The Federal Reserve said Monday that it will build and operate a real-time payments system, a long-awaited decision that was sure to please many smaller financial institutions while antagonizing the nation’s biggest banks.
“The U.S. real-time retail payment infrastructure stands to gain from competition,” Fed Gov. Lael Brainard said during a speech in Kansas City, Mo., “including through higher service quality and lower prices over the long run, which in turn should support wider adoption.”
The announcement ended years of uncertainty about whether the central bank would take a hands-on role in a modern U.S. payments network or instead defer to the private sector.
The Fed said that it expects the new service — called FedNow — to be available in 2023 or 2024. That is roughly in line with a timetable that the central bank established back in 2013. But it is well behind the subsequent goal of a Fed-convened task force, which said that by 2020, everyone in the U.S. should be able to receive fast, secure payments.
Big banks argue that the Fed’s involvement will slow adoption of real-time payments in the U.S., which already lags behind much of the rest of the world. The Clearing House, a payments company that is owned by the nation’s largest banks, has been operating its own real-time system since 2017.
But many small banks and credit unions, wary that their interests will not be taken into account, have declined so far to sign up for the big-bank-owned system.
“While having the Fed facilitate payments adds competition and provides choice, that choice will likely slow adoption,” Sarah Grotta, an analyst at Mercator Advisory Group, said in an email. “There is also a danger of a two-tiered system, at least for a while, where large banks have their platform and smaller banks have theirs, until there is a competitive reason to offer both.”
Brainard said that a private-sector operator acting alone would face significant challenges in establishing a real-time network with nationwide reach. She also pointed to the Fed’s historical role as the operator of payment networks that knit together all of the nation’s banks and credit unions.
“To ensure fast payments are available to everyone, FedNow will be accessible to all banks, no matter the size,” Brainard said in her speech. “Given our long-standing service connections with more than 10,000 banks across the country, the Federal Reserve is uniquely placed to deliver this outcome.”
Brainard also said that the U.S. payment system would be more vulnerable if it had just one provider of real-time payment services. “We are mindful of the serious safety issues associated with a single point of failure, a risk that will rise as faster payments grow,” she said.
During her speech, Brainard acknowledged that private-sector efforts are under way to establish a payment system that bypasses U.S. banks and currency altogether, specifically citing Facebook’s Libra project as an example. She defended the involvement of banks, saying they have the trust of consumers and businesses that want real-time payments.
A Fed official who spoke on condition of anonymity said that the central bank plans to grant access to its new service only to depository institutions, shutting down the idea that tech giants like Amazon or Google might be able to use the platform to bypass the banking system.
If a company that does not have a bank charter wanted access to the Fed’s system, that would require congressional approval, according to the Fed official.
The Fed official also said that pricing for the service has not yet been determined, and that the agency will rely on market practices closer to the service’s launch to pinpoint what banks will be willing to pay. The official said the central bank has determined that it can achieve cost recovery over the long run.
Brainard said that 90% of the comments that the Fed received in response to a request for comments last November called for the central bank to operate a real-time payment service.
She argued that immediate access to funds could be especially important to households that live paycheck to paycheck, which may incur overdraft fees or late fees as they wait for funds to become available. Small businesses also stand to benefit since immediate access to funds from a sale may eliminate the need for expensive short-term financing, she said.
But the Fed left a host of questions unanswered, such as how it will make its system interoperable with the existing system built by The Clearing House. Brainard said that while interoperability is an important goal, it is not yet clear whether interoperability will be an initial feature of the Fed’s system.
The Fed said that it is seeking comment on how FedNow might be designed.
“During its engagement with the industry, the Federal Reserve intends to explore interoperability and other paths to achieving the ultimate goal of nationwide reach for faster payment,” the central bank said in a list of frequently asked questions.
Other issues that need to be addressed more fully include how to tackle fraud on the Fed’s real-time network, said Kim Ford, executive director of the Faster Payments Council, which represents banks, payment networks and companies that use the payment system, among other stakeholders.
“We want the Fed to work with us as well as the broader industry,” she said.
Stephen Lange Ranzini, the CEO of University Bank in Ann Arbor, Mich., and a former member of a Fed-convened task force on payment security, called on the Fed to build a system where all data is encrypted end to end at all times.
A system with proper security features would eliminate the need for consumers to remember passwords when making transactions across the Internet, he said.
