For most people, the move toward real-time payments is a silent revolution, a mashup of new codes churning deep behind the scenes, far removed from the dip of a credit card at a payment terminal.
Despite its lack of flash, instant settlement is still a seachange for banks. Think automobiles displacing horses and carriages. Or a more recent example — ridesharing apps and the taxi industry.
"Uber and Lyft, for example, came on the scene in ridesharing and changed how taxis worked. You can see FedNow and RTP having that kind of impact in the U.S. payment market," said Mike Jorgensen, head of emerging solutions and strategy at U.S. Bank Global Treasury Management, who was also referring to the impact that ridesharing apps have had on payment companies, which for years have tried to emulate the "Uber experience."
And now real-time payments are about to get a massive jolt from the government, as the Federal Reserve's FedNow Service launches. FedNow will move real-time payments beyond the early adopters by potentially signing up thousands of financial institutions, launching instant settlement into the mainstream lexicon.
But challenges remain, including addressing subtle differences between The Clearing House's real-time network, RTP, and FedNow, as well as managing costs.
"Getting up and running on FedNow is more expensive than many financial institutions have internalized," said Joshua Siegel, a partner specializing in payments and banking at Capco, a consulting firm.
Where's FedNow…Now?
FedNow, which is slated to go live in July, will join The Clearing House's RTP network, which has more than 300 participants and covers about 70% of the addressable deposits in the U.S. There are also dozens of real-time payment systems in other countries, and both RTP and FedNow are taking steps to support international payments.
FedNow, which could bring more than 9,000 financial institutions into the real-time payments market, has been in the works for years. It was initially announced in 2019 with an intention to launch in 2023 or 2024.
However, the initiative hasn't been met with universal fanfare. Some politicians, The Clearing House and mostly larger banks were initially opposed to FedNow on the grounds that it was an overreach from the central bank and there was plenty of payment processing innovation coming from the private sector. The opposition has eased over time, and the RTP rail saw a boost in adoption shortly after the announcement that FedNow would happen.
FedNow is currently certifying participants with those that are certified by mid-June being ready to launch in July. About 120 organizations have participated in a two-year pilot program for FedNow, and some work on connecting the payment system to banks started in late 2022.
For banks and payment companies, the hope is FedNow will allow real-time payments to scale quickly, providing more efficient processing as digital payments become a larger part of the overall payment market. And real-time payments, while still in early stages, are expanding rapidly. There were more than 195 billion real-time transactions recorded globally in 2022, according to ACI Worldwide data released on March 28. That's 63% higher than the 121 billion recorded in 2021. ACI projects that real-time payments will reach 512 billion by 2027, or 28% of all global electronic transactions.
"FedNow will be a catalyst to jump-start real-time payments," said Craig Ramsey, head of real-time and account-to-account payments for banking at ACI Worldwide. "We're seeing a marked increase in interest from all sizes of banks and credit unions."
Part of real-time payments' growing popularity is related to the business needs the service addresses. In March, U.S Bank released research that found 40% of businesses want better access to working capital while 39% want to improve the overall payment experience.
Thirty-six percent want immediate reconciliation and 32% see real-time processing as a competitive edge.
"We want to make it easy for our clients and essentially meet them where they are," said Anu Somani, head of global payables and embedded payments at U.S. Bank, which is based in Minneapolis.
U.S. Bank is developing a strategy to automatically route payments over the rail — either FedNow or RTP — that best fits the user's needs in terms of processing time, cash position, and how a specific transaction fits within a broader set of purchases. For instance, the purchase of one item could set off a chain of other transactions.
"This should create more value for B2B payments," Somani said. "There's a lot of benefit that comes along with instant settlement."
U.S. Bank's research also found that more than half of businesses want to improve the transaction experience for vendors and customers, while 47% want to transform the business-to-business payment experience so that it mirrors consumer person-to-person payments. Real-time payments could be a catalyst to move more businesses to digital payments.
"Businesses had gotten used to the payment inefficiencies," said Jorgensen, who added real-time processing adoption to date has been mostly early movers. "FedNow will help us expand our reach."
