After a long wait, FedNow, the instant payments service from the Federal Reserve Board, launched on July 20 after first being announced back in 2019. It will enable real-time clearing and settlement of payments 24 hours a day, 365 days a year and is designed to help lay the groundwork for the modernisation of the US financial services industry.
“With the FedNow Service, the Federal Reserve is creating a leading-edge payments system that is resilient, adaptive, and accessible,” said Tom Barkin, president of the Federal Reserve Bank of Richmond and FedNow Program executive sponsor. “The launch reflects an important milestone in the journey to help financial institutions serve customer needs for instant payments to better support nearly every aspect of our economy.”
When FedNow goes live, 57 organisations including banks, payment companies and technology providers will be ready to start using the service, having completed a formal testing and certification process. This group includes 41 financial institutions, 15 service providers and the US Department of the Treasury.
Different from other instant payments services
FedNow is not the first instant payments service in the US. The Clearing House’s (TCH) RTP has been live since 2017. However, it is only available to federally insured institutions, whereas any depositary institution eligible to hold accounts at Federal Reserve banks can access FedNow. This means FedNow has the potential to create a much larger network effect.
That said, RTP has a significant head start and is accessible by banks and credit unions accounting for around 90% of the US’s demand deposit accounts. Take up has been relatively high, with around 65% of demand deposit account holders able to use instant payments powered by RTP via their institution, and usage is growing — the second quarter of 2023 saw a 12% volume and 18% value growth over the first quarter of 2023, according to the TCH.
The US also has other payment services, such as Zelle, Venmo and CashApp that are quick enough for the millions of customers using them, even if they do not clear and settle in real-time like FedNow and RTP. Zelle, owned by a consortium of banks, has a network of more than 1800 institutions offering its services via digital banking, meaning it is yet another sizeable alternative to FedNow.
Banks that have already expended resources to connect to these alternatives will mostly be reluctant to join FedNow straight away — they already have the ability to offer instant payments to customers via services that customers know and use. This means FedNow’s differentiators may not be as important as it first appears in terms of helping it gain ground at speed.
Connecting to FedNow is not simple
The majority of the more than 4000 banks in the US will not be connecting directly to FedNow; instead, they will be waiting for their core system providers to help them do so. Most of the largest providers, including Jack Henry, FIS and Fiserv are in the group ready to go live at or shortly after FedNow’s launch — however, there are other significant requirements banks must meet before they are ready to connect.
Key to institutions being prepared to start using FedNow are an understanding of what instant settlement will mean in terms of their liquidity needs and how to handle reconciliation in an ‘always on’ environment. Achieving this will require evaluating back-end processes and in some cases, system upgrades — and as the FedNow blog points out, neither of these happen quickly at most banks.
Additionally, getting compliance teams up to speed on how to manage and prevent the fraud that always comes with a new payment mechanism will be a significant undertaking for banks. The Fed has acknowledged this, as “the initial release of the FedNow Service will include features to help banks manage fraud risk and mitigate fraud losses”, according to Loretta J Mester, president and CEO of the Federal Reserve Bank of Cleveland. However, combating fraud is a constant process because it is continuously evolving, meaning banks need a long-term anti-fraud strategy for instant payments, as to work out how to use the Fed’s tools most effectively.
Such considerations are likely a major reason many banks opted not to join the first cohort of FedNow users, or were not ready to complete the testing and certification process.
FedNow’s use cases
For FedNow to achieve widespread adoption, it needs enough institutions to connect to create a network effect and for that to happen, they must see a reason to do so given the barriers outlined above.
The Fed always planned for the rollout of the new system to happen in phases, and has stated that functionality at launch will be a ‘baseline’ that facilitates several use cases including account-to-account payments and consumer-to-business bill pay. Jim Gillespie, chief product officer at Dragonfly, foresees high demand for solutions based on FedNow that make such transactions easier.
Unfortunately, due to the long-tail market of financial institutions and deliberately slow pace of change, I fear the launch will be less felt than the industry hopes for the next several years
“First, they will be adopted most quickly by consumers in situations where they make the process of payments easier. For example, an electrician completes work at your house … gives you their payment information … and you use your phone to pay them for the work on the spot. That’s a lot easier than mailing an invoice and waiting for a check to process, and it’s likely less expensive than a credit card payment,” he adds.
Future phases will address issues hindering greater customer adoption, such as interoperability between RTP and FedNow, and person-to-person payments initiated by a user alias such as a phone number or email, as well as additional use cases where transactions are known to be complex and/or expensive (such as cross-border payments), according to Ms Mester.
However, it should be remembered that FedNow is only the infrastructure and whether banks are able to launch services built on top of it that customers choose to use over methods such as card, cheque or automated clearing house transfer will only depend partly on FedNow’s functionality — it will also require institutions to have the creativity and resources to develop superior alternatives.
The long-term view
FedNow is an ambitious new payment rail, but everyone involved understands that it will take time to have any sort of significant impact due to the sheer size of the financial services market in the US and a widespread culture of risk avoidance.
Walt Cox, head of partner banking at Valley National Bank said: “FedNow is critical payment infrastructure allowing the US to finally move closer to the 70 plus other countries supporting real-time gross settlement capabilities. Unfortunately, due to the long-tail market of financial institutions and deliberately slow pace of change, I fear the launch will be less felt than the industry hopes for the next several years.”
In short, hopes for FedNow are high, but industry members and observers remain cautious. It will take major effort by both the Fed and the early adopters to ensure it gains traction.
