U.S. banks may struggle to adopt a key new global payments protocol

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While U.S. banks retooled their payments systems last year for the launch of the Federal Reserve's FedNow faster-payments service, many were also preparing for ISO 20022, an international financing messaging standard that goes into effect in March 2025.

Banks are still working through the adoption of FedNow. Many banks only support receiving instant payments rather than also sending them, for example; and to tackle the fraud risk, banks may also need to add a vendor relationship specifically to cover real-time transactions. The timing of FedNow's launch only added to banks' workload while the ISO 20022 deadline holds firm — and over a third of banks say they'll miss the deadline, according to a survey from KPMG.

Years in the making, ISO 20022 aims to create a common international language for financial messaging that will simplify cross-border payments by including incremental data with each payment. This data includes details about the purpose, context and status of the transaction, with the identity and roles of participants.

U.S. banks' adoption of ISO 20022 will bring the Federal Reserve's existing Fedwire Funds service into alignment with other payment systems around the world, and while it may not pose a huge challenge for the largest banks, midsize and smaller banks may struggle to comply.

The American Bankers Association, The Clearing House and the Independent Community Bankers of America this week published a letter to payments regulators detailing some of the technical and cost challenges for smaller institutions to comply with ISO 20022. The groups see particular hardships for some U.S. banks in adopting ISO 20022's recommended use of Business Identifier Codes or Legal Entity Identifiers, which clash with existing U.S. business payment identification protocols. 

"International efforts to improve the format and data integrity of cross-border payments, whether through ISO 20022 or otherwise, will require a more inclusive approach that recognizes the size and diversity of the U.S. payments system," the letter said.

Proponents expect ISO 20022 to expand U.S. banks' potential to serve corporations that increasingly participate in cross-border commerce with customers and suppliers. About 60% of corporations are interested in these automated payment tools, according to a recent report from Datos Insights.

"ISO 20022 will make payments more affordable, quicker and transparent," Datos said in its report, noting that most corporations are eager to capture ancillary benefits, including "intelligent routing," to automatically choose the optimal rail for a transaction based on speed, cost or other variables. 

A common use case would be when a corporate client initiates a payment via an application programming interface, or API, and immediately receives a confirmation message with the ISO 20022 format providing a summary of all relevant details of the transaction, according to Datos' report.

In a survey Datos conducted of U.S. corporate finance professionals at 1,037 midsize and large organizations during the third quarter of 2023, 57% said they were interested in using automated payables and receivables software, and 46% said they plan to use ISO 20022 for this purpose. 

ISO 20022 also supports the growing use of embedded finance, which provides access to financial services through links and portals built into companies' customer-facing platforms and websites, according to Datos' recent report.

Many U.S. banks still have work to do to prepare for ISO 20022 when it takes hold a year from now, and so do banks and corporate organizations in other global markets, said Galia Beer-Gabel, a partner at Tel Aviv-based Team8, a venture capital and company-building firm, who headed sales and market development at PayPal in Eastern Europe for several years through 2020. 

"ISO 20022 will likely bring many improvements for payments, and for managing anti-money-laundering and protecting against fraud, but it's going to take time for this to evolve and deliver on the promise," she said, noting that establishing standards are just the first step toward developing broadly accepted payment practices and use cases.

Around 40% of U.S. financial institutions — particularly smaller financial institutions and community banks — are behind on their preparations, according to industry experts. About one in four U.S. banks hope to comply with the standard by October 2025, and about 10% have no specific time frame set for ISO 20022 compliance, KPMG said in a recent report, based on a survey of 200 U.S. banks in October 2023.

"The potential of having a common messaging standard for finance globally is huge, but it's still not well understood by many at this point," said Booshan Rengachari, founder and CEO of Finzly, a Charlotte, North Carolina-based fintech that provides payment infrastructure and consulting for banks adopting faster payments and cross-border payments tools.

Many U.S. banks operating with legacy payment infrastructure will need to upgrade their platforms to support ISO 20022. To make a seamless shift to the standard, a bank typically requires API-based ISO 20022 message processing, along with internal support for relevant message types and business processes, according to Rengachari.

Many midsize banks are broadly overhauling their payment systems to create a new, centralized architecture supporting multiple payment rails including ACH, FedNow, The Clearing House's RTP network and ISO 20022, he said.

"There is much to be gained, from increased efficiency to faster settlement times and better data quality and transparency," along with the opportunity to support more types of corporate transactions," Rengachari said.

The Committee on Payments and Market Infrastructures, an international standards body managed by the Basel, Switzerland-based Bank for International Settlements, oversees ISO 20022.