Two months ago, the long-awaited FedNow real-time payments system was launched in a wave of anticipation from the banking community.
“The most important thing that I would tie to July 20 is the fact that the rail is live,” said Mihail Duta, Director of Solution Consulting and Transaction Banking at Finastra. “There’s been kind of “wait and see, FedNow, is not live yet.” Well, now it’s live. It’s real. It’s here. It’s up and running.”
The customer demand for real-time payments has been rising. “We’re undergoing a sea change in Americans attitudes and expectations around payments,” said Joshua Siegel, Partner at Capco. “The world and the economy in the US, specifically, is becoming geared towards much faster delivery of products and services. And in the payment ecosystem has to support them.”
According to a recent survey conducted by Temenos, over a third of consumers are unhappy with the current speed of bank transfers. Younger generations, in particular, are dissatisfied with the bank payment experience, and many opt for payment providers over their banks despite finding banks and credit unions more trustworthy.
After multiple delays, the banking system’s “wait and see” approach to real-time payments is understandable. Existing options were deemed unattainable for many smaller banks and fintechs. While the demand for real-time payments was evident, FedNow’s continued delays meant that many institutions had few viable options to offer the facility to their customers.
“FedNow’s launch created a different level of urgency for real-time payments. The reality has set in that it’s here,” Duta continued.
While real-time payment networks have existed within the banking ecosystem for a few years, FedNow was touted to be different. Led by the Federal Government rather than a consortium of large banks, it’s launch came with a promise of evolution in the banking sector, particularly for smaller banks.
Only two months on, there has been a shift in how financial institutions are regarding real-time payments. Although adoption is slow, it’s steady and has key elements that could make it a game changer.
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Slow but Steady Adoption
Since launching in July, the number of FedNow participants has grown. The service launched with 57 “early adopters,” including large banks, credit unions, and influential fintechs. In two months, that list has increased to include 72 participating institutions, 20 settlement agents and liquidity providers, and 20 certified service providers.
“If we look at where FedNow started, the number of participants continues to increase quite quickly,” said Duta. He explained that the payment rail also included institutions that hadn’t been a part of any other real-time payment system before, which could drive further adoption.
“An interesting aspect with FedNow, which catches the attention of financial institutions and credit unions, is the fact that the Treasury Department is an active participant,” he said. “That’s important is because the majority of financial institutions do have some interaction with the Treasury Department.”
“That adds to that level of urgency around enabling FedNow because if one of my customers were to receive a payment from the federal government, whether it’s a benefit payment, for example, they would probably prefer that they receive it faster.” He explained that could add a competitive advantage for financial institutions that integrated into the FedNow system to receive payments.
“If you Wait For Customer Demand, You’re Already Behind”
Duta explained that one of the main reasons for a delay to FedNow’s uptake by institutions has been its optionality. Unlike other nations’ systems where real-time payment systems caused a “big bang” of real-time banking, FedNow is an optional payment rail much like the existing Real-Time Payment (RTP) system from the Clearing House.
However, despite this optionality, he explained that banks should pre-empt a wave of consumer demand and use FedNow integration as a competitive advantage.
“Even though it’s market-driven, it doesn’t mean banks should wait to adopt,” said Duta. “If banks are going to wait for their customers to ask for FedNow, they’re already behind… They can wait, but it’s a dangerous waiting game. There is a risk of losing your customer base by not offering and getting in front of the fact that you should offer instant payments right now.”
Already, financial institutions targeting small businesses have been inundated by requests for real-time payments.
“All our customers were asking for Zelle,” said Herman Man, Chief Product Officer of Bluevine. They want real-time payments. They want the ability to move funds. There’s a pent-up demand for this.” However, until the launch of FedNow, many, like Bluevine, could not meet that demand due to barriers to accessing the Zelle and RTP networks.
For many, FedNow, therefore, poses an opportunity for competitive advantage. “It’s a unique opportunity for institutions to pull customers from competitors,” said Siegel. “Merchants will be predisposed to switch services if the difference in service speed is so compelling.”