The need for speed
FedNow's impact will initially be in building scale more than introducing real-time payments as a concept. The Fed is entering a real-time payments market that is already more than a half decade old, with numerous real-time payment products from others already live. PNC has used The Clearing House's RTP rail so workers can access their pay a day earlier than their scheduled payday, for instance.
UMB Bank is also looking to both RTP and FedNow to improve the bank's ability to respond to changes in traditional payroll practices in response to economic uncertainty and the growth of contractors and gig economy workers. A group of mostly large banks, working through the RTP rail, also offer real-time billing, or request for pay, which pairs instant invoicing with instant settlement as a financial management tool.
"You can do a quick pay disbursement to freelancers, or a travel advance, so there's an obvious use case," said Paul LaRock, director of Treasury Strategies, a division of the business technology firm Curinos.
Utilities and other monthly expenses also come to mind, LaRock said, adding real-time pay can help mitigate overdraft risk.
"There's some use for this with the utilities themselves," LaRock said, noting it could reduce water or electricity shut-offs for non-payment. "If someone pays their bill, the utility could call the crew back from the road. It literally wants to work that fast."
Real-time payments have also been applied to use cases as varied as supply chain management and financial inclusion. RTP is seeing a boost in volume from a higher number of banks and credit unions on the network, as well as more payment originators, said Greg MacSweeney, head of communications for The Clearing House. He noted that 65% of direct deposit accounts are now on RTP, and it should hit 70% in the next few months. As of today, RTP has 320 financial institutions on the network.
The Clearing House expects that trend to continue as banks move payments away from ACH to peer-to-peer apps, like Zelle, to RTP, MacSweeney said. Today, around 2 million transactions a month come from Zelle, and that number will also increase in the coming months as more banks migrate Zelle transactions from ACH to RTP. There are also a number of merchant processors who are sending payouts to retailers, restaurants and other businesses in real time over RTP, according to MacSweeney.
"Cash flow is critical for many businesses, especially small and midsize, and getting real-time access to funds is a game changer," McSweeney said. "Traditionally, merchant settlement would happen two [to] three days later. This is challenging over weekends or over holidays, where settlement may be more than two to three days. And there's also real-time payroll and earned wage access frequently. It is still the fastest growing use case on RTP."
FedNow also plans to offer real-time billing as an early feature and plans to develop additional products over time. "It will help those who are living paycheck to paycheck, or those making last-minute payments to avoid surcharges. Those are uses I can think of immediately," said Nick Stanescu, business executive of the FedNow Service at the Federal Reserve.
For example, FedNow plans to include tools to support invoice information and connections to back-end processing for businesses.
"A business may have a cash flow problem and will be able to request and receive payments from another business more quickly," Stanescu said.
The Fed's "use case arena" mentions mobile and online person-to-person payments as a potential FedNow beneficiary. Instant payment processing can better position banks in the P2P market to execute these payments via their mobile banking app or website. This places the bank at the center of the transaction, according to the Fed. The bank also assists the payer in initiating the payment, facilitates clearing and settlement and credits the payee's accounts with funds.
In many cases, mobile payment apps such as Block's Cash App or PayPal's Venmo execute the actual payment and enroll the consumers. The party that initially enrolls the consumer for a payment service is generally better positioned to cross-sell other services and to analyze transaction data.
P2P apps also include Zelle, an Early Warning-led service. A group of banks owns Early Warning, and there is an emerging app, called Chuck, which aims to be an alternative to Zelle for smaller banks.
But FedNow could serve as an alternative to the bank-led Zelle P2P network, according to Siegel.
"FedNow will democratize and broaden access to instant payments, including for any smaller institution that has access to the Fed."
Real-time, but not all the time
Real-time payments will most likely be a premium product for years, since not every transaction needs to settle instantly. There is also an additional cost for real-time settlement. Both RTP and FedNow charge $0.045 per payment, and FedNow has a lower transaction limit of $500,000, compared to RTP's limit of $1 million. There are other costs that could lead banks to incrementally add real-time payments or limit its use.
