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The Green Sheet Online Edition

November 26, 2023 • Issue 23:11:02

FedNow could innovate the payments ecosystem

By Dean Nolan

Though instant payments have been on the radars of financial institutions since The Clearing House introduced the RTP Network six years ago, last summer's launch of the Federal Reserve's FedNow Service changed the question from, will instant payments will become prevalent? to when will instant payments become a core part of the U.S. payments ecosystem?

The answer hinges in the short term on when banks and credit unions commit to receiving instant payments and then in the longer term on when they begin to originate instant payments and request for payments on behalf of their consumer and commercial customers.

Use cases and value propositions to drive strategy

Instant payments are unique, providing 24/7 availability, instant settlement, irrevocability and enhanced data. With around-the-clock access, consumers and businesses can make payments exactly when they need to be made. On the other side of the ledger, irrevocability allows recipients of instant payments to immediately use the money they've received without fear of recall or dispute.

Finally, both senders and receivers are provided with immediate confirmation of the payment, alleviating uncertainty of the status of the payment. In the payments ecosystem, these value propositions have enabled banks and credit unions to better meet the needs of their customers and members by enabling use cases not well-supported by current payment modalities. Some of these have included.

  • Earned wage access: A new form of payroll that enables employers to pay their employees at the end of their shifts. This extends to freelancers and gig workers who are paid when they complete their work. Having the capability to pay workers instantly provides a competitive edge to organizations that use instant payments compared to those that still use the ACH.
  • Digital wallet unloads: A drawback to digital wallets is that they aren't always efficient or fast for consumers to unload funds. Instant payments alleviate this concern by allowing wallet holders to withdraw money right away. Instant unloads have become widely adopted in a short period of time as evidenced most notably in gaming where they went from proof of concept to table stakes in around 18 months.
  • Government payments: FedNow is being used for government disbursements via the Treasury Department's Bureau of Fiscal Services, which supports payments for 22 government agencies. Banks and credit unions receiving FedNow payments can get these needed government payouts to their customers two to three days faster than their competitors who are not receiving instant payments.

As value propositions begin to evolve, other industries are starting to incorporate instant payments into their business models. One such industry is real estate. When closing a real estate transaction, the law requires immediate and final payment to all participants. As a result, most real-estate payments are done by wire transfer, which is one of the more expensive forms of payment.

This includes an estimated 10% of real estate closing payments which are under $10 (with many only for $.01 or $.02). Since the ACH provides neither immediate nor good fund payments, there were no other options available until instant payments came along and provided a far more efficient method of settling the small ticket payouts as well as many other payments associated with real estate transactions.

Additionally, through the use of payment requests, instant payments are poised to change the entire closing experience by supporting payouts to occur in real time from the closing table.

Instant payments poised to drive significant change

The disruption caused by instant payments in payroll and digital wallets, and the pending changes in real estate and other industries, are just the tip of the iceberg. However, with any innovation that bursts onto the scene, there is a tendency to believe that legacy solutions will be phased out.

We saw this with ACH and the advent of debit cards, both of which were touted to be the end of cash and checks. Many of the same prognostications are now being made regarding FedNow and RTP. There is no disputing that instant payments are poised to disrupt several industries. How deeply they impact the existing payments ecosystem and where disruption will occur all depends on whether their value proposition resonates with consumers and businesses.

While it's possible to identify consumer and business trends and predict the direction markets are headed, it's almost impossible to accurately pinpoint where an innovation will take hold. The payments industry last experienced something like this 40 to 50 years ago with the ACH, which didn't see rapid adoption until direct deposit came along. What that game-changing use case will be for instant payments and how quickly it will come about is still to be determined.

What is known is that we all live in an immediate-gratification society, making it a perfect fit for instant payments. Additionally, the current commerce environment is littered with legacy processes built around the assumption that instant payments are not possible.

Today, a vast number of innovators are looking at ways to fundamentally change business models based on the immediacy and other benefits of instant payments. When combined with other "instant" technologies like APIs, we could be looking at a future where everyone is paid right when work is performed, when merchants settle payments as they are made, when treasury managers are balancing payables and receivables in real-time, or perhaps even one where medical payments occur in a manner that we can all understand. The bottom line is that instant payments are ushering in a new set of possibilities and opportunities. It's essential that financial institutions, businesses and service providers across the payments ecosystem develop plans for when they will participate in instant payments and how they will best monetize the opportunity for their organizations and customers. end of article

Dean Nolan is the Managing Director of Commercial Payments for SRM, a trusted advisory firm serving financial institutions across North America and Europe. Dean is a seasoned expert specializing in building opportunities within the payments industry and has delivered billions in revenue growth and cost savings across a diverse range of organizations. To learn more about SRM, visit www.srmcorp.com.

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