip to the gate because there's good reasons for all the safety precautions that we have.

Yeah, so one of the things I tried to point out on when everybody talks about faster payments, you have a receiver of the payment and you have a sender of the payment. The person receiving the money always wants their money fast. I never met anybody who didn't want to get the money fast. But there's lots of incentives sometimes for the sender to not want to send them so fast—delay the payment, 'I'll send it to you later'—or the intermediary. So there's a tension between the senders and the receivers and incentives. So when I've talked about fast payments, you have to figure out their use case. Why does the sender want to send the money faster? And remittances is a typical, classic example. I want to send the money back to my family, I want it to get there fast, and I want it to get very cheaply. Once you get outside of that obvious case globally, it becomes very murky kind of exactly what the business case is. Sometimes are the gig economy. We see this all the time. People don't want to be paid daily. I want to get paid daily, my employer won't do it. Go ask them why. But I mean, that's the point is that the senders are firms that want to say, 'I'll pay my workers daily.' Why do they want to pay their workers daily? Well, it turns out they have recruiting and retention incentives for certainly fast food employees or gig workers that they pay them to give them incentive to stay. So it's those kind of use cases you have to think about. And so, like I said, globally remittances are a big thing, but you know, in the US, you know, there's not a ton of remittances pouring into the US. Most of the remittances are going out. And so this is a public policy question of how important do we put that relative to the other use cases that we're still developing in the US for faster payments.

Yeah, I mean, when I think back, it's one of the things I've tried to stress is that a large part of safety in the payment system is resiliency and redundancy. Nobody wants to get on a plane with one engine, right? I mean, you want two engines for a reason on that plane. So it's kind of the same idea. You'd like to have multiple systems in case there's a problem or something fails in one, that you could easily switch over to another. That's my view of how I see ACH. We have private CHIPS, we have Fedwire. These are the way we do this to make sure that if something goes wrong, the payment system doesn't go down. Banks use both systems daily to try to make sure they have operational risk. So that's a critical part, I think, of what the Fed does is provide redundancy and resiliency to the system. That if you just have one system alone and something goes wrong, your entire payment system collapses. This is a situation you run into with Pix in Brazil, UPI in India. If those systems go down, their entire payment systems go down. There's no alternative. There's no switch where you would flip it. Okay, so that's where FedNow, in particular, over time, FedNow in some ways we're just a resilient backup for how the private sector works.

Yeah, I mean, that's a critical thing. We want to think about these systems working. The way I was just saying, if a bank wants to send some payments over CHIPS, some over Fedwire, that they can do that pretty seamlessly without a lot of differences in the way they do that. Make it simple. So you want that kind of property, like the ISO 20022 system of messaging. We want consistent messaging across systems. This is a global thing, and this is all based on, you know, agreement. Nobody can force anybody to adopt these standards. So they've got to have good reasons, there's got to be consensus, and then when that happens, we all move to that system. But that takes time. It doesn't happen just overnight.

Yeah, so I mean, we typically always talk about cyber risk as being some nefarious thing that some bad state actor or foreign actor is going to impose on. But we just learned with the CrowdStrike problem that sometimes a cyber incident has nothing to do with malicious intent. It's just something bad goes wrong, and then we see what the consequences are. So probably CrowdStrike might be the biggest cyber event that the country has faced in a long time, and it had nothing to do with anybody trying to have ransomware or take anything hostage or disrupt anything on purpose. So I mean, the lessons I've kind of taken is regardless of what the source is, whether it's malicious or not malicious, you got to have your systems ready to go. So obviously, you know, and these are simple four points probably everybody in this room knows, but I kind of think of it as: first of all, you have to prepare in advance, right? We all know that these things can happen. Prep in advance, see how you're going to deal with it, who's going to be in charge, what's the process for recovery and rebooting the systems. Two, everybody's got to be involved pretty quickly. Too often these things are siloed, 'Oh, that team will take care of it,' but the problems start multiplying fast outside of that group, and if you don't have people involved from the beginning, then you're trying to play catch-up all the time and the problem gets worse. Then the third thing is automation. If you can have these systems such that you can quickly reboot systems through automation rather than human control and intervention, that's where you can get these things up and running much faster than if you have a bunch of people having to talk to each other, get approval above and do some. And then the last thing is, one thing we've learned, I think, in our own payment system is, you know, a cloud-based architecture gives you a lot more automation tools and resiliency than if you just kind of doing things on your own. So I mean, that's kind of the four points I took away mainly after the CrowdStrike incident to how to think about resiliency.

