Financial institutions in the United States have been preparing for FedNow, a real-time payments system from the Federal Reserve, ever since its announcement in 2019. It will bring the U.S. on par with other countries and the European Union that have had Real-Time Payments for years.
Until now, consumers only had the option for real-time payments through third-party apps like Zelle and CashApp. These existing payment systems act as an intermediary between the sending and receiving bank. By contrast, FedNow will settle directly into bank accounts. There’s also the RTP network from The Clearing House for Real-Time Payments, but only about 65% of checking accounts are covered.
After its initial pilot program, FedNow was rolled out to all financial institutions in the U.S. in July 2023. While it may take some time before consumers see FedNow offered at their bank or credit union, the benefits of real-time payments are undeniable.
Safer Real-Time Payments
Over the years, third-party payment providers like Zelle have come under fire for fraud. A common scenario is that consumers are tricked into sending a Zelle payment. In about 90% of cases, banks do not repay the consumer in any way, because the payment is considered “authorized.”
The Federal Reserve is taking many steps to reduce fraud and make real-time payments safe in FedNow. FedNow uses ISO 20222, which is a globally adopted messaging standard, and will encrypt data both in transit and at rest. FedNow also requires multi-factor authentication. Financial institutions can also opt to put additional parameters in place to classify fraudulent transactions.
Additionally, the Federal Reserve is providing education around best practices and encouraging financial institutions to put additional safeguards in place. Real-time fraud detection systems that banks put in place can rely on algorithms that identify fraudulent activity.
Faster Payments and Paychecks
Many electronic payments in the U.S. rely on the Automated Clearing House (ACH), which has been in place since the 1970s. Electronic transfers completed via ACH take anywhere from two to four business days to settle. In 2017, same-day ACH was introduced, allowing transactions to settle on the same business day. However, there are still limits around same-day ACH, including that payments are processed in batches and can take several hours.
Unlike ACH, FedNow’s instant payments will be available 24/7/365. Not only will this make a huge difference for consumers sending payments to each other, but also for businesses. Any bank account in the U.S. at a participating financial institution could use FedNow, which means paychecks could be sent instantly. Gig-economy workers could get paid immediately for work performed that day. Immediate access to paychecks could mean that consumers are less likely to rely on short-term or payday loans.
Eventually, it’s expected that ACH and FedNow will exist as a single system or that FedNow will have interoperability with other existing payment systems. However, “the model and timeline for achieving interoperability will depend on the level of commitment and engagement across the industry,” according to the Federal Reserve.
Greater Financial Flexibility and Accessibility
When most consumers think of instant payments, they think of swiping a credit card. However, not all consumers want to use credit as their preferred payment method. Millenials and Gen Z in particular have are less likely to use credit cards than other generations. Others may not qualify for a credit card, making credit inaccessible as a payment option.
Some consumers feel they have more financial control if they pay directly from their bank accounts. Yet debit cards still can take time between authorization and settlement, which can lead to accidental mismanagement of a consumer’s bank account. The consumer may think they have more money than they actually do because the debit transaction hasn’t been settled.
Real-time payments with FedNow would give consumers more flexibility to use their preferred method of paying directly from their bank accounts. And since FedNow is available to every financial institution in the U.S., it wouldn’t have the same barriers that some consumers face with credit. Consumers would additionally be able to make real-time, last-minute payments for rent or utilities, avoiding late fees or late payments that damage their credit.
Payment Innovation Improves the Economy
The faster money moves, the better for the U.S. economy as a whole. Consumers benefit from convenience and speed, making it easier for them to manage their money and spend their money. Money that rotates through the economy faster benefits both the payee and the payer — with businesses also benefitting from cash in their accounts more quickly. Payments will no longer be stuck in a days-long processing window.
While FedNow is exciting, its future is also unknown. Some financial institutions have been hesitant to adopt FedNow, due to the proliferation of other payment options available. On its own, FedNow has no user interface, meaning that a participating institution has to implement some type of internal or third-party application to make FedNow available for use, a significant technological barrier for smaller institutions in particular.
FedNow has the most benefit if all financial institutions participate, making it a truly interconnected system. Right now, many are still in “wait and see” mode. After all, consumers in the U.S. don’t know what they’re missing since there hasn’t been a single real-time payments system. Trustly is proud to be a participating member in the FedNow drafting committee and is committed to improving the new rail to increase adoption.
There’s no doubt that real-time payments substantially improve the financial lives of consumers, which has a ripple effect on the economy. Will FedNow be the answer? Or will the Federal Reserve struggle with FedNow adoption?
To learn more about Trustly’s real-time payouts powered by Open Banking technology, click here.