Over the past decades, legacy bank payments systems in the U.S. that handle trillions of dollars in transactions each day have failed to modernize with an eye to seamlessly solving the challenges of consumers and businesses. Cross-border payment costs remain high, transaction speeds remain slow and overall adoption of digital technologies remains spotty. It is not surprising, then, that researchers at the Federal Reserve Bank of Richmond concluded the U.S. is lagging behind other countries in adopting mobile payments innovations, and researchers affiliated with MIT found that the “U.S. experiences substantial frictions due to legacy infrastructure, market fragmentation, and lack of competition.”

These challenges persist despite the U.S. having the deepest capital markets, the best talent, a large consumer base and the world’s top technology hubs. Europe, while lagging the U.S. economy overall, has produced more successful new payments and related fintech firms. What explains the paradox, and what could be done to restore U.S. leadership?

The failure to date is largely the result of outdated regulations and policies that have entrenched traditional banking models and locked in legacy money movement systems. Yet, making money movement more integrated, seamless and programmable would allow businesses to better serve customers and reduce costs. Additionally, reducing our singular reliance on banks that engage in maturity transformation — that is, borrow short and lend long — would reduce risk and increase system resilience.

While leading U.S. payments-focused firms have taken significant strides to solve these problems, more can be done by recognizing such firms with modern chartering and licensing frameworks — notably by including the option of a federal payments charter that permits direct access to national payments systems.

Disincentives for Modernization

A host of factors contribute to the suboptimal state of U.S. payments systems. Legacy providers make lemonade out of lemons, deriving substantial friction-based revenue from services tied to existing payment “rails” — the financial infrastructure that facilitates moving money from one party to another — including overdraft and non-sufficient funds fees that may result from slow money transfers. And because only banks have direct access to payments systems, there is little incentive for them to pursue changes that could undercut current revenue from legacy payment rails.

Today, nearly half of payments through the bank-to-bank Automated Clearing House network are originated by just two financial institutions, while over 93 percent are originated by the top-50 banks. Past research on the 25 largest bank holding companies found that “payment services bring in from one-third to two-fifths of [their] combined operating revenue.”

Smaller banks, meanwhile, typically do not invest heavily in payments technologies, relying instead on lending activities or interchange fees associated with existing payment rails to generate revenue. On this latter point, researchers at the Federal Reserve Bank of Richmond directly link the lack of payments technology modernization to collective reliance on credit card rails first built in the 1950s and debit card networks launched in the 1980s.

Consider, too, that traditional banks are typically focused on taking deposits from one side of their platform to fund lending activity on the other side, which is typically more lucrative than payments processing and gets more resources from the bank. This often means there is less incentive to invest in the deposit side, where modernization could better address the needs of customers in an increasingly digital world.

Despite their sophistication and wherewithal, corporate treasury departments face inefficiencies due to outdated banking services. These inefficiencies result in increased workloads, higher operational costs, and revenue losses, with 86 percent of treasurers reporting disruptions caused by traditional banking applications. Dependence on outdated systems exacerbates risks of human error, delays, and decision-making based on stale data, which can lead to costly missteps. These challenges are even more burdensome for small businesses, which often lack the resources and scale to absorb the inefficiencies and financial disruptions. 

In his recent book, Beyond Banks, Dan Awrey similarly seeks to answer a basic question: “why the United States was able to send 24 men to the moon, but seems chronically incapable of delivering a cheap, fast, secure, and universally accessible system of money and payments.” His work explores a fundamental conflict embedded within the structure of our financial system:

This tension is a product of the fact that we rely on banks to perform three critical and, at least as presently constituted, intertwined functions. The first is the provision of loans and other types of financing to people, businesses and governments, thereby necessitating that banks hold risky and often illiquid longer-term assets. The second is money creation, with short-term and highly liquid bank deposits representing by far and away the largest source of money in the modern economy. The third is payments, where banks serve as both the gatekeepers and custodians of the vast and sprawling network of financial plumbing that moves money across time and space in satisfaction of our financial obligations. As economist Matthew Klein recently put it, this essentially makes banks “speculative investment funds grafted on top of critical infrastructure.”

