Developments in the Real-Time Payments Landscape

Abstract

This survey provides an overview of the real-time payment (RTP) landscape in the US in light of the Federal Reserve Board's new RTP offering, "FedNow."

It also discusses the practical implications of the wider availability of RTP.

Introduction

In today’s digital world, technology plays an increasingly important role in financial services. Particularly in the payments space, consumers and businesses have come to expect faster and more responsive payment systems solutions and the ability to send and receive payments in real time. According to a 2022 survey of U.S. consumers conducted by the Federal Reserve Banks, 75 percent of those surveyed indicated that they currently use some form of electronic “faster payments” systems that are able to send funds from payer to payee within seconds or up to a few hours and 61 percent said they were likely to use such services more in the future.

While banks and fintech companies have introduced these new faster payments products and services, many of these solutions, despite their appearance, do not actually move funds in real time, but rather clear and settle funds through traditional payment systems that can take days to process in line with standard practice. This is in contrast to the “real-time” payments services available in many countries (which in some cases have been available for decades) where clearance and settlement of funds occur almost instantaneously via services that operate twenty-four hours per day, seven days per week, 365 days per year (“24x7x365”).

The United States has been relatively slow in its adoption of payments systems that can move funds in real time and operate 24x7x365 and has only started to develop such systems in recent years. In 2017, The Clearing House (“TCH”), a banking association and payments company owned by some of the world’s largest commercial banks, launched the first real-time payments rail in the United States called the RTP^® network (“RTP”). Most recently, the Federal Reserve launched its version of a real-time payments rail, called the FedNow^® Service (“FedNow”), on July 20, 2023. With two real-time payments rails in the United States, this survey will explore the features of these relatively new solutions and how they fit into the existing U.S. payments landscape.

What Are “Real-Time Payments”?

Despite having similar nomenclature, faster payments are not the same as “real-time payments.” Rather, there are various types of faster payments, of which real-time payments is just one form. Faster payments are generally regarded as “payments in which the transmission of the payment message and the availability of final funds to the payee occur in real-time or near real-time and on as near to a 24-hour and 7-day (24/7) basis as possible.” This means that in order to qualify as a faster payment, the transaction must immediately be reflected in the accounts of the payer and payee, and the payee must be able to use the funds sent by the payer immediately after they have been sent.

Aside from these general criteria, faster payments can differ in many ways. The three major distinctions are: closed-loop systems versus open-loop systems; deferred settlement versus real-time settlement; and net settlement versus gross settlement.

Closed-Loop Versus Open-Loop. A faster payments system can either be closed or open. In a closed-loop system, payment options are offered by a single central provider where both the payer and the payee must maintain an account in order to transact. Examples of closed-loop systems include PayPal, Venmo, and Cash App. In a closed-loop system, the payer and payee can transfer funds instantaneously between each other within the system; however, a transaction, deposit, or withdrawal of funds outside the closed-loop system usually requires a transfer to another account at a financial institution via traditional payment rails, which can take up to a few days to settle. In contrast, in an open-loop system a payer is able to pay broader groups of payees even if they have an account with a different financial institution.

Deferred Settlement Versus Real-Time Settlement. Another feature that can differ among faster payments systems is the method in which payments settle (i.e., once the payment has cleared, the manner in which the payee’s financial institution receives final funds from the payer’s financial institution). With deferred settlement, the transfer of final funds between the payer's and the payee's financial institutions occurs after the payee’s financial institution has made the payment available to the payee and generally at the end of a pre-defined settlement cycle or point in time, e.g., at the end of a business day. Depending on the systems involved, deferred settlement can take anywhere from minutes to days, as seen with traditional payment rails such as ACH transactions. Real-time or instant settlement means that the transfer of final funds between the payer’s financial institution and the payee’s financial institution occurs concurrently with the transmission of the payment message from the payer to the payee, just seconds before the payee’s financial institution makes the funds available to the payee.

Net Settlement Versus Gross Settlement – Real-time and deferred settlement are typically associated with another set of features: “net settlement” and “gross settlement.” Deferred settlement generally occurs at the end of a pre-defined settlement cycle, and usually involves the process of “net settlement.” With net settlement, the payments network tallies all of the payments sent and received among institutions in the network and offsets those amounts to determine an aggregate net amount that each institution owes to the other at the pre-determined settlement time, thereby reducing the amount of funds that are required to be settled. ACH is an example of net settlement. On the contrary, “gross settlement,” where the network settles transactions on a transaction-by-transaction basis, is often associated with real-time settlement. Therefore, a real-time, gross settlement system contemplates that a payer’s financial institution will pay a payee’s financial institution each time a payment transaction occurs and for the amount of a payer’s payment.

