On FedNow

One of the most interesting developments in the last week has been the launch of FedNow, an instant payment settlement service for banks and financial institutions from the Federal Reserve. Up until now, settlement times between banks in the United States vary between one to three days. The promise of FedNow is instant settlement for banks that adopt the service. Its costs are minimal and the benefits immense.

For example, the Request for Payments (RFP) feature automates reconciliation between Accounts Payable (A/P) and Accounts Receivable (A/R) and enables automatic and instant disbursal of payments in an invoice date. Instant settlement accelerates the velocity of money and boosts the economy. It also streamlines and simplifies the complexity of payment processing.

The Federal Reserve is the primary settlement layer for all payments in the United States. Therefore, the launch of FedNow should have sent competitors and payment services scrambling to revisit their offerings. In the current payments landscape, its impact is expected to be minimal. In the long term, however, its effect will be more dramatic.

A Payments War ?

The Federal Reserve has a legal mandate to provide the cheapest and fastest possible means of transfer for payments. But the agency has dragged its feet on fulfilling this mandate while private players have raced ahead. Zelle, a consortium of privately-owned banks, provides instant transfers for its members. As does Venmo, a payments app that enables instant transfers to customers while processing actual bank transfers that run into many days in the background.

The Fed’s delayed entry into instant transfers has led some analysts to dub this as the start of payment wars. On a broader note, it could signal a shift away from credit cards towards debit-based payments, they say. In Brazil, Pix, a similar instant payment method, has racked up phenomenal growth since its launch in November 2020. It processes more than $3 billion worth of transactions daily. “If it (FedNow) catches on, the biggest losers are likely to be the major credit card issuers,” writes Felix Salmon at Axios. This is because credit cards charge hefty interchange fees.

But credit cards are deeply entrenched into the average American’s spending habits. According to the Federal Reserve Bank of Atlanta, 77% of US adults had, at least, one credit card. Compare that to Brazil, where credit card penetration stood at 40.4%. The average American has 3.4 cards while the number of cards per Brazilian has only recently risen to two per person.

Besides the convenience and international liquidity that accompany credit card ownership, such cards also offer attractive rewards to enhance their utility to customers. The promise of instant debit transfers, while attractive, is unlikely to compensate for these add-ons.

An Ecosystem of Payments

The Federal Reserve has said that the FedNow service is designed to be a “foundation for the broader payment ecosystem” to develop new services. Some examples of such services include bill payment, immediate payroll processing, and brokerage account funding.

Other examples include neo-banks or tech platforms that work with multiple banks and financial institutions with access to FedNow to provide an aggregated menu of services in a single interface. Likewise, the service offers small banks, that have traditionally lagged big banks in offering competitive products and services, the chance to offer a wider array of choices to their customers and compete on an even keel. Because they will have access to the FedNow window, big banks will become more powerful. But that power will come at a cost. Specifically, the capital requirements for access to FedNow is steep for big banks because they assume greater risk as a backstop for liquidity in the system.

What About Crypto?

There’s also been some discussion about the implications of FedNow introduction on crypto. After all, instant settlement has been a long touted feature for cryptocurrencies and stablecoins.

The use cases for such tokens, especially domestically, become challenging with FedNow. Why bother with a stablecoin – an instrument that is backed by the US dollar – when the bank offers instant settlement for the currency itself.

However, stablecoins will retain their utility across borders.

The FedNow system is a domestic system, meaning it does not work out of the country. The United States will have to fashion agreements and partnerships with other jurisdictions. Meanwhile, stablecoin legislation, even though it is flawed, has at least made an appearance in Congress. This means that it is on the radar of legislators.

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