FedNow Brings Instant Payments to the Banking System

On Jul 20, 2023, the Federal Reserve launched FedNow, its instant payments service. Work on the service began in late 2018 with a solicitation of public comments, with initial details announced in 2020.

At launch, 57 organizations were certified to use FedNow. The Fed expects that number to grow throughout 2023 and beyond and hopes to eventually include every financial institution in the country.

What is FedNow?

Developed as part of the Fed’s efforts to modernize the payments system, FedNow enables 24x7x365 transaction processing that is faster and less expensive than existing systems such as ACH.

Most FedNow transactions cost just $0.045 (4.5 cents), significantly cheaper than the $0.20-$1.50 range for ACH. Participating institutions must also to pay a $25 monthly participation fee, which is a negligible cost.

Payment amount limits have initially been set at $500,000, but participating banks have the ability to use a lower limit if they want.

What are the benefits to bank clients?

While the addition of instant payment processing will not revolutionize the banking experience for most consumers, being able to receive a paycheck, incoming invoice, or transfer from an app such as Venmo as soon as its sent will help avoid overdraft fees or late payment fees that could be incurred due to the delay in funds settlement. The lack of weekend and holiday delays will be particularly helpful for people who rely on using cash instead of debit or credit cards.

Businesses will see the same benefits when it comes to avoiding fees as well as some smoothness when it comes to accounting, particularly if they currently rely more on wire transfers than ACH transfers. These businesses would also save substantially on fees as wire transfers can be costly. There could also be some streamlining of accounting.

What are the benefits for banks?

With FedNow, banks will be able to offer low-cost services for their clients and improve the customer experience by allowing transactions to be executed quickly and painlessly, particularly in situations where a wire transfer would have previously been needed. This will make them more competitive with fintechs like the aforementioned Venmo, which already offers instant payments. Banks can also slightly reduce headcount or shift employee resources due to needing to process fewer transactions manually.

Additionally, instant processing will make it easier for banks to monitor their liquidity levels and capital reserves, as they won’t have to account for in-flight transfers. In an increasing “just-in-time” financial sector, FedNow will help them manage these liquidity-related risks.

What are the potential risks for banks?

While it doesn’t have any direct downsides, the arrival of FedNow does exacerbate (or at least complicate) a couple of existing challenges banks already face.

Yet another competitive challenge

First is the challenge of staying competitive and up-to-date with technology. Many smaller banks that don’t have the resources of giants like JPMorgan Chase or Citibank are already struggling with managing the rapid pace of technological progress. FedNow joins a list of challenges that includes offering mobile banking, spend management controls, modern credit card programs, and more. 

As is the case with the implementation of other new technologies, banks will have to choose between building a solution themselves or partnering with a solution provider to offer instant transactions.

Potentially faster bank runs

Second, banks will be even more vulnerable to a bank run as there will not be any speedbumps to slow down the pace of funds withdrawals. We got a preview earlier this year with the failure of Silicon Valley Bank, which became the first significant bank in 15 years to face a bank run. Even without the availability of 24x7 instant transfers, existing digital banking and payment processing technology allowed panicked customers to withdraw funds faster than ever before. The withdrawal speed meant that management could not find additional capital or restore confidence to stop the run before the bank became insolvent. With instant transfers, it’s possible that a bank facing a run could end up insolvent on the same day as a run begins.

This means avoiding bank runs will be even more important than ever. The need for bank management to ensure that their capital and risk profiles are strong and that customers don’t feel their funds are at risk is even greater. It is also important to avoid communication mistakes that could shake customer confidence.

Learn more about FedNow

While implementing FedNow will not be a quick project, the Fed has built an extensive website with considerable resources to help financial industry professionals understand instant payments and what it will take to become a participant. You can find this resource library here

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