Expectations are changing: 62% of consumers plan to use faster payment services in the near future. We at Orum are working to help our customers benefit from this fundamental change.
One way we’re doing that is by participating in a large industry development from the United States Federal Reserve, who are rolling out the first new payment system since the 1970s.
This new rail, called FedNow is a new instant payment platform the Federal Reserve Banks are launching in 2023. FedNow will provide financial institutions of every size, and in any location across the nation, access to safe and efficient instant payment services in real time, 24 hours a day. Orum’s instant payment solutions can help financial institutions seamlessly adopt the FedNow Service when it launches.
In this guide, we are going to touch upon the most important facts about FedNow and what it might look like once it’s finally here.
Key features of FedNow
FedNow’s introduction is a significant transformation of the US’s payments infrastructure. This service differs greatly from older payment systems like ACH. FedNow is built on ISO 20022 standards, which focus on improving payment speed, traceability, and transparency.
FedNow will be an instant settlement and clearing service for online payments. This means that the banks on either end of a transaction can instantly exchange associated information and move money between relevant customer accounts. Thanks to instant processing, the sender and the receiver of a transaction can get notified immediately on whether the payment was successful.
One of the key improvements over current payment rails is that FedNow will process transactions 24/7. Unlike ACH or wires, FedNow will clear and settle payments on:
- Bank holidays
- Nighttime and any other time of day outside of business hours.
Who can use FedNow
FedNow will support most common payment types:
- Person to person (P2P)
- Consumer to Business (C2B)
- Consumer to Government (C2G)
- Government to Consumer (G2C)
- Business to Consumer (B2C)
- Business to Business (B2B)
- Business to Government (B2G)
- Me to Me (A2A)Account to Account (A2A)
This service will be, in some ways, similar to another recently introduced payment type, Real-Time Payments (RTP) from The Clearing House. While both RTP and FedNow seem to be similar – in that they clear and settle domestic USD payments 24/7, the difference is how they access interbank liquidity and confirm settlement at the recipient accounts.
FedNow will leverage participating Banks’ existing master account at the Fed while the RTP rail requires participants to have a separate pooled account for liquidity at The Clearing House.
In the RTP rails, interbank settlement happens prior to the RDFI (the Bank where the recipient’s account is) confirming the existence and good-standing of the recipient’s account whereas under FedNow, interbank settlement will be after the RDFI has confirmed the recipient’s account information. These differences may require participating Banks to have operational procedures and systems configured appropriately for each of the rails.
The only significant limitation of FedNow, at least initially, will be the small transaction limit. The Federal Reserve has determined that at launch transactions will be limited to $25,000 each. Until this limit is increased, the service may not be too useful for larger enterprises and will probably primarily serve small businesses, retail organizations, and P2P payments.
How does it work?
How can the Federal Reserve accomplish FedNow’s year-round and 24/7 processing?
The new payment rail will operate automatically and much more efficiently than current alternatives. All funds will transfer and settle in real-time. In fact, FedNow guarantees that all settlements will be processed within 20 seconds, and often much faster.
An instant payment system includes the following aspects:
- Authorization, certifying that a transaction is legitimate
- Posting, immediately creating a record of the payment
- Settlement, instantly moving money between two accounts from one bank to another.
- Notification, confirming whether the transaction was successful or failed.
These four aspects are often grouped together into two larger categories:
- Clearing – exchange of information about a payment and potential fraud screening
- Settlement – actual movement of money between the sender and receiver accounts
FedNow’s fees are expected to be the following:
- $25 monthly participation fee for financial institutions (per routing number)
- $0.045 per credit transfer paid by the sender
- $0.01 fee for each (optional) Request for Payment message (RfP) paid by the party requesting it, both for new payment notifications and returns
- $100,000 initial credit transfer limit that can be decreased or raised by financial institutions up to $500,000
These fees are quite low compared to some other payment systems and settlement services, such as wires. That is thanks to FedNow being operated by the Federal Reserve. Since the Federal Reserve is a government organization, they are not for profit and can offer more competitive pricing for the benefit of banks, businesses, and consumers.
Many benefits of FedNow are like the advantages of other real-time payment systems:
- Efficient business operations due to increased flexibility and cash flow control
- Quicker access to salary payments for individuals instead of delayed payroll
- Cheaper processing costs for transactions across categories
- Promote financial inclusion by allowing small businesses and community banks to participate in real-time payment services
- Facilitate innovation in the payments industry by providing a new platform for fintech companies and other innovators to build upon
The largest unique benefit of FedNow in particular is its integration with the Federal Reserve’s larger network. Unlike RTP, FedNow will support smaller community banks around the country. So FedNow is likely to be most helpful to local financial institutions and their account holders.
FedNow is expected to be a more flexible and neutral platform that will support a broad variety of instant payments. It may fulfill some of the suggested benefits that could be derived from another potential payment innovation, namely, a central bank digital currency. Therefore, FedNow is expected to be a game-changer for the payments industry and a key contributor to the future of the US payments system.
New Payment Infrastructure
The biggest issue with FedNow is that implementing this system requires a completely new payment infrastructure. Since transactions will only work between FedNow participating banks, wide adoption may take years. Financial institutions will have to integrate with the new network, and it may take time for customers to adjust to the new payment method.
Another problem is security. Unlike traditional slower payment methods, FedNow will not offer any type of payment reversal or chargeback functionality. While this can be a benefit, it can also be abused. There is a lot of chargeback fraud that hurts legitimate businesses, resulting in lost revenue and cash flow. Since all transfers process and settle instantly, once the money leaves the sender’s bank account it is instantly available for the receiver to use as they might wish.
Interoperability with Other Payment Systems
While FedNow is expected to be a major transformation of the US payment infrastructure, it will also have to work in conjunction with other payment systems, such as the Automated Clearing House (ACH) network and RTP. It remains to be seen how well FedNow will integrate with other payment systems, as interoperability across payment systems would benefit business and banks.
Implementing a new payment system like FedNow is a complex technical undertaking. Financial institutions will have to ensure that their systems are properly configured to work with the new network, and there may be technical challenges associated with integrating with other payment systems. Any technical issues that arise could cause delays and disruptions in the payment process.
FedNow will also include some optional features that financial institutions can opt into. These include:
- Fraud prevention
- Receive-only participation
- Requests for payment
- Payment inquiry support tools
How will FedNow affect the ACH network?
FedNow is the first new payment rail since ACH was introduced over 50 years ago.
As such, FedNow’s deployment will affect the popularity of ACH due to instant settlement in the Fed Master Accounts of participating banks.
However, ACH will not become redundant. The ACH Network allows for pulling funds via ACH Debits – compared to FedNow (and RTP) which are credit payments only. .Pulling funds is a core requirement for multiple businesses. Therefore it seems that ACH and FedNow will coexist to solve for different business needs across speed, direction of funds flows and cost.
If you’d like to learn more about ACH, you can read our ultimate guide to that payment system here. And if you’d like to learn more about Orum and how we can help you speed up payments, reach out here! We’d love to chat.
- Businesses should expect the Federal Reserve to continue its fight against inflation, with comments from Fed members suggesting that they are unlikely to stop hiking interest rates until at least a range of 5.25%-5.5%.
- The Federal Reserve’s goal of 2% inflation is likely to take time to reach, and costs of living are likely to continue to fluctuate.
- Global tech leader TechCrunch highlights the power and order Fednow can bring to the ever chaotic ecosystem of B2B payments.
Currently 30% of financial institutions plan to launch RTP in addition to the 15* of banks and 12% of credit unions that are already onboard.