Realtime Settlement, FedNow to launch in the US

Most central banks are racing in designing and piloting CBDCs (Central Bank Digital Currency). CBDC seems to be the next big tech innovation in the bank spheres. Wait, if that is the case, why is one of the worlds dominant leader, U.S, focused on introducing FedNow?, could this be an end to CBDC development in the US?, what proposition does FedNow bring?

What is FedNow?

The US central bank, the Federal Reserve (Fed) will launch the country's first real-time payment service known as FedNow. FedNow is an instant payment infrastructure that enables individuals and business to transfer money, promising a faster payment rail for financial services, offering immediate access to funds regardless of the day or time. This will run parallel to 'RTP', the privately built network by the consortium of banks, and operated by The Clearing House.

Why the Introduction of FedNow?

Evolving industry demands from individuals and businesses as well as the need to set the pace in providing an infrastructure for real-time payments necessitated the need to introduce the FedNow service. The FedNow service offers flexibility, fast, cheap, affordability and real-time settlement. The service will support a broad range of potential use cases in the coming years when it comes to payments and settlements. More prominent of its intent is to break the existing dominance of one player in the real-time payment space. Affording customers the opportunity to choose which platform they would like to employ in receiving and making payments.

Will FedNow payment system compete with CBDCs?

CBDC in the US and FedNow can all be seen as payment infrastructures and could complement each other but may vary in some of their objectives with CBDC in the US, dollar will have to be digitally issued just like the fiat, digital issuance of currencies have advantages and disadvantages beyond the scope of this post.

The FedNow however does not issue currency as may be the case for CBDCs, it however improves and enhances the already existing system in place in the US in an efficient manner as purported.

According to The Federal Reserve, there is no decision to issue CBDC and will only proceed with an authorizing law. Testifying before the House Financial Services Committee in March 2023, Chair Powell said a central bank digital currency is, “something we would certainly need Congressional approval for.”

How does FedNow work?

A sender be it an individual or business initiates a payment by sending a payment an instruction to its Financial Institution(FI) through an end user interface outside the FedNow Service for onward submission to the FedNow service. The sender’s FI is responsible for screening the payment in accordance with message format, processes and controls setup for the service.
The FedNow Service sends the contents of the payment message to the receiver’s FI to seek confirmation that it intends to accept the payment instruction or message as. The receiver’s FI will have to verify the instructions to confirm the receivers details, the receiver’s FI sends a positive response to the FedNow Service, confirming that it intends to accept the payment message.
The FedNow Service debits and credits the designated master accounts or ledgers of the sender’s and receiver’s FI (or those of their correspondents), respectively.
The FedNow Service sends a payment message forward to the receiver’s FI with an advice of credit and sends an acknowledgement to the sender’s FI that settlement is complete.
The receiver’s FI makes funds available to the receiver immediately. This crediting to the receiver’s account as well as the debiting of the sender’s account by their respective FIs happens outside the FedNow Service.

FedNow vs ACH & Other Realtime payments

The FedNow service will provide inter-bank clearing and settlement, this enables funds to be transferred from the account of a sender to the account of a receiver in near real-time and at any time of the day.
With financial institutions participating in the FedNow Service, businesses and individuals can send and receive instant payments in real time, around the clock, every day of the year. Financial institutions and their service providers can use the service to provide innovative instant payment services to customers, and recipients will have full access to funds immediately, allowing for greater financial flexibility when making time-sensitive payments as well as improve cash flow management for recipients.

While ACH (The Automated Clearing House), remains the most commonly used network in the US, the system is unavailable after 5pm and weekends, and three (3) to four (4) days can pass before funds reflects in beneficiary accounts.

FedNow, a threat to Bank profitability or a complement

While some school of thoughts opine that a widely used instant-payment system could increase fraud. Enhanced processing time could also means more time to allow verification and security measures to stop bad actors. Similarly, some argue that being able to move large sums of money out of bank accounts immediately could introduce instability in the banking system by disrupting bank profitability and deposit mobilization efforts.

Pricing approach of FedNow

On the issue of fees, both systems will be equivalent at 4.5 cents per originated transaction, so there is no clear price advantage for either solution. While they support similar use cases, including B2B (Business-to-Business), B2C (Business-to-Consumers), and P2P (Peer-to-peer), transaction limits have been set. A lower transaction limit of $500,000 compared to the RTP’s $1 million transaction limit.

Launch date for FedNow

The Federal Reserve has launched its own real-time payments system on July 20, 2023. Though years behind tech-based private-sector competitors, it will be a game changer for transactions in the U.S. Thus being the first and only digital instant-payments system that is both created and backed by the government. As a result, many banks will see it as a larger, safer system able to transfer money faster for consumers and businesses.

So far, 35 early adopters, including JP Morgan Chase and Wells Fargo, two of the four largest banks in the U.S., have signed up whilst an additional 16 institutions will be providing these services for banks and credit unions.

FedNow could be the next big thing in the US when launched and gains traction. Customer acceptance is key to boost the adoption and usage of this system. A boost in volumes and values is envisaged from this real-time payment system. This will open up adoption for other value added services and cross-border usage in the near future.