Liquidity Risk Versus Credit Risk. It is important to note that deferred, net settlement and real-time, gross settlement each present different risks for financial institutions involved in these transactions. With deferred, net settlement, credit risk is present for the payee’s institution, as it essentially extends short-term credit to its payee-customer from the time it credits such customer’s account for such payment until settlement occurs and it receives funds from the payer’s institution. There is less credit risk with real-time, gross settlement because settlement occurs for each transaction before or concurrently with the crediting of any accounts. While credit risk is lessened with real-time, gross payment, liquidity risk is introduced. Liquidity risk is the risk that a financial institution does not have sufficient funds to fund a transaction and cannot readily obtain alternative funding from other sources. The deferred, net settlement structure reduces the liquidity risk because each financial institution’s total settlement obligation is offset by what other network participants owe it. In addition, having pre-designated settlement times that are typically within the operating hours of intraday credit markets and/or the Federal Reserve’s Discount Window provides financial institutions with an opportunity to access additional liquidity.

These features should be kept in mind to understand the distinction between faster payments and real-time payments. Effectively, real-time payments are faster payments that operate in a real-time, gross settlement, open-loop system. Of the various faster payments systems in the United States (which all require financial institutions to make funds available to payees in near real time on a 24x7x365 basis), only RTP and FedNow operate with real-time gross settlement.

The Existing U.S. Payments Landscape

While real-time payments only entered the U.S. payments landscape in 2017, there have been a number of other payment systems that have been facilitating payments in the United States over the years. Below are a few main examples.

Wire Transfers. Wire transfers are electronic payment services that typically handle high-value transactions between businesses and as a result generally settle on a gross basis. In the United States, the Federal Reserve and TCH each offer wire transfer services: Federal Reserve’s FedWire and TCH’s The Clearing House Interbank Payments System (CHIPS). Wires can be used for both U.S. domestic and international payments and are typically irrevocable once the recipient institution has processed the transfer on its end, thereby unable to be reversed, repudiated, or charged back. While wires typically settle immediately, settlement must occur during banking system operating hours and the entire delivery process of a wire can take days.

ACH. The Automated Clearing House (“ACH”) is an electronic funds–transfer system run by NACHA that processes large batches of both credit and debit transactions. In the United States, both the Federal Reserve and TCH offer ACH services: the Federal Reserve’s FedACH and TCH’s Electronic Payments Network. ACH processes payments in batches, with multiple payments in a batch, rather than individually. While traditional ACH can take days to settle, same-day ACH now exists for an additional cost, which allows for payments to be initiated and settled on the same day. However, same-day ACH is still not real-time processing; rather it is batch processing that is made possible by multiple settlement windows. Payments made by ACH are also subject to reversal and recall of funds within a specified period of time according to applicable law and operating rules.

OCT/ Push-to-Card. For faster payments that run through the card networks, there is what is known as an “Original Credit Transaction” (OCT) or Push-to-Card technology. The Push-to-Card technology allows users to send money to a debit card in seconds using the debit card rails provided by Visa or Mastercard, known as Visa Direct and Mastercard Send, respectively. The transaction works like a return, e.g., if an item purchased with a debit card at a merchant is returned, that money is instantly credited back to the debit card, and the funds are available to spend immediately. With Push-to-Card services like Visa Direct and Mastercard Send, the only difference is that this push transaction does not have a related purchase transaction.

Development of Real-Time Payments in the United States

In late 2012, the Federal Reserve announced its intention to focus on ways to improve the speed and efficiency of the U.S. payment system, while maintaining safety and accessibility. The Federal Reserve then engaged with various industry stakeholders and conducted studies on potential solutions. In parallel, in the private sector, TCH started to develop RTP in 2014.

