Related Links

• FedNow Explorer
• FedNow FAQ, Federal Reserve Board of Governors
• Speeding Up Payments

Transcript

Tim Sablik: Hello, I'm Tim Sablik, a senior economics writer at the Richmond Fed. My guest today is Vanity McDaniel, a senior payments business advisor for the Richmond Fed's payments outreach team. Vanity, welcome back to the show.

Vanity McDaniel: I'm excited to be here. Thank you for inviting me back.

Sablik: I'm very glad to have you back on to talk about payments because there have been some big developments in that space recently. The Fed recently said that it would be launching FedNow, a new real-time payment service in July. FedNow was first announced in 2019 and it marks the first new payment rail created by the Fed in 50 years.

To start, can you explain what a real-time payment is and how it compares to other payment methods?

McDaniel: Great question.

Instant payments allow individuals and businesses to send and receive payments within seconds at any time of the day on any day of the year. Those transactions are able to occur essentially 24-7 by 365, allowing the receiver of a payment to use the funds almost instantly rather than waiting a few minutes, hours [or] days for the transaction to clear or settle. Financial institutions with master accounts at the Fed will have direct access to FedNow. Consumers and businesses will have access to FedNow via their financial institution or a third-party payment platform.

I also want to specifically mention that FedNow isn't related to digital currency and it isn't replacing cash. It is simply another payment rail or financial service we provide to institutions.

In addition to the Federal Reserve, there is only one other instant payment option that is currently available in the U.S. and that is currently through the Clearing House, which is owned by some of the largest financial institutions in the U.S. Their instant payment is called Real-Time Payments or RTP, because we all love acronyms. Similar to FedNow, financial institutions have access to real-time payments and consumers and businesses have access via their financial institution or a third-party payment platform.

The immediacy of instant payments is what really distinguishes it from traditional retail payment methods such as ACH, checks and wires. The payment methods I just mentioned operate based on traditional banking business days. Typically, payment transactions at your financial institutions occur Monday through Friday and occur within traditional banking business hours, except on holidays. Once those transactions are submitted during their designated timeframe, there's still a lag in time for transactions to clear or settle, which impacts how quickly a person would have access to those funds.

There is an exception and that is wires. Once a wire is submitted correctly, again Monday through Friday except holidays, those funds are available immediately and they are irrevocable.

Let's look at ACH for a moment. ACH transactions are essentially a batch file of thousands of transactions, typically things like bill pay or payroll. For example, same-day ACH files are submitted by financial institutions to the Federal Reserve, and there are only three windows of time those transactions can be submitted. Those funds will be available for use same day, as long as the files are properly submitted and received by the Federal Reserve within their designated timeframes.

Unlike traditional payment methods, instant payments allow financial institutions to submit transactions to the Federal Reserve 24-7 by 365. And, the transaction clears within seconds, so the funds are available immediately for use.

Sablik: Thanks for that explanation and spelling out those differences between the payments that people are more familiar with now.

Diving a little bit deeper, how does FedNow actually work? What will it look like for the average consumer?

McDaniel: By definition, the FedNow service provides interbank settlement that enables funds transfers from a sender's bank account to a receiver's bank account, immediately and at any time. Financial institutions and their service providers will be able to build on this fundamental capability to offer value-added services to their customers.

There will be a request for payment functionality that could enable bill payment use cases. Financial institutions will also have the ability to include information about the payments such as billing or invoice information, which could support business-to-business use cases. There will be liquidity management tools available. This will allow financial institutions to transfer funds to each other on evenings, weekends [and] holidays, and this will be available to all FedNow participants.

It will be important for financial institutions to constantly understand their liquidity position to ensure they have adequate funds to cover transactions. Again, in a traditional banking environment where transactions occur only on bank business days during bank business hours, the institution knows its liquidity position at the end of each day. But with instant payments transactions happening 24-7 by 365, financial institutions need additional tools to assist them.

Lastly, there will be fraud management tools available.

