July 25, 2023
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Will FedNow Revolutionize Real-time Payments?

The pace of technological change has created the expectation of instant results – especially in the area of real-time payments. So, how does the new FedNow real-time payments program impact the broader payments ecosystem? And, what will remain unchanged?

Recent years have seen the rise of real-time payment apps like Venmo, Zelle, Cash App, and WorldRemit. While this trend is partially driven by a growing preference for instant results, real-time payments also fulfill a variety of pressing needs. For example, there are certain situations where immediate access to funds becomes a necessity, such as transferring money to a family member during an emergency. But, many services that cater to the need for real-time payments impose substantial fees. Today's consumers demand the same level of speed and convenience provided by real-time payment apps, coupled with enhanced features, at a significantly lower cost – or even free of charge. The United States Federal Reserve Bank has answered this demand by launching the new FedNow real-time payments program that is now offered by participating banks and credit unions.

In this post, we’ll take a closer look at the scope of the FedNow program as of its launch in July of 2023. We’ll also explore the impact of this program on the current and future state of the broader payments ecosystem. Finally, we’ll look at which aspects of payments are unlikely to be impacted by the launch of FedNow – which includes the Fed’s exploration of the potential for a future digital currency and the ongoing importance of protecting sensitive customer data.

The Current and Future Scope of FedNow

The FedNow program is set to modernize real-time payments by providing a faster, more efficient, and cost-effective alternative to existing payment systems, including its existing Fedwire and FedACH services. As of its launch, the FedNow program has garnered support from a limited number of financial institutions, but the impact is expected to increase as more banks and credit unions join the initiative. Participating financial institutions will be charged relatively modest fees for using FedNow, which will likely be passed on to customers.

The initial focus of the FedNow program is to provide immediate availability of funds, enabling businesses and individuals to make and receive payments in real-time, around the clock, including holidays and weekends. The FedNow service will provide increasing utility to both businesses and consumers as more banks roll out the ability to both send and receive FedNow payments.

This service will be particularly beneficial for:

  • Small businesses with time-sensitive financial transactions, who may be able to keep smaller amounts of capital on hand or rely less on lines of credit due to the elimination of delays in accessing new funds
  • Consumers who value instant accessibility to their funds, including individuals who might need instant access to the funds from their paycheck, or who value the ability to pay a bill at the last minute on the due date – potentially avoiding late fees

In its recent press release, Federal Reserve Chair Jerome H. Powell had the following comments about the FedNow service:

"The Federal Reserve built the FedNow Service to help make everyday payments over the coming years faster and more convenient," said Federal Reserve Chair Jerome H. Powell. "Over time, as more banks choose to use this new tool, the benefits to individuals and businesses will include enabling a person to immediately receive a paycheck, or a company to instantly access funds when an invoice is paid."

Now that we’ve covered the current and future scope of FedNow, let’s look at the impact that it’s expected to have on the wider payments ecosystem.

The Impact of FedNow on the Payments Ecosystem

I expect FedNow to have an increasing impact on the payments ecosystem over time, but this impact will not be evenly distributed. Let’s take a closer look at the various payments methods in use today, and how they could be impacted by FedNow – starting with the most obvious candidates for disruption: wire transfers, ACH transfers, and existing real-time payment networks.

Wire Transfers

FedNow is expected to have significant impacts on the traditional wire transfer industry by providing a quicker and more cost-effective alternative. The reduced processing time and fees associated with FedNow could make wire transfers less attractive, especially as more banks adopt the FedNow service. These impacts include increased competition, potential cost savings for users, enhanced accessibility with 24/7 processing, streamlined processes, and a potential shift in market preferences away from wire transfers.

ACH Transfers and Checks

The FedNow program is likely to have a significant impact on traditional ACH transfers and checks, as it offers a faster and more convenient alternative. With FedNow's promise of real-time, 24/7 payment processing, customers and businesses alike will develop higher expectations for faster payments across the board. 

This will likely lead to increasing competitive pressure for traditional payment methods like ACH transfers and check-based payments to enhance their speed and efficiency. With the real-time capabilities of FedNow, there will be a push to update the batch ACH system to support faster payments, reducing settlement times and streamlining payment processes. 

FedNow could also accelerate the decline of paper checks as more businesses and consumers become accustomed to instant payments.

All of this depends on the widespread adoption of FedNow by banks and credit unions, but assuming that this occurs, both ACH transfers and checks are likely to decline in popularity. 

Existing Real-time Payments Networks

The entry of FedNow into the market will undoubtedly intensify competition among existing real-time payment networks and providers. Established players like the Clearing House's RTP network and private-sector payment providers will face increased competition, spurring innovation and improvements in service offerings. 

This competition will benefit businesses and consumers by driving the development of faster payments, enhanced features, and potentially lower costs. But, it may also create some confusion among consumers who are faced with a proliferation of real-time payment options.

