Mastering the FedNow Service: Your Guide to Instant Payments in the U.S.

FedNow is the Federal Reserve's new real-time gross settlement (RTGS) system that will operate alongside the Clearing House's Real-Time Payment (RTP) service. FedNow will settle payments between financial institutions in real time, 24/7, and incorporate a clearing step where financial institutions need to accept the payment to reduce returns. This step helps avoid unnecessary returns across the service. It will utilize the ISO 20022 message standards to ensure compatibility and seamless integration for financial institutions.

The FedNow Service will be deployed in phases, with the initial SPR staged production rollout taking place in July 2023. With November being when the scheme will be open to all participants.

While both FedNow and Fedwire are RTGS systems, meaning they move money in real time between financial institutions and require both participants to be on the network, their intentions are quite different. Fedwire focuses on wholesale payments and allows for bank-to-bank transactions where end user accounts are not required. In contrast, FedNow is focused on lower-value payments, with the limit starting at $500k for banks. The primary payment use cases for FedNow include account-to-account (A2A) transfers, person-to-person (P2P) payments, bill pay, and payroll. Additionally, FedNow differentiates from Fedwire by being available 24/7 and offering lower pricing.

When considering the costs associated with joining the FedNow Service, it is important to note that its pricing structure falls between that of ACH and Fedwire. While FedNow is priced higher than ACH, it remains more affordable compared to Fedwire transactions. In terms of pricing comparison with the Real-Time Payment (RTP) system, FedNow and RTP are expected to have mostly similar pricing, with only minor differences between them.

It seems unlikely that FedNow will completely replace ACH, as there are still many use cases for which ACH is the better solution. However, over time, we expect to see a shift in payments from ACH to faster payment rails like FedNow, which offer benefits such as real-time settlement and increased security. As the ecosystem around faster payments matures, more banks and businesses are expected to adopt this new system.

FedNow is the federal reserve central bank faster payment scheme offering that is under development with plans to go live in 2023.  The Clearing house RTP – is the private offering in this space and has been live since end of 2016. The Federal Reserve's FedNow service and the Clearing House's RTP service are both faster payment schemes designed to improve resilience in the economy and modernize payments in the US. Both services have many similarities, as the intent is for these two schemes to parallel each other and support resilience in the economy. However, there are some differences between the two services. Primarily, FedNow will work with the Federal Reserve accounts of their customers, while RTP is a pre-funded model with reserves held at the Federal Reserve Bank of New York in a joint account for all RTP participants.

Although RTP and FedNow Service share some similarities, they won't interoperate. This means that even if a bank is connected to the RTP system, it will still need to establish a separate connection and configure its solution to work with the FedNow Service. It's essential to test the differences between the two systems and make any necessary adjustments to the bank's solution to ensure compatibility with FedNow.

Understanding and addressing these differences through thorough testing is crucial for a smooth integration with the FedNow Service. By adapting their solutions and testing their functionality with the new system, banks can be better prepared to offer customers the benefits of real-time, instant payments through both RTP and FedNow Service platforms.

FedNow payments are handled out of the reserve accounts at the Federal Reserve. Since FedNow will be available 24/7, liquidity is less of a concern compared to the current private sector solution, RTP, which relies on liquidity in and out of the RTP joint account via Fedwire. However, even for FedNow, financial institutions may need to borrow liquidity from another institution, or correspondents supporting respondents on the service may need to receive or disburse liquidity for their participants. To address this, FedNow is supporting a liquidity management transfer (LMT) available during select hours to facilitate the movement of liquidity between financial institutions.

The Federal Reserve has not confirmed whether compliance and OFAC screening will be required. However, most institutions are currently assuming that it will be required. To accommodate this, financial institutions must be able to integrate with a real-time compliance/sanctions screening system (or utilize a service provider) so they can complete the payment leg that requires them to accept the payment.

In the development and implementation of the FedNow Service, it's crucial for financial institutions to take a proactive approach to interoperability and testing. By building the infrastructure, creating documentation, refining operational procedures, and implementing the necessary tools, such as user interfaces, institutions can identify and address potential issues early in the process.

Embracing an agile approach to the development and testing of real-time payment systems like FedNow is essential in today's fast-paced financial landscape. By prioritizing interoperability and testing from the outset, financial institutions can ensure a smoother, more efficient implementation process and fully harness the benefits of instant payment solutions.

At Form3, we're here to ensure you are ready to participate in the real-time payment space from day one with simple implementation and testing ahead of the go-live date. Contact us today to find out more.