FedNow and Instant Payments for America

Just four weeks ago the Federal Reserve switched on their new instant payment system, FedNow. The service has been designed to help make everyday payments faster and more convenient by giving consumers and businesses the ability to send and receive payments instantly.   

Banks and credit unions of all sizes can now sign up to use the new inter-bank payment system to instantly transfer money for their customers, any time of the day, any day of the year. And currently there are 35 banks and credit unions, 16 payments processors, along with the U.S. Department of the Treasury’s Bureau of the Fiscal Service who are FedNow-ready.    

FedNow’s features closely follow those of RTP (Real Time Payments), which are operated by The Clearing House but are available only to larger banks and institutions. Real-time funding has been available in the U.S. since 2017, so the concept of instant payments isn’t particularly new or groundbreaking – but access to this speed of funding, and the prospect of a secure, centralized system available to all financial institutions, regardless of size, certainly is.   

Does that mean we can all now expect instant payments? Not quite. Like all recent payment innovations in the U.S., adoption of FedNow will be gradual. The financial services market in the U.S. is as large as it is complicated, and there are many players to contend with. But the demand from merchants and consumers is here, and so is the support from the Federal Reserve, so we should see increased access to instant payments over the next two to three years.   

Why Are People No Longer Happy to Wait for Their Money to Clear Through Financial Systems?

Over the past five years demand for real-time payments has steadily risen, and it continues to accelerate.   

As U.S. businesses navigate supply chain complexity, tight labor markets and rising costs, 62% noted cash flow management as one of their most impactful challenges and reported a need for greater flexibility and speed in their payment options.¹

Recommended:10 Key Questions: MORAL MONEY SUMMIT ASIA 2023

We are already seeing an increased demand for real-time payments from our merchant customers.

People are no longer happy to wait for their funds to clear through financial systems, and businesses are looking for options that provide more control over their day-to-day cashflow. The gig economy also continues to drive speed of service expectations amongst U.S. consumers and businesses: DoorDash advertises that they pay their drivers daily, while apps like Zelle and Venmo already allow for sending money to businesses and consumers in almost real-time.   

Getting money faster will be a game changer for merchants and their consumers. Faster access to funds increases liquidity and reduces the need for short term credit to cover expenses while waiting for receivables. For a vendor or service provider, the prospect of being paid instantly is incredibly powerful. Meanwhile, for the business owner, the flexibility of 24/7/365 service allows for consistent, timely payments to key vendors and partners. It is important to note the FedNow service is only for retail-based payments, and to those using a FedNow-ready financial institution.    

In the consumer-to-consumer or person-to-person payments space there are many established providers, much trusted by consumers for their speed and ease.

However, with business-to-business payments, the availability of established providers has lagged – when this is where it is needed most.

Think about small businesses like a restaurant, for example. In a typical week the restaurant owner needs to pay their vendors on a Monday or Tuesday, but they don’t typically get a lot of diners on those days, as they make 90% of their weekly takings during the weekend. Currently that restaurant is faced with the prospect of paying their vendors late each week as they must wait until Tuesday or Wednesday to see the weekend’s takings in their business account.

But with FedNow, it will be possible for this restaurant to access funds on any day, allowing them to pay out to vendors and employees much more quickly.   

Will FedNow Replace Zelle and Venmo? 

Zelle and Venmo are closed loop systems, which means they provide their services only to people within their network, supporting consumer-to-consumer or person-to-person payments rather than business-to-business payments. Conversely, FedNow is a secure, centralized system built to allow open, consistent access to all banks, financial institutions and payments processors once they have completed the necessary integration work – which will serve both consumer and business payments. Consumers will be able to use FedNow as another option for sending money to friends and family and we will see more innovation in the person-to-person payments space. In the meantime, Venmo and Zelle will remain popular with consumers, and may even benefit from using the FedNow service in future.   

A key consideration with consumer-to-consumer payments is funds protection. Unlike FedNow, many money transfer providers are currently unable to insure funds being transferred. But under the Federal Reserve’s new system, both payers and payees have greater peace of mind that their funds are being transferred not only quickly, but also safely and securely. The fact that the FedNow service is both regulated and protected by the Federal Reserve brings another level of comfort and clarity for financial institutions and their business customers.

Faster Payments Are a Game Changer

The wider availability of instant payments is set to change the way we think about cashflow, fraud prevention, and the overall pace of business. Historically businesses large and small have operated with the concept of a one- or two-day float – so settlement lags, and the requisite cashflow challenges they present, have been tolerated up until now. But that will all change with the wider adoption of FedNow, as it will compel financial institutions to upgrade their infrastructure to be able to move and settle money 24 hours a day, seven days a week.   

The main challenges with adopting the new system will be in establishing effective fraud monitoring and prevention controls, alongside resourcing the technical and business process redesign work required to integrate and adopt FedNow.   

Current delays in payment processing and funds settlement are the result of existing longstanding business processes, not to mention the time needed to review transactions for potentially fraudulent activity. And while the advent of artificial intelligence and machine learning are making great strides in improving fraud detection at financial institutions, the complexity in delivering a payments service at the faster pace FedNow demands should not be underestimated.   

The systems change and business process redesign needed for FedNow integration may take a financial institution anywhere between 12-36 months to implement, depending on their available in-house expertise. But the bigger shift will be from a business operations perspective. Many CFOs are trained to expect money to move at a certain pace – accelerating that pace will force businesses to change their mindset and the way they operate around money movement.    

As payment systems get faster, initiatives like FedNow are changing not only the speed of when people and businesses can access their money, but also the overall pace of business. Like Fedwire, FedACH, and RTP which came before it, FedNow is the next natural step in the evolution of faster payments for America – and while it is surprising that it hasn’t happened sooner, it is most certainly welcome.

Reference:

¹ Study: Business, Consumer Appetite for Faster Payment Options Grows – FedPayments Improvement