Real-time payments are on the rise

The Federal Reserve’s new FedNow instant payments system starting later this year may eventually have cross-border capabilities, a Federal Reserve official said last week.

While that real-time system will only be available in the U.S. market at first, Fed officials are already considering ways the technology can be upgraded, said Nick Stanescu, a Fed senior vice president overseeing FedNow.

FedNow officials are starting to “think ahead in terms of how this could support instant payments, not just in the U.S., but also for cross-border types of use cases,” Stanescu said during a FedNow town hall webcast on March 23 that attracted about 900 viewers. “July is just the beginning.”

The new real-time system will be the most significant upgrade to the U.S. payments system since automated clearing house payments became available in the 1970s. FedNow will operate 24 hours a day, seven days a week and on holidays, allowing for almost instantaneous settlement of transactions.

Enabling cross-border transactions is also a goal of FedNow’s real-time rival operated by the country’s biggest banks, namely the RTP network. The Clearing House, which is owned by about 20 big banks, launched the RTP network in 2017 and has been expanding its services ever since. 

Cross-border is ‘holy grail’ of real-time payments

TCH began exploring a cross-border offering with the pan-European payment provider EBA Clearing and the international financial messaging company Swift last year. They developed a link between their networks that was operationally feasible, but the legal and administrative aspects of the system haven’t been worked out yet, said Jim Colassano, senior vice president of TCH’s product development and strategy. 

“We’re trying to push it as quickly as possible because this is one area where if you talk to the market, if there’s one thing they would like to see coming out of all the instant payment work that everybody is doing, both for us and FedNow, it’s the ability to make cross-border payments instantaneously,” Colassano said this week in an interview. “That is the holy grail so we do want to get there as quickly as possible.”

That said, Colassano wouldn’t comment on exactly when TCH and the two partners would embark on a full pilot of their cross-border effort.

FedNow plans for alias directory

FedNow officials are planning for other enhancements as well. The new nationwide real-time payments system will be able to accommodate evolving technologies, release new features, pursue system updates and undertake “periodic, large-scale enhancements,” Stanescu explained during the hour-long webcast. Financial institutions participating in the FedNow system will be able to choose whether to adopt additional features, he said.

In particular, FedNow planners are focused on security aspects. “We’re very much focused on those enhancements that are supporting the safety of the system,” Stanescu said.

Specifically, FedNow officials have received feedback that some “high-demand” FedNow use cases would require the ability to originate payments on the basis of a phone number or email identity, what the industry refers to as an “alias” that doesn’t reveal other personal information. 

To accommodate that interest, the central bank is reviewing the development of a FedNow “alias directory” for financial institutions so they could manage accounts in such an environment. The only extensive alias directory that exists today is offered by the peer-to-peer electronic payment system Zelle, Colassano said. Zelle is operated by the company Early Warning Services, which is owned by seven big U.S. banks.

“We received strong feedback from financial institutions, and from other organizations, that an alias directory should be considered as part of the service,” Stanescu said. “So, looking ahead, post-July, we are exploring various approaches to supporting alias-based payments natively in a future release of the FedNow service.”

That alias service would require FedNow participants to build functionality on top of the new system to meet end-user needs, the Fed official said. Other value-added services the Fed is considering could include APIs used for informational purposes, for reporting purposes and for sending and receiving credit transfers, he said.

FedNow takes on RTP

The Fed lined up 120 financial institutions and payments processors to participate in developing the FedNow system over the past two years. A group of about two dozen early adopters are now gearing up to be a part of taking the new system live in July.

Smaller community banks and credit unions have been especially eager for the arrival of FedNow because many have been reluctant to sign up with RTP, given its operation by their larger bank rivals.

Even though FedNow will be a competitor to the RTP network, the “megaphone” that the Fed has used to publicize real-time payments has been a benefit to The Clearing House system, too, in terms of spreading the word about real-time payments, Colassano said.

He’s not worried about the competitive threat from FedNow, at least at the start, because he understands, based on TCH’s experience, that real-time payments systems take years to develop. So, FedNow won’t catch up to RTP’s reach and services anytime soon, he asserted. 

It’s also not clear which participants will be on board when FedNow rolls out in July and that’s a key factor, Colassano said. “You need to really compare what FedNow is going to be delivering in July versus what you can get through the RTP network on that same day, and when you draw that comparison there are some very stark differences,” he said. 

Five years from now, those differences will have narrowed and the decision for banks will likely be a draw, but for banks deciding over the next year or so, Colassano said the RTP has more to offer.

