FedNow: Hype or reality?

Posted by Checkbook on Jun 04, 2024

FedNow: Hype or reality?

FedNow is an interbank instant payment infrastructure that aims to transform payments in the US. FedNow Instant Payments, launched by the Federal Reserve on July, 2023, promising to transform how money moves electronically. It had been in planning for 4+ years.

Where does the US stand in real-time payments

Faster payments in the United States are finally picking up in the realm of real-time payments, with projections indicating a fourfold increase in transactions by 2027 (more here). Despite the initial slow adoption compared to global leaders like India (UPI) and Brazil (PIX), the U.S. has seen significant growth driven by The Clearing House’s RTP network and new FedNow system. This momentum was catalyzed by the pandemic, which underscored the need for quick, secure, and efficient digital payment solutions. As financial institutions and businesses increasingly integrate real-time payment capabilities, the U.S. is poised to transform its financial landscape, fostering greater financial inclusion and control for consumers​

FedNow Process flow image

Enter FedNow

FedNow represents the Federal Reserve's solution to facilitate instantaneous financial transactions. Positioned as the Federal Reserve's entry into the realm of digital currency, it is the first U.S. government-created and -backed platform, which serves as a dedicated infrastructure designed for interbank transactions. Known as FedNow Instant Payments, this system is tailored to meet the needs of banks, credit unions, and qualifying institutions, enabling them to swiftly process transactions.

Distinguishing itself from prevalent payment applications such as Venmo and Cash App, which operate outside bank accounts, FedNow facilitates real-time transfers directly between bank accounts. Operating seamlessly around the clock, 24/7/365, FedNow Instant Payments aligns with the demands of modern banking practices, while also accommodating the rapid evolution of fintech platforms. It is available to depository institutions across the United States, allowing individuals and businesses to send instant payments directly from their accounts.

What are the features of FedNow Instant Payments?

FedNow Instant Payments is a 24/7/365 service with a transaction limit of $500,000, making it ideal for frequent, lower-value transactions. This feature is specifically designed for mobile and online person-to-person payments.

But don’t we already have RTP(™) so why do we need two different ones?

Two different systems working with the same protocol to solve the same problem. Having two systems independent of each other gives Financials Institutions and ultimately their customers i.e. individuals more choice and greater resilience. It the simplest level it provides for redundancy. The financial world is full of more than one system designed to solve the same problem - think VISA and Mastercard. While the two systems are built differently by different institutions, banks/financial institutions can join either or both thus providing both a choice as well as greater resilience. In terms of interfacing with each it’s important to note that each system follows the ISO 20222 protocol for exchanging data and hence the interoperability one with the other should not be a problem.

Both are engineered to deliver seamless, uninterrupted 24/7/365 processing, Accessible not only to banks and credit unions but also to certified service providers, FedNow Instant Payments represents the Federal Reserve Bank's proactive response to the escalating demand for real-time financial transactions independent of The Clearing House’s RTP By enhancing the speed and efficiency of interbank transactions, FedNow positions the Federal Reserve Bank and its participating institutions at the forefront of a dynamically evolving financial landscape.

How FedNow Works?

FedNow isn't just a payment service; it represents a fully-fledged instant payment system meticulously crafted to foster inclusivity. It caters to a diverse spectrum of banking institutions, ranging from large-scale banks to community banks and credit unions - basically any financial institution under the “Fed umbrella” will be able to access the FedNow network.

Here's a glimpse into its functionality:

Instant Transactions: Payments are processed in seconds, any time of the day, including weekends and holidays. It uses ISO 20022 protocol which provides for greater flexibility in amount and type of data that can be transmitted. This is in complete contrast with the ACH system where each side sees a limited number of characters i.e. 22 characters - all upper case describing the Payee to the Payor and Payor to the Payee. ISO 20022 provides for much richer data set to be sent with each payment thus enhancing reconciliation between Payor/Payee and minimizing errors.

