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Fed Pulls Back the Curtain on Real-Time Payments Service

  • By Andrew Deichler
  • Published: 8/11/2020

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With COVID-19 relief payments expediting the need for faster transactions, the Federal Reserve Bank of Chicago has revealed new details on the FedNow Service. The central bank said that the system would be an interbank 24x7x365 gross settlement service with clearing functionality to support instant payments domestically.

FEDNOW

The Fed went into detail about why it chose to develop its own system after previously taking more of an advisory role in the faster payments space. The central bank pointed out that in the aftermath of its plan to improve the “speed, safety and efficiency” of payments in the United States, only one private sector entity established a real-time gross settlement service—The Clearing House’s Real Time Payments (RTP) Network. The Fed said that if real-time payments had only one provider in the U.S., it could pose significant risks to the payments system at large.

“In particular, the Board explained that a single private-sector service would face significant challenges in establishing an accessible infrastructure for instant payments with nationwide reach, would result in limited competition that could have negative effects on pricing and innovation, and could create a single point of failure in the nation’s instant payments infrastructure,” the Fed stressed.

And while the RTP Network has yet to come close to ubiquitous adoption, the Fed has relationships with more than 10,000 banks. The central bank believes that the reach it already has will bring instant payments closer to ubiquity.

However, not everyone is on board with the Fed’s decision to operate its own real-time system. PYMNTS noted that more than 2,200 of the comment letters that the Fed received from individuals argued that it should not be competing with the private sector. Many of the comments warned that the Fed’s system would lead to less innovation and competition.

The nation’s largest banks, which own The Clearing House, have been unsurprisingly critical, claiming that FedNow would slow adoption of real-time payments. However, smaller banks and credit unions have be hesitant to sign up for the RTP Network and may see promise in the Fed’s system.

Sarah Grotta, an analyst at Mercator Advisory Group, believes that while the Fed’s system will add competition and choice, it will also likely slow adoption. “There is also a danger of a two-tiered system, at least for a while, where large banks have their platform and smaller banks have theirs, until there is a competitive reason to offer both,” she told American Banker.

COVID RESPONSE

In a speech, Federal Reserve Board Governor Lael Brainard explained that the current crisis is driving the demand for real-time gross settlement. “The rapid expenditure of COVID emergency relief payments highlighted the critical importance of having a resilient instant payments infrastructure with nationwide reach, especially for households and small businesses with cash flow constraints,” she said.

Brainerd noted that after sharply reducing spending early in the COVID crisis, Americans greatly increased their purchases in the 10 days following the distribution of government relief payments. The urgency with which these emergency payments were spent highlights the importance of rapid access to funds, she said.

And it’s not just consumers that are asking for faster payments. Brainerd noted that in the nearly 200 letters the Fed received from key stakeholders, many indicated that they are eager to see the service go to market as quickly as possible.

On the corporate treasury side, the crisis has increased the calls for a full-scale migration to electronic payments, though not necessarily real-time. “Ultimately, when we come out of this, everybody needs to make an effort to push to electronic payments so that we can get rid of these checks,” noted AFP Chairman Bob Whitaker, CTP, senior vice president of corporate finance for DHL, in a recent Treasury in Practice Guide.

But while both businesses and consumers may want another instant payments system now, it will be some time before they get it. FedNow won’t be launching until 2023 or 2024.

The Fed is taking a phased approach to its rollout of the new system, similar to what Nacha did a few years ago with its Same Day ACH Service. The first release of the service will provide core clearing and settlement features to support market needs and help banks manage the transition. Based on stakeholder engagement, additional features will be added over time.

KEY FEATURES

Much like the initial versions of the RTP Network and Same Day ACH, payments will be capped at $25,000 when FedNow launches. The service will operate on a 24-hour business day, including weekends and holidays. In addition to payments, the service will also support the transfer of remittance information.

The Fed noted that because the service processes and settles each transaction on a 24x7x365 basis, participants will need adequate funds or available credit in their accounts at all times to settle transactions. In some circumstances, participating banks may supply liquidity to users facing a shortfall through a servicelike Fedwire Funds. However, when those services are closed, an alternative source of liquidity may be needed. As such, FedNow will provide a liquidity management tool to support both FedNow and the RTP network.

One of the primary concerns from stakeholders was around payments fraud and how the new system would address it. Brainerd noted that to reduce fraud, participating banks will be able to limit transaction activity based on the knowledge of their own customers’ history. She added that as the Fed gathers more insights from banks’ usage of the service, more fraud tools may be implemented.

Additionally, given that the Fed’s goal is to achieve nationwide reach for FedNow and be interoperable with RTP and any other real-time networks that could emerge, the service will use the ISO 20022 standard.

One of the most interesting features of FedNow is that it allows participants the option to only receive payments and not originate them. According to Nick Stanescu, FedNow Service business executive, the decision to add this feature emerged late in the development process. “It was, in large part, in response to the feedback that we have received during our listening tour from financial institutions of all sizes,” he said. “And we made this call to allow receive-only participants, in order to support financial institutions that are looking to add functionality for the end-users in a phased approach. This functionality allows the additional benefit allowing for less restriction on adoption and allows the FedNow network to grow faster.”

The Fed’s phased approach enables the central bank to gradually roll out more functionality for the service, Stanescu added. For example, the Fed envisions support for alias-based payments, in which a payment can be sent to a recipient using an email address or a phone number. These types of payments are “high-priority” items for later phases, as are extended remittance information and fraud mitigation tools, he said.

LOOKING AHEAD

Though the current crisis added to the sense of urgency for FedNow, the Fed remains committed to 2023-2024 as its targeted time of release. That feels like a long way off, so the Fed will continue to provide updates on its progress leading up to that time, Stanescu said. Closer to the release, the central bank will announce a specific timeframe for launch.

In the meantime, he encourages corporate treasury departments to get involved in the FedNow community, so that they can educate themselves on instant payments and to start making a plan for adopting FedNow. “Ultimately, it's that first step about staying educated on instant payments that will help them in developing their instant payments strategy,” he said. “They should start evaluating, from a planning perspective, the various types of changes that will need to happen within their infrastructure to support and offer instant payments of up to 24 hours a day, seven days a week, 365 days a year.”

For more insights on FedNow and real-time payments, don’t miss The Top 5 Reasons Your Business Needs Faster Payments Today, which is part of the Payments session track at AFP 2020. Register for AFP 2020 here.

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