Dive Brief:

• India towers above other countries in a ranking of global real-time payments adoption, based on total 2022 transactions, with Brazil a distant second, followed by China, according to an ACI Worldwide report published this week. The U.S. ranks 8th, according to a spokesperson for ACI, and fares even worse based on a per capita count, ranking 33rd, the report said.
• Real-time payments are expected to comprise 27.8% of all electronic payments worldwide by 2027, according to the report. U.S. real-time payments volume is expected to jump to 11.4 billion by 2027 from 2.8 billion last year, according to the report published this week.
• Real-time payments worldwide will rise to 511.7 billion transactions by 2027, the report predicts. Last year, consumers and businesses worldwide drove a 63.2% year-over-year increase in real-time payments to a record 195 billion real-time transactions, the report said.

Dive Insight:

ACI Worldwide’s report is a reminder of how far behind the U.S. is in real-time payment adoption, despite having the largest economy in the world. The U.S. doesn’t even rank in the top 10 countries with respect to real-time payment transactions per person per month, according to the report.

By comparison, Bahrain, with a population of 1.5 million people, currently ranks second by that count, behind Thailand, and is predicted to rank No. 1 on that basis by 2027, with 83.3 real-time payment transactions per person per month, followed by Brazil and Thailand, per the report. 

“This year’s report highlights how consumer and business adoption of real-time payments accelerates when the conditions are right,” Craig Ramsey, ACI’s global head of real-time payments and banking, said in a release accompanying the report.

Real-time payments were introduced in the U.S. in 2017 by private sector companies controlled by the country’s biggest banks, including the RTP network operated by The Clearing House. Still, such instant payments have been slow to catch on, partly because smaller U.S. banks have been leery of partnering with their larger rivals.

The real-time landscape in the U.S. is expected to change dramatically later this year when the Federal Reserve launches a nationwide real-time payments system called FedNow in July. That upgrade to the U.S. payments system will be the most significant change for making and settling payments in decades.

“The countries at the top of our league table — Bahrain, Brazil and Thailand — are all relatively recent enablers of real-time payments,” Ramsey noted. “Concerted industry collaboration and government mandates, widespread merchant adoption, strong brand recognition for a scheme, and related services, such as digital wallets, have provided the perfect combination for strong growth in these markets.”

Digital wallet adoption, which goes hand-in-hand with the rise of electronic payments, has been more widespread in countries in Asia, according to consumer surveys by ACI, with Thailand, Vietnam and India topping that list.

This report builds upon previous research from ACI Worldwide about the lag in U.S. real-time payments adoption. A 2022 report from the organization found that India, Brazil, China, Thailand and South Korea were outpacing the U.S. in real-time payments adoption. 

ACI Worldwide’s report comes as the company and fintech peer Jack Henry & Associates prepare for the launch of FedNow. Those companies as well as Bridge Community Bank and Star One Credit Union are among the entities planning to be early adopters of FedNow.

Bridge Community Bank, the processor ACI Worldwide, Star One Credit Union and the fintech Temenos are among the companies that expect to be early adopters of the FedNow faster payments system when it goes live in July.

FedNow is expected to be the most significant upgrade to the U.S. payments system in decades, allowing consumers and businesses to make and settle payments in seconds via U.S. financial institutions that offer the service. Payments players are eager to offer the speedier settlement process to their customers, as the U.S. plays catch-up with other countries, such as China and Brazil, in offering real-time payments.

Asked why ACI is participating, that company’s head of real-time payments, Craig Ramsey, didn’t miss a beat in explaining the investment. “It’s the future,” he said in an interview this week. “The future of payments is digital. The future of moving money is faster. The future of payments is 24-7.”

Those are all attributes of the Federal Reserve’s new FedNow system. It will be a rival to the RTP real-time payments network created by the bank-owned The Clearing House in 2017. That private system hasn’t attracted users as quickly as might have been expected and the aim of FedNow is to rev up real-time use, but whether that will happen remains to be seen.

About two dozen companies are involved in the final stage of testing the system now and will also likely be part of a FedNow certification program, according to companies involved in the program. Also on that list are larger players, including JPMorgan Chase, the investment bank Goldman Sachs and the payments processor Fidelity National Information Services (FIS).

Federal Reserve officials have declined to specify which companies are expected to go through the certification program aimed at getting companies up to speed for the launch of the new real-time payments system. JPMorgan, Goldman and FIS didn’t immediately provide a comment. The central bank’s pilot program began last year and has been testing the system through messaging with some participants.