Awrey further argues that older bank regulatory frameworks “can also erect significant barriers to entry, undercut competition, impede the development and adoption of new technology, spur destabilizing regulatory arbitrage and exacerbate the too-big-to-fail problem.” Not surprisingly, then, to the extent that more targeted or special-purpose banks have sought access to Fed payments systems, they have been disfavored and relegated as so-called “Tier 3” banks, with little transparency from the Federal Reserve on what kind of standards would satisfy such heightened scrutiny.

Bank-Fintech Partnerships

Beyond the challenge of a system that lacks incentives to pursue payments modernization is the downside of exclusive reliance on bank-fintech partnerships. While most such partnerships are well managed and should remain strongly supported, they create operational, resiliency, supervisory and customer-access risks. Many firms are effectively navigating this complexity, but it is not optimal from the perspective of end-users of the payments system for such partnerships to be the only viable path for payments-focused firms.

More specifically, U.S. payments systems rely on a small number of banks supporting retail payments at scale. Many payments firms work through bank partnerships to interconnect with these systems. And both regulatory and competitive pressure risks further constricting access to payments services through these partnerships, rendering the payments ecosystem increasingly fragile — not to mention concentrated among a handful of vertically integrated conglomerates.

Payments firms and their customers are vulnerable if a bank partner exits whole categories of commercial activity. Some payments firms have built networks of multiple redundant partnerships to serve the widest possible market. But not all payments companies can do this — especially newer entrants. Moreover, these partnerships create chokepoints that reduce competition and innovation in financial services because banks’ exclusive access to payments systems increases their bargaining power over payments firms, especially smaller ones, that would otherwise serve as competition.

Slow Adoption of FedNow and Legacy Infrastructure

Against this backdrop, it is no shock that adoption of the Fed’s real-time payments network, FedNow, has been slow. Many banks have reported difficulty integrating their own technology due to legacy infrastructure. And beyond ubiquity challenges, FedNow depends on banks to extend the system to end-customers. There is little evidence that FedNow is being deployed throughout the economy in a way that satisfies key access, inclusion and economic objectives. 

Financial institutions have invested heavily over the decades in legacy systems that power existing payment models, and replacing them would be costly. This dependence on outdated technology frustrates efforts to embed financial services within broader digital platforms. Moreover, smaller banks often rely on third-party vendors for payments technology, limiting their ability to independently connect to real-time rails.

Notably, foreign jurisdictions have modernized their payments systems by expanding access for nonbank payments firms. The Bank for International Settlements found that nonbank participation increases adoption of real-time payments. And, in countries including India and Brazil, where large investments have been made into modernizing payments systems, consumers are able to enjoy leading-edge digital experiences.

Impact on Financial Access, Inclusion and Innovation

The existing tech deficit within the U.S. payments system has far-reaching consequences, undermining financial access and inclusion and frustrating efforts to integrate financial solutions within platforms. Despite advances, particularly online, small businesses still struggle with outmoded payments systems that are digitally duct-taped. This absence of digitally native payment solutions is increasingly incompatible with the growth of the online economy.

Legacy payments technologies are also incompatible with modern software architecture and digital design. More specifically, current trends around Web3 decentralization and the seamless flow of data are incompatible with systems that cannot communicate across platforms. In his 2024 letter to shareholders, JPMorgan Chase’s CEO, Jamie Dimon, noted that banks must challenge the status quo — particularly in payments — where innovators had taken the lead “by working with [software] developers” to build modern solutions. However, legacy financial systems still struggle to integrate with modern treasury management and related analytics tools.

Payments firms have stepped in to fill these gaps, improving access with approaches that integrate seamlessly with accounting, treasury management and broader software applications. However, as noted, current policies require these firms to operate exclusively through banks, adding costs, delays and complexity, and impeding adoption of modern technologies. Put another way, payments firms are forced to integrate with the lowest common denominator technology possessed by the partner, limiting the benefits of digital-first solutions.

