Better Late Than Never: Federal Reserve Platform Will Finally Bring Instant Payments To More Banks–And Customers

After a decade of study and development, the Federal Reserve is finally launching FedNow, a system that could eventually mean businesses and consumers have near instant access to payments (including paychecks) and money moved between financial accounts.

Back in 2017, The Clearing House, a consortium of the nation’s largest banks, including JPMorgan Chase
JPM
and Bank of America
BAC
, rolled out its own high speed money transfer system, the Real Time Payments Network (RTP). But so far the volume of money RTP is moving is comparatively miniscule. In the first quarter, $26 billion was transferred over RTP, equal to 0.13% compared to the $19.7 trillion sent over the nation’s dominant Automated Clearing House, which takes between one to three business days to move money. ACH is typically used to pay recurring bills, paycheck deposits and loans. Another $277 billion was sent in the first quarter over FedWire, a Federal Reserve run service for one-time wire transfers.

Small banks, in particular, have been reluctant to sign on to the big-bank-controlled RTP system. Industry experts predict that more banks and credit unions will now sign up for FedNow and that the existence of two competing systems–known in paymentspeak as “rails”—will speed innovation and the widespread adoption of instant payments in the U.S., a relative laggard when compared to Europe, India and Brazil.

“This is part of this inevitable shift to safe, instant, bank-data payments here in the U.S.,” says John Anderson, head of payments at Plaid, a perennial on the Forbes Fintech 50 list, which connects financial services apps with consumers’ bank accounts. (It has its own Instant Payouts on Transfer service which allows businesses to disburse loan payments, insurance payouts and wages instantly.)

The adoption of real time payments in the sprawling U.S. banking system, with more than 4000 banks, another 4,000 credit unions, and an overlay of hundreds of fintechs which work through banks, has been something of a chicken and egg problem. To use a new instant-payments system (like RTP), financial institutions need to build an interface for customers to interact with, which can be time-consuming and costly. But many banks and fintechs didn’t want to make that investment until they were convinced that other banks, regardless of size, would be on an instant payment rail too and that customers would come to demand instant payments.

FedNow makes that universal adoption more likely, making the technology investment more compelling. Tellingly, nearly a quarter of financial institutions were waiting for the FedNow launch to even adopt a real-time payments strategy, according to a report from financial services consulting firm Cornerstone Advisors.

“FedNow is part of the solution, it’s that last piece of the puzzle,” says Davi Strazza, president of North American at Adyen, a Dutch payment processor. “It’s just cost efficiency and cash flow. How do we help merchants move money fast–extremely fast, real-time, if possible.”

Adyen holds a European banking license and a U.S. Federal Foreign Branch license, which allows it to offer business checking accounts and small business loans. It isn’t listed as participating with the RTP network, but is one of the 41 financial institutions which had completed certification to use FedNow by the end of June–before it even launched. Another 15 service providers, some of whom will help build the infrastructure small banks need to connect to FedNow, have also been certified.

In the short term, smaller institutions are likely to gravitate to FedNow while larger institutions stick with RTP. (Because the RTP system is used by the big banks, it already reaches 65% of deposit accounts in the United States. For consumers, the most visible application of RTP is the Zelle peer-to-peer money transfer system, which the big banks launched to compete with PayPal’s
PYPL
Venmo and Block’s CashApp.)

Over time, as demand for instant payment grows, institutions of all sizes are likely to adopt both networks to ensure they are able to reach all U.S. consumers and businesses regardless of the size of their financial institution, predicts Reed Luhtanen, executive director of the U.S. Faster Payments Council, a trade organization working towards modernizing the U.S. payments system.

