Payment Rails and Other Tales

In Glenbrook’s Payments Boot Camp, we are always talking about payments systems – how they work, how they evolved, who uses them, who provides them, who profits from them, and how they are changing. So I was a little surprised when one of the participants approached me recently at break and asked if we would be talking about payment rails.

The question made me think we should do more in our workshops to explain the differences between payments systems, payments networks, payments schemes, and payments rails. There are a lot of inconsistencies in how these terms are used. On one hand, you could make the case that these are all just synonyms. And for most people, that’s probably the right way to think about these terms. But there are some subtleties here that are worth understanding, which is what I want to explore today.

In our book, “Payments Systems in the U.S.”, we offer a side-bar distinction between payments systems and payments networks. We say a payment system has common protocols and rules across one or more providers of the system. So ACH is a payments system with multiple providers, or operators, of the system that all follow the same set of rules. We’ll circle back to how common the rules are in ACH, but for now it’s a good example of a payments system. In the world of cards, there are common protocols and technical standards used throughout the card system, but each card brand has its own rules. So we think of Mastercard as one of many payments networks inside the card system.

If we were to overgeneralize, most things that enable payments between counterparties are payments systems. PayPal would be referred to as a payments system and not a payments network. Zelle would be referred to as a payments system. Venmo is a payments system. Every payments system has its own rules and its own processing model.

Here’s where the subtleties kick in. A more nuanced view of payments systems would make a distinction between payments system rules (which in isolation are often referred to as the scheme rules) and the underlying processing of the transactions (which in isolation is often referred to as the rails). Let’s drill down on that:

  • Payments Scheme – Speaks to the business rules that bind the participants to the payments system, the economics of the transactions, and the common brand that is used to describe and discuss the payments system.
  • Payments Rails – Speaks to the technical connectivity path, the various transaction formats, and the tags used to indicate the purpose of the transaction.

We see this distinction between scheme and rails in many payments systems in Europe. In the U.K., for example, the Faster Payments Scheme Limited is the joint venture that controls the Faster Payments scheme rules; Vocalink operates the Faster Payments rails. This distinction is important because regulators in Europe look favorably on the separation of scheme and rails as an important way to encourage competition. Requiring separate ownership is thought of as a smart way to avoid monopolistic control of a payments system.

In the U.S., there is little distinction between scheme and rails. Generally, the same entity that controls the scheme also controls the rails. So Visa, for example, controls both the Visa scheme and the Visa rails. The argument for commonality of control is that the scheme and the rails go hand-in-hand and product innovation often requires coordinated adjustments to both scheme and rail. The same common control model is used by Mastercard and American Express. They each control their respective scheme and rails. Discover is slightly different, as it will separately lease the use of its rails to other schemes.

The real exception to this approach in the U.S. is with the ACH system. NACHA controls the scheme rules and there are two operators, The Federal Reserve and The Clearing House, that control their own respective rails. Financial institutions, as members of the ACH system, get to choose which rail they will use. Some use both rails, most will choose one rail versus the other. While each operator follows the NACHA business rules for ACH, they each have their own processing rules that clarify how their rails work.

Aside from the ACH exception, most payments systems in the United States have common scheme rules and processing rails, so why make the distinction at all? Why not just call it a payments system? It’s really just the way we talk in the world of Fintech. The odds are that when you hear your friends at the office talking about payment rails, they are just using a hipster term for payments systems. That’s unfortunate, because the actual distinction between payments schemes and payments rails is one of the most powerful concepts in today’s contemporary payments industry.