Accessibility: This will need the financial institution to “connect” to the FedNow network. While this “connection” may sound simple in reality it is likely to be an involved process for each financial institution. Since most banks use third party software to run their “core” i.e. their core IT infrastructure is often outsourced to companies like Fiserv, FIS - they are likely to have to wait until these companies have enabled FedNow in their software offering. The larger banks - many of whom own more of their core processing - are likely to build their own connector to FedNow. Regardless it will be years before all the financial institutions are connected to FedNow. Of course some FIs could connect to RTP and achieve similar results, however in the long run most institutions will likely be connected to both to provide greater flexibility and resilience

Integration with Apps: Fintech and payment processors will be able to collaborate and use FedNow through their partner bank relationships. .

Key applications of FedNow Service

FedNow Service encompasses a range of functionalities tailor-made to meet the needs of the market. Again, many of these use cases can also be addressed equally well by RTP(™)

Fast Account-to-Account Transfers: Facilitates rapid transfers between accounts, addressing the need for swift transactions in the market.

Support for Emerging Use-Cases: Equipped to handle emerging use-cases such as bill payments, adapting to evolving consumer preferences and market demands.

Liquidity Management Transfer Capability: Efficient transfers ensure participants can promptly meet instant payment service demands.

Interconnectivity: Seamless transfers between participants' master accounts and a joint account at a Reserve Bank enhance interoperability and accessibility for private-sector instant payment services.

Security: Backed by the Federal Reserve, FedNow Service offers users security and reliability, instilling confidence in the system's integrity and operations. The key issue when considering security is a paradigm change from batch mode transfers to real-time. This is a huge change that will have profound implications in terms of fraud prevention and risk assessment. Unlike ACH transactions which are settled in batch mode overnight and or 2 working days, FedNow will work more like wire transfers i.e. once the payment is made the funds are netted off from the Payor bank account and effectively settled. While it may be possible to retrieve wrongly sent funds in some cases in most cases, once the payment is sent - it will be permanent with no to little recourse for reversing and/or error correction. This will necessitate the needs for a new set of tools that work in real-time as malactors come with up new vectors to conduct fraud in real-time

Dynamics of FedNow Instant Payments

Platform for Online Dollar Transfers: FedNow enhances the ease and speed of transferring dollars and digital currencies without replacing them.

Federal Control and Backing: FedNow operates under federal oversight, ensuring reliability and security.

Facilitation of P2P Payments: Financial institutions can use FedNow to process mobile and online person-to-person (P2P) payments, integrating the instant payments infrastructure.

Enhanced Institutional Positioning: By leveraging FedNow, financial institutions can offer real-time P2P payment options to a broad customer base.

Increased Institutional Control: This system signifies a shift towards greater institutional participation and control in payment transactions.

Dynamic Financial Landscape: FedNow fosters a more vibrant, diverse, and expedited financial operations environment.

While the above features are available thru RTP(™) , FedNow distinguishes itself primarily through its backing by the Federal Reserve. This provides stability and widespread integration but also fosters a heightened sense of confidence and security.

Benefits of FedNow

The deployment of FedNow as well as RTP(™) can significantly impact both personal and commercial financial activities:

Immediate Access to Funds: Greatly improves cash flow management for businesses and convenience for individual users.

Increased Efficiency: Saves time with instantaneous processing, bypassing the waiting periods associated with traditional banking systems.

Around-the-Clock Availability: Ensures uninterrupted transactions 24/7, accelerating access to paychecks and incoming payments while expediting bill payments and optimizing account management.

Challenges faced

Requirement for Universal Adoption: Universal adoption of the Federal Reserve Instant Payments service is crucial for maximizing benefits. Mixed participation may result in transactions defaulting to Automated Clearing House (ACH) processing, with the traditional delays associated with ACH as well as posing potential overdraft risks.