While instant transactions offer greater liquidity and convenience for consumers and businesses, they also mean the potential for real-time fraud. Instant payments make it far more difficult to recover funds if they are sent by mistake or under false pretenses. Zelle has come under fire from regulators for not doing enough to combat fraud on the platform. In 2021, as much as $440 million in scam transactions occurred across the network. In the same way that Zelle added features like a prompt to slow users down before they approve a transaction, financial institutions adopting a real-time payments rail will need to develop strategies to manage fraud. One tactic RTP has adopted is a transaction limit of $1 million. FedNow has initially set a default transaction limit of $100,000, though individual banks can adjust it up to $500,000.

The FedNow rail is coming online amid a shift in the way consumers manage their finances. The number of fintech startups offering everything from digital banking and brokerage services to peer-to-peer payments and lending grew exponentially during the pandemic. As a result, more people are distributing their wealth across multiple accounts for different purposes. This fragmentation creates a need to move money quickly between accounts to make loan payments, execute trades or pay friends back from digital wallet accounts. While today it can take as long as several days to transfer money between financial accounts, FedNow is designed to expand access to instant money movements that consumers are increasingly coming to expect.

Faster payroll deposits–particularly for hourly workers with earnings that vary from week to week–could be a big plus. Some American workers who live paycheck-to-paycheck take out costly loans while they wait to access earned wages. Luhtanen, of the U.S. Faster Payments Council, notes that an advertisement for employees at a restaurant chain near his home promises that they’ll be paid within a few minutes at the end of every shift and that the funds will be deposited directly into their bank accounts. “That poster raises awareness that ‘Hey, payments are catching up with the rest of the way the communication world works in the 21st century,’” Luhtanen says.

Consumer use of instant movement of money will also depend on costs. For example, Venmo currently charges a 1.75% fee for RTP instant transfers from a user’s Venmo account to his bank account, but offers slower ACH transfers for free. FedNow will charge $0.045 per credit transfer plus a $25 monthly fee per bank or credit union, but it will be up to the banks and other financial service providers how much they charge customers.

Fintechs interested in launching or improving products using real-time capabilities will be able to route transactions through either RTP or FedNow depending on which network (or networks) their customers’ financial institutions have adopted. Elizabeth McQuerry, a partner at payments consulting firm Glenbrook Partners, predicts that ultimately both FedNow and RTP will mean accelerated adoption of real-time payments and higher volumes across both networks. “In order to say I’m offering any type of service, you need to be able to offer it to all of your customers. What fintechs want is full reach to all financial institutions in the U.S.,” McQuerry says. “The only way they can get something similar to that is by connecting to both networks via a bank or credit union.”

FedNow and RTP aren’t the only ways payments are being sped up. The dominant Automated Clearing House is run by payments association NACHA, which includes JPMorgan Chase, Bank of America and First Citizens Bank. In 2016, it introduced same-day ACH, which processes payments in one business day and is today the largest growth driver for the network.

Meanwhile, consumers are increasingly using the card networks (Visa
V
and Mastercard
MA
) and their rails (instead of cash) for daily purchases thanks to the convenience, fraud protections and rewards programs they provide. However, interchange fees, the 1% to 2% fees charged to merchants every time a consumer swipes a card, are a pet peeve of retailers across the country.

FedNow and RTP could potentially enable additional payment options like “pay-by-bank” to take off in the United States. Pay-by-bank solutions allow consumers to pay merchants directly from their bank accounts, an option that would appeal to merchants looking to circumvent interchange fees on card networks like Visa and Mastercard. In India and Brazil, it is common for consumers to pay retailers directly from their bank accounts using real-time payment networks UPI and PIX. A key part of why these networks have been adopted abroad is because the governments of both India and Brazil have mandated that financial institutions adopt these real-time rails. It’s unlikely there will be a federal mandate to adopt FedNow.

“Looking ahead, especially if you use Brazil and India as examples, it becomes really exciting when you move from business to business back-end infrastructure to consumer-facing products and the protocols for fintech companies to build on top of those rails,” Adyen’s Strazza says. “Before you know it you have things such as UPI in India that has high market share and creates a whole different dynamic of innovation.”