What Instant Payments Will Look Like in the Age of FedNow

Bankers worry that faster payments — or faster transactions of any kind — will put both the banking provider and customer at risk. A majority of the time, it's a risk that banks and credit unions just don't want to take, regardless of how secure FedNow is predicted to be. What are the concerns, and should they stop financial institutions from adopting instant payments?

Instant payments are finally poised to take off in the United States. Nearly 60 countries already have real-time interbank payment systems, whether run by the central bank or a private entity.

Of course, helping customers pay and get paid is a core banking service, regardless of the size of the bank. But most U.S. banks have been slow about adopting new payment methods that customers want.

Payments between businesses, called B2B for short, are the ripest for disruption.

Check usage has declined steadily among businesses as they digitize accounting processes. Even so, checks are still common for this customer segment.

About one-third of B2B payments in the U.S. are still made by check, according to the 2022 Association of Financial Professionals Digital Payments Survey. And about 80% of businesses still use paper checks to pay bills.

Checks can take days to clear, making cash flows challenging to predict, and are costly to process for both the sender and the receiver. Banks earn some fee revenue here, but they need to do better for the customer. Instant digital payments are the answer.

So, what’s the best way for banks to digitize most, if not all, B2B payments?

A Pivot To Cloud-Based APIs

Many banks have told us their business customers are reluctant to shift to cloud-based application programming interface, or API, integrations of payment-processing gateways. Cost, complexity, and a perceived lack of quality solutions are the most common excuses for holding off on technology modernization.

But integrating payments with a bank’s enterprise resource planning (ERP) software — and tying them to back-office functions such as accounting, payroll, payables, and receivables — can yield significant benefits in terms of efficiency and accuracy.

The Federal Reserve’s instant-payment system FedNow, set to launch in mid-2023, will offer banks of all sizes a range of features to automate and digitize payments for businesses. For example, FedNow will include expanded messaging capabilities consistent with the ISO20022 industry standard that banks have been implementing.

Instant payments are not new to the U.S., though. The Clearing House, a consortium of major banks, introduced an instant payments service called RTP back in 2016. However, adoption outside the top-tier banks remains relatively modest despite steady growth.

Why has RTP adoption by banks been modest? First, many don’t want to be beholden to a system controlled by the big banks, much like Visa and Mastercard used to be. More fundamentally, many may not believe their customers need or want instant payments.

But market surveys suggest otherwise. According to a recent study by the Federal Reserve, three out of four businesses and two of three consumers think their bank or credit union must offer faster payments.

Get With the Program:

Two out of three people say their primary banking provider needs to deliver faster payments.

With the experience of Zelle fresh in their minds, many banks may not trust the security of instant payments, whether via RTP or FedNow. Fraudsters have wrangled billions of dollars from people who instantly transferred money to them using Zelle.

Payments in Today’s World: Instant and Permanent

When we say instant payments, what we mean is an instant settlement. Once you hit send, the money is gone. Legislators have called on banks to refund customers in these situations, but banks are pushing back.

How can instant payments benefit bank customers? Here are some use cases, ranging from the most promising to the least.

1. Using instant payment systems like RTP or FedNow, companies can send and receive e-invoices that include a request to pay with a secure link so the recipients can make the payment in real-time. Businesses can request payment in this fashion from all customers, both consumers and businesses. B2B instant payments also include expanded messaging capabilities consistent with ISO2022 standard, enabling advanced analytics to drive efficiencies and revenue opportunities.

2. Workers have been tough to find and retain since the pandemic started. Yet, any business that employs hourly workers should know that many live paycheck to paycheck. With instant payments, companies can set up an instant, on-demand payroll, a key differentiator in the quest for talent.

3. Consumers can pay bills before they are overdue with the confidence that the payment was posted immediately. In addition, same-day payments do not require a fee, which is usually $10 or more.

4. Consumers can move money instantly between accounts, whether at that institution or different ones. New accounts can be funded immediately. Adding money to, and taking money out of, mobile wallets and prepaid cards can be instant; no more waiting to use the money or paying for the privilege as with Venmo and PayPal.

5. Consumer-to-merchant payments will be much more challenging for instant bank-to-bank payments to nudge aside, although banks are exploring that option. Cards have ubiquitous acceptance, robust consumer protection, and offer payment grace periods and rewards in the case of credit cards. JPMorgan Chase is piloting a pay-by-bank service with MasterCard that will bypass cards.

6. Person-to-person payments will also be a tough market to crack, given the established usage of Zelle, Venmo, Square Cash and others.

Undoubtedly, more use cases will develop as instant payments drive banks and fintechs to innovate new services.

RTP vs. FedNow

FedNow fees will be comparable to those of RTP. The 4.5 cent cost per transaction is the same — but RTP costs the sending institution about 5.5 cents, net of incentive rebates, for each request for payment sent vs. 1 cent for FedNow. For 2023, the Fed will waive its $25 monthly fee per routing number, which RTP does not charge, and discount the first 2,500 transactions, an annual value of $300 and $1,350, respectively.

A bank would use its current Federal Reserve master account for FedNow, whereas it has to maintain liquidity in a separate account to use RTP.

What’s the elephant in the room? Because payment settlement is instant and irrevocable, banks naturally worry that instant payments, whether via RTP or Fed Now, are much more vulnerable to fraud.

The recent surge of fraud on the Zelle network, and the resulting scrutiny from Washington, don’t help. But Zelle is primarily used for person-to-person payments, whereas we believe the most significant potential for instant payments resides with business payments.

Separate from P2P:

Bear in mind that the security issues happening in the P2P spaces are not reflective of the technology and data protection capabilities of other payments software.

Most importantly, Zelle lacks two-way communication, a key fraud prevention measure. With RTP and FedNow, the receiver of a payment, or the receiver of a request for payment, can ask the sender a question.

Referred to as a request for information, it provides a mechanism for two-way communication on a secure channel, the same one that the funds traverse.

There’s another elephant in the room. Many banks lack the resources in-house to implement new technologies, so they are justifiably concerned about the cost and complexity of implementing instant payments. However, there are plug-and-play solutions for RTP and FedNow today and resources for integrating this payment software with a bank’s existing infrastructure.

Banks must deliver instant-payment solutions to businesses to retain customers in the next few years as the FedNow network grows.

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