Dependency on Universal Acceptance for P2P Transactions: Seamless P2P transactions rely on both individuals using the service, highlighting the necessity for universal acceptance of FedNow by both the sending as well as the receiving institutions to effectively derive benefits from instant payments.

The FedNow Service and its impact in the U.S.

Two years after its announcement in 2019, a pilot program commenced in 2021, welcoming over 110 organizations to participate in testing the service.

In its pilot period, the FedNow Service facilitated over 1.8 billion real-time transactions, yielding cost savings of $648 million for businesses and consumers, while also generating an additional economic output of $1.4 billion(more here). Additionally, in 2021, the total value of noncash payments surged to $128.5 trillion, with approximately 205 billion transactions recorded in the U.S., equating to over 600 payments per American(more here). Clearly FedNow has a huge market ahead of it

The FedNow Instant Payments system has also demonstrated its effectiveness in both standard scenarios and in the realm of P2P transactions, previously constrained by limitations in real-time fund transfers. Features such as request for payment send and receive capabilities have markedly enhanced the payment experience for users.

The Future of FedNow

As digital currencies continue to gain traction, the role of services like FedNow becomes crucial in establishing a bridge between traditional banking and modern financial technologies. It holds the potential to further expedite the adoption of digital payments by providing a reliable and efficient transaction framework.

Experts also anticipate that FedNow could progressively divert transaction volume from cards, wires, ACH, and other payment channels. Initial impacts are projected to be more pronounced on B2B transactions, such as invoicing and vendor payments, which prioritize real-time speed and certainty. As adoption increases, both consumer and business transactions may transition towards instant options for P2P transfers and bill payments (more here).

With RTP (Real-Time Payments) already embraced by nearly 40% of large enterprises in the US, the impending launch of FedNow is expected to expedite the global transition to real-time payments (more here). This acceleration promises substantial benefits for financial institutions, businesses, and payment providers alike.

How to Prepare for the Adoption of FedNow

Businesses can prepare for FedNow by:

Updating Technological Infrastructure: Start by adding instant payment technology platforms like Checkbook.

Educating Stakeholders: Train staff and inform customers about the benefits and changes associated using instant payments through Checkbook’s all encompassing platform which provides both RTP(™) as well as FedNow capabilities with the same API, efficiently.

Reviewing Financial Policies: Adjust cash flow management and payment practices to maximize the benefits of instant payments.

Frequently Asked Questions

What is the purpose of the FedNow Service?

The FedNow Service is intended to provide immediate payment services for the convenience of individuals and businesses. It also incorporates tools to prevent fraud and enable request for payment capabilities, however those have yet to be tested and the RfP solution is still in beta.

Will the FedNow Service lead to dominance in the instant payment solutions market?

Although the FedNow Service comes with real-time fund transfer capability, it’s too early to predict its outright domination in the competitive market of instant payment solutions. In addition to RTP(™) there are other methods for moving funds instantly i.e. OCT (Push to Card) as well as wires. But it can be seen that instant and real time payments are the roadmap for the future of money movement.

Can FedNow freeze your account?

No, FedNow does not have the authority to monitor or freeze private bank accounts. That remains in the bank’s preview.

Which major banks will not use FedNow?

Several of the nation's top banks such as Bank of America, Citigroup, PNC, and Capital One Financial have not yet joined the FedNow Service, though this may change in future (more here)

What exactly is FedNow's instant payment?

The instant payment service provided by FedNow enables banks and credit unions to transfer funds immediately for their customers. This service is not directly available to individual consumers and businesses.

Are checks and ACH becoming obsolete?

Despite a decline in check use, it remains a popular form of payment. In fact, in 2022, there were around 11.5 billion check transactions, marking it a commonly frequented payment method. We are on a mission to change that, here at Checkbook.

ACH remains the largest payment rail by total volume, however now that the long awaited movement to real-time and instant has started it will peak out and the curve will decline in favor of faster payments.

Talk to us and tell us how we can help you make your money movement simpler with our single API system.