It’s now official. The Fed plans to build its own instant clearing and settlement rails.
Introduced on Monday by Federal Reserve Board Governor Lael Brainard, the Fed’s instant payment scheme FedNow is designed to offer an option for consumers and business to transfer money instantly or nearly instantly in a “ubiquitous, safe and efficient” manner from one bank account to another.
“We only get to make this kind of decision once every 30 or 40 years,” Brainard said, noting that this was the biggest payments oriented move made by The Fed since the early 1970s and the implementation of the ACH system.
“At the end of the day, we really had to look into the future and the most decisive question was: Ten years from now, 20 years from now if we decide not to invest in real time payment infrastructure will we have carried out our responsibilities to the U.S. financial system and the U.S. economy?” Brainard asked.
The announcement was long anticipated — arguably since the Fed launched its 500-person Faster Payments Task Force in 2015 and announced its intention to take a seat at the table in an industry-wide conversation about how faster payments would evolve in the U.S. Two years later, the Fed published its final report that left the door open for it to take on a more direct role in picking up the pace of payments nationwide, “as necessary and appropriate.”
Today, the world got its first glimpse of what that role will look like — though much of the concrete details remain under wraps. But, as Karen Webster observed in a commentary earlier this year — yesterday’s announcement makes concrete something that the Federal Reserve has been signaling increasingly clearly for the last five years.
“The Fed’s interest in faster payments was never simply as an interested, but passive, bystander ... The Fed sees an opportunity to introduce competition in the faster payments space as a second operator of faster payments rails, like it is today with ACH,” she noted.
Why Now For FedNow
Consumers and businesses alike, Brainard noted, are aware of and enthusiastic about real time payments — the demand is clearly there.
As is, she said, the need for the Federal Reserve and its ubiquity within the US banking system. The problem with the private solutions in the market, Brainard noted, is that they are “closed loop” making real-time transfer services only between those app users — and some apps simply can’t reach all of the approximately 10,000 banks in the United States. The Fed is already connected to all 10,000 of those banks, and as a result can create truly universal access to faster payments for any financial services institution that wants to provide them.
“FedNow will permit banks of every size in every community across the country to provide real-time payments,” Brainard said, “Everyone deserves the same ability to make and receive payment quickly and securely, and every bank deserves the opportunity to provide that to their customers.”
Moreover, she noted, it is the uniqueness of the scale the Federal Reserve can bring to the project that pushes it into its purview, since Monetary Control Act bars the The Fed from creating a system unless it is not possible for the private sector to do so. The private sector can, and has with the Fed’s support Brainard said, but they can’t build it will nearly universal nationwide access that the Fed can. For the new inter-bank system, the Federal Reserve will speed up its settlement and clearing processes for payments between banks. It'll be available 24/7, 365 days a year, and will be initially limited to $25,000.
Brainard also noted that the universal accessibility of the system is particularly important — as those most likely to suffer from payments delays are low-income Americans living paycheck to paycheck, those on a fixed income and small businesses. Consumers living paycheck-to-paycheck, she noted, face overdraft fees and late payment fees when their funds are delayed by even a day or two she noted. Cash flow and access to funds from a sale, she said, are often the difference between a small business being able to pay their bills and their staff or having to take out high interest, short-term loans to cover their expenses.
Moreover, she noted, by providing a modern instant payments infrastructure, The Fed can offer a scaffolding for future innovation — which means the question isn’t just about what are the things we know we can make possible today.
“It is what are the use cases and new efficiencies we will discover when there is a system for instant payments that is truly nationwide. That doesn’t exist today.”
And, in fairness, it isn’t exactly going to exist tomorrow either. The Fed is currently requesting comments on the design of the service — which it expects to make available in 2023 or 2024.
What Comes Next
The reactions to the Fed’s announcement are still rolling in, but given the conversation up until now it is fair to expect they will be divided.
The Clearing House, an association of the 26 largest banks, operates the RTP network — has in the past been open about its concerns for an instant payments platform built and operated by The Fed. The main issue is a concern that an updated Fed system could result in a delay in the adoption of real time payments. There are also concerns that the Fed might also start offering volume discounts to users in an effort to compete for customers, which would force banks to do the same.
“We have a real-time payments network. It’s operating,” said Steve Ledford, senior vice president for product and strategy at The Clearing House. “If the Federal Reserve decides to launch its own network, it’s just delaying the access to faster payments to everybody.”
However, in the immediate aftermath of the announcement, TCH was a bit more neutral in its tone. In a statement released shortly after the announcement, TCH touted the rapid expansion of the RTP network since its 2017 launch, vowed to continue pushing that expansion and had only one, slightly pointed, statement to offer about the FedNow offering.
“While we will stay abreast of the Fed’s efforts to develop its own real-time payments system which may become available in 2023 or 2024, our focus will remain on ensuring that the RTP network has reach to all depository institutions,” The Clearing House noted in a statement shortly after the announcement.
Small- and medium-sized banks, credit unions, FinTechs and large retailers, on the other hand, have been highly supportive of the Fed’s efforts, and excited at the possibility of an instant payment method that might allow them to sidestep card network interchange fee or big bank control.
“There’s just a fear that the big banks really don’t have a need for the smaller banks and would rather just control all components of banking in the country,” said Kathy Strasser, chief operating officer of River Valley Bank.
The big remaining question, however, is the time to market, which would put the Fed’s instant payments offerings into wide circulation in 3.5 years at the soonest and five years from now at the outside. As any good payments and commerce watcher knows — five years is an unbelievably long time. In five years, we might all have decamped to Mars with Elon Musk and Instant Payments will require quantum computers to account for the distances between planets. That sounds like a rather wacky outside possibility, we wholeheartedly admit. But then again, in 1995, carrying supercomputers in our pockets or instructing Alexa to turn off the lights also would have seemed pretty unlikely as things that would exist in our lifetimes.
Which is the point — disruptive innovations are by their nature unpredictable, and five years is a long time in an ecosystem that evolves in a different direction every five months. Brainard noted that time to market was an important consideration, but that stakeholder feedback, security and ubiquity were equally important considerations, as was taking the time to do it right.
Which means as of today we know The Federal Reserve is going all-in on instant payments — and building the underlying infrastructure to support it. What exactly that will looking like and what it will mean is still in the design process.
And it remains unknown what the state of the instant payments race will actually be, when The Fed is ready to start running it in earnest a few years from now.