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Friday, August 21, 2020

Green Sheet interviews Dr. Jack T. Baldwin, BHMI

Dr. Jack T. Baldwin is chairman and CEO at BHMI, a software solutions provider specializing in back-office payment processing solutions and creator of the Concourse Financial Software Suite. In this recent interview with The Green Sheet, presented in Q&A format, he shares insights on The Federal Reserve's FedNow initiative in progress.

How would you describe the FedNow program?

FedNow is a nationwide “instant payment” network under development by the Federal Reserve. When completed in 2023 or 2024, it will provide a mechanism for individuals and organizations to transfer funds from an account in a given bank to an account in another bank within seconds. And, after a transfer has occurred, it is irrevocable – the recipient of the transferred amount has complete control of the funds.

FedNow payment services will be available for use 24 hours a day, seven days a week, 365 days a year – FedNow instant payments can be made around the clock. The FedNow payments network will be operated by the Federal Reserve and will be accessible to any bank within the Federal Reserve system. Customers of banks that choose to be part of FedNow will be able to experience the benefits of unrestricted access to funds within seconds of transfer initiations.

What impact do you expect the program to have on traditional commerce?

FedNow provides an alternative option to traditional payment channels that some individuals and organizations will find appealing. This could include individuals who need to make payments quickly to avoid overdrafts or other penalties or individuals who need to move money that can be accessed immediately.

Recipient businesses could receive unrestricted funds immediately, which improves their cash flow and reduces the need for borrowing. Other businesses that need to dispense large numbers of payments quickly, like insurance companies paying damage claims, would be obvious beneficiaries of an instant payment network.

Not all current participants in commercial transactions would necessarily be drawn to an instant payment network. For example, although declining, there are a significant number of check users in the U.S. who are comfortable with the delays attendant to check payments – and who take advantage of the cash float associated with check payments.

There will also still be users of credit cards who prefer to make payments by credit card because they can delay making actual outlays of cash until payments actually have to be made to cover credit purchases (they have use of their cash for a longer period of time).

The instant payments capability offered by FedNow will not necessarily eliminate the need for other payments options. However, it is anticipated that the convenience, speed and finality of immediate payments will find greater appeal and acceptance by individuals and organizations over time.

Additionally, new overlay services built upon instant payment plumbing offered by the Federal Reserve and private organizations will increase its utility and attractiveness. Instant payments will definitely create new and expanding opportunities for funds transfer participants.

What economic and logistical benefits will FedNow provide to consumers and businesses during COVID-19?

Although the Federal Reserve is being encouraged to expedite development and deployment of FedNow, it is not currently scheduled to be operational until 2023 or 2024. Consequently, unless COVID-19 cases remain out of control for an extended period of time, FedNow will arrive too late to affect consumers and businesses from a pandemic perspective.

Nevertheless, a dramatic increase in digital payments has occurred during the coronavirus shutdown. Individuals and organizations are buying and selling electronically because face-to-face commercial transactions are difficult or impossible due to COVID-19 restrictions.

Instant payments are fully supportive of digital transactions and are generally less expensive to use for merchants than debit or credit cards because of lower fees. If FedNow were currently available to consumers and businesses, it could have a major effect on the types of payments options used in financial transactions.

What potential opportunities and challenges will FedNow present to financial institutions and merchant service providers?

Obviously, FedNow will permit financial institutions to provide the benefits of instant payments to their customers. In some cases, this will permit financial institutions to gain a competitive advantage over their rivals who do not provide FedNow access.

FedNow will also give financial institutions the ability to provide instant payment services to customers who have been convinced of the advantages of realtime payments and want their banks and credit unions to provide instant payment capabilities.

A number of the challenges to offering FedNow services were revealed in comments to the August 2019 Federal Reserve announcement that confirmed the goahead for the network. Two of the biggest issues noted by financial institutions in the comments were:

  1. How can financial institutions accustomed to providing banking services during normal weekly business hours support the 24x7x365 services offered by FedNow?

  2. How can financial institutions provide additional funds to their Federal Reserve master accounts used to fund instant payments after hours? FedWire services typically used to refresh master accounts are not available on a 24x7x365 basis.

Because of the importance of these two issues, the recent Federal Reserve announcement indicated that financial institutions could use external service providers or agents to oversee their FedNow operations, especially afterhours operations.

Additionally, the Federal Reserve announced a “liquidity tool” that could be used by FedNow (and other banking) participants to refresh reserve accounts after hours – the tool essentially would permit banks with surplus funds in their reserve accounts to transfer funds to banks with deficient reserves.

FedNow provides merchant processors with a new payment mechanism that merchant customers can use to acquire goods and services. This expands the number of ways that customers can pay merchants, and merchant processors that provide this capability can obtain a competitive advantage over merchant processors who do not.

The challenges that merchant processors confront supporting FedNow services essentially consist of adjustments to current merchant payment processing. Existing funds tracking, reporting and related support functions would need to be adapted to accommodate FedNow payments, but these are services that already have to be provided by merchant processors for existing payment types and channels.

Consequently, while some adjustments will need to be made, there should be no major disruption of existing procedures.

How can financial institutions and third-party service providers effectively prepare and participate in the initial phase of FedNow?

The Federal Reserve recently released a new service announcement to address comments received from interested parties responding to the August 2019 Federal Reserve announcement. The recent announcement also provided additional feature details for the first phased release of FedNow. The purpose of this service announcement was to help financial institutions and third-party service providers start their planning to accommodate and take advantage of FedNow.

The announcement admitted that there were significant remaining questions to address before organizations could fully plan for FedNow, but it represents a start. The Federal Reserve indicated that additional FedNow details would be announced as they were determined by the FedNow planning group. The intention was to provide as much advanced notice as possible to permit appropriate planning by potential FedNow participants and thirdparty support partners.

With the aid of Federal Reserve feature notifications, it can be expected that larger financial institutions will assume much of the responsibility of making the necessary internal changes to support 24x7x365 processing and address the afterhours master reserve account liquidity issues needed to support FedNow services.

Like much of their current processing needs, smaller financial institutions are likely to outsource FedNow service processing to third parties specifically offering such services. end of article

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