The US Federal Reserve (Fed) is preparing to launch a new financial network that would eliminate any wait time for sending and receiving payments. The system is now being tested by more than 100 market participants.
The FedNow Service, which has been in pilot since Jan. 2021, is planned to launch in July.
“It’s a game changer for some businesses,” said Debbie Buckland, a director analyst for financial services at research firm Gartner. “It’s the first Federal Reserve-sponsored real-time system.”
What is FedNow?
In simple terms, FedNow is Zelle for banks and businesses — a digital payments network based on federally insured accounts that can be debited for payments.
FedNow will allow businesses to bill a customer for parts or services and receive that money instantly, instead of waiting hours or days, as they must today.
For example, an insurance company can send a request-to-pay message to a customer. The customer receives that message through their digital banking application, and they can then view the bill and select to pay it. The FedNow system instantly debits the customer’s account and pays the insurance company in real time.
FedNow helps with reconciliation, because when the recipient receives the payment, it also gets information about who sent the payment and for what reason — in this example, an insurance premium payment.
FedNow would be especially useful for accelerating supply chain payments because it increases liquidity. That liquidity is helpful for supply chain participants — especially small businesses — who in tough economic times would benefit from instant payments for parts supplied for manufacturing.
“It helps small businesses because they’re receiving instant liquidity,” Buckland said. “They don’t have to wait for three or four days, and it’s good for the consumer paying the bill, because they’re not accruing late fees because the business sent them a request for payment prior to the due date expiring.”
Any transaction would fail if there are no funds in a primary or linked account for payment purposes.
Guaranteeing transaction authenticity
The US is among the last nations to implement a real-time payments network based on a central bank system, according to Buckland. Canada is also currently rolling out a real-time rail (RTR) payment and settlement network for banks and businesses.
Up until now, some banks have been reluctant to use a real-time payment and settlement system that wasn’t backed by the Federal Reserve banking system, Buckland said. This would guarantee the authenticity of a transaction.
The FedNow real-time payment and settlement service will incorporate clearing functionality into each payment, allowing banks and businesses using it to instantly determine if the payor has the funds to cover a purchase.
“If I’m sending money to you, that money is deposited into your account from mine, and it’s instantly available,” Buckland said. The opposite is also true. If you charge someone for a service, that money is instantly debited from their account.
FedNow will run on the Fed’s FedLine, an IP-based network and messaging system that currently provides payment and information services to more than 10,000 financial organizations.
"With the launch drawing near, we urge financial institutions and their industry partners to move full steam ahead with preparations to join the FedNow Service,” said Ken Montgomery, first vice president of the Federal Reserve Bank of Boston and FedNow program executive.
What businesses need to do now
Early adopters will have to complete a testing and certification program to prepare for sending live transactions through the system.
More than 110 banks piloted the settlement system, including BNY Mellon, Citi, Capital One Financial, Goldman Sachs, JP Morgan Chase, TD Bank, U.S. Bancorp, U.S. Department of the Treasury’s Bureau of the Fiscal Service, and Wells Fargo, according to the FedNow Pilot Program.
Buckland suggests that businesses start considering how they can use a real-time payment and settlement system. For example, are your customers younger in age and are they more often late in paying bills than others? Would an instant billing and payment system be beneficial to both business and consumer?
“We really believe that age of your customer drives which payment rail they’ll use,” she said.
Businesses can also find creative ways of using an instant payment network. For example, contracted and gig workers could be paid once a task is completed instead of waiting to be paid on the 15th and 30th of each month.
“This can also be used by companies to retain workers, because rather than paying twice a month, you can pay at more regular intervals, such as at the end of a shift,” Buckland said.
FedNow or other payment networks?
There are two primary differences between FedNow and traditional payment systems — automated clearinghouse services (ACH) and wire transfers, such as Western Union or the Fed’s own Fedwire service. ACH transactions settle just once at the end of a business day. Wire transfers are faster but charge user fees. Wires are also not used for multiple or batch transactions, and they’re still not real time; they can take several minutes or several days for remittances or cross-border payments.
FedNow is not a replacement for existing ACH and wire networks, but an additional payment rail when real-time payments and settlements are needed. There will be a fee for the FedNow Service, as well.
The Federal Reserve has been investigating more than one way to create a real-time payment system. It is also investigating the potential of a central bank digital currency (CBDC) as the backbone for a new, secure real-time payments and settlements system.
In Feb. 2020, the Federal Reserve began considering a Central Bank Digital Currency as the backbone for a new, secure real-time payments and settlements system.
The move toward a form of government-backed digital currency is being driven by fintech firms and a banking industry already piloting or planning to pilot cash-backed digital tokens, according to Lael Brainard, a member of the US Federal Reserve's Board of Governors.
US payment fintech companies plan to use a Fed-backed real-time payment system to build new products and services to compete against banks, according to a Gartner report. “Banking leaders need to adopt real-time payments quickly to maintain competitive advantage in an evolving field,” the company said.
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