An innovative payment service has just made its debut in the finance sector.
The US Federal Reserve has introduced FedNow; a new instant payment platform that will facilitate transactions at any given time. This is distinct from other customer-centric payment services like Venmo or Zelle in that its implementation hinges on the adoption by banking institutions.
This is the inaugural real-time payment system from the US central bank. It could potentially transform the landscape of how both businesses and individuals execute and accept payments. However, its reception has been mixed, with not all parties fully ready or enthusiastic to embrace this transition.
What is FedNow?
FedNow is the Federal Reserve’s innovative real-time payment service. It allows patrons of participating banks and credit unions to transfer and receive funds within mere seconds, round-the-clock, and every day of the week.
This opens up the opportunity for financial transactions to be finalized on weekends, holidays, and beyond typical banking hours. FedNow offers a flexibility that conventional online transfers via the Automated Clearing House (ACH) Network currently don’t provide. ACH transfers, which operate in batch mode, typically require one to three business days for completion.
In the words of Federal Reserve Chair Jerome Powell, presented to the House Financial Services Committee on March 8, “FedNow will enable all banks in the United States — irrespective of their size — to offer real-time payments and instant fund availability to their customers.”
FedNow is accessible to all banks and credit unions. However, participation is not mandatory. Also, while direct usage of FedNow isn’t available for consumers, businesses, and non-bank payment service providers, they can engage with the service via a participating financial institution. Digital-first banks and payment aggregators will be required to establish a partnership with a participant bank to avail the service.
How Does FedNow Differ from Conventional Payments?
FedNow effectively turns the traditional concept of ACH payments on its head by facilitating “instantaneous” transactions. Under the Federal Reserve’s definition, payments between banks usually necessitate two key procedures: clearing and settlement. FedNow executes these processes in mere seconds.
In terms of cost, similar to other services provided by the Federal Reserve, FedNow imposes fees on participating institutions. However, whether these costs will be transferred to customers remains to be seen.
As for transaction limitations, the Federal Reserve restricts transfer amounts to a ceiling of $500,000. They also set a default transfer limit of $100,000 for a financial institution, which can subsequently adjust this limit upwards or downwards.
For now, FedNow only caters to domestic payments between U.S. financial institutions. For those who need to make overseas transactions, wire transfers through a bank or money transfer firm or multi-currency accounts for long-term travelers are advisable.
Despite the novelty of FedNow, we must temper our expectations for its immediate impact. Initially, only 57 organizations support the system. Many of them operate in a “receive only” mode, allowing customers to receive but not send money.
Moreover, it’s important to note that the adoption of FedNow is completely voluntary. This stands in contrast to countries like India or Brazil, where the central bank has made the use of the official instant-payments system compulsory. However, given the Federal Reserve’s push for its adoption, it’s reasonable to anticipate a surge in the popularity of instant payments in the forthcoming years.
How Will FedNow Impact Banks?
Instantaneous payments pose certain challenges for financial institutions. For instance, when a payment is initiated on a Monday and reaches the recipient’s account by Thursday, the sending or receiving bank capitalizes on the interim interest, not the customers involved.
The availability of round-the-clock payments further compounds the threat of bank runs. Customers may instantly transfer up to $1 million from their accounts at any time, even when the bank is closed. Thus, there could be a substantial acceleration in the rate of deposit withdrawals. Furthermore, the frequent use of peer-to-peer payments for unauthorized activities is a cause for concern among banks.
Additionally, it’s important to note that FedNow is not a consumer-focused product in the same vein as Venmo or Zelle. It operates more as an infrastructural framework in the background.
To level the playing field with countries like India in terms of instant payment systems, numerous U.S. financial services companies will need to invest significant effort and capital. This must be done to upgrade applications and infrastructure in order to accommodate this new technology. Costs could reach into the millions, even for smaller institutions.
Growing Pains to be Expected
Banks face a considerable learning curve with the implementation of FedNow. The new system might equip smaller banks with advanced technological capabilities to compete with larger institutions. But, it could also erode revenue streams for all financial institutions. Consumers and businesses may choose to use the new payment system over traditional credit and debit cards.
But, from the perspective of consumers and businesses, the introduction of the efficient FedNow system may well result in a gradual reduction of payment costs. This is partially due to the stimulated competition within the payments industry.
This means users will gain increased access to cost-effective and rapid payment options. Thus, FedNow would enhance their ability to manage cash flow with improved efficiency. This will be particularly beneficial for small businesses, as it offers them the opportunity to mitigate payment delays and decrease operational costs associated with payment handling.
Several industry executives anticipate a rather unobtrusive initial launch, followed by a more substantial promotional push later in the year. The system’s successful implementation will largely depend on the number of banks that decide to participate.
Early adopters, as acknowledged by the Federal Reserve, include major banks such as JPMorgan Chase, Wells Fargo, BNY Mellon, and U.S. Bank. The list also contains a selection of smaller financial institutions, such as Bridge Community Bank, First Internet Bank of Indiana, and Quad City Bank & Trust.