Next week, ACI will deliver its annual report card on real-time payment use worldwide, showing that the U.S. remains a laggard, depriving its economy of more efficient payments. That said, it will also predict that FedNow could help trigger a four-fold-plus increase in real-time payments volume by 2027, driving up transactions from about 2.5 billion to about 11.5 billion transactions over the next four years.

Bob Steen, the CEO at Bridge Community Bank in Iowa, is eager to get started by way of participating in FedNow’s certification program. His bank is teaming with processor Jack Henry & Associates and Open Payment Network to make it happen.

“We’re in the certification process right now,” Steen said, explaining that the program gives his bank a head start on rivals. He’s been keen on the real-time payments concept for years, and formerly served on the now-defunct Faster Payments Task Force.

Getting a competitive edge

While Bridge is a small bank, Steen likes being ahead of the curve when it comes to technology, noting that his institution was one of the first to move ahead with digital imaging of checks and with same-day ACH payments. “This is just a natural progression,” Steen said of FedNow.

The thousands of community banks, regional banks and credit unions nationwide have been wary of joining in the RTP real-time service offered by their larger rivals.

“We believe that if community banks are going to be relevant, they have to stay current in payments, they have to offer that,” Steen said, noting all of the upstart competition, such as merchant payments company Square, on-demand pay startup DailyPay and peer-to-peer payments fintech Venmo. “Our customers are doing things without us, and we’ve got to get that business back.”

Being part of the FedNow program definitely requires an investment in staffing and technology, but Steen expects it to pay off in the long run. “We’re operating on the proposition that faster has value,” he said. Even though his customers aren’t asking for the real-time option today, he knows they’ll want it when they see it.

Steen hasn’t figured out exactly how his bank will charge for the new service, but it will find a way to monetize it, he said. “The risk is that our competitors don’t charge anything,” he said.

One big positive that the system has going for it is the participation of the U.S. Treasury Department, Steen said. The department hasn’t necessarily joined in prior Fed innovations and it was troublesome, he said.

“I think they figured out they can’t be a laggard in this thing,” Steen said, noting the big volume the Treasury Department adds to the system. “It’s a real boost to the process.” 

Creating a ‘superior’ system

Gary Rodrigues, CEO of Star One Credit Union in Santa Clara County, California, is similarly excited about being one of the companies taking part in beta testing for FedNow and the certification process, he said.

“At the beginning of the year we were able to establish connectivity,” Margarete Mucker, Star One’s executive vice president of operations, with respect to Star One’s work with FedNow. For now, it’s mainly the test transactions without any customers involved, amounting to “technical communication” between servers, she explained. Echoing a recent announcement from the Fed, she said the plan is to be live before the end of July. 

There is a cost to pursuing the new FedNow technology that not every organization can afford, Rodrigues said. But he considered it worth pursuing because it offers advantages over existing real-time tools like Zelle. Star One began using Zelle about three years ago and customers have taken to it, but it doesn’t provide around-the-clock instant settlements like FedNow will, he explained. 

That’s an improvement in service that he believes his Silicon Valley tech employee customers want. “It seems to be a good fit for our members,” he said. “Faster, cheaper, more efficient all gave us reasons to pursue FedNow.”

The credit union has had a “positive” experience working with the Fed on the project in weekly meetings over the past two years, Mucker said. And Rodrigues believes the U.S. system will be “far superior” to any real-time payments system in other countries. He expects it will not only be more secure and safer to use, but will also maintain privacy by way of a tokenized system that veils information from the federal government.

He’s pleased to receive the service directly from the Fed, as opposed to relying on the big banks or large card network companies Visa and Mastercard, he said. “The nice thing about this is our direct relationship with the Fed puts us in the driver’s seat,” Rodrigues said. “For a smaller organization like Star One, I think, it puts us in a good position to compete going forward.”

The upcoming launch of FedNow might present more payments competition for the ACH Network, but Nacha CEO Jane Larimer largely envisions that forthcoming real-time service meeting different payment needs.

Speaking to a crowd of payroll professionals Monday, the CEO of the organization that oversees the ACH Network acknowledged the July arrival of the federal government’s instant payments system bringing another contender into the electronic payments space. 

“On one level, every payments system competes against each other, right?” Larimer said. She and William Sullivan, Nacha’s senior director and group manager of government and industry relations, discussed electronic payment developments with KPMG Managing Director Mindy Mayo at the American Payroll Association’s conference in Arlington, Virginia this week.

