A lot of ink has been spilled speculating about FedNow, the US government’s forthcoming real-time payments infrastructure — especially how and why it differs from The Clearing House’s RTP product, same-day ACH and Visa Direct, etc.
However, few have considered the key factor governing its ultimate success: will consumers, businesses, and institutions actually adopt FedNow? Fortunately, we have a lot to learn from the rest of the world, where real-time payment systems have proliferated in recent years, and can use their example to identify gaps in the US system.
Hold On, What’s RTP Again?
Real-time payments use digital infrastructure called payment rails to move money from sender to receiver instantly. A 1970s Japanese system called Zengin was the world’s first RTP system, and nearly six dozen markets now have working real-time payments systems. Almost three quarters of the world’s population has (or will soon have) access to instant payments. The world’s biggest systems by transactions include India’s Unified Payments Interface (UPI), which now supports 64 percent of India’s merchant payment transactions, China’s Internet Banking Payment System (IBPS), Brazil’s Pix, and the UK’s Faster Payments Service (FPS).
RTP technology has been most successful in countries like Brazil, China, and India, where sparse card payment infrastructure fails to satiate a large appetite for electronic payments. In those countries, RTP has effectively leapfrogged card-based payments as the most popular payment method.
The benefits of RTP are clear: speed, convenience, ubiquity, safety, and value for money. Consumers avoid late fees and credit strikes that often come from lengthy payment processing transactions. Users can only send money that they have in their account, eliminating bounce backs and chargebacks for businesses. RTP is also cheaper than credit card rails — especially for high-value items — and transactions are untethered from bank opening hours. And when businesses are paid in real time, shortened cash conversion cycles reduce the need for short-term financing and accelerate economic growth.
So in a large, wealthy, card-happy country like the US, what’s it going to take for RTP to take off? Which gaps are waiting to be filled? And what analogues can we draw to the rest of the world?
1) Bank Adoption and Network Connectivity
It’s worth asking why US payment infrastructure is so outdated compared to the rest of the world. Part of the answer is that key parts of the value chain — such as The Clearing House (TCH) and processors — are owned by banks, who have few incentives to disrupt themselves. And even if they wanted to, the largest financial institutions don’t have the reach necessary to impose a new payment system on the entire industry. The top five US banks only account for 46 percent of total commercial banking assets, compared to 87 percent in Brazil.
As with social networking, an instant payment network becomes exponentially more valuable as more banks are plugged in. But if the last bank to join the network benefits the most, no one has a strong incentive to be first. Systemic upgrades to payment systems, core dependencies, and technology constraints are costly, and legal, risk, compliance, and audit factors are operationally challenging.
In other words: banks need strong incentives to act. A few community banks at a recent Fintech Meetup panel I attended in Las Vegas saw real gaps in the technical capabilities of current RTP offerings, and wondered whether to adopt a new provider or wait for their current one to catch up. The majority of the banks in the long tail are in a “wait and see” mode. It remains to be seen whether incumbents or startups can help the long tail of smaller community banks and credit unions integrate with FedNow rails.
2) Regulatory Power
RTP adoption is strongest in countries where regulators play a leading role, collaborate with financial institutions, and provide attractive pricing. Most governments adopt RTP in response to population needs, using it to drive everything from consumer protection to financial inclusion. The Brazilian government, for example, is mandating that all institutions (including fintechs) with more than 500,000 active customer accounts must participate in Pix. In addition, the government involved all classes of constituents in the design process to represent perspectives and interests from large banks, smaller banks, and fintechs. In key issues like security protocols, constraints for smaller banks were considered and middle ground was found with large banks, so that all could have a similar level of technical readiness on day one.
In the US, banks are regulated by state and federal governments. At the federal level, the Federal Reserve, the FDIC, and the OCC all function as regulators, with different parts of the biggest banks scrutinized by different bodies. So while the Federal Reserve wants to implement FedNow, it doesn’t have the same regulatory heft as its peers elsewhere in the world. And even if it did, a new system would have to comply with the laws of fifty separate states.
3) Consumer Protection and Fraud Management
Other than payroll direct deposit, P2P, and wire transfers, the majority of US financial activities are pull-based, meaning payers provide PINs or signatures that grant recipients permission to extract funds.
However, both FedNow and TCH’s RTP only enable push payments, which reduces chargeback risks based on insufficient funds, but opens up a whole new set of fraud vectors based on account takeovers and social engineering fraud such as scams and fake QR codes. Authorized Push Payments (APP) was a huge problem after Faster Payments was launched in the UK, and to protect the UK consumers from APP fraud, the payments regulator pushed forward with scam reimbursement.