The Harm of Derisking and Debanking

Allowing traditional banks to serve as gatekeepers to the payments system opens the door to two related and often synonymous issues: derisking and debanking. The U.S. government defines “derisking” as “the phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk.” This can lead to the “debanking” of large customers, financial partners and whole industry sectors. While debanking is usually the result of necessary derisking, broader motivations — including regulatory pressures and competitive concerns — can result in terminations that may not be in the public interest. Australia offers a high-profile example. Nium, a provider of low-cost foreign exchange services that competes with incumbents, says it has been debanked by at least seven institutions without clear explanations or opportunities to remedy any compliance deficiencies.

The 2023 U.S. Treasury De-risking Strategy emphasized that “de-risking undermines several key U.S. government policy objectives by driving financial activity out of the regulated financial system, hampering remittances, preventing low- and middle-income households … from efficiently accessing the financial system, delaying the unencumbered transfer of international development funds and humanitarian and disaster relief, and undermining the centrality of the U.S. financial system.” The Bank for International Settlements has further noted that the high costs of compliance with due diligence checks against financial crime have contributed to a 29 percent decline in correspondent banking relationships between 2011 and 2022, reducing the capacity of banks to service smaller, underserved markets.

Regulators’ intensified focus on reputational risk has negatively impacted banks by involving examiners in day-to-day business management rather than solely focusing on risks to a bank’s safety and soundness. The Bank Policy Institute has consistently criticized this nonpublic regime, stating that reputational risk is “rarely, and likely never, a safety and soundness risk.”

BPI describes such practices as “examination as political consulting” and asserts that bank examiners have created a supervisory system “subject to no checks and balances” that operates in secrecy, imposing penalties not based on law or regulation. These penalties, ranging from restrictions on business growth to forced divestitures and increased fees, significantly hinder banks’ operational autonomy. Public figures like venture capitalist Marc Andreessen have emphasized the urgent need to address these challenges to ensure that the financial system supports economic innovation and inclusion.

Debanking Multiplied

To the latter point on inclusion, when a bank derisks by terminating a customer, the material impact can be severe. And if the bank’s decision affects a payments partner serving thousands of downstream customers, the resulting disruption can expand exponentially.

Banks do need controls over downstream payments partners to manage risk and ensure compliance. However, compliance can be achieved in nuanced ways and tailored to the circumstances — something payments firms specialize in so that they can serve broader classes of customers. Rigid supervisory expectations or narrow bank-partner policies may stifle operational flexibility and result in offboarding lawful customers.

Exclusivity agreements compound these challenges by preventing payments firms from forming alternative partnerships that could broaden their reach. When banks exit partnerships or limit end-users, payments firms face challenges in maintaining service continuity, which in turn reduces the availability of payments processing.

Moreover, banks’ unilateral rights to terminate partnerships introduce additional risks for payments firms and their customers. This cautious, risk-averse approach can stifle innovation and reduce diversity in business operations, ultimately hindering economic resilience.

Finally, recent bank failures further demonstrate the vulnerability of small businesses and payments end-users to the loss of basic economic functionality. While the federal government ultimately provided a backstop to Silicon Valley Bank’s uninsured depositors, the same guarantee does not appear to exist for small businesses served by Oklahoma’s First National Bank of Lindsay.

The Solution: Direct Access for Payments-Focused Firms

Under both Republican and Democratic administrations, the U.S. Treasury has recommended the establishment of a federal payments framework and harmonization of regulations to protect users, safeguard the financial system and support responsible innovation. In a speech before she left office, Treasury Under Secretary for Domestic Finance Nellie Liang highlighted technology-driven changes in payments and proposed a federal payments charter to “promote innovation and fair competition that benefits consumers through a consistent and comprehensive, though calibrated, regulatory framework … [and that] raises the possibility that [payments firms] could get direct access to some public payment rails, like FedNow.”

