FedNow Explained: The New Landscape of United States Payments
“Instant Payment”
A phrase that rings a bell for countless Indians!
However, today, our focus shifts to the United States and its Instant Payment infrastructure, the FedNow.
Let’s dive in!
What is FedNow?
FedNow is an instant payment system developed by the Federal Reserve, the central bank of the United States. This system allows banks across the US to provide instant payment services, enabling businesses and individuals to send and receive funds instantly, 24/7, 365 days.
The start:
In 2020, Lael Brainard, a prominent figure at the Federal Reserve, announced the plans for the FedNow service. This visionary project aimed to establish a “neutral platform” empowering the private sector to develop secure and efficient instant payment solutions nationwide.
Fast forward to July 20, 2023, FedNow materialized, marking the debut of the first common-use Real-Time Gross Settlement (RTGS) system offered by the Federal Reserve, equipped with instantaneous payment capabilities.
Who Can Leverage?
It is accessible to both individuals and businesses who are customers of participating financial institutions and credit unions. It’s important to mention that all banks in the US have the option to participate in FedNow. Additionally, for a transaction to occur, both the sender’s and recipient’s banks must have opted into the FedNow system.
Use Case:
- Consumer to Business [C2B] — (Eg: Phone bill payment)
- Business to Business [B2B] — (Eg: Payment made between merchants for goods/services)
- Business to Consumer [B2C] — (Eg: Refund made by the merchant to your account)
- Person to Person [P2P] — (Eg: Payment made to your friend or family member)
- Account to Account [A2A] /Me-to-Me — (Eg: Crediting your wallet)
- Consumer to Government [C2G] — (Eg: Paying taxes to the government)
- Government to Consumer [G2C] — (Eg: Social security payments)
- Business to Government [B2G] — (Eg: Merchants paying state taxes)
How FedNow Moves the Money?
A go-to view:
Authorization
Before making a FedNow payment, the sender needs authorization from the recipient to debit/ credit their bank account. This permission is usually obtained through agreements or online approvals.
Initiation
The sender (individual or a business) starts the payment process using their bank’s interface. They provide details like the recipient’s account info, the amount to send, and why they’re sending it. This part happens outside of Fed Now.
Transmission
Phase 1: The sender’s bank sends the payment message to the FedNow Service, which checks that everything is in the right format and meets the necessary rules.
Phase 2: FedNow Service then sends the payment message to the recipient’s bank to see if they’re willing to accept the payment. The receiver’s bank decides what to do with the payment message (accept, reject, or accept without posting).
Settlement and Clearing
If the recipient’s bank accepts the payment message, FedNow finalizes the payment by moving money between the sender and receiver’s banks. This process happens quickly, usually within 20 seconds. Once the payment is settled, FedNow informs the recipient’s bank to make the funds available to the recipient immediately. They also let the sender’s bank know that the payment is complete.
Features of the FedNow:
The FedNow Service offers optional features tailored to financial institutions’ preferences:
1. Send and Receive
- Enables sending, receiving, and returning of customer payments.
- Supports credit transfers with other institutions for instant liquidity.
- Facilitates customer-initiated Requests for Payment (RFPs) and receipt of RFPs on behalf of customers.
2. Receive Only
- Focuses solely on receiving payments.
- Allows receiving payments to address liquidity needs.
- Enables returning received payments and sending, but not receiving, RFPs.
3. Liquidity Management Transfers:
- Allows high-dollar-limit credit transfers with scheduled availability, even without Fedwire Funds Service.
4. Settlement Services:
- Supports correspondent/respondent relationships.
- Specifically settles FedNow transactions for correspondent-using financial institutions in the correspondent’s master account.
There are currently 564 financial institutions participating in Fed Now, and 30 additional institutions are serving as settlement agents and liquidity providers.
FedNow Vs ACH
The Automated Clearing House (ACH) network has been the go-to for electronic payments in the US for decades, handling both credits and debits. However, the landscape of U.S. payments is experiencing a shift with the introduction of FedNow.
Let’s explore the comparative dynamics of these two systems.
The Calm Before the Storm
Yes, you heard it right!
Here is the answer:
Fees in FedNow
For
- Customer credit transfers — $0.045 per item
- Customer credit transfer returns — $0.045 per item
- Liquidity management transfers (LMT) — $1.00 per item
- Request for payment (RFP) — $0.01 per item
Now you would have probably understood why we said, “the calm before the storm”.
The Sunshine and Shadows:
Though FedNow is
· Real-time
· Reduced risk of fraud (compared to ACH)
· Enhanced accessibility and
· Improved cash flow management
We can’t ignore its challenge and this convenience comes with certain pitfalls, for example, higher transaction costs.
But!
FedNow still holds much promise as it continues to evolve.
P.S: What topic do you think we should explore next? Let us know in the comments.
