Is FedNow a mistake?

The Federal Reserve is closing in on the launch of its real-time payment settlement system, which is meant to be a much-needed update to the antiquated check clearing system. Whether it was worth the wait remains to be seen.

Federal Reserve Vice Chair Lael Brainard had a simple message Monday to relay to the banking industry: FedNow, the central bank's faster payments settlement network, is almost here, and the financial industry needs to get ready now to hit the ground running.

This is good news on its face. The Fed has spent almost a decade poking around the question of how to update the automated clearing house, and in 2019 said definitively that it would, in fact, build its own real-time settlement network and call it FedNow. 

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Of course, The Clearing House — a consortium of the country's largest banks — had already entered the field in 2017 with its RTP Network. The introduction of a competing real-time payments system run by the Fed would give banks — particularly smaller banks — a choice in which operator to use, mimicking the interchangeable operation of public and private settlement services on the ACH system. If it worked then, it should work now, right?

The debate over whether the Fed should be building its own faster payment rails is, at least in part, a proxy fight between large and small banks. Small banks don't want to be beholden, even indirectly, to their larger competitors for something as critical to their business as payment settlement. And as a general matter, monopolies only really make sense in certain circumstances — electric and water utilities, for example, or, closer to home, financial market utilities. 

The counterpoint to that perspective is that RTP was already in existence five years ago, and if the Fed had simply named it as the solution to faster payments, the industry would likely have gotten in line, albeit grudgingly. By anointing RTP as the coin of the faster-payments realm the Fed would not have renounced its ability to regulate RTP; it just wouldn't be competing with it head to head.

I don't have a dog in that fight, and at any rate it's a moot point — FedNow is coming sometime in the second quarter of 2023, and that reality will have to sink in for better or worse. I suspect that over time FedNow and RTP will find a way to coexist, so long as the rather thorny questions of interoperability are adequately addressed.  

But the Fed is also poking around the question of whether to embark on the creation of a central bank digital currency, or CBDC, an innovation that Brainard last month called a "natural evolution" of the payment system. There are a number of different shapes that a CBDC could take, but the fundamental concept is that a CBDC would be government-issued currency that lives on a blockchain, yielding the efficiencies of digital-native cryptocurrency combined with the faith and credit of the government of the United States.

Sounds great, but here again there is a diversity of opinion about whether such a system is warranted or even desirable. 

Co-opting cryptocurrency and blockchain technology makes sense on some level. Despite the recent tumult in the crypto markets and spectacular failures of some stablecoins, cryptocurrencies account for roughly $1 trillion in value as of this writing, so crypto is clearly something for which there is consumer demand. The much-anticipated ethereum "merge" could potentially reduce much of the energy waste posed by cryptocurrencies, giving ether and the decentralized finance protocols built on it new energy. And other countries — most notably China — are already moving in this direction, so the U.S. is loath to be left behind by its biggest economic rival. 

Payments

Fed's Brainard says FedNow launching in 2023 and banks need to get ready

August 29, 2022 2:15 PM

On the other hand, if China was going to jump off a bridge, would you do it, too? Some of the most compelling theoretical benefits of a CBDC are greater surveillance of spending — which would make anti-money-laundering efforts vastly simpler — and faster payments. As many current and former policymakers have pointed out, the utility of a CBDC in combating illicit finance would be far outweighed by the ickiness of having the government know what I buy and from whom. And more to the point, if you have not one but two real-time payments rails, any efficiency arguments for a CBDC are fatally undermined.

FedNow is coming next year — that battle is over. But if the Fed also wants to pursue a digital currency, it will have to be very deliberate and explicit about how a CBDC would complement rather than replace a payment rail that it spent so much time and money getting off the ground. At a time when the Fed is asserting its independence to navigate the economy out of an inflation spiral, it should consider its credibility in the payments sphere just as carefully.