Trump administration officials have said much the same in the past. In 2018 the Treasury concluded:

There has been very little relative change to the back-end processes that actually move value throughout the financial system. … Regulation of payments is fragmented; further, the core payment systems exist to move money between financial institutions and their customer accounts and as such, only regulated financial institutions have direct access to the infrastructure. … This fragmented approach to payments governance has perhaps in some ways entrenched legacy systems and slowed down innovations in areas like faster payments.

Policy commentators, including one of these authors, have suggested various approaches to modernizing payments by recognizing state-based chartering frameworks and providing a path for such supervised entities to directly access Fed payments systems. The goal should be a viable chartering framework focused on payments system modernization, including an optional federal payments charter that directly integrates payments firms into national payments infrastructure.

These frameworks would recognize distinct business models focused on payments and tailor regulation accordingly. Other jurisdictions including the UK, EU, Brazil, Singapore, Canada, Australia and Japan are ahead on this, having introduced (or begun developing) frameworks granting nonbank payments firms access to national payment rails to drive lower costs, greater access and faster, more efficient payments.

Traditional banks argue that nonbank payments firms exploit an “unlevel playing field” for unfair advantage, yet no viable federal license exists for payments businesses, and access to payments infrastructure remains restricted. In reality, payments firms do seek clear, direct regulation aligned with their models, but some banks oppose these proposals. They can’t have it both ways — claiming unfair regulatory gaps while opposing new payments regulation. Without reform, this regulatory moat will continue to protect incumbents at the expense of consumers and small businesses, stifling innovation and competition.

The Case for an Optional Federal Payments Charter

An FPC provides a compelling solution to these problems, including the debanking problem. An institution focused solely on money movement — without engaging in lending — would narrow some of the risks that traditional banks cite when closing accounts. Policymakers might also consider fair access requirements to ensure payments services are not improperly restricted for political or other nonbusiness considerations. To this end, given payments firms’ focus on enhancing access and serving broad customer segments, fair access requirements may be more readily supported. While traditional banks face mutualized deposit, lending and other banking risks that frequently result in enhanced scrutiny of customers (and the broader risk of debanking), payments firms could serve wider customer segments, subject to financial crime compliance and other tailored risk management requirements.

An FPC could also help address inefficiencies in the current regulatory framework for payments firms while improving business operations, competition and risk management. A national framework allowing direct access to Federal Reserve payments systems and card networks would reduce costs and provide more resilience for end-users.

Direct access would also bolster competition by enabling digital-first payments firms to leverage advanced technologies directly on top of payments infrastructure. This would foster innovation and improve service quality, benefiting businesses and consumers alike. Additionally, the current reliance on a few large banks for nearly half of the nation’s payment volumes creates significant concentration risks. Allowing payments firms to have direct access diversifies participants, mitigates single points of failure and strengthens the system’s overall resilience.

An FPC similarly deals with regulatory issues. Payments firms currently navigate a complex web of state and federal requirements while remaining dependent on banks, which face inconsistent compliance burdens and regulatory pressure across a range of necessary risk management and illicit finance obligations.

Tailoring Regulation to Mitigate Risks

A well-crafted FPC (created by Congress) would address conflicts and ensure consistency with other state and federal laws, provide direct access to the Fed payments system, and facilitate a chartered entity’s membership in private payments networks. A payments firm receiving such a charter would be limited to providing payments and related technology services, avoiding traditional banking activities such as lending. 

The key attributes of the FPC that would maximize public benefits while mitigating risks are:

1. Access to Core Infrastructure: FPC legislation should require the Fed to grant chartered firms appropriate access to Fed master accounts and related payments services. Private payments networks (e.g., credit card networks) should also be required to grant memberships to chartered firms, similar to requirements in many other countries.
2. Tailored Regulation: An FPC should be subject to regulations that recognize key distinctions between payments firms and traditional banks. FPCs should be required to safeguard customer funds by holding high-quality, liquid assets. Congress, moreover, should explore a proper framework for payments firms that protects customers with priority over other creditors. Capital requirements should also be risk-based and tailored to the more limited risks faced by payments firms compared to lenders.
3. Parent and Affiliate Regulation: Requirements imposed on corporate parents and affiliates of an FPC should be tailored to mitigate “contamination risks” such as shared use of technologies or operational interdependencies. The historical separation of commerce and banking activities was underpinned by a legitimate concern that commercial activities of an affiliate would influence the bank’s lending activities, undermining prudent decision-making or favoring the commercial affiliate over independent competition. However, since FPCs would be precluded from lending, these concerns are not present. 
4. Flexibility to Innovate: An FPC should be able to offer new products without prior regulatory approval. Requiring prior approval would stifle productive experimentation. Meanwhile, stakeholder risks would be mitigated through compliance with applicable laws, supervisory assessments and enforcement mechanisms. 
5. Fair Access: An FPC should be obligated to ensure that consumers and businesses engaged in lawful activities have access to payments services — subject to financial crime, anti-fraud and related risk management requirements — without impediments caused by political or other nonbusiness considerations.

Banking Is Evolving

Inherent in the argument in favor of a federal payments charter is the recognition that the business of banking is constantly evolving to meet market needs. An informative example of this evolution — though an admittedly imperfect one — can be found in the history of the Diners Club card, launched in 1950 by a nonbank to reduce the need to carry cash for transactions. This charge-card innovation revolutionized payments and laid the foundation for the credit card system as we know it today. In fact, it’s the reason Bank of America introduced BankAmericard in 1958, which later became Visa.

Years later, the Office of the Controller of the Currency began issuing special-purpose bank charters for non-deposit-taking credit card banks. These tailored charters enabled nonbanks to operate safely and effectively within the financial system. By facilitating the growth of credit card banks, the OCC recognized and ultimately fostered payments innovation, increasing competition and positioning the U.S. as a global leader in payments. 

The OCC’s approach demonstrated a key principle: innovation and variety in banking should be encouraged and incorporated safely through flexible regulatory frameworks. Tailored chartering has helped integrate new technologies into the financial system. As the payments ecosystem continues to evolve, modernized chartering frameworks can build on this legacy, ensuring that payments firms will be empowered to drive innovation, competition and system resilience.

Why Policymaker Action Is Needed

While the credit card bank example underscores the broad chartering authority that bank regulators already possess, Congress should go further in shaping an optional FPC rather than relying on the regulators. For one thing, despite precedent and broad statutory authority, bank regulators have faced resistance in the past when pursuing special-purpose or novel charters that would undermine the market power of legacy providers. Congressional action could avoid prolonged legal disputes.

Second, Congress can codify proportionate and tailored regulatory requirements for payments firms, avoiding future shifts in regulatory posture. Third, regulatory preference for traditional insured depository banking models do not easily enable a payments firm to both hold and move customer funds without engaging in lending.

Finally, while Congress works on broader legislation, the Fed could take immediate action to advance payments modernization. As noted above, special purpose state banks should have a clear path to gain access to national payments systems. The Fed should reverse the presumption that a special-purpose bank is riskier solely because it is state-chartered and not regulated for the risks associated with borrowing short and lending long. This presumption is fundamentally flawed, and the law does not require it. Rather, the banking system should welcome diverse and dynamic models.

The Virtues of Charter Variety and Payments Modernization

Tailored chartering could further enhance payments system resiliency by avoiding the over-concentration of traditional insured depository banking models, which engage in maturity transformation and are subject to associated risks.

The traditional banking model has systemic vulnerabilities, including risks of runs and failures. Including special purpose payments firms that do not engage in maturity transformation can diversify the ecosystem and enhance its resiliency.

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The mechanics may be construed as complicated, but the underlying idea is not. Modern chartering frameworks, including an optional FPC and recognition of payments-focused banks, would foster innovation, expand financial access and advance competition, even as they enhance resilience. By embracing modernization and multiplicity, Congress could ensure the U.S. builds a more inclusive, efficient, and secure payments ecosystem that benefits businesses, consumers and the broader economy.