The rollout of the FedNow Service is only the beginning of the journey. Enhancements will be made to the FedNow Service over time to support safety, resiliency, and innovation. There are several items on the agenda after the official rollout. Some of these are near- to medium-term efforts and others longer-term considerations. So let me conclude with a few of these.
Growing the number of financial institutions using the FedNow Service
Since the value of a payment service ultimately depends on the number of users, the Fed will be focused on growing the number of institutions that use the FedNow Service for sending and receiving payments. The U.S. does not have a mandate that financial institutions offer the service, unlike other countries, including Brazil, which mandated that banks offer its Pix instant payments service. In addition, we have a complex financial industry, with a variety of different types and sizes of institutions. For many financial institutions, getting ready to use FedNow will take some investment. Some organizations will need to upgrade older payment infrastructures, accounting procedures, and other back-office processes to accommodate the expanded 24×7 operating hours. But these investments will allow them to offer this new instant payment service to customers, who are increasingly demanding faster payments.
Educating the public and financial institutions: Fraud mitigation and depositor runs
Growing the network will also require increasing public awareness so that it understands not only the benefits of instant payments but also the implications of fast finality of payments. Financial institutions that participate in FedNow, as in other payment services, serve as a primary line of defense in protecting their customers against fraud. The initial release of the FedNow Service will include features to help banks manage fraud risk and mitigate fraud losses. It will include tools that allow participants to reject payments to and from accounts they have designated as suspicious and to put limits on the amount of the transaction. In addition, there will be tools that help a financial institution investigate erroneous or suspected fraudulent transactions. Combating fraud is a dynamic endeavor, so the service will be offering more fraud-prevention tools over time.
Educating financial institutions about the value of the service and all tools offered within the service is also on the agenda. For example, in the aftermath of the bank closures earlier this year, some have raised concerns that the ability to move money quickly at all times of the day and night might exacerbate a bank run. It is true that FedNow and other payment services can be used to move money; however, banks have tools they could use to mitigate large outflows of deposits. For example, within FedNow they could lower their transaction limit, restrict access to the service to certain non-wholesale customers, or change to “receive payments only” status. They could also design their own controls to limit the total volume of transfers to manage their risks while serving their customers. Future releases of the FedNow Service may allow configurable transaction limits by customer type, if such limits are deemed useful. In addition to a bank being able to borrow from the Fed during the hours the discount window is open, a bank could use liquidity management transfers to replenish its master account balance from private funding sources on the weekend when the discount window is not accessible, which would help to mitigate the effects of deposit outflows on the health of the bank.
Interoperability
Another issue on the agenda is interoperability. The Fed is committed to working toward interoperability between instant payment systems. FedNow is designed on the ISO 20022 standard, which is already used by RTP and other payment systems globally, and that will help support interoperability through routing. Payment industry stakeholders have told us they want a real-time payment capability so that any payer can reach any payee, regardless of which faster payment system their banks use. Such interoperability has not always been a given in the U.S.; it took decades to achieve that for ACH and credit and debit cards and no doubt it will be a challenge for instant payments. But the Fed continues to engage with RTP to discuss how best to accomplish this goal.
Person-to-person and cross-border payments
Financial institutions would like to be able to use FedNow to offer person-to-person (P2P) payment services whereby customers can originate a payment using an alias such as an email address or phone number. The initial release of FedNow will not include a directory service that would be needed for P2P payments. Instead, a bank could use a private-sector directory to access routing information in order to transmit alias-based payments on FedNow. The Fed is looking at various approaches to provide alias-based payments as a way to enhance the FedNow Service in the future.
Another use case is cross-border payments. There continue to be frictions in moving retail payments across borders. FedNow is for domestic payments, but it has the potential to be used for cross-border payments in the future if legal, policy, and operational challenges can be solved.
Payment rails
A longer-run issue has to do with the payment rails themselves. It seems likely that over time those payments that are time-sensitive will shift from the traditional payment rails of check, ACH, and wire to the instant payment rails of FedNow and RTP. The timing and extent of such movements across payment rails are difficult to predict and will be affected by the pricing of payments services by market participants, as well as other factors. In thinking about the evolution of the payment rails, it may seem more efficient to have fewer rails for smaller-transaction payments, but those efficiencies need to be balanced with ensuring that the payment system has sufficient redundancy to remain resilient.
Conclusion
A well-functioning and secure payment system is vital to our economy. As we modernize the payment system, it is important to remember that the foundation of a successful payment system is the public’s confidence in it. The public needs to be confident that the system will be: available whenever the customer needs it; efficient at routing and settling payments; resilient against cyberattacks and fraudulent actors; and reliable without the public having to know the intricacies of the infrastructure behind it. As the payment system evolves, the Fed, the industry, and end users will need to continue to collaborate to ensure that the modern payment system lives up to its promise of being efficient, safe, resilient, and available to all. That’s the best way to maintain the confidence of the public the Fed serves.
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July 13, 2023 at 03:00AM
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An Update on the Federal Reserve's Instant Payments Service: FedNow® - Federal Reserve Bank of Cleveland
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