FedNow and the Future of Instant Payments

Consumers and businesses want instant payments and they'll switch institutions to get them. When it comes to real-time payments, a senior Fed payments executive stresses that the strategy of 'wait-and-see' won't pay off. Banks and credit unions that aren't early adopters risk losing market share.

PayPal. Venmo. Google Pay. Cash App. Zelle. These technology companies and closed loop payments networks have seen surging growth. PayPal’s overall payment volume in Q4 2021, for instance, jumped 23% year over year.

They’re all about speed and convenience. Or at least the perception of it. While Zelle P2P transactions are essentially immediate, a typical PayPal transaction still takes three to five business days to clear. The key, though, is that to the consumer who just got reimbursed by a friend for movie tickets, the payment appears instant. And that’s all that matters to the seven out of ten consumers who use mobile payment devices to send or receive payments, according to the Cleveland Federal Reserve Bank.

When it comes to paying bills, getting a direct deposit, and other everyday payments tasks, consumers are an impatient lot: 21% say they’ve abandoned a financial transaction because the speed of money movement would take too long, a 2021 American Banker report found. For consumers with household incomes of more than $100,000, the percentage jumps to 31%.

FedNow, the Federal Reserve’s instant payment service — scheduled for a mid 2023 launch — aims to change all that and give smaller banks and credit unions a fighting chance in the payments ecosystem.

The Cost of Not Innovating Fast Enough:

A fifth of consumers have abandoned a financial transaction because the speed of money movement would take too long.

FedNow enables financial institutions to help payers initiate a payment, facilitate clearing and settlement, and instantly credit a payee’s account. The goal is not only to recapture payment transactions volumes, but to attract and retain consumers and businesses that are hooked on fast money transfer.

It’s a particularly crucial feature for business banking customers. According to a Fed survey, nearly two-thirds of businesses (and more than three in four large and very large businesses) indicate that access to faster payments would factor into their decision to switch banks in the future.

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Details of Upcoming FedNow Instant Payment Service

Banking Transformed Podcasts

FedNow, the first wholly new payments platform from the Federal Reserve in 40 years, is a real-time interbank settlement system built from the ground up, noted Nick Stanescu, FedNow Business Executive, in a Banking Transformed podcast hosted by Jim Marous, Co-Publisher of The Financial Brand, CEO of the Digital Banking Report.

FedNow is also ISO 20022 native, the standard of electronic data exchange between financial institutions, allowing more data to be transmitted with payment messages.

“We believe that FedNow is going to be a game-changer that is going to revolutionize payment systems in the U.S,” said Stanescu.

Speed Wins Over Customers:

Nearly two-thirds of businesses would change financial institutions to get access to faster payments.

Any bank eligible for Federal Reserve financial services — regardless of size — can use FedNow, leveling the playing field for smaller banks and credit unions, explained Stanescu.

The Federal Reserve will initially give banks a 20-second window to process messages but in reality, the Fed expects banks to settle most payment messages in just a few seconds.

Because FedNow is applied against the master accounts that depositary institutions hold at the Reserve Banks, there’s no outstanding obligation between financial institutions and less need to move around liquidity to pre-fund instant payment activity.

At launch, FedNow will include foundational features for payment clearing and settlement, starting with ACH transactions followed by mobile banking and point of sale transactions.

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Use Cases for Instant Payments

From girl scout cookies sales to bond bail payments, Stanescu believes that the use cases for FedNow are numerous, especially if banks and credit unions partner with fintechs to create digital overlay services on top of FedNow.

For consumers, instant payments via FedNow promises increased flexibility, access to liquidity and transparency. They won’t have to schedule their mortgage payment five days in advance and hope it gets there in time. They can send the payment on the day its due and be confident that it was received.

FedNow can help businesses improve cash flow management, payment operations efficiency, ease of access and security, an important function since nearly 75% of micro businesses and 60% or more of all the other businesses surveyed cite managing cash flow and working capital among their top concerns.

Businesses will be able to pay suppliers in real time, get paid in real time, and operate more efficiently by associating funds with the correct invoice. “Those functionalities will improve efficiencies and cash flow,” Stanescu stated.

Early use cases will likely revolve around bill pay and account-to-account and business-to-business payments. Stanescu anticipates a strong use case in payroll such as paying workers daily so they have immediate access to funds to pay bills.

Not the Only Real-Time Payment Option

FedNow isn’t the first instant payment network. The Clearing House’s (TCH) Real-time Payments (RTP) platform launched in 2018. RTP processed 45 million transactions for $19.7 billion in the third quarter 2022, up 10% from the second quarter.

And TCH, which is bank-owned, is launching new features and capabilities. Secure Token Exchange replaces account numbers with tokens for additional security when sending or receiving payments. Document Exchange provides access to PDF or XML documents such as bills, invoices, and remittances as part of an RTP payment or request for payment message. TCH also increased the value limit for corporate payments from $100,000 to $1 million.

All that doesn’t faze Stanescu. Competition between instant payment rails is good for the industry, the Fed exec states. Banks and credit unions can choose which network to use based on payment type, amount, and which network is most cost-effective for a particular payment. Two instant payments networks also provides redundancy in case one goes down.

Read More: How Banks Can Meet SMB Demands for Omnichannel Payments

Will Faster Pay Bring Faster Fraud?

With faster funds the threat of faster fraud rises as well. Stanescu says that in addition to upgraded security tools and controls, the Fed will also focus on educating financial institutions how to manage fraud risk, conduct investigations, and provide returned funds connected to fraud and errors. The Fed is also planning to provide consumer education and outreach programs.

As banks and credit unions consider FedNow, Stanescu recommends talking to their customers and members on the one hand to understand how they could benefit from instant payments, and on the other hand questioning service providers about how they will support instant payments.

The Fed has a variety of resources to get banks and credit unions ready for FedNow instant payments and a 24/7, 365 environment. Here are two:

Learn More:

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