What Is FedNow ?
The FedNow Service is a rapid payment system that the Federal Reserve will launch in July 2023. Participating banks can provide their consumers with the capacity to send and receive money in seconds by utilising the central bank’s new platform. In addition to shortening the time it takes to move funds, the new platform allows transactions to be processed at any time, including after hours, on weekends, and holidays.
Sending and receiving money in real time may not be a foreign concept to you, especially if you’ve used services like Venmo, Cash App, and Zelle. These payment-processing applications are unlikely to disappear, but if your bank participates in FedNow, you’ll have another option for performing near-instant financial transactions.
FedNow’s integrated clearing capability allows it to process transactions far faster than the Automated Clearing House (ACH) system, which is the current platform in the United States for sending and receiving cash electronically. ACH transactions normally take one to three business days to complete, and while Same Day ACH was introduced in 2016, it is far from instantaneous. Given this time limit, the Fed considers Same Day ACH as a “faster payment” solution, making FedNow a “instant payment” platform.
How FedNow Works ?
The structure of a FedNow transaction is similar to that of other rapid payment services. You make a payment through an interface provided by your banking institution. Your bank validates that you have sufficient funds to make the payment before initiating the transaction via the FedNow platform. FedNow withdraws monies from your account and deposit them in the recipient’s account once the payee’s financial institution accepts the transaction.A request for payment (RFP) capability is also included in the service, which has the potential to assist firms streamline their invoicing processes.
While the process appears simple enough, the FedNow platform must perform two critical activities in order to permit financial transfers:
- Clearing refers to the exchange of information regarding a payment between the originating and receiving financial organisations, which may include the detection of fraudulent conduct.
- The process of debiting monies from the payer’s account and depositing them to the payee’s account is referred to as settlement.
Both of these stages are completed in a matter of seconds via the FedNow system. FedNow adheres to International Organisation for Standardisation (ISO) 20022 norms, which are an international standard for sending and receiving electronic communications that aid in the security of financial transactions and promote compatibility with other payment systems.
Why is the Federal Reserve Bank developing FedNow ?
Instant payments are predicted to expand at an average yearly rate of 23.6 percent between 2020 and 2025, making them one of the most rapidly expanding kinds of digital payments. More than 50 nations have already created immediate payment networks that enable cash posting and settlement in real time. Consumers and businesses in the United States can already make immediate payments through Zelle and the RTP® Network, which are both privately held systems owned and run by Early Alert Services, LLC and The Clearance House, respectively. The Fed began looking into the possibility of building a centrally owned and operated rapid payments network in 2013, and in 2015 it created the Faster Payments Task Force (FPTF) to look into opportunities to implement instant payments.
The FPTF decisively decided in favour of establishing a network in its final report, which was published in 2017, and made suggestions to support its implementation. The United States Treasury announced its official support for an immediate payments network in 2018, and the US Federal Reserve Board announced in 2019 that it would begin constructing the FedNow Service. Finally, the Fed is creating FedNow to enable banks of all sizes across the United States to provide safe and efficient rapid payment services to their consumers.
What Are the Benefits of the FedNow Service?
One of the most significant advantages of FedNow is that it provides assistance to a broader range of financial institutions, including smaller community banks. While RTP is as efficient, it is not widely used; it is now supported by a few institutions in the United States. Numerous financial institutions and non-bank payment providers, such as Venmo and Paypal, already provide fast payments or transfers using RTP networks, although at a cost. FedNow is intended to expand the availability of quick payment services to more banks.
FedNow went on to say that they are “uniquely positioned to build an instant payment facilities, given their extensive track record of operating payment systems to promote a safe, successful, and broadly accessible payment infrastructure.”
More consumers will be able to benefit from quick payments as FedNow use expands. Businesses may function more efficiently with rapid settlements since they know exactly how much money they have at any one time. This is also perfect for people who need their paycheck sooner. Both businesses and people profit when transferring money is cheaper and settling is faster.