Now, I can't speak to what FedNow will look like to the average user. But I would assume that FedNow could be linked to existing mobile payment applications that people are already using. And I'm sure fintechs and other organizations will continue to build and create additional platforms to enhance the user experience for instant payments.

Sablik: Another question that I'm sure you've gotten a lot is, why is the Fed launching this system? What problems is it hoping that instant payments will help solve?

McDaniel: Back in 2017 [or] 2018, the Federal Reserve Board assessed the need for a new payment service. During that time, they considered input from the public, historical experiences and their own analysis. Ultimately, the Board concluded that the private sector was unlikely to provide an infrastructure for instant payments with reasonable effectiveness, scope and equity. More importantly, the private sector will likely face significant challenges in providing equitable access to [the] more than 10,000 diverse financial institutions we have across the country.

The Federal Reserve is well positioned to overcome the challenge of nationwide access as we already provide financial services to financial institutions throughout the country. And we already have existing nationwide payment infrastructure with established customer service relationships. Overall, the development of FedNow will allow the Federal Reserve to retain its ability to provide stability and support to the banking system and the broader economy.

As far as what problems will instant payments solve, beyond speed and convenience, instant payments will be beneficial for individuals and businesses by allowing them to make time-sensitive payments whenever needed, rather than waiting minutes, hours or days for transactions to settle. Instant payments will also provide flexibility, which is important especially for individuals and households on tight budgets. Receiving a payment in real time can help them avoid the need to use expensive check cashing services, high cost borrowing like payday loans or even incurring overdraft fees or late fees, which could be detrimental to their current financial position. Immediate access to funds and the ability to instantly make bill payments is also beneficial for small businesses where these businesses may otherwise use costly short-term financing.

Sablik: You mentioned fraud just a little bit ago. Some of our listeners may have seen stories about issues around fraud with other real-time payment services. Since these systems are designed to complete transactions instantly, that can leave little window to reverse payments and making it tricky to deal with cases of fraud. What protections are built into FedNow to deal with that?

McDaniel: Similar to any other payment service, fraud happens and it's unfortunate. Although FedNow allows for payments to settle or clear instantly, speeding up the payment settlement process will cause bad actors or fraudsters to become more sophisticated. The Fed understands the importance of having tools to combat fraud. Those tools will be offered at the launch in July.

There will be a negative list feature. Negative databases are created from many different types of data that are associated with risky or fraudulent activity.

Financial institutions will have the ability to set lower credit transfer limits. The maximum transaction limit will be $500,000. Participants will have a default limit of $100,000 with the option to adjust it up or down. This limits the size of potential fraudulent transactions.

Institutions will have the ability to specify certain conditions under which transactions will be rejected. Participants will be able to reject payments to and from suspicious accounts. And, of course, there will be a reporting feature and functions as well.

As FedNow evolves, more features will be developed over time. So, [there's] more to come in the future from a fraud perspective.

Sablik: Looking ahead, do you have any idea of what comes next after the initial rollout in July?

McDaniel: I don't know the specific details of what the FedNow team has planned after the rollout. But I will say the initial rollout will essentially provide basic core functions. The FedNow team has a phased approach to developing and expanding the FedNow service, which will allow the Federal Reserve to move quickly while providing flexibility to adjust and add features in response to industry need and changes to technology.

There are also plans to offer additional features in the [FedNow] service related to fraud prevention, error resolution and case management. Other features might include support for bulk payments and application programming interfaces or API capabilities. So, be on the lookout.

If you want to learn more about FedNow, I encourage you all to visit explore.fednow.org. The site has a lot of user-friendly resources about FedNow.

Sablik: Vanity, thank you so much for coming on the show to give us this overview of FedNow.

McDaniel: This has been fun. Thank you for inviting me back.

Sablik: Listeners can definitely check out that website that Vanity mentioned and we will also have links on the show page for that resource. And, if you enjoyed this episode, please consider leaving us a rating and review on your podcast app.