Is FedNow a game-changer?

Lindsay Lehr

Managing Director

In the fury of real-time payments growth in Latin America and beyond, the United States Federal Reserve quietly launched its own version of an RTP system in July of this year. This has caused much inquiry in and outside of the United States, primarily because until now, the US has not had a centralized faster payment system but rather a patchwork of private initiatives from banks and fintechs. But FedNow was launched quietly — without much fanfare and with essentially zero consumer-driven marketing. This has caused many to ask: What is FedNow and what will its near-term impact be? 

To help answer this question, we invited US payments industry experts Marcia Klingensmith of Fintech Consulting LLC and Erin McCune, from Bain & Company, to help answer these questions in a PCMI Coffee Chat on August 21^st.

The history of RTPs in the US 

The Coffee Chat first helped us understand the history of real time payments (RTPs) in the US and how massively it differs from other markets like Brazil or India, where the government has played a heavy hand since the beginning. The US RTP market is characterized by two phenomena:

As many payments practitioners know, the US payments infrastructure is characterized as large, clunky, and legacy-reliant: it features a heavy use of checks and non-real time ACH. RTPs have existed in niches, starting with the launch of fintech Venmo in 2009, which quickly became the leader in P2P payments. Decades after many world markets, same-day (not yet real time) became available in 2016. Seeing the RTP trend ramping up, a consortium of the largest banks came together to launch Zelle in 2017 (the closest thing we have Pix) as an effort to remain competitive and avoid customer attrition to other RTP services. Today, over 1,800 financial institutions participate in Zelle and transacted over US$600 billion in 2022.  

Also in 2017, The Clearing House, also owned by the country’s leading banks, implemented Real Time Payments, considered the first US’s first new core banking system in 40 years, with nearly 400 banks participating today (representing 65% of US checking accounts).¹ The key difference between Zelle and TCH RTP is that RTP is meant to improve ACH payments but is not consumer-facing, while Zelle is positioned more as a P2P tool with a consumer-oriented brand. In 2022, it was announced that Zelle would begin to settle transactions using the RTP network, signaling some interoperability between the two networks, but essentially, they operate independently.

Despite the availability of real-time payments, US consumers and businesses have not adopted them to the same extent as in other markets. Brazil’s Pix amassed over US$2 trillion in payment volume in 2022,² only two years after its launch. In contrast, real-time payment volume in the US in 2022 was about half of that, despite having an economy that is 23 times the size of Brazil’s. Three companies accounted for RTP volume in the US last year: Venmo with US$224 billion,³ Zelle with US$629 billion⁴ and TCH RTP with US$76 billion.⁵ This is due to several factors, including: 

• Mature use of credit and debit cards

• High use of checks

• Fragmented banking sector (over 5,000 banks and credit unions)

• High penetration of community banks and credit unions, 3,000 of which do not participate in Zelle or the TCH RTP network

• Lack of interoperability of faster payment systems

• General consumer contentment with the status quo

FedNow: Yet another layer to the US RTP story 

In July 2023, FedNow was launched. Owned and operated by the US Federal Reserve banks, it is arguably the first incursion for the public sector in faster payments in the US. The FedNow is a bit of a mystery to observers of the RTP industry. Why does the US need another RTP system? Is it consumer-facing? Who is participating? What will be the implications?

First is to understand FedNow vs. its closest competitor, RTP. As Marcia Klingensmith explained, RTP has higher transaction limits (up to $1 million), while FedNow caps it at $500,000. RTP is also open to any federally insured deposit holder, while right now, FedNow has 72 banks in its network as of September 2023. However, its long-term intention is to be a solution available to long-tail financial institutions in the US (over 3,000 who are not a part of Zelle or RTP). As a government-sponsored initiative, its goal is to be an accessible network to promote deeper penetration of fast money movement.

FedNow is likely to be a long-term infrastructure play, not a consumer-facing brand, meaning that it depends 100% on banks and other FIs to implement and deploy. There are many challenges to this, including:

• No government mandate. Participating in FedNow is optional and is not a likely choice for large FIs already utilizing TCH RTP and/or Zelle.

• High cost and lack of knowhow. Most banks, especially smaller ones, are dependent on external service providers to develop APIs and make other technology adjustments necessary to connect to faster payment services.

• Lack of bank demand. Due to the cost and complexity of connecting to faster payments, combined with low necessity, banks may not feel the urgency to do so. This also represents an opportunity for technology providers to raise this demand, encouraging small banks to participate more widely in payment verticals that increasingly depend on fast payments, including gig economy payouts, payroll, and merchant settlement.

Despite these challenges, enthusiasts insist that FedNow marks the start of a new era of payments in the US, setting the stage for a more innovative payments landscape overall, including the enablement of Open Banking. Some argue that beyond moving money, FedNow will help the moving of data, which could be transformational for fraud detection, AI and machine learning applications, payment automation and cross-border payments.  

On this note, Erin McCune shared a helpful framework to predict FedNow use cases, with government applications being the first and in most demand. This would be followed by B2B use cases, especially disbursements and SME invoices (notoriously slow), and in the long-term, consumer applications. Under this framework, FedNow could help to transform the slowest and most opaque parts of the US payment system. In turn, this will shake up the competitive environment, creating new risks and opportunities for banks and their providers.

What should payment providers do now?

Given this scenario, a few key action items emerge. Small banks and credit unions are mostly ignorant of global RTP trends and the long-term risk they are facing by not participating. As such, technology providers should begin educating banks on this trend and preparing to service them with FedNow connectivity. Setting up banks to receive fast payments is the first and most fundamental step.

With the launch of FedNow, other faster payment networks, like Visa Direct and Mastercard Send®, also have a new opportunity. There is increased curiosity about faster payments thanks to the launch of FedNow, and these networks, already well-entrenched among digital wallets and the gig economy, may have the opportunity to engage with new financial institution customers. If they can beat the implementation costs and complexity of FedNow, they may have an entirely new set of clients to go after.

Finally, third-party providers, such as billing software and payroll companies, may also have new opportunities to build faster payments into their products and be a conduit between financial institutions and the payment rail. These enablers can be strategic door-openers to the right technology partners.

The US will continue to forge its own unique path amidst the global RTP landscape: slow, behind the times, and fragmented. FedNow is not going to break any records in the short term, but over time, it could provide the foundations required to put the US on a path more like those of the UK or Europe. But this is highly speculative, and even in the case of FedNow traction, Zelle and RTP are not likely to decline. In the end, in a US$23 trillion economy, there is room for everyone and more.

Sources