July 26, 2022
The launch of the FedNow service is seen as a major milestone for the adoption of instant payments in the United States. But what do banks need to know about this new service? How can they prepare themselves and ready their testing ahead of day one? Below are answers to some of these key questions surrounding the launch of the new Federal Reserve Bank’s instant payments service.
FedNow is the Federal Reserve's new real-time gross settlement system that will go into effect alongside the clearing house's Real Time Payment service. FedNow will settle payments between financial institutions in real time, 24x7, and incorporate a clearing step where financial institutions will need to accept the payment in order to reduce returns. This step will help to avoid unnecessary returns across the service. It will use the ISO 200022 message standards to ensure compatibility and seamlessness for financial institutions.
FedNow announced that production launch will be in 2023 starting with pilot customers and quickly moving into allowing general availability. Exact dates haven’t been announced yet, but a 2nd/3rd quarter period has been suggested.
FedNow and Fedwire share many similarities technically speaking. Both are RTGS (real-time gross settlement) systems, meaning that they move money in real time between financial institutions and require both participants to be on the network. However, the intent of each service is quite different. Fedwire focuses on wholesale payments and allows for bank-to-bank transactions where end user accounts are not required. While Fedwire may see end user traffic (think about your refinance payment, for example), the main intent of the payment scheme is less focused on this space, and generally not focused on retail or smaller value payments. FedNow, on the other hand, is focused on lower value payments. With the limit starting at $500k for banks, and with the expectation that it's the P2P space (really low value) that will drive large portions of the volume, the payment use cases primarily being looked at are around A2A (e.g. moving money between an individuals bank account) P2P (e.g. paying someone back for that bar bill), bill pay, and payroll. FedNow also differentiates from Fedwire by being available 24/7 and always "on", as well as an intent to have lower pricing.
It seems unlikely that FedNow will replace ACH completely. 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 such as FedNow. This is because faster payments offer many advantages over ACH, such as real-time settlement and increased security. As the ecosystem around faster payments matures, we expect to see more and more banks and businesses moving to 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. 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 prefunded model with reserves held at the Federal Reserve Bank of New York in a joint account for all RTP participants.
FedNow payments are handled out of the reserve accounts at the federal reserve, and since FedNow will be available 24x7 , the issue of liquidity is less of a concern then the current private sector solution RTP – which counts on liquidity in and out of the RTP’s joint account via Fedwire. For RTP since Fedwire is not available on the weekend, this proves to be a bit of a challenge. That being said, even for FedNow, Financial institutions may need to borrow liquidity from another institution or correspondents who are supporting respondents on the service may need to receive or disburse liquidity for their participants. For that, FedNow is supporting a liquidity management transfer (LMT) that will be available during select hours (possibly when Fedwire is not available – to be confirmed) to support the movement of liquidity between FI’s.
Currently the Federal Reserve has not confirmed that compliance and OFAC will be required. However right now most institutions are assuming it is required similar to the RTP system. To support this FI’s must be able to integrate to a compliance/sanctions screening in real time (or utilize a service provider) so they can complete the payment leg that requires them to accept the payment.
With FedNow on the horizon the time for banks to 'wait and see' is fast coming to an end. At Form3 we're here to ensure you are ready to play in the real-time space from day one with simple implementation and testing ahead of the go-live date. Contact us today to find out more.