By Dr. Jack T. Baldwin
As we head into 2023, there is speculation on how the FedNow launch will ultimately unfold and impact our faster payments landscape. For payments organizations and financial institutions (FIs) that have been hesitant in their adoption strategies, the impending launch could mean real pressure to make quick decisions on what to choose, but they must also consider how that choice could impact them, especially when it comes to their back-office operations.
Recently, the Fed updated its timeline for the FedNow launch, estimating it will now go live sometime between May and July of 2023. In anticipation, it seems likely the FedNow group will continue to carry out an organized approach to educating FIs and potential service providers with webinars, educational materials and sessions discussing FedNow features. The group has also organized pilots to give FIs and service providers an opportunity to start testing interfaces and applications prior to launch.
With the advantage of having access to an already-existing infrastructure in the Federal Reserve network itself, the team seems poised to hit their date. Additionally, they have also leveraged processing functions inherent in the existing network, such as settlement, within the master accounts of banks.
Another advantage supporting adoption is that many of the FIs, and most of the service providers, have already gone through a similar implementation effort with the competing RTP network that went into production in 2017. In fact, the ISO 20022 messaging for FedNow is essentially the same as that for RTP.
While FedNow will offer many benefits, new real-time core functions and capabilities represent some of the most significant impacts. The biggest shift for many is that FedNow will operate on a 24/7/365 basis. Credit transfers will require the sender to initiate payment, rather than the recipient, and it will be for domestic payments only (no cross-border payments at least initially).
Because it is a true, instant payments environment, all transfers are irrevocable and will be restricted to participants that maintain Federal Reserve accounts. Current master Fed accounts will be used for interbank settlement, and funds will be available in recipients' accounts in near real-time.
Institutions will have the option to join FedNow as "receive-only" banks and non-bank service providers, and correspondent banks can process for banks. Though the transaction size limit is still being determined, participants can choose to set a lower limit for themselves. Account activity reporting (including intraday balances) and other similar capabilities will be provided by FedNow for detection and fraud prevention, with a seven-day accounting regime as the standard.
Future updates that are planned or considered include: additional fraud fighting tools; use of alias directories to simplify transaction routing; APIs to assist in the creation of overlay services; and, ultimately, interoperability with RTP. Other potential additions could include debit pull transactions and cross-border payments.
FedNow provides an alternative to traditional payment channels that will have some real world applicability. 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.
Perhaps most importantly, FedNow may motivate a number of FIs that have been sitting on the "instant payments fence" to finally commit to instant payments support. The Clearing House's RTP network has been in production since 2017, so an instant payment option has been available for years (not to mention other similar options like Visa Direct).
But some banks and credit unions, particularly smaller ones, have been loath to join a network controlled by their larger competitors—even with RTP promising that all network participants would be treated equally (that is, no special treatment for the larger banks that own The Clearing House and RTP). So, institutions that have been reluctant to commit to RTP may choose to commit to FedNow because they consider the Fed to be a fair broker that will treat all members equally.
Potential roadblocks for FI adoption of FedNow include the increased cost and operational complexity, as well as the issue of interoperability. While FedNow has implemented the same basic ISO 20022 message set adopted by RTP, the two networks are not interoperable. Unless a sending bank or payments company has links to both networks, it cannot complete a credit transaction to a receiving institution unless they are both on the same network.
The expectation is that the two networks will derive standards to overcome this in the near future. Alternatively, a third-party routing hub could be created to accept credit transactions from either network and route them accordingly.
All prospective FedNow participants should consider which of their internal and external solutions may be impacted by instant payments and whether they would need to have 24/7/365 availability. Concerns for systems integration include knowing the additional capabilities, if any, that would be needed to handle real-time processing. Systems must also be set up to alert customers of payments received or other status messages and to meet anticipated requirements to make funds available immediately.
It is also important to know the desired customer experiences and functionality, along with the security and resiliency implications to support around-the-clock activity. For FIs ready to adopt FedNow, the FedNow Service Readiness Guide, https://bit.ly/3hMF4yA, is a valuable informational resource.
FIs and payments companies must also consider how interaction points for their customer-facing and internal staff might be impacted by the FedNow service. This includes online banking, mobile banking, text banking and Interactive Voice Response (IVR) systems. For FIs, this may mean teller and/or customer care interfaces for initiating transactions and accessing information about transactions, dispute investigations or requests for payments may also need updating.
What will the reporting needs be for customers in a 24/7/365 environment, and how can FedNow transactions be incorporated into this reporting? Understanding the alerts, notifications and/or other information relative to instant payments that will be made available to customers will be helpful to answering these critical questions.
It will be important for participants to decide where their FedNow transactions will settle. Settlement may occur in an FI's own master account with a Federal Reserve Bank, or the FI may choose to designate a correspondent, such as a banker's bank or corporate credit union.
If an FI decides to settle in its own Federal Reserve Bank account, the appropriate processes will need to be in place to manage account balances and ensure compliance with the Payment System Risk (PSR) policy under an expanded window to process transfers on a 24/7/365 basis. When using a correspondent to handle a settlement, institutions will also need to consider the specific agreements that may be required for this settlement, such as thresholds or liquidity management considerations.
Additionally, institutions that send credit transfers or provide settlement services through FedNow will need a strategy to maintain liquidity for instant payments. As with settlement, this may involve either making internal adjustments, sourcing liquidity from the Discount Window, another FI or via a correspondent. Participants will be expected to manage their master accounts in compliance with Fed policies, including the PSR policy on intra-day and overnight credit. FedNow will support FI-to-FI liquidity transfers in support of instant payments.
Considering the potential for shorter processing times for instant payments, prospective users should review their back-office processes that require manual oversight and intervention. Any operations that can be automated will significantly help streamline all relevant workflows.
Participants should also consider how FedNow may impact their processes and reports for accounting and reconciliation. Account balance management will become more complex in a 24/7/365 environment where payments settle continuously in master accounts. Organizations should consider how they will monitor balances around the clock, deal with issues during nonstandard business hours, and for reconciliation, if their current windows will work with instant payments.
While many FIs and organizations may still be weighing the costs of adoption versus their needs, the future of payments is real-time, and FedNow provides a viable pathway to that future. Regardless of the network, those that wait are only delaying the inevitable and will likely find themselves playing catch-up and at a competitive disadvantage later.
Dr. Jack T. Baldwin is chairman and CEO of BHMI, a leading provider of product-based software solutions focused on the back office processing of electronic payment transactions and creator of the Concourse Financial Software Suite®, www.bhmi.com/concourse_financial_software_suite/.
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