Monday, 18 January 2021

What Is FedNow?

What Is FedNow?
29 May

FedNow is a real-time gross settlement (RTGS) service proposed by the Federal Reserve that is intended to speed up payments for everyone. Essentially, it will serve as a faster alternative to the payment systems we know today — the automated clearing house (ACH), debit cards, checks and wire transfers.

It’s not a consumer-facing payment system that we’ll use to make payments rather than through our own banks, though. Rather, FedNow will reconfigure the back end of the payments system to expedite the process of sending payments. First announced in August 2019, FedNow is targeted to go live in 2023 or 2024.

How FedNow will work

FedNow, a project led by First Vice President of the Federal Reserve Bank of Boston, Kenneth C. Montgomery, will operate 24 hours a day, seven days a week, 365 days a year. This means consumers will no longer have to wait on business days to pass for payments to send. The Fed plans to make use of its existing connections to over 10,000 U.S. banking institutions to make this possible.

Here’s how the proposed FedNow payment system will work:

Consumers, or payment originators, will continue to communicate with our own financial institutions about the payments they want to send. In its early days, payments through FedNow will be limited to $25,000. Once the consumer has communicated the necessary information to the institution, the institution will then send the consumer’s payment information through the FedNow Service.

Then, FedNow will confirm with the receiving financial institution that the payment recipient’s, or beneficiary’s, information is valid. Once the payment’s associated information is settled between both banks, the payment can be cleared to move ahead. Its next stop is the beneficiary’s financial institution, which can then send the payment to the beneficiary.

FedNow will also have the capability to add descriptive information to a payment to denote remittances or invoices, for example, in compliance with an ISO® 20022 standard (an internationally agreed-upon standard platform for the development of online messages).

Why FedNow is necessary

For many Americans, waiting a few days for an online payment to clear is a mere inconvenience. But for the millions of Americans who live paycheck to paycheck, days-long waits for payments can be financially disastrous. FedNow is designed to help level the payments playing field.

For one, FedNow would cut out one of the major downsides to traditional banking — long payment wait times — and potentially bring people back to traditional banking. A recent MagnifyMoney survey found that 53% of Americans live paycheck to paycheck, which means they don’t have any money left over after all of their expenses are paid. In addition, the FDIC found that in 2017, 8.4 million American households were unbanked, meaning they don’t have a checking or savings account.

When these populations are forced to wait for their paycheck or bill payment to clear, it’s not just an inconvenience; it can mean the difference between putting food on the table or not or having the lights shut off. Missed bill payments also often lead to more fees and interest payments, digging a deeper financial rut. FedNow could eliminate this dangerous lag in payments and offer a safer banking environment for those who are currently unbanked or underbanked.

FedNow would also introduce some financing ease for individuals and small businesses. In the Federal Reserve’s announcement for FedNow, Federal Reserve Board Governor Lael Brainard acknowledged that a real-time payments system would be “especially important for households on fixed incomes or living paycheck to paycheck,” as well as for small businesses, which could then potentially avoid short-term financing options.

“Everyone deserves the same ability to make and receive payments immediately and securely, and every bank deserves the same opportunity to offer that service to its community,” Brainard said.

A real-time payments system would also prove invaluable in times of crisis. For example, during social distancing amid the coronavirus pandemic, online and cashless payments became king. Such a system would have offered a significant boost, especially when it came to sending out economic impact payments to American taxpayers. Instead of waiting weeks — or even months — for their stimulus checks, Americans could have received some financial relief immediately.

Why the Federal Reserve?

The Federal Reserve is more uniquely positioned to offer a real-time payments system than a private company. For one, the Fed is already connected to over 10,000 U.S. institutions. Through these connections, the Fed can provide equal service to banks both big and small. Private solutions could not offer the same kind of reach.

The Federal Reserve’s position would also allow it to continue fostering competition between institutions instead of removing it, which was important to organizations that weighed in on the proposed system. Additionally, commenters have observed that FedNow would “decrease market concentration and provide a neutral platform for innovation,” setting a benchmark from which other institutions could improve upon.

Effectively, the Fed is stepping in sooner rather than later to create a safe and secure model before a private — and inherently exclusive — real-time payment service pops up. The Fed also notes that a single private provider could pose “serious safety issues associated with a single point of failure.” In other words, access to more than one real-time payment system is crucial to avoid a total breakdown if one system were to shut down.

The response to FedNow

A widespread real-time payments system is unprecedented in the U.S.; however, Europe, Mexico and Australia already have their own real-time interbank payment systems in place. With so many players (big banks, small banks, consumers, the government and the Fed itself) everyone has an idea of how FedNow should — and shouldn’t — go.

