In December 2019, the US Federal Reserve announced plans to develop a 24/7/365 real-time payments (RTP) and settlement service called FedNow. The service is expected to launch sometime between 2023 and 2024, with the intention of benefitting both businesses and consumers.
The Federal Reserve System is a member of the US Faster Payments Council, which aims to expedite faster, more secure payments and provide education about fraud mitigation. The Fed is among the over 140 current members of the Council, including many large corporations and financial institutions.
After years of uncertainty, the Fed’s announcement has finally answered the question of whether the central bank would participate in a modern US payments network, or instead defer to the private sector.
The idea behind the FedNow service is that round-the-clock, near-instantaneous fund transfers can economically benefit both businesses and individuals. RTP is a hot topic within the payments industry, and the Fed’s plans to create a ubiquitous RTP framework will continue drawing eyes to the trend.
A study commissioned by the Fed estimated that each year real-time payments are delayed could cost consumers about $10 billion in non-sufficient funds (NSF) charges, late fees, and reconnection fees for utilities.
The Fed’s move to RTP — as an alternative to The Clearing House, a group of large banks — is a big change for US payments.
The supporters and critics
Once established, FedNow will be in direct competition with a private RTP system established by The Clearing House in 2017. Naturally, many private-sector banks — particularly those that have already built their own RTP infrastructure — are resistant to the idea of the Fed developing an RTP network that will operate alongside them. But many smaller banks are praising the news, recognizing that FedNow will give them access to RTP without having to pay competitors for the service.
Fed Governor Lael Brainard believes that FedNow will provide necessary competition and help ensure that banks of all sizes can access instant payment services. He said that the Fed does not plan to stifle the existing privately-run system. Kansas City Fed President Esther George added to that sentiment, stating that the central bank would like to one day see the two systems be interoperable.
One thing that’s clear is that RTP is a desirable, popular payments trend. Consumers are already using RTP apps like Venmo and Zelle to send and receive funds, so there’s already a demonstrated demand for RTP on a wider scale. RTP has been adopted by many industry participants and the Fed’s entry into the space is likely to increase adoption rates.
RTP is beneficial to merchants, particularly small- to mid-size merchants, because it means immediate payment for goods/services. No lag time and no waiting for funds to settle could be very important to business owners, particularly those that live paycheck to paycheck. This would improve cash flow and accounting efforts, make it quicker to grant chargebacks and reverses, and minimize the likelihood of overdraft or late fees.
The UK and Australia have already adopted a form of RTP within their treasury systems, in response to consumer and industry expectations. Like EMV technology, RTP is entering the US payments space a bit later than other areas of the world.
The future of FedNow
As FedNow is developed and rolled out, the government will need to consider several things in order to ensure the system’s success.
The near-instantaneous nature of RTP could potentially lead to more fraud. Faster transactions provide less time for fraudsters to engage in transactions, but that also means financial institutions will have less time to verify the validity of a transaction. This could lead to transactions settling before fraudulent activity is detected.
Market participants will have to invest in infrastructure, making some degree of modification to their systems in order to accept real-time payments. This might include the development/licensing of new technology and the introduction of application programming interfaces (APIs). We have yet to learn if the Fed will mandate use of its future RTP infrastructure or if participants will be able to use third-party technologies. And if third-party technologies come into play, will they remain proprietary or will they maintain more of an open source concept?
Cybersecurity must also stay top-of-mind during this process. The FedNow system could create a single point of failure, creating a serious risk as faster payments become more prevalent. Making FedNow interoperable with The Clearing House’s RTP system could alleviate some of this risk.
With many questions yet to be answered, we can expect some interesting changes to the fintech industry over the next few years as FedNow is developed and implemented.