Card-based Payments

FedNow primarily focuses on peer-to-peer (P2P) and business-to-business (B2B) payments, but it may indirectly impact card-based payments in the future. The availability of faster payments through FedNow could potentially reduce reliance on card-based transactions for certain use cases, especially in scenarios where immediate settlement is crucial. And, as real-time payments gain traction, this could influence the industry's approach to speed and accessibility.

In the short term, FedNow's launch probably won’t have an immediate impact on card-based payments. This is because credit and debit cards offer a familiar and widely accepted method for transactions, and also because credit cards allow consumers to contest transactions after the fact.

The long-term impact of FedNow on card-based payments is unknown, but I expect these payments to remain prevalent for the foreseeable future across many consumer transactions, including point-of-sale transactions, e-commerce transactions, and recurring payments.

App-based Payments

App-based payments, which are popular with the unbanked population, may see minimal impact from the launch of FedNow. These services cater to specific user needs, specifically the need to send and receive payments without the use of a traditional bank or credit union, so they are likely to thrive alongside the FedNow program. App-based payments among unbanked individuals are also likely to remain popular for international remittances.

Additionally, the Federal Reserve has clarified in their FedNow FAQ that they have no plans to launch a FedNow app.

Cash Payments

While digital payment methods are becoming increasingly popular, cash is expected to remain an important form of payment for certain segments of the population, including the unbanked population, and for specific transactions. Some individuals may prefer cash for reasons such as privacy, security, or other personal preferences. Additionally, cash is often used for small-value transactions, informal or peer-to-peer transactions, and in situations where electronic payment options may not be readily available.

So, while FedNow offers a viable alternative to cash transactions – especially those involving larger sums – it is unlikely to replace cash in the near future. I expect that cash will remain relevant for many people and situations, even as digital payments continue to grow.

What Isn’t Impacted by FedNow?

As noted above, while FedNow promises significant changes in the payments landscape, several areas will remain relatively unaffected: app-based payments, the use of cash, and international remittances. 

Two other significant areas that aren’t impacted by FedNow include the possible future introduction of a Central Bank Digital Currency (CBDC), and the importance of financial data privacy.

Does the FedNow Service Pave the Way for a CBDC?

In short, no.

The Federal Reserve is exploring the potential implementation of a Central Bank Digital Currency (CBDC) to supplement existing central bank reserve account balances and physical currency. This program, if launched, would be separate from FedNow, as noted in the recent  FedNow FAQ.

If the Federal Reserve eventually launches a CBDC, it’s possible that there could be competition between FedNow and a CBDC due to their shared feature of instant transfers. However, a CBDC would hold an advantage in terms of privacy. That’s because while FedNow transactions are tied to bank accounts and can be traced, CBDC transactions may offer enhanced privacy features. CBDC transactions could provide individuals with increased anonymity and confidentiality compared to transactions conducted through the FedNow system. 

Another aspect of finance and the payments ecosystem that’s unaffected by the launch of FedNow is the importance of financial data privacy – and the challenges associated with protecting it.

The Importance of Financial Data Privacy

With the advent of new payment systems like FedNow, the importance of protecting sensitive customer financial data remains paramount. In fact, the inability to reverse real-time payments that are later found to be fraudulent increases the importance of preserving financial data privacy by isolating, protecting, and governing the sensitive personal data of bank customers.

This is because data breaches continue to be a threat to financial institutions and their customers, from individuals with just a checking and savings account to the largest businesses.

And as the volume of real-time transactions increases, the need for effective data protection becomes more critical than ever.

Skyflow Data Privacy Vault can play a crucial role in safeguarding customer data in the ever-evolving payments ecosystem. Built on a zero trust architecture and employing multiple encryption and tokenization techniques, Skyflow helps to ensure that sensitive information remains secure both at rest, and throughout the entire transaction process.

Open Questions About the FedNow Service

While FedNow has the potential to revolutionize real-time payments in the United States, some concerns remain unresolved. One such concern is the risk of potential fraud, given that real-time payments cannot be easily reversed once initiated.

The success of FedNow will also depend on the fees charged by participating banks. Ideally, these fees should be competitive with other real-time payment options, ensuring broader adoption by financial institutions and consumers alike.

Additionally, the impact of FedNow will be contingent on the number of banks both sending and receiving payments through the system. As more financial institutions join the program, its influence on the broader payments ecosystem will become more pronounced.

Final Thoughts

FedNow is poised to impact the payments landscape by introducing real-time capabilities and transforming customer expectations. As this innovative payment system gains traction, many traditional payment methods will face increasing pressure to adapt and enhance their speed and efficiency. 

Businesses and individuals will have more options for real-time payments, while the broader financial ecosystem will experience increased competition, innovation, and modernization. With FedNow, the future of payments is expected to offer a more seamless and immediate transaction experience for everyone involved.

In conclusion, the launch of FedNow represents a significant step towards meeting the growing demand for faster and more accessible real-time payments. While some aspects of the payments landscape may undergo a transformation, certain areas, such as app-based payments, cash usage, and international remittances, will likely remain relatively unchanged.

As the payments ecosystem continues to evolve, trust and security will remain vital to providing a seamless and secure financial experience for all consumers of US banking services.