In 2015, the Federal Reserve published a white paper, “Strategies for Improving the U.S. Payment System,” where it outlined a strategy to “achieve ubiquitous, safe, faster payments for U.S. consumers and businesses.” Subsequently, in late 2015, the Federal Reserve created the Faster Payments Task Force (“FPTF”), which comprised various payments industry stakeholders, including financial institutions, non-bank payment providers, regulators, and businesses, among others. The FPTF solicited private sector stakeholders to submit proposals for “a full end-to-end payments solution,” with such proposals to be judged against the criteria developed by the FPTF. TCH was one of sixteen private sector stakeholders to submit a proposal, which achieved the highest possible rating of “very effective” for thirty of the thirty-six criteria and “effective” for the remaining five criteria. Two years later in 2017, the FPTF completed its work and published its findings in a two-part report. In this report, the FPTF proposed a variety of recommendations related to faster payments, one of which was to design and implement a “24x7x365 settlement service” that supported the needs of faster payments. Meanwhile, TCH’s real-time payments solution, RTP, debuted in November 2017.

Approximately a year later in October 2018, the Federal Reserve issued a notice and request for comments on “potential actions” it could take to facilitate real-time interbank settlement for faster payments. In response, the Federal Reserve received over 350 comments with over 90 percent of commenters favoring a Federal Reserve–operated real-time payments system. TCH was not in favor of the proposal.

In August 2019, the Board of Governors of the Federal Reserve System announced its intention to create a real-time gross settlement service called FedNow and solicited comments. Although not the first real-time payments provider in the United States, the expectation is that FedNow will result in greater access to real-time payments given the Federal Reserve’s reach of more than 10,000 financial institutions connected to its system.

How Are RTP and FedNow Similar? How Are They Different?

At a fundamental level, both RTP and FedNow are 24x7x365 real-time, gross settlement, open-loop payment systems that transfer payments through a “credit push” process. Each system operates every day of the year and continuously processes and settles payments on an immediate basis within seconds. Additionally, since each system pushes payments from payer to payee, these payments are irrevocable.

Despite these fundamental similarities, RTP and FedNow each have certain unique features which we explore below.

Eligible Participants

Both the Federal Reserve and TCH do not allow end users (i.e., individual consumers or businesses) to engage directly with FedNow or RTP, respectively. Rather, end users are able to use such services only if their financial institutions participate with FedNow or RTP as applicable, and if their financial institutions offer such features to them.

Both platforms have generally broad eligibility criteria for financial institutions that wish to participate. For RTP, any federally insured U.S. depository institution may participate by connecting directly or via an electronic connection provided by a third-party service provider (e.g., a core processor, a hosted gateway, a bankers’ bank, or a corporate credit union). With respect to FedNow, any organization eligible to maintain a master account with a Federal Reserve Bank is eligible to participate in FedNow. Such organizations generally include, but are not limited to, depository institutions, member banks, U.S. branches and agencies of foreign banks, certain organizations for which a Federal Reserve Bank acts as a fiscal agent, and Edge and agreement corporations. As a result, non-banks, such as payment companies and non-bank lenders, cannot directly participate in FedNow, but can act as service providers or agents for participating organizations.

FedNow settles payments through the respective participating member’s (or its correspondent’s) master account held at the Federal Reserve Bank. And FedNow’s unique liquidity management transfer feature allows participating financial institutions to send credit transfers between each other (either directly or through service providers) even during non-business hours in order to support liquidity needs in light of FedNow’s 24x7x365 operations. On the contrary, RTP settles payments in RTP’s joint, master account at the Federal Bank of New York, thereby requiring all participating banks to prefund the joint account and maintain sufficient balances to meet liquidity needs.

Fees & Transaction Limits

Both FedNow and RTP charge only a flat fee of a few cents for each transaction (as of the date of this survey’s submission, each service’s fee is $0.045). In 2024, FedNow also plans to charge a monthly participation fee for each routing transit number that enrolls in the service to receive credit transfers. RTP does not have any monthly fees.

With respect to transaction amounts, RTP’s limit is $1 million, whereas FedNow has a limit of $500,000. However, the standard limit for all FedNow participant institutions will be $100,000, which participants may adjust down or up to the $500,000 limit.