Competition aside, there are payment system attributes that appeal to users in different scenarios. As the public and private sectors both work to speed up payments, FedNow is likely to fill gaps left by the ACH Network, Larimer said. 

In a payroll setting, those mainly involve payment timing, whether it’s an employee who needs to be paid on a holiday, an immediate payment for an employee who’s been terminated, or the ability to pay an employee several times per day, Larimer told the crowd. 

Real-time payments that settle immediately might be better suited for high-priority situations, whereas direct deposit through ACH is efficient and reliable for standard payroll duties, she said.

As people need or want money more often, or at times when the traditional banking system isn’t open, “instant payment systems can be a great way to fill those gaps,” Larimer said. There’s already a private real-time payments system in operation called RTP, which is operated by The Clearing House. 

Payment trends such as earned wage access – providing employees with earlier access to their paychecks – have gained steam in recent years,  The private sector is embracing ever-faster payments in a variety of use cases, sometimes bypassing the ACH system. For instance, this week, Amazon said it would add a faster payout capability for merchants, including on weekends.

These developments haven’t gone unnoticed by Nacha: The organization has progressively made changes to adapt to an environment prizing faster and more frequent payments.

The ACH Network currently settles four times each day: three times intra-day and one time overnight, Larimer said. Nacha and the ACH operators – The Clearing House and the Federal Reserve – added late-night ACH services last November to enhance their transfer services. 

Nacha is focused on improving the ACH system to ensure “we have the characteristics and the attributes on the payment system that our end users and our processors and our financial institutions need and want,” Larimer said. 

Still, the ACH Network operates within the confines of Fedwire and the National Settlement Service, which is run by the Fed, Larimer noted. 

“It wasn’t a Nacha decision not to pay on Saturday or a holiday,” Sullivan told the payroll crowd. “It's because there’s no National Settlement Service during those times.” The Fed has talked about expanding those hours, “and I think they will,” Sullivan added.

If the National Settlement Service offers longer hours in the future, Nacha aims “to see how we can move within that space, to have additional settlement windows,” Larimer said. 

To that end, Nacha wants to make sure the U.S. is covered from a same-day ACH perspective, Larimer said. She noted the last settlement window for the West Coast closes at 3 p.m., so adding another time later in the day for that region, including the Pacific and Mountain time zones, would be beneficial.i

“I think that the future is going to a place where you’re looking at 24-by-7 payments and banking and accounting for the banks,” Larimer said.

That’s not going to happen next week or even next year, she said, and once change does occur, it takes large companies and processors time to adjust their back-ends to take advantage of payment system changes, she said.

But “my hope is that someday the ACH will be settling every day of the week,” she said.

Dive Brief:

• The Federal Reserve on Wednesday laid out a timeline for rolling out its real-time payments system FedNow, spelling out its aim to certify participants next month and go live with a July launch.
• The central bank next month will begin a certification process with some FedNow participants, building on input from its pilot program. The Fed and the early adopters ensured they’d be ready by June for the July kickoff, according to a Wednesday press release.
• In its notice, the Fed encouraged banks and businesses to get ready to use the new system. “With the launch drawing near, we urge financial institutions and their industry partners to move full steam ahead with preparations to join the FedNow Service,” the release said.

Dive Insight:

The Fed’s announcement comes as the central bank is grappling with turmoil in the banking industry touched off by recent regulatory takeovers of Silicon Valley Bank and Signature Bank.

Despite depositor and investor fears rippling through the banking industry, the Fed will plunge into arguably the most ambitious new payments initiative taken on by the federal government in decades.

The Federal Reserve had said previously that it would launch FedNow as early as May and no later than July. Wednesday’s details about timing make clear how it will proceed in unfurling the new system after years of planning.

The Fed had said last August that it would begin “technical testing” of the new instant payments system last September as part of an ongoing pilot program.

The companies that intend to go live in July include some of the largest payments processors, as well as financial institutions of all sizes, the Fed said in its release. A spokesperson for the Fed didn’t immediately respond to a request to identify the companies involved. The U.S. Treasury will be included in the new system from the get-go, the Fed release noted.

The question remains as to what extent banks nationwide will decide to use the Fed’s new real-time payments system. A similar, privately-operated real-time payments service, offered by the nation’s biggest banks, has been slow to gain traction.