Yeah, so in the crypto universe, you know, you're trading all these objects. I've given some speeches on how I think about the crypto universe, but one of the critical things that popped up in trading in this world, which is a completely different set of rails, traditional rails, is that there's always a demand for a safe, liquid asset, something with stable value that you can move in and out of positions. There wasn't such an instrument in the crypto world, so they created one. This is what you got to love about markets. There's a demand, there's a problem, they created a way to solve it. So they created stablecoins, a dollar-denominated token that always paid off a dollar no matter where it was. Had various firms that provided these stablecoins. Stablecoins were just a solution to a problem that existed in finance in the crypto world. When you look at it, it simply becomes a synthetic dollar. That's the way I often think about stablecoin, a synthetic dollar. It has the same kind of properties in some ways as standard commercial bank money, and it can be redeemed at will. But because it's not backed by government, it's not backed by FDIC or anything like this, they suffer from run risk. You could see this with any of the stablecoins back about two years ago when there was a crypto crash. There was a break in the peg on these things as people started running on the coins. That still would exist in anything that we would allow in the US through legislation. So what we would have to do is make sure legislation ensures, just like we do with banks, that if I go in and I want to convert my dollar in my checking account into a dollar bill, that I'm guaranteed I'm going to get that. That requires a lot of regulatory structure, a lot of things in the banking. So to make that happen, you'd need a similar sort of thing with stablecoins. In terms of using it illicitly, again, that's where we want some information. We have to have some oversight and regulation of the stablecoins. But they can potentially unlock a lot of, if you think about just a simple payment stablecoin, not a banking function, but a true payment stablecoin, there's a lot of potential to eliminate inefficiencies in the payment system and various other ways, allow entry, competition, and whatnot. And the banks are free to issue it themselves if they wanted to. I just see this as something that can have a lot of potential benefits. It opens up new sets of rails, new sets of trading. But we do want to have legislation and make sure that they're pretty much run-proof. We have better insight as to how it's being used. Once you're on a blockchain, you could track where it went and who had it. It's a lot easier to track that than US currency, I can tell you that much. So when people are worried about illicit finance, you can track on a blockchain a lot easier where this was, who had it, what it was being done. And if you can control the entry and exit points, it's actually a lot safer than actual US currency.

Yeah, I mean, the thing that's kind of funny is our financial system is already completely digitized. I mean, nobody's trading physical objects around on any given day. This is kind of a funny thing when people think about, 'Oh, we got to be digital.' We already are. We have been forever. When I was in India, India up until 10 something years ago was like 95% physical currency was their medium of exchange. So for them, moving in 10 years from 95% physical cash to 95% digital is a big innovation. But this happened for us over about 50 years. This is nothing really new. So all that matters is kind of what is the digital object that you're sort of using for payment. Tokenization is a way to take maybe your bank account and trade it on a different set of rails. The example I always use: you go to a casino, they don't let you use cash at any of the tables. You go to a window, they give you a token, you go around the table, you trade it, trades on that platform, and at the end of the night, you go and you cash it out back into cash. That's tokenization. That's exactly what people talk about when they talk about tokenization. You're just converting one object technically into another digital object that'll trade on a different set of payment rails. So for the US, it's just moving from a digital system we already have to slightly different digital systems as we move forward with things like tokenization, smart contracts, and whatever.

Yeah, I mean, there was a lot of excitement about CBDC, and it was like, 'Look what it can do! It can do this, it can do that.' And I viewed all that as kind of like an infomercial. What's an infomercial? 'Look at this, it minces, it mashes, it slices, it dices! Look at all the wonderful things it can do!' But the whole point of an infomercial is to get you to avoid asking a simple question: 'Do I really need this?' And that was how I look at all the CBDC excitement a few years ago. What are you solving by having this thing? And I literally just asked a question. I put it out, and globally, everybody's having a very hard time answering the question, 'Why do I need this? What is it replacing that the private sector isn't already doing and doing well?' And so I think as other central banks in the world have stared at that, they're starting to kind of walk back. Doesn't mean they're stopped, they're not looking at it. We're continuing to look at it. But you really have to ask yourself, what is the problem that this is solving? And if you can't answer that question, why are you wasting your time on this?