Instant payments finally reach America with FedNow
Afinance america plumbing is too long a maintenance point. The current payment “rails” on which it is based – built by a group of the country’s largest banks to replace paper checks – are more than fifty years old and run according to an antiquated code. Although it is robust, the system is very slow. American payments are less sophisticated than those in the rest of the rich world, and indeed those in much of the poor world as well.
It’s a problem that the Federal Reserve is trying to fix with an instant payment system, which it launched on July 20. Aptly called FedNow, this allows Americans to send money to their relatives, through their existing financial institutions, and to settle payments instantly. All told, 35 banks and 16 payment providers have signed up to use the service.
Most US bank transfers are free but processed in batches, often taking days to settle. Peer-to-peer networks, such as Cash App, appear much faster to customers but, under the surface, they rely on the old system. Regulators have warned that funds held on these apps may not qualify for deposit insurance in the event of failure. Credit cards, which offer flexible rewards at the cost of even juicier fees, also use existing rails. According to the San Francisco Fed, nearly a third of payments last year were made using plastic.
Usually, Americans use different methods for different types of payment: a water bill is paid through a bank transfer; $100 owed to a friend is sent through a payment app; purchases on Amazon are made with a credit card. One real-time payment solution should improve the quality of all.
JPMorgan Chase and Wells Fargo, two heavyweight banks, have signed up to FedNow. But Wall Street is not completely on board: there is a longer list of institutions, including Bank of America, Citigroup and Goldman Sachs. Although the older system is slow, it is also profitable for those involved. Financial institutions can take advantage of slow settlements to park money in short-term interest-bearing securities overnight, or simply keep the money at the Fed to collect interest. They also pocket late payment fees and some make money from their own instant payment systems, such as The Clearing House, which is run by a group of banks.
Some observers, recalling the banking turmoil this spring, worry that FedNow could destabilize the financial system. A report by Moody’s, the credit rating agency, warns that the new scheme could make bank runs more likely by making it easier for investors to flee. Such concerns are likely to be overblown, however. The current system, where weekends are closed for business, didn’t bring much relief to Silicon Valley Bank and others a few months ago. Additionally, because FedNow is a backup system, participating institutions are able to set limits based on their risk appetite. They can, for example, block payments or limit transactions.
Other countries are also light years ahead of America – and no more vulnerable to a bank run. In India, for example, instant payments are the norm, accounting for 81% of domestic electronic transactions last year (see chart). In Thailand and Brazil they accounted for 64% and 37% respectively. Emerging markets have embraced instant payments partly because of demographics (consumers are younger and more open to change), partly because of cash crunch (policymakers are keen to reduce the size of gray markets, and increase tax collection) and partly because, unlike America, new payment systems have not had to push aside existing ones, and those who have benefited from them.
FedNow is unlikely to change payments immediately. The scheme will only support “push” transfers – those initiated by users themselves. In contrast, FedNow’s counterparts in Europe and India have “pull” capabilities that businesses could use when they get permission (which enables, say, regular payments for electricity). Fed officials say they have no plans to expand the system for such use, but bankers suspect this will be the next step.
Another obstacle to mass adoption will be: the American consumer, for whom paper-based payments hold a special hold. according to here Globally, a payment company, around a fifth of money transfers in the country happen by cheque. However, it will be good for them to have the choice, just like the rest of the world. ■
Editor’s note: This piece has been updated to include news of the FedNow release.
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