Payment Flow

At a high level, FedNow and RTP have similar payment flows. The payer initiates a transaction through their financial institution’s end-user interface. The payee’s financial institution then validates the payment according to its internal processes and, if validated, then submits a message to FedNow or RTP as applicable, who verifies the message, and then sends the message to the payee’s financial institution to confirm that it will accept payment. The payee’s financial institution may accept, reject, or accept without posting the payment (in the event that the payee is not the intended recipient). If the payee’s financial institution accepts, FedNow or RTP as applicable then debits and credits the accounts of the payer’s and payee’s financial institutions or correspondent financial institution and sends confirmation of the transaction to both participating financial institutions. The payee’s financial institution then credits the payee’s account immediately, making such funds, available and the payer’s financial institution informs the payer of the successful completion of the payment. All of these steps happen in a matter of seconds.

Interoperability

It is important to note that, due to technological incompatibilities, RTP and FedNow are not currently interoperable in that a financial institution cannot send and receive payments between these two systems. To send a payment through either RTP or FedNow, both the sender and receiver will need to be using the same system. Despite this, both TCH and the Federal Reserve have indicated they are looking to work toward interoperability in the future.

Governing Laws and Regulations

RTP transactions are primarily governed by: (i) the RTP System Operating Rules and incorporated governing documents; (ii) Article 4A of the Uniform Commercial Code (“Article 4A”); and (iii) the Electronic Funds Transfer Act (“EFTA”) and Regulation E (“Reg. E”).

FedNow transactions are primarily governed by: (i) its own governing documents, such as the FedNow Service Operating Procedures; (ii) Regulation J (12 C.F.R. pt. 210), which was amended in 2022 to add subpart C to address FedNow and which incorporates Article 4A; (iii) to the extent applicable, the EFTA and Reg. E; and (iv) the Federal Reserve’s Operating Circular 8.

Real-Time Payment Use Cases

From gig economy disbursements to splitting bills for dinner or rent, to insurance payouts, the number of potential use cases continues to expand as the payments ecosystem embraces the promise of real-time payments. Continued adoption will show more businesses that real-time payments can fill important needs, such as providing customers immediate access to funds (e.g., emergency disbursements), moving money efficiently (e.g., transactions with suppliers and trading partners to improve overall business relationships, or moving funds to employees for bonus or payroll payments), and supporting time-sensitive transactions (e.g., paying bills on the date they are due). Similarly, real-time payments may be beneficial to individuals, especially those who have less liquidity, as immediate settlement of funds can help to keep track of finances and also pay bills on time thereby avoiding late fees.

Impact of FedNow Service on the Payments Industry

The launch of FedNow will likely have a significant long-term impact on the payments industry. Financial institutions and other payments service providers are strategically working toward innovating and offering new products to meet the growing appetite for real-time payments with new use cases such as those described in the prior section. FedNow will likely have commercial implications for participants in the payments ecosystem and spur key stakeholders (such as financial institutions, payments service providers, and businesses) to devote necessary resources to support instant payments if they have not done so already.

There will also be challenges to resolve and associated costs of managing these issues. Real-time payments will likely come with increased risk of fraud, misdirected payments, and potentially even “bank runs.” Banks will need to upgrade their fraud detection and prevention systems to mitigate the shorter processing times. Additionally, FedNow may present added technology expenses, particularly for smaller institutions that decide to participate. These costs include adding the technology needed to send and receive instant payments, and the technical work required to adopt ISO 20022, the international messaging standard adopted by FedNow and RTP. Furthermore, enhanced support for 24/7 exception handling and changing customer-facing documentation and processing to showcase the new settlement option will also add to these costs.

Commercial Implications

Payments providers will have to consider how to recoup the potential loss of lucrative interchange fees to real-time payments products, because real-time payments cost less to process than other types of payments transactions such as debit and credit transactions. FedNow is also offering key pricing discounts for new customers in 2023 as part of its incentive pricing that will likely spur bank participation, though roll out and widespread adoption by businesses and consumers will inevitably take some time.

With real-time payments becoming more readily available as a payments service in the United states, especially at the business to consumer level, merchants may scrutinize the higher rates that they currently pay to facilitate acceptance of payments methods that are not real-time payment products and may seek to renegotiate those commercial arrangements in their payments contracts. Merchants in particular may reevaluate their customers’ appetite for different types of functionalities in their payment methods, which come with different fees imposed on the merchants.