FedNow may present added technology expenses, particularly for smaller institutions. These costs include adding the technology needed to send and receive instant payments, and the technical work that goes with adopting ISO 20022, the international messaging standard that guides FedNow's real-time processing. Banks will additionally need to upgrade security to mitigate the fraud risk that results from vastly shortened processing times.
"There's also expanding support for 24/7 exception handling, and changing all of the customer-facing documentation and processing to showcase the new settlement option," Siegel said.
The scale of FedNow and the overall growth of real-time processing should reduce the cost over time, according Siegel, but banks will still likely pick and choose how they use real-time payments.
We're seeing a broad level of interest. But the very smallest banks, which have fewer resources, may be more cautious.
"Not everybody will jump on the new service on day one, but we will see a lot of traction with FedNow payments," said Heman Daswani, principal consultant in the business solutions group at bank technology firm Temenos. Banks could delay turning FedNow on immediately while they are still exploring uses cases for instant settlement or while they decide what kinds of payments really need to settle instantly before executing the technology upgrades, according to Daswani.
To help with the expense of managing two distinct real-time payment systems, banks will need to determine what products they can and should offer that make use of FedNow, RTP, or both — and what they should charge as a premium for real-time processing. "We're seeing a broad level of interest," Siegel said. "But the very smallest banks, which have fewer resources, may be more cautious."
Also, as FedNow gets closer to launching, there has been a contention, largely in political circles, that FedNow will reduce the need for a digital dollar. The right-leaning Cato Institute, for example, says FedNow performs many of the same functions as a wholesale CBDC, which is designed to move large funds instantly between banks.
That's in contrast to retail CBDCs, which are designed for consumer use. FedNow and a digital dollar are not the same thing. FedNow is an instant settlement mechanism for the transfer of U.S. dollars from one financial institution to another; a CBDC is a digital version of the U.S. dollar or other respective underlying sovereign currency itself, Siegel said. The U.S. has not formally decided to issue a CBDC.
"In that FedNow reduces friction and increases speed in the transfer of units of monetary value, it may get the U.S. closer to achieving some of the value that a CBDC would ultimately provide," Siegel said.
Another consideration
FedNow and RTP don't work exactly the same way. These subtle differences mean that more work is required before the two networks are interoperable. MacSweeney, the head of communications for The Clearing House, said that there have been no new developments in the two networks being interoperable since the Fed is currently focused on launching its service.
Under the RTP hood, payers send funds from their bank to The Clearing House. The payment goes through the recipient's financial institution or another third party, where it's made available to the payee in real-time rather than traditional one to three business days.
Through FedNow, in contrast, a sender initiates a transaction by sending a message to their bank through an interface that's outside of FedNow. The sender's bank screens the payment then submits a message to FedNow. FedNow verifies the message, then confirms the recipient's bank will accept the payment. FedNow then debits and credits the master accounts of the sender and recipient's financial institutions or correspondent financial institution. The recipient's bank credits the recipient's account. That may sound like a lot of steps, but it's designed to take a few seconds.
RTP's banks settle payments at a master account at the Federal Reserve Bank of New York, while FedNow settles through its member banks' accounts at the Federal Reserve. There also isn't 100% overlap in transaction messaging between FedNow and RTP.
In earlier interviews, Clearing House officials said they are working with FedNow to share messaging protocols and other details to ensure the two networks can work together and with partners outside of the U.S. By relying on ISO 20022, which is designed to accommodate international e-commerce and other cross-border digital payments, FedNow says it will be able to work with other real-time payment systems inside and outside of the U.S.
"We are working globally with other payment systems as we design the FedNow service and messaging," Stanescu said.
There are also dozens of technology firms that are building connections between financial institutions and both FedNow and the RTP network. FedNow curates a list of technology firms, though it does not endorse specific providers. The Clearing House maintains a similar list, and both The Clearing House and the Federal Reserve are working with large bank technology firms to enable hookups for both rails.
"For us it works in tandem," U.S. Bank's Somani said. "RTP launched six years ago. Bringing in FedNow makes it a more complete solution. We're talking with clients on how to think about FedNow, to develop a holistic strategy around real time that includes both."
