The recent launch of FedNow promises to democratize access to instant payments for all Federal Reserve participants. We examine how banks and their customers stand to benefit.
More than 8 out of 10 retail banking customers and over nine out of 10 businesses in the US want the ability to send and receive instant payments – but today only 10% of US banking institutions provide this service to their customers1.
All that changed this July when the US Federal Reserve launched the FedNow Service, which facilitates instant payment services by financial institutions nationwide around the clock, every day of the year. Instant payments via FedNow mean recipients will have immediate and full access to funds, with particular benefit for time-sensitive payments, backed by the security and ubiquity of the Federal Reserve.
How will it work?
FedNow will allow account holders to send payments from their bank account to any other account at a participating bank. Currently funds sent across the FedWire service settle close to real time but can only be settled within the designated window (i.e. 9pm – 6pm Mon-Fri) . The FedNow service will allow banks to settle their customers payments around the clock and on weekends/public holidays. The Fed achieves this by offering a dedicated channel utilizing the ISO20022 standard through which banks will send and receive payment instructions and confirmations – allowing the fed to debit and credit dedicated FedNow ABA accounts.
FedNow Payment Lifecycle
What is the difference between FedNow and RTP?
In 2017, The Clearing House launched the RTP service – the first Real Time Payments platform for US dollar. Since it’s launce the adoption rate has been mixed with many bigger institutions adopting the service whilst many other FI’s choosing to wait on the side lines until the federal service launched their own service. The industry perspective on why the adoption has not been widespread is anchored around a core theme – RTP© is governed and owned by large FIs and as a result perceived to be more focused on benefits for those same larger institutions. The Federal Reserve’s FedNow on the other hand promises to allow banks to provide instant payments at a farther reach and scale with all the security and liquidity management that comes with the Federal Reserve.
FedNow – Potential benefits vs RTP
The new normal
An ever-increasing volume of payments are being transacted outside the traditional banking ecosystem due to the rise of native digital platforms such as Paypal and Wise. With its speed and accessibility, FedNow presents a clear opportunity for banks to regain the initiative in the payments space and claw back those ‘lost’ payments volumes.
Supporting the gig/creator economy –An estimated 30-40%% of the US workforce participates in the gig economy in some way2. The creator economy is estimated to be $100B-plus industry and expected to be one of the highest growth markets3. Many of the participants of this economy leverage other means outside their banks ecosystem to access payment of services on an immediate basis (i.e. Visa Direct/Paypal). Most banks – due to ACH/Wire limits – cannot offer the same level of service in terms of payment immediacy. Banks should be looking to claw back this payment volume by leveraging FedNow to settle payments immediately and any day of the week direct to the participants bank account – keeping the entire lifecycle of the transaction within the banks ecosystem. This will also allow for additional cross selling of tailored banking products to these types of customers.
Digital Experience – FedNow will allow FI’s to deliver a seamless and customer focused digital experience for payment processing. The deferred settlement models (i.e. ACH) make it difficult for banks to provide the same ‘immediacy’ experience that non traditional platforms (i.e. Venmo, Paypal) provide. FedNow will essentially be able to enable banks to provide a P2P service with settlement occurring directly between the customers bank accounts. Enabling the bank to control both the payment flow within it’s own ecosystem.
Risk and efficiency benefits – FedNow promises to enhance operational efficiency by allowing banks to optimize payment forecasting and manage payment liquidity, opening up opportunities to build efficiencies across the entire payments lifecycle. The instant nature of settlement of payments will remove deferred settlement risk from their balance sheets.
Currently financial institutions aim to provide access to customers funds — but this only allows access to a portion of those funds, sufficient to mitigate the settlement risk between counterparties. FedNow will open the possibility to provide access to funds (for good use) immediately – eliminating settlement risk altogether
Cross-border payments – A hyper-connected world has turned traditional domestic banking customers into global citizens. The interoperability between various central banks and global markets instant payment services is inevitable. Leveraging FedNow will allow banks to get a jump start on building for a future where international payments will be conducted with the ease and speed of their domestic equivalents.
The Federal Reserve – along with TCH – see facilitating instant payments across jurisdictions as the holy grail. FedNow currently serves USD domestically – however with the inflight X-Border initiatives, the service will scale to work in conjunction with other central bank instant payment networks (i.e. NPP) to ensure instant settlement of funds to any beneficiary in the world.
What are the considerations to adopt FedNow?
Adopting and successfully implementing FedNow is not simply a technology question. Most FI’s fall into the trap of focusing on the technical implementation – neglecting the other facets which are required to successfully delivery FedNow to their customers.
The Last Word
A pre-eminent instant payment service for the US has been overdue for many years. FedNow gives banks the ability to offer a payment service that meets the expectations of the modern bank customer. Banks should be looking to adopt the service to build out cutting edge customer payment experiences. The first step should be in defining ‘how’ they will best utilize FedNow – a strategy that will mesh with the wider digital and payments vision of the bank.
REFERENCES
1. https://fedpaymentsimprovement.org/wp-content/uploads/pandemic-spurs-faster-payments-demand.pdf
2. https://www.mckinsey.com/featured-insights/sustainable-inclusive-growth/future-of-america/freelance-side-hustles-and-gigs-many-more-americans-have-become-independent-workers
3. https://influencermarketinghub.com/creator-earnings-benchmark-report/
4. https://www.bankingstrategist.com/community-banks-number-by-state-and-asset-size
5. https://www.pymnts.com/news/b2b-payments/2022/mid-market-us-firms-use-real-time-payments-only-4-pct-of-the-time/