Risk of Fraud and Misdirected Payments with Real-Time Payments

One hidden cost of real-time payments is the heightened risk of fraud and misdirected payments. With real-time payments being a “push” payment, once the money is pushed to a designated bank account, there is no way to recall the payment and get that money back. With the speed that is expected of a real-time payment transaction, the mechanisms that banks traditionally have in place to identify and stop bad transactions before they occur are effectively obsolete. This means that banks need to have robust systems in place to analyze customer activity, recognize aberrations, and flag problems in real-time.

Authorized Push Payment Fraud

There are many opportunities for fraud with irrevocable payments. For example, fraudsters typically try to trick their victims into voluntarily sending payments from the victim’s bank account to a bank account owned or controlled by the fraudster. By using sophisticated tactics, including psychological manipulation and impersonation scams to present seemingly legitimate requests for money, these bad actors are able to dupe their victims into authorizing such payments. Because real-time payments transactions are irrevocable and because settlement happens in real-time, victims cannot reverse a payment and the funds are usually long gone by the time the victim discovers the scam. Therefore, the onus is not only on banks to prevent funds from leaving customer accounts, but also, in some instances, to keep money from coming in.

Account Takeover Scams

Like other payment systems, real-time payments are susceptible to account takeover scams, in which fraudsters use phishing or other scams to mine for a victim’s private financial data. The fraudster then uses the private financial data to assume control of the victim’s accounts. Once the fraudster assumes control, the fraudster then pushes payments from the victim’s account to an account controlled by the fraudster. Because of the speed at which real-time payments move, account holders who are not actively monitoring their accounts may not even know that their funds are being stolen until the funds are already gone.

Combating Real-Time Payment Fraud

Both RTP and FedNow have implemented tools to assist in defending against fraud. For example, FedNow will offer a “negative list” feature for banks that can identify bad actors, which allows institutions to block entities from transacting with their customers or to put a temporary hold on funds so that such institutions may conduct additional screening. Other features available at launch include message signing, which will validate that the message contents have not been altered or modified, and reporting features and functionality, including reports on the number of payment messages that were rejected based on a participating financial institution’s settings. This information can be used to verify that transactions align with a financial institution’s own records and detect whether a bad actor may have interceded or deleted records.

RTP has also deployed tools to combat fraud, including implementing tokenization on accounts, and has imposed requirements on its participants to help bolster security, such as requiring sending participants to verify the identity of their customers with multi-factor authentication. Additionally, both FedNow and RTP participants are able to restrict the types of transactions they participate in, such as joining as a “receive-only” participant, thereby allowing the participant to only deal with risk management in one direction.

In terms of liability to the extent there is fraud, as between on the one hand, RTP and FedNow, and on the other hand, the participating members, the risk of loss is largely on the participating members. In Operating Circular 8, the Federal Reserve disclaims all liability for transfers that are completed, in part, through FedNow and that were authorized by a FedNow payer customer, but which the FedNow participating member learns may have resulted from fraudulent activity. In the RTP Participant Terms and Conditions, the participant member is liable to and is required to indemnify TCH for any “costs” arising from the participant’s own acts and omissions related to its participation in RTP, which would likely include authorization of fraudulent transfers.

Bank Run Concerns with Faster Payments

In today’s increasingly swift and digital banking world, the modern day “bank run” no longer comprises long queues of customers waiting in front of a bank to withdraw their money, but rather queues of pending online or mobile-app transactions. With the backdrop of certain bank failures still fresh from the early months of 2023, there is concern that the very nature of real-time payments, touted as a benefit and convenience to businesses and consumers alike, could quickly lead to a bank’s demise, as transactions that could be cleared in seconds could supercharge future bank runs.

FedNow and RTP have certain tools to help protect against this risk, such as their individual transaction amount limits. However, with the expansion of real-time payments, the payments industry and regulators must continue to work together and develop best practices and regulations to mitigate these new risks to the banking system.

Conclusion

The rollout of FedNow alongside RTP in the United States means that financial institutions now have decisions to make when it comes to real-time payments offerings. For example, they will need to determine what products they can and should offer that make use of one or both of these real-time payment rails, and how much they should charge as a premium for real-time processing to help with the expense of managing two distinct real-time payment systems. There are dozens of technology firms that are building connections between financial institutions and each of FedNow and RTP. These efforts will hopefully help real-time payments achieve the ubiquity that it needs to become truly successful in the United States and for real-time payments to serve as an important and viable option for the payments needs of businesses and consumers alike.