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After years of work, the US Federal Reserve has announced that its new 24/7/365 instant payment system has officially gone live. VIXIO discusses how the new payment system is expected to change the payments landscape, what can be expect from the service from day one and what comes next.
Last Thursday (July 20), the Fed announced the launch of its long-awaited instant payment service, FedNow.
FedNow has been in the making for nearly four years and, over the past year, the expectations have been set high regarding how the new payment rail will change payments and the US economy at large.
“We strongly believe that there are a lot of compelling reasons to support the real-time networks in the United States,” said Elspeth Bloodgood, product manager at core banking service provider Jack Henry.
Although “they are not going to support 100 percent of use cases”, it makes sense when businesses want to reduce next-day operational costs or when the consumer needs the instant availability of funds, Bloodgood added.
In line with the Fed's intentions, the initial release will focus on a core set of clearing and settlement functionality, along with some value-added features. However, more features and enhancements are expected to be added in the future.
One area of future development is interoperability with its private counterpart, The Clearing House’s (TCH) RTP network, as the two networks currently do not interact. This could become a significant hindrance in terms of reach that could have an impact on FedNow’s potential growth.
“Because they are not going to interoperate, that leaves institutions with questions about which ones they should be on. If they are going to be on any of them at all,” Bloodgood noted.
Although both networks have indicated a willingness to change this in time, it is unlikely to happen in the near term.
There is a lot of interest in the market for FedNow from banks of all sizes, especially as they geared up to the actual go-live date of the rail, Mihail Duta, director of global solutions consulting for Americas at Finastra, said.
This is reflected in the 120 institutions that took part in the FedNow pilot and the 57 entities that have been certified as “early adopters” of the network. They include 35 banks and credit unions, as well as the US Department of the Treasury and 16 service providers that support payment processing for banks and credit unions.
Although interest in the new instant payments service has been generally high, currently many institutions participate on a receive-only basis, meaning their customers cannot initiate an instant payment.
This is particularly the case with smaller institutions, while larger banks, such as Chase, Wells Fargo and US Bank, will connect in a sending capacity too.
“Businesses are interested in receiving funds faster but then the question arises if everybody is receiving who is sending?,” Duta pointed out.
Filling in the gaps
Although several media outlets describe FedNow as the first payment system reform in the past 40 years, that is not entirely true. Americans can already send money within seconds via the bank-owned TCH RTP network, which launched in 2017 with the vision of creating a ubiquitous instant payments network in the US.
But figures published by the TCH on the fifth anniversary of the service showed that RTP processed just 45m transactions in Q3 2022, despite 85 percent of banks and credit unions having technical access to it via providers such as Jack Henry, Finastra and others.
Having the infrastructure and the connectivity, however, does not necessarily mean financial institutions develop use cases and promote them to their customers.
The launch of FedNow may help give the necessary impetus for institutions to start developing those use cases as the awareness and interest in instant payments grow, thanks in part to the promotional efforts undertaken by the Fed.
Although RTP is owned by the largest US banks and is typically designed to meet the needs of big banks, FedNow has a stronger focus on helping encourage participation among smaller institutions, filling in the gaps within the industry.
“The Fed has a representative for every financial institution. They can walk in, they can hold their hands, they can assist them in filling out forms,” Bloodgood explained.
The Fed has made a lot of steps in recent years to educate businesses about the possibilities of the instant payments network, Bloodgood argued. As a result, the market has a more sophisticated understanding of instant payments now than when RTP launched five years ago.
Institutions are “seeing the momentum that’s been built by all the work that the Fed has done”, Bloodgood said.
“They are beginning to come to us and say ‘I need to figure out a way how to put this into my strategy’ instead of ‘what is instant payments’.”
This means that the time may be ripe for instant payments to really take off in the US, where FedNow and RTP can operate both complementary and competing networks.
“They are going to be in competition but that’s good,” Bloodgood said.
“RTP has a role,” Duta agreed. “It started five years ago and will continue to play a role in the instant payment space in the US.”
For instance, TCH announced last May that it is working with EBA CLEARING and SWIFT to develop a cross-border instant payments service, which is now in the pilot phase.
Larger institutions particularly may find this feature compelling, according to Bloodgood, and may choose to use the RTP rails over FedNow.
“In the US it is all about providing options — RTP is one option, FedNow is another option,” Duta pointed out.
There is precedent for having a private and a public option, such as the ACH or Fedwire and CHIPS, where wholesale payment rails "can sit side by side”, he added.
A long list of compelling use cases
There are a number of compelling use cases that experts believe FedNow will be able to support. However, many will likely only materialise when more institutions decide to join as a sender.
One of these cases is digital wallets, such as Square, Venmo and PayPal, which are the biggest use cases for The Clearing House’s RTP network today.
PayPal’s product management has suggested that users would be willing to pay between 1 and 1.5 percent of the transaction value to make payments instantly rather than waiting for one to three days for a normal cost-free ACH transfer.
“That means that people really want the availability to get funds and they want them right away,” Bloodgood pointed out.
Another use case is gig payments where Bloodgood said it is estimated that workers would pay 75 cents to move funds instantly.
Payroll and earned wage access (EWA) products are breakout use cases, said Bloodgood, noting this is one of the fastest growing payment segments. For example, Jack Henry figures show that payroll payments are growing 6 percent month-on-month across the RTP instant payment network.
But Bloodgood said she believes the US market “is behind the curve” on the send side where products have not yet been developed as opposed to integrations that allow large institutions to move high volumes.
“That’s the challenge for the industry to get products that leverage the instant payment rails to move those funds to those institutions that want and need them both for consumer and business payments.”
Experience on the RTP network, however, suggests that institutions have a growing appetite to experiment with various monetisation models such as flat fees, fees to the recipients, fees to the sender or interchange-type fees in a 1 to 1.5 percent range.
“There are monetisation opportunities, a lot of which is going to come in with ‘send’,” Bloodgood noted.
Until those opportunities unfold, the largest contributor to the growth of FedNow volumes is likely to be the US Treasury, which has joined as a full participant.
This will allow the government to send various payments associated with tax refunds, social security payments or disaster relief to institutions on the receive side. As such, the Treasury could become one of the largest senders at the beginning, Duta said.
Large institutions such as Chase, Wells Fargo and US Bank are also expected to contribute to volume in the early days.
On the horizon
Currently, many institutions that joined on the receive side are looking at other institutions and how adoption progresses.
As with any new network, financial institutions have to figure out the risks, such as scams, fraud, timing and several other risks related to the new service, Bloodgood said.
But the most important factor that can contribute to the success of FedNow is smaller businesses joining the network as senders.
In the beginning, people “are going to move slowly but as they find things they are comfortable with and where they can analyse the risk they are gonna move forward”, she said.
“I think it is going to be a hockey stick but we don’t know how long it’s going to be low before it starts to take on,” Bloodgood said, adding that she does not expect send applications to the Fed to rise until next year.
Additionally, FedNow is going to use the new ISO20022 messaging format, Duta noted. This is already making an impact in the US payments space.
“Banks are going to adjust to this new world of having a lot more data available to them and having a system to support that,” he added.
Although the RTP and the FedNow network do not use exactly the same messages, Bloodgood said there is a 95 percent overlap.
“I like to say the Fed speaks ISO with a Boston accent and RTP network speaks it with a New York accent.”
Over time, Duta expects the Fed to move into exploring the possibility of cross-border payments.
Duta said he is “fairly certain” the Fed is going to look at this area in the future.
