The Federal Reserve is finally stepping into the real-time payments arena.

By Todd Beauchamp, Loyal T. Horsley, and Deric Behar

On August 5, 2019, the Board of Governors of the US Federal Reserve System (the Fed) announced that it plans to roll out a real-time payment and settlement service by 2023 or 2024. The service, named FedNow, is being developed with the stated goal of modernizing the national payment system. Facing political and societal pressure to upgrade the national payment system, the Fed sought comment on the development of a faster payment service in late 2018. After receiving more than 350 comments, the Fed is now moving forward and seeking additional comment on the best way to design the system so that it maximizes inclusivity and utility for all stakeholders. The Fed envisions that FedNow will capitalize on its nationwide infrastructure to provide consumers, businesses, and banks the ability to safely make and receive immediate and fully settled payments 24 hours a day, seven days a week.

Funds in transit will no longer have to suffer in limbo

FedNow is based on the concept of Real-Time Gross Settlement (RTGS), for which interbank settlement happens on a payment-by-payment basis, with interbank settlement and clearing functionality. Under FedNow, banks will be able to settle payments instantly through credits and debits to their accounts with the applicable Federal Reserve Bank. The Fed plans to develop the interbank settlement service while “other parties, such as banks, payment processors, and providers of payment services, could develop end-user and auxiliary services that build upon the core functionality.” The benefits are manifold: businesses will be able to process transactions and see real-time posting of payments for their goods or services; the risks to businesses and individuals of payments “bouncing” is greatly reduced; low- or fixed-income individuals who need immediate access to their paycheck funds will hopefully experience fewer overdrafts and late payments (and fewer attendant penalties); and the use of short-term financing and high-interest payday lenders, viewed by many as exploitative, could be reduced.

Is FedNow friend or foe? Depends on whom you ask

The Fed is certainly not the first central bank to recognize the importance of a real-time national payment system. Many other developed economies already have one in place, including the United Kingdom, Japan, Mexico, and Australia. While the US’s entry into this space is welcome (if not overdue), the four-to-five-year implementation target for FedNow is a bit protracted. Notably, while the US government is just entering this space, a private-sector real-time payment service owned by many of the world’s largest banks — The Clearing House Payments Company LLC’s Real Time Payments (RTP) system — has been operational in the US since 2017. While the Fed stated that it does not seek to undermine the private-sector system — instead aiming to provide a competitive choice to stakeholders in an effort to “promote [banking system] resiliency through redundancy” — FedNow could have a major impact on RTP’s adoption and growth. On the one hand, automated clearing house (ACH) operations provide a degree of comfort, since both the Fed and The Clearing House currently operate ACH services in relative harmony. However, the Fed indicated that interoperability between RTP and FedNow was not a priority for the initial FedNow launch. Many stakeholders believe the systems should be interoperable to achieve safety and resiliency through redundancy, and it is likely that such feedback will be provided to the Fed during the current comment phase.