In real-time payment schemes with both pull and push payments, such as Pix and India’s UPI, accounts are secured through aliases that trace back to users’ bank accounts. The country’s Central Bank president, Roberto Campos Neto, has said that Pix may be Brazilians’ digital identity in the future. To reduce Pix scams and fraud, friction has been selectively reintroduced to shut down opportunities for fraudsters, and Brazil has created a “Special Return Mechanism” where users can request a refund in case of a system failure or fraud, or use the “Contact Us” function from the Central Bank to register a complaint.
In the US, there doesn’t seem to be political appetite to adopt a national digital identity. The Fed may host a directory of public account identifiers, or provide banks with a link to existing directory services to allow transactions without exchanging users’ account information. It may also include embedded fraud mitigation and identity authentication features. In the absence of a universal standard, every bank must solve identity on its own, creating large gaps in the US real-time payments system through disparate user experiences. Will fraud detection startups like Unit 21, Sardine, and Alloy step up to fill them? Will the US regulators step in to provide consumer protection for APP fraud? We see an arms race developing around data models and fraud capture.
4) Third-Party Integration and Productization
All over the world, RTP systems have successfully integrated with other financial services. Pix has standardized the UX and user journey so that consumers who go through Pix with one bank’s app can easily pick up usage from other fintechs or financial institutions. Pix is also in the process of rolling out automatic recurring payments, utility payments, contactless payments, credit facilities, and international e-commerce compatibility.
In Australia, Zepto helps merchants issue and settle refunds in real-time, driving increased customer loyalty. And Europe’s Volt enables real-time “pay-by-bank” services across international payment rails, a key necessity for cross-border e-commerce. In contrast, FedNow will likely restrict access to banks in the Fed system to begin with, and will only allow fintechs to participate if they partner with financial institutions.
Anywhere real-time payments are occurring, startups have built engaging UI layers to facilitate their use among consumers. For example, Chinese market leaders like Alipay and WeChat use QR code vouchers to integrate instant payments and add loyalty elements to a mobile wallet. Across China, India, Singapore, and Thailand you’ll find retailers, street food vendors, and motorbike taxis displaying QR codes for instant payment. For now, FedNow is definitely more of a back-end system than a front-end experience — and it remains to be seen who will be the first to productize its user experience.
5) Backend Integration
To make payments “real-time” and convenient on the surface, a lot of things have to happen behind the scenes, including liquidity management, real-time settlement, and instant reconciliation.
Historically, liquidity challenges have been a hurdle to RTP adoption, particularly for smaller FIs. Businesses and banks that participate in the FedNow schedule need to reset their mindset about fully loaded liquidity. To enable true real-time payments they need to move funds to a federal reserve bank account and have all the required funds before they pay out.
For businesses, integration with ERP systems and instant reconciliation by linking transactions to invoices would be the key to adopting real-time payments. To manage their treasury better, businesses want something that mirrors their debit or credit card transactions, identifies when “pay by bank” transactions are made, and settles in the timeframe and currency they want. A horizontal solution provider will be best-placed to fill this gap.
6) Interoperability
For a real-time payment to go through — on FedNow or otherwise — both the payer and payee need to be using an RTP service. FedNow and The Clearing House’s RTP solution won’t be interoperable but, thanks to a standardization approach called ISO 20022, FedNow and TCH can send and receive messages using the same standard. This is a step closer to instant settlement and domestic financial communication in the US.
Sending money across borders poses a whole new set of challenges for RTP systems like FedNow. Indonesia, Thailand, Singapore, Malaysia, and Philippines have piloted cross-border initiatives together. With the launch of RTP in Indonesia and New Zealand in 2022, the Asia-Pacific region leads the world in its journey toward standardization and regional interoperability.
For its part, FedNow will only support domestic transactions. It remains to be seen who will connect the US with international rails, and how banks will manage both RTP and FedNow after the latter’s launch.
One Step at a Time
We see FedNow’s launch as an incremental improvement, as opposed to a paradigm shift in the US payment system. Like oil in a machine, FedNow will smooth out money movement by making it more timely, convenient, and cost-effective.
While we still need to wait and see how FIs and startups disruptors will rise to the occasion and fill in those critical gaps identified above, it’s fair to wonder what is likely to happen in the US after FedNow launch — will the adoption curve be more like UK’s Faster Payments which has been gradually replacing cash and checks? Which use cases will gain the most traction? Where the economic opportunities might lie? I’ll unpack some trends and make some predictions in a follow-up to this post.
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