18 Apr What is FedNow?
Why is the Federal Reserve Bank developing FedNow?
Why is the Federal Reserve Bank developing FedNow?Instant payments are one of the fastest-growing forms of digital payments, with a projected compound annual growth rate of 23.6 percent from 2020 to 2025. Central banks in more than 50 countries have already implemented instant payment networks that support the immediate posting and settlement of funds.
U.S. consumers and corporations can already access instant payments via Zelle and the RTP® Network; these are both privately held systems, owned and operated by Early Warning Services, LLC and The Clearing House, respectively. The Fed first began to explore the possibility of introducing a centrally owned and operated instant payments network in 2013 and formed the Faster Payments Task Force (FPTF) in 2015 to identify opportunities to implement instant payments.
In its final report, published in 2017, the FPTF overwhelmingly ruled in favor of establishing a network and issued recommendations to support successful implementation. In 2018, the U.S. Treasury offered its official support for an instant payments network, and in 2019, the Federal Reserve Board announced that it would begin developing the FedNow Service.
Ultimately, the Fed is developing FedNow in the interest of enabling financial institutions of all sizes across the U.S. to provide safe and efficient instant payment services to customers.
Through financial institutions participating in the FedNow Service, businesses and individuals can send and receive instant payments in real time, around the clock, every day of the year. Financial institutions and their service providers can use the service to provide innovative instant payment services to customers, and recipients will have full access to funds immediately, allowing for greater financial flexibility when making time-sensitive payments.
The FedNow Service will be deployed in phases, with the initial launch taking place July 2023.
The video below follows a payment over the FedNow Service from start to finish, highlighting what financial institutions need to know about their role in the process.
What is FedNow?
FedNow is the Federal Reserve’s new instant payment service that will enable customers at participating banks and credit unions to send and receive money within seconds, 24/7 and every day. You’d be able to complete payments or transfers on weekends, holidays and after banks’ business hours, which isn’t the case for standard online transfers such as those through the Automated Clearing House Network. ACH transfers are processed in batches and tend to take one to three business days to complete.
“What FedNow will do is it will enable all the banks, any bank in the United States — not just the big ones — to offer instantly available funds and real-time payments to their customers,” said Fed Chair Jerome Powell before the House Financial Services Committee on March 8.
FedNow will be available to all banks and credit unions, but there’s no requirement for them to join. Consumers, businesses and non-bank payment providers won’t be able to use FedNow directly, but they can through a participating financial institution. Neobanks, which aren’t banks, would need to partner with a participant bank.
How FedNow works
Payments between banks typically require clearing and settlement. Clearing means that banks exchange information about a payment and can include other activities such as checking for fraud. Settlement involves moving money to the recipient’s account. FedNow will make clearing and settlement occur within seconds, according to the Fed.
Transfer speed: Instant. The Fed defines an instant payment as a recipient having full access to funds within seconds of the payment being sent.
Cost: As with other Fed payment services, FedNow will charge fees to its participating institutions, but it’s unclear if banks will pass on FedNow costs to its customers.
Amount limits: The Fed will cap transfer amounts at $500,000 and set the default transfer limit at $100,000 for a financial institution, which can raise or lower its limits.
Other limits: FedNow will be initially limited to domestic payments between U.S. financial institutions. Consider wire transfers through a bank or money transfer firm — or multicurrency accounts for long-term travelers — if you need to make overseas transactions.
Two uses for FedNow at its launch include bill payments and account-to-account transfers. Being able to send money instantly could be helpful, especially if you’re on a tight budget and susceptible to late payment fees.
You could pay right when a bill is due and receive immediate confirmation that a payment is accepted. And there’s no risk of overdrawing your bank account or paying overdraft fees since your bank has to verify sufficient funds before initiating an instant payment. Instant account-to-account transfers would allow you to manage your accounts across banks easily.
Why FedNow matters
FedNow is not the first real-time payments service in the U.S., but it will likely expand the reach of instant payments to more institutions nationwide. The Fed already provides access to its payment services to more than 10,000 banks and credit unions, either directly or through an intermediary. In contrast, the privately owned entity The Clearing House has operated the RTP network for real-time payments since 2017, but only about 300 financial institutions participate. The RTP network is available to nearly any bank or credit union.
Peter Tapling, payments industry consultant and managing director of PTap Advisory, LLC, speculates that FedNow adoption among financial institutions will take time. One promising sign, he said in an email, is that the U.S. Department of Treasury’s Bureau of Fiscal Service is on the list of participants in FedNow’s pilot program. The department is responsible for issuing payments, such as tax refunds and Social Security benefits, to the public on behalf of the federal government, among other financial operations. The U.S. Treasury’s use of FedNow, Tapling said, may create urgency for more banks to join the service once it’s available
What does a FedNow payments flow look like?
The general process is as follows:
- A payer initiates a payment by sending a payments message to their financial institution through an end-user interface outside of FedNow.
- The payer’s financial institution receives the payments instruction and, provided the payer has sufficient funds in their account, authorizes the transaction.
- The payer’s financial institution submits a payments message to the FedNow Service.
- FedNow validates the payments message and sends the contents of that message on to the payee’s financial institution for acceptance or rejection.
- The payee’s financial institution sends a response to FedNow either accepting or rejecting the payments message. If the payee’s financial institution rejects the message, FedNow will notify the payer’s financial institution of payments failure. If the payee’s financial institution accepts the message, FedNow automatically deducts funds from the payer’s account and posts them to the payee’s account.
- FedNow notifies all parties of the successful transfer of funds, and the transaction is complete.
How will financial institutions benefit from FedNow?
The Fed’s announcement of its plans to launch the FedNow Service has generated positive reactions in the industry, with the general consensus that the new service will be a positive driver for faster instant payments adoption in the market.
FedNow is expected to:
- Make instant payments technology accessible to a wider audience, including smaller community banks, thereby increasing equitable access for all businesses and individuals
- Reduce overall payment processing costs for banks and other non-bank financial institutions
- Provide individuals with instant access to paychecks and other electronic fund transfers for improved cash flow management
- Optimize liquidity management and cash flow forecasting for businesses, enabling them to better manage operational expenses and maintain positive vendor relationships
- Conform to the new ISO 20022 standard, enabling participants to send and receive rich data, including non-value message types and RfP messages
- Promote instant payments security through the development of industry-wide standards for disputing fraudulent transfers, ISO 20022 conformity and the use of payments authentication
Will FedNow replace the ACH Network?
No, FedNow will not replace the Automated Clearing House Network (ACH); instead, it is expected to complement ACH services.
A bit of background: ACH is a U.S.-based electronic funds transfer network for consumers, businesses, and federal, state and local governments. It is commonly used to complete direct deposit and direct payment transactions. ACH transfers typically take anywhere from one to three business days to complete.
The National Automated Clearing House Associations, or NACHA — the organization responsible for ACH governance — introduced Same Day ACH in 2016. As its name implies, Same Day ACH posts and settles payments the same day that they’re initiated — a significant improvement, but not exactly immediate. For this reason, Same Day ACH is considered a faster payments system rather than an instant payments system.
Rather than replace ACH or Same Day ACH, FedNow is expected to provide greater redundancy for payment operations, thereby preventing any potential payment network bottlenecks. In the longer term, the Fed intends to establish payments interoperability between FedNow and ACH.
CURATED BY OZZIE SMALL
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