Technology companies in the payments space should pay close attention to the Federal Reserve’s (the Fed’s) upcoming launch of a long-awaited new payment system, the FedNow Service. The system will change the consumer payments landscape by providing a new instant payment alternative to existing retail payment rails.
It is rare for the U.S. central bank to build a wholly new payment rail, and importantly, the federal government has also announced its backing for instant payment systems. The FedNow Service promises to both pose challenges to fintech companies whose business models depend on activity over existing payments rails and offer key new opportunities to innovators in the space. These new drivers and risks will be important considerations for many players in the market and critical to their success.
The Fed's Instant Payments Platform
An instant payment is a new type of payment from one bank account to another, where the recipient receives final funds in near real time, enabled by immediate interbank settlement of the payment. This means there is no buildup in interbank obligations, and end users can instantly send and receive money. This is an improvement to payments via credit or debit cards and automated clearinghouse (ACH), which come with higher costs or delays to receiving final funds.
FedNow, expected to launch between May and July of this year, will be the central bank’s new core instant payment infrastructure. It will process retail payments in real time, twenty-four hours a day, 365 days a year, with funds made available immediately for use by the payment recipient. Eligibility to participate in the new system will generally be limited to U.S. banks; these banks, in turn, would offer instant payment services to individuals and businesses. The new system is a much-needed upgrade to the national infrastructure for retail payments, which is currently closed on weekends and can at times take several days before funds are available. The Fed’s ultimate aim is to give consumers and merchants faster access to their funds and greater flexibility to manage cash flow, at low cost and with reduced payment risk.
A key milestone was the Fed’s October 2022 publication of the legal terms and conditions governing FedNow transfers, which contain granular legal details about the service. These terms reveal important shifts to the status quo and critical ways the FedNow Service will impact the competitive outlook for retail payments, especially for fintech companies.
Challenges and Opportunities for Technology Companies
The Fed’s launch of FedNow this year is significant because it will enable banks of any size to offer convenient instant payments with nationwide reach. This will alter the retail payments landscape in three critical ways:
FedNow will challenge some major players in the payments industry: Instant payment systems like FedNow may ultimately prompt companies that depend on revenue from activity over existing payment rails, such as fintechs and partner banks that rely on credit or debit card interchange fees, to rethink their business models. It will similarly impact established nonbank providers of peer-to-peer payment services, such as dominant fintech companies that offer alias-based payment services (which allow senders to more conveniently make payments using only the email address or cell phone number of the recipient, without having to know their bank account information). Understanding the relative strengths and limitations of instant payments will be critical for both types of entities to adapt.
In addition, emerging digital asset payment rails, such as stablecoins and cryptocurrencies, may appear risky compared to payments over FedNow. To address this problem, it will be even more critical for companies offering these digital asset-based products to adopt robust legal foundations, risk-based measures to ensure regulatory compliance, and appropriate controls to manage operational risk.
FedNow will offer a fast, low-cost payment rail for digital platforms: The Fed’s legal terms and conditions for FedNow generally limit eligibility to banks, but e-commerce merchants and other digital marketplaces that have accounts with banks participating in FedNow can also take advantage as recipients of instant payments. If these merchants and marketplaces enable an instant payment option that a customer can select when purchasing goods or services online, they would have a significantly lower-cost alternative to traditional credit and debit card rails.