FedNow real-time payments are here. What should the banks do now?

OBSERVATIONS FROM THE FINTECH SNARK TANK

Years after other developed countries had real-time payments in place, they are finally coming to America. The Federal Reserve recently confirmed that FedNow, the government’s version of real-time payments (RTP), will launch this summer.

Two big questions remain: 1) How will RTP develop, and 2) What effect will it have?

Real time payment confusion

Clearly, not everyone is clear on what FedNow is. In an embarrassingly incorrect tweet, Democratic presidential candidate Robert F. Kennedy, Jr. referred to FedNow as a central bank digital currency (CBDC), claiming that “CBDCs grease the slippery slope to financial slavery and political tyranny”.

FedNow is not a CBDC – it is a payment service, not a form of currency, and it does not eliminate cash or any other current payment method.

There is also some confusion about who will use the new payment service.

A Forbes article on FedNow argues that the key factor in its success will be whether or not consumers, businesses and institutions adopt it. This is not entirely accurate. Consumers and businesses will not “adopt FedNow.” In fact, they will probably never know what FedNow is.

The key factors driving FedNow’s success are: 1) How many financial institutions will adopt and deploy FedNow? 2) What types of payment services (ie, use cases) will they use FedNow for? 3) How successful will these institutions be in marketing these payment services to consumers and businesses?

Banking demand for FedNow and RTP

A study by Cornerstone Advisors found that 13% of banks and credit unions have already implemented real-time payments and that another 30% plan to go live with them by 2023.

Of the financial institutions that intend to launch RTP this year, 36% plan to use FedNow, 28% will go with both FedNow and The Clearing House (which has delivered real-time payments to financial institutions since November 2017), and 13% will choose to deploy only TCH’s offer.

Among the banks and credit unions planning to launch RTP after 2023, one-third will use FedNow, but 60% have not yet determined their RTP strategy.

FedNow Use Cases

What will financial institutions do with FedNow?

Among banks – which tend to have a higher percentage of businesses (versus consumers) in their customer base than credit unions do, business-to-business (B2B) payments and account-to-account (A2A) transfers are the most popular use cases for RTP, followed by accelerated salary payment.

Among credit unions, A2A transfers, expedited consumer payments and recurring bill payments are the most popular use cases for real-time payments.

What do we need real-time payments for, anyway?

To understand what banks need to know about RTP, I spoke with Peter Davey, SVP and Head of Product Innovation and Labs at TCH. Davey shared what he learned from TCH’s rollout of real-time payments back in 2017:

“When we launched, we felt that B2B payments would be the primary use case to move to the network. We were wrong – a lot of that ended up being B2C payments.”

Davey thinks it will be different in 2023, but:

“Many companies are going through their own modernization processes. They are looking for ways to make payments frictionless in the back office. They don’t want to do a lot of manual reporting, and banks have to serve these needs by creating API interfaces to ERP systems and third-party integrators.”

The send-receive challenge

Do the banks that have already implemented RTP have a head start? Maybe not. Davey points out that most people only have the ability to receive real-time payments, not send them. This is a problem because, as Davey explains:

“The send-side products are what the customers want. If I just had a loss to my car or home, I can receive a payout from my insurance company in real time. But if I need to make payments to companies that cover my car or home repairs, how do I get the money to do so them In reality? They want immediate use of the funds to enable them to serve me.”

Davey concludes that:

“If the banks don’t have the access or the tools to be able to send transactions, they’re really just going to end up being the net receiver of those transactions at the end of the day, so you’re not modernizing the whole acquire-to-pay process that you want to be able to do within B2B area.”

How will real-time payments evolve?

According to Davey, there are several ways in which RTP can evolve:

“The Fed and TCH have been collaborators and competitors for a long time. We interact quite well today, whether it’s on a technical side like the ACH network or in the back office of a financial institution or through the banks’ core suppliers. We’ll see that same dynamic with FedNow , where the banks’ core providers will provide the tools to connect to both networks. And in real time they will decide whether to send it over the TCH network or FedNow. It can be more complicated if a bank gets a better rate to send a payment over The RTP network compared to FedNow.

It’s going to depend on who has the endpoints. Right now TCH has a network that is five years old, we have the endpoints. When the Fed launches in July, how many endpoints will they have and how quickly can they increase those endpoints?

As providers such as Fiserv, FIS and Jack Henry succeed in selling RTP to their customers, we will see growth on both networks if they can easily turn on both networks, as opposed to one outperforming the other. And then it’s going to come down to basic economics as to why a bank or credit union would use one over the other.”

What banks and credit unions need to do now

Growth in real-time payments must be seen from a couple of perspectives:

• Payment volume versus bank adoption. With many of the largest banks already on the TCH platform, the RTP volume on that network will probably dwarf the volume on the FedNow platform for quite a few years. But the growth in the number of institutions on the FedNow platform will probably far exceed the number of banks TCH adds to its platform over the next five years.
• Use case volume allocation. There are many possible use cases for RTP. The question of which platform – TCH or FedNow – will grow faster is unclear. The important question is which platform will be better for a particular use case – and whether that use case generates increased income for the banks or not.

The vast majority of banks and credit unions that have not yet implemented RTP rely on third-party technology providers for payment processing, and these providers will be the ones connecting the institutions to the RTP networks.

But what banks and credit unions need to do today is decide: 1) Which RTP use cases will be most important to their customer base; 2) How much (if anything) to charge for the new payment service; and 3) How to market (ie communicate and sell) the new services.

For many financial institutions, this is easier said than done.

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