Some companies, including the payments processors ACI Worldwide and Jack Henry & Associates, have already declared their readiness to aid in the launch of the government’s new system.

The Fed is apparently verifying such companies will be prepared. “Certification encompasses a comprehensive testing curriculum with defined expectations for operational readiness and network experience,” the release said.

For its part, the Federal Reserve banks are eager to catch up to other countries that have already expanded their real-time payments systems with widespread use.

The Fed acknowledged in the release that there will be more work to be done and that the July launch is just a first step, saying it will continue working with service providers to “implement the service throughout 2023 and beyond.”

“Growing the network of participating financial institutions will be key to increasing the availability of instant payments for consumers and businesses across the country,” Ken Montgomery, the Fed executive heading up FedNow, said in the release.

FedNow, the instant payments system being launched by the Federal Reserve later this year, may be particularly useful to lower-income segments of the U.S. population.

At least that’s the theory of some Fed researchers who study lower-income communities’ financial needs. The key reason a faster payments system could prove useful to such people is the clarity that comes with speed, said Brian Clarke, a senior business strategy manager at the Federal Reserve Bank of Boston who’s part of a team of researchers studying faster payments impact. 

“It's actually the delivery of the funds at their destination that is going to be very important for a lot of low-income users,” Clarke said in an interview on March 7. 

The lag between when a consumer makes a payment on a bill and the moment when that biller actually receives the payment can make a difference with respect to additional fees, such as an overdraft penalty if the payment lands after other payments are made in the interim, he explained. It can also affect late fees. “More access to faster payments may make a difference,” he said.

FedNow is due to arrive as early as May, Federal Reserve officials have said. It’s the biggest payments innovation by the central bank in decades, aimed at expanding the availability of real-time payments nationwide. It will build on limited offerings from private sources, such as the real-time payments network services offered by bank-owned The Clearing House.

The U.S. is playing catch-up on the faster payments front, with many countries around the world already having instituted their own instant payments systems. While The Clearing House service has drawn in mainly larger bank users, FedNow is expected to broaden the appeal more to regional and smaller banks.

It will be up to the financial institutions to take the next step of extending the real-time payment services to businesses and consumers, likely with an assist from fintech players. Creating that ubiquity and stoking competition among the service providers will be key in making the new system affordable to consumers, particularly the lower-income segments, Clarke noted.

“What we're hoping happens is that it's cheaper to offer it to the end-user because it's more ubiquitous,” Clarke said. That may be even more true for some expensive services. “Because those are fee-heavy transactions, they may be most likely to be impacted by the ubiquitous real time payments,” he explained.

Clarke’s team has been studying the financial needs and behavior of low- and moderate-income consumers ever since Fed surveys have shown that about 40% of Americans couldn’t afford to pay for a $400 emergency.

Fees add up, especially when consumers start bouncing checks. A Fed website post last month regarding Clarke’s research noted Americans paid $10.7 billion in overdraft fees in 2021, with lower-income households shouldering $6.7 billion of that burden, according to the research nonprofit Financial Health Network.

“Overdraft fees can be as high as $35-$40 each time an account is overdrawn,” Clarke said in the post. “That’s a stiff penalty to pay for overdrawing by a few bucks, and it can quickly add up.” 

Having more options for payments, including real-time payments, should increase competition and be a beneficial thing for for all users, Clarke said. “Low income users will have as much, if not more to gain, from ubiquitous real-time settlement,” he predicted.

Jim Angel, a Georgetown University professor who served on a faster payments committee, agrees that real-time payment services could be particularly alluring to lower-income consumers. If you’re living paycheck to paycheck, having more certainty on when a payment is made and avoiding the threat of being overdrawn is a real benefit. “It’s basically a way to avoid those nasty overcharges,” he said.

Still, whether FedNow can make real-time services widely available to consumers remains to be seen, Angel said, explaining that he’s been disappointed in the past by slow-moving improvements in the payments system. For instance, services like Zelle have restrictions that make them of limited use, he pointed out, noting you can’t use it to pay for groceries or rent. 

The clarity that makes FedNow appealing to lower-income Americans may also make it more appealing to unbanked consumers who have a mistrust of the banking system, Clarke predicted. The same payment lag that may lead to unexpected fees for some consumers also stokes mistrust among others who wonder where payments are during the settlement process, he said.

“Being able to log in where your bill is due and see that your account is in good standing, I think that would go a long way towards repairing some of the mistrust that's out there about payments and the banking system,” Clarke said.