However, attaining this infrastructure requires additional investment, which smaller institutions with less available resources have to justify. Currently, smaller institutions are grappling to find suitable use cases which may delay widespread adoption.
“One of the things that we all need to think about is what are the use cases where instant payments make sense and add value,” said Laura Merling, Chief Transformation Officer. She explained that while real-time payments may make up a part of the future of banking, smaller institutions like Arvest are currently observing the rollout of FedNow to understand where real-time payments fit in best for their business model.
According to Siegel, for those institutions who do find the right use cases, it could add to institutions’ growth and competitiveness. “There are very compelling use cases that will drive additional revenue and reduce costs,” he said. “The projections that we have done show that most banks can get a return on their investment in less than a year. That is predicated on choosing the right the right use cases.”
Existing Options And How It Differs
The Clearing House’s RTP network, live since 2017, by comparison, has over 350 participating banks, many of which feature in FedNow’s network. Owned by a consortium of larger banks, it was the private sector’s response to rising demand for real-time payments. According to the company, its network of participants holds almost all demand deposit accounts in the banking system, and the RTP system currently reaches about 65% of them.
However, some have criticized RTP’s adoption rate and say that FedNow will likely be more attractive to financial institutions.
“Just about every financial institution in the US has a relationship with the Federal Reserve,” said Duta. “It’s a known quantity; it’s somebody they know they trust. Compared to RTP’s 65% reach, FedNow will probably reach 100% of all DBAs in the US from a scale perspective.”
“RTP is owned by The Clearing House, which is owned by larger institutions,” said Siegel. For some smaller institutions, this is a way for them to get on instant payment rails without returning some revenue to those larger banks that some consider competitors.”
Luther Liang, Director of Product at Grasshopper Bank, explained that FedNow, as a government entity, also represented stability for smaller institutions.
“There’s not a tonne of differences in the protocols,” he said. “But for us, particularly as a startup, we see that as a safer bet over the long term. Clients don’t specifically ask for one or another. They’re generally taking the same perspective of, you know, as long as you have one, we’re pretty happy.”
He explained that while many of Grasshopper’s clients had requested Zelle for business, which now makes use of the RTP network, this option was too expensive for small institutions, creating barriers for them to onboard.
“A Mentality Shift”
FedNow represents an opportunity for smaller institutions to engage in the real-time payment system they were previously unable to access. However, despite its appeal, the move to real-time may be a slow one, affecting the speed of adoption.
For now, most institutions are focused on becoming “receivers” within the FedNow network, which represents less development of a new infrastructure to support real-time payments.
As real-time payments are instantaneous and irrevocable, many fraudsters have used them to target new areas of the payment system. In India, where the use of their real-time payments system is high, APP fraud is high, growing while other areas of fraud decrease. Similar trends can be seen elsewhere, with banks caught up in disputes over the responsibility of APP fraud avoidance.
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Allowing financial institutions to receive payments faster does not carry the same fraud risks and infrastructure development to support the function.
“It’s almost a conservative play,” said Duta. “It’s easy to enable. It’s less risk from a bank perspective because it’s just about deposits coming in. All they are enabling is the ability to receive additional deposits faster for my customers and members.”
As the focus turns toward “send,” however, a larger shift in approach to banking may be needed.
“What it means is a move from business hours to a 24/7 365 model,” said Liang. “It means you’re going to need to implement things like real-time transaction monitoring, extra staff, and you’re going to have to be keeping a much closer eye on your cash flows as well… A lot of balance sheet management changes will have to happen. If you’re a smaller institution that doesn’t have experience with that, that’s going to be a really big mindset change.”
However, he explained that this change in mindset may be a good thing, ultimately affecting all areas of payment handling.
“It’s going to lead to a better banking experience across the industry,” he said. “A lot of the things you need to do in order to support this kind of payment will also lead to a better client experience across all of your payment methods.”
“If you have to have the staffing and the tech to review a FedNow payment and make a decision, you’ll be able to use it for an ACH transfer or a wire. There’s going to be a really strong tech ecosystem around those types of functionalities, serving banks and financial institutions.”