Better productivity, fewer errors, and increased consumer comfort are all business benefits. FedNow might assist teams in B2B scenarios (especially those involved with A/P and A/R) correctly monitor and post incoming money (and so prevent having to reverse errors) in addition to the back office benefits given by quick, non-reversible availability of cash. FedNow could also be useful for consumers who need to closely monitor their exiting funds. In the case of B2C, quick payments have the potential to drastically alter customer spending (and lives), particularly for individuals who live paycheck to paycheck.
FedNow’s initial version will also contain several optional capabilities, such as fraud prevention measures, QR codes, the opportunity to initially join as a receive-only member, requests for payment capacity, and tools to assist participants in addressing payment queries.
What Are the Business Use Cases for FedNow?
Businesses will be able to use FedNow for both B2B and B2C purchases in the future years.
Business-to-Business (B2B) payments, particularly Requests for Payments (RFP) (or other e-invoices), can be game changers in maximising access to financing for enterprises. RFPs that will allow companies to charge customers directly, allowing the customer to approve and transmit payment in a single step from their banking app.
Business-to-Consumer (B2C) payments via FedNow have the ability to provide enormous personal value to customers and end-users. For example, while claimants currently require quick insurance claim reimbursements, those payments are typically made via paper cheque (in addition, insurance payouts can take up to 70 days or an undetermined “reasonable time”). The implementation of FedNow for insurance distributions would vastly increase access to funds for individuals in urgent need.
According to a recent Federal Reserve poll, more firms see the value of speedier payments rails like FedNow. Interest exists in firms of all sizes and across use cases.
Businesses will also want to ensure that they have a ledgering system in place to handle and track FedNow payments for both B2B and B2C payments. You can’t wait to document and reconcile such transactions because speedier payments are instant. Comprehensive, well-managed Know-Your-Customer (KYC) and Anti-Money Laundering (AML) policies are also required.
What Sets FedNow Apart From ACH and Other Conventional Payment Methods?
Faster payments, such as FedNow, necessitate rails that differ from standard bank rails, such as ACH, in three ways.
1. Processing (Batch vs. Transaction)
Traditional rails employ batch processing for ACH, which means that relevant FIs prepare and batch ACH payments before transferring them in bulk to a clearing house. Batching makes sense due to the enormous amount of ACH payments processed on a regular basis.
Batch processing, on the other hand, causes delays. Payment files, on the other hand, are processed in real-time as they come in, on a per transaction basis, with transaction processing. This greatly enhances the speed of money flow; the anatomy of a quicker payment, such as FedNow, involves payment by payment progress through initiation, permission, transmission, embracing oneself, and receipt at a virtually immediate rate.
As a result, improved controls, partner risk assessment, and transaction monitoring may be necessary, which may affect how transactions are ledgered and provide new issues for compliance programmes.This article discusses effective practices for reducing potential fraud linked with FedNow.
2. Settlement Times
Clearing via typical bank channels occurs at predetermined intervals using ACH. Clearing occurs transaction by transaction in accordance with ISO20022 for speedier payments such as FedNow—this communications cadence and an agreement between FIs allows transactions to be credited in real-time. ACH is processed using deferred settlement, which occurs at predetermined periods or on a schedule. FedNow will use real-time settlement, which means that settlement will take place on a transaction-by-transaction basis, practically at the same time as clearing.
This is also known as a gross settlement, in which FIs clear and settle funds transaction by operation. Deferred settlement for ACH uses netting (or net settlement), which involves aggregating events between the same parties to prevent reserve depletion. Real-time gross settlement (proposed for FedNow) is substantially faster and has distinct consequences in terms of liquidity and credit risk than postponed net settlement.
3. Finality vs. Reversibility
Unlike an ACH, which can be reversed or came back transactions on quicker payment rails are final, and so money is guaranteed. Because the majority of FedNow payments will most likely be credit (or push) payments, a payer will only be able to commence payment if they have adequate cash. This safeguards businesses against chargebacks on returns such as insufficient funds (NSF).
In the case of RFPs, the more rigorous the data and specifications, the less likely errors will be similar faults in the case of ACH may cause a reversal. Mistakes are far less frequent if, for example, the amount sought in the RFP is correctly provided by the payee and cannot be altered. “Amount due” will be needed as a field in all FedNow RFPs. Connie Theien, SVP of the Federal Reserve System, explains the difference among FedNow and different payment rails in this video.