Government’s response to FedNow

  • The Payment Modernization Act of 2019 was introduced in July 2019 requiring the Fed to create a real-time payments system.
  • The House of Representatives’ task force on Financial Technology has criticized FedNow’s $25,000 limit and target deadline of 2023 or 2024.

Just days before the Fed’s initial announcement on FedNow, the Payment Modernization Act of 2019 was introduced to the House by Rep. Ayanna Pressley, co-sponsored by Rep. Jesús “Chuy” García and Sens. Chris Van Hollen and Elizabeth Warren.

The Payment Modernization Act of 2019 was proposed to confirm that the Fed has the authority and therefore should build a real-time payments system. The act also includes assurances that the system would be fast, efficient and fair.

The act called to attention the Fed’s failing to create a real-time payments system, something its Faster Payments Task Force, launched in 2015, promised to do by 2020. In 2019, with no such solution in sight, the bill’s sponsors made their own move to push the Fed to action. About 10 days later, the Fed made its FedNow announcement.

Still, the U.S. House Committee on Financial Services Task Force on Financial Technology voiced some concerns regarding FedNow in a September 2019 hearing. Namely, the task force criticized FedNow’s low $25,000 limit and its long-term timeline. Still, the sponsors of the Payment Modernization Act of 2019 applauded the Fed’s announcement.

“I look forward to working with my colleagues on the Financial Services Committee to ensure that this system is implemented in a timely, transparent and responsible manner,” said Rep. Pressley. As for the act itself, it has not moved past its introduction in July.

Small banks’ response to FedNow

  • Small banks stand to benefit greatly from a Federal Reserve-led RTGS, as they could be left behind if private monopolies created the system instead.
  • Community banks highly value and trust the Federal Reserve and support FedNow.

With its ability to level the payments playing field across all institutions, FedNow has found support from small and community banks especially. Smaller banks are less likely than bigger banks to have the capital and resources to build their own real-time payments system. They could also be more easily excluded from a private real-time payments system that would be more likely to serve bigger institutions first.

In September 2019, at the House Committee’s task force hearing on FedNow, Bob Steen, chairman and CEO of Bridge Community Bank in Mount Vernon, Iowa, voiced community banks’ support of FedNow on behalf of the Independent Community Bankers of America. Recognizing that a real-time payments system “must create access for all institutions, regardless of size or charter type,” Steen noted that a private solution could not meet this goal.

“A real-time payments system is too important to be entrusted to a private monopoly,” he said. “The two dozen largest banks simply cannot own and operate the U.S. payments system.”

Further, Steen noted that community banks already put high value and trust in the Fed, which extends to its FedNow proposal.

Tech’s response to FedNow

  • TransferWise supports FedNow, as the Federal Reserve is in a uniquely central position to provide the service fairly and competitively.
  • Google encourages the Fed to model FedNow after India’s central bank’s RTGS, and suggests that FedNow must be inclusive, mobile-first, low-cost, simple and helpful.

Also present at the House Committee on Financial Services Task Force on Financial Technology hearing was Harsh Sinha, chief technology officer at TransferWise, a global international payments tech company. TransferWise has invested in its own real-time payments service to move money around the world, and currently, more than 20% of TransferWise payments are completed in less than 20 seconds.

Sinha recognized that it’s not easy to move money around, and that “both the private sector and Federal Reserve play a vital role” in the payments space. Still, Sinha noted that as a central bank, the Federal Reserve is uniquely placed to “guarantee ubiquity for financial institutions and inclusiveness for consumers,” as well as speed and longevity. He also noted that the payments system opens up direct participation to nonbanks, like increasingly popular neobanks, to help ensure competition and innovation, and “that financial institutions are incentivized to pass along the benefits of speed and lower costs to consumers.”

Tech giant Google also weighed in via a letter to the Federal Reserve from Google’s head of U.S. government affairs and public policy, Mark Isakowitz. In the letter, Google encourages the Fed to model FedNow after India’s real-time payments system, Unified Payments Interface (UPI). UPI was created and is run by the National Payments Corporation of India, a payments regulator governed by India’s central bank, which Google had worked with closely in the past.

Google attributes UPI’s “amazing results for banks, consumers, other players within the payments ecosystem and India’s central bank” to the fact that it’s an interbank transfer system that works in real time and is “open” to technology companies (like Google itself) creating applications to help users send money within the system. Google also recommended that FedNow prioritize low fees to promote accessibility and innovation.

Isakowitz also made sure to mention what online payments look like for Google, suggesting that the Fed would do well to include these considerations as well. “Industry and government should work together to grow ecosystems where payments are inclusive, opening up economic growth for everyone,” he wrote, adding that the future of digital payments is also mobile-first and “about making payments simple and helpful.”

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