When we think about the U.S. Federal Reserve, it’s usually in terms of interest rates, money supply or some other facet of monetary policy. Beyond those responsibilities, the Fed plays a much larger role in the payments space than most people realize.
The Federal Reserve currently operates the Automated Clearinghouse (ACH) Network, the infrastructure on which we conduct most interbank payments. However, the organization recently announced plans to develop a new round-the-clock, real-time payment and settlement process called FedNow. This will enable faster payments processing and settling to serve the more than 10,000 financial institutions across the country.
FedNow will combine real-time gross settlement (RTGS) with integrated payments clearing. The service will settle interbank obligations using adjustments to the institutions’ master accounts held at regional reserve banks. Receiving banks will then be required to make those new funds available to customers immediately after receipt, up to a value limit of $25,000 at first. Contrast this with the existing ACH process, which works by maintaining multiple records and reconciling them against one another at the bank level.
Why is the Federal Reserve Implementing FedNow?
The amount of information passed back and forth via the existing ACH network is massive. The National Automated Clearing House Association (NACHA) reports that the ACH network processed 23 billion individual payment transactions in 2018 alone, totaling $51.2 trillion.
Even though there’s a lot riding on ACH transaction clearing, the existing process is time-consuming and not immune to errors. Inconsistencies in technology can create hiccups if one party is reliant on legacy systems. It may even open the door for fraudulent activity in some cases.
At present, the U.S. lags behind other countries in adopting faster payments technology. The U.K., for instance, embraced similar tools more than a decade ago. Other countries like India, Australia and Singapore have made significant advancements on this front that are well beyond the current payment tech curve here in America.
It’s been proposed that the main reason for slower adoption in the U.S. was the lack of a mandate. If institutions aren’t forced to make moves in tech innovation, they often won’t sign onto new initiatives. After all, no one wants to be a guinea pig for an untested technology when there’s trillions of dollars on the line.
FedNow represents a major opportunity. The technology offers a coordinated avenue of approach to arrive at a much more efficient payments process, all backed by the security of the Federal Reserve.
Faster Payments Benefit Everyone
Making the payments process more efficient benefits everyone involved. Faster and less-costly payments clearing saves money for institutions, potentially several billion dollars every year. These savings can, in turn, be passed along to consumers.
FedNow will also work alongside third-party private entities. Interoperability is a cornerstone of the plan, with the organization looking to integrate FedNow into other RTGS infrastructure operated by private companies. The result: Faster payments without the risk of inconsistencies or errors caused by incompatible processes.
Ultimately, the FedNow initiative will serve as the bedrock for instant payments in the U.S. As the Fed explains on its website, the service is intended to “facilitate an efficient payment system by creating a foundation on which banks across the country and the broader payment industry can build modern, innovative and safe faster payment services.”
The idea isn’t simply to enforce faster payments using a top-down approach, but to convince private companies to get on board and collaborate. They want to make developing faster and more efficient payments infrastructure an enticing prospect for institutions, thus motivating payments innovation while preserving competition.
Of course, this hasn’t allayed everyone’s concerns. Smaller banks, credit unions and tech companies looking to expand into the payments space all like the idea of FedNow, but larger institutions are critical of the move.
With FedNow in place, smaller players would no longer be forced to work through a larger bank to gain access to the ACH network. One can see why big banks would be in opposition, as the move bolsters prospective competitors and upstarts at their expense.
The Fed expects rollout of FedNow sometime in 2023 or 2024, so expect plenty of debate in the meantime. One thing is certain – instant payments are an inevitability. The longer we push back adoption, the more inconsistent and inefficient our payments processes will be.
Monica Eaton-Cardone is COO and co-founder of Chargebacks911