U.S. real-time payments capabilities lag behind those of some other countries. The Federal Reserve’s proposed FedNow system offers consumers advantages, but it could impede the growth of private real-time payments systems.
Real-time payments systems are taking off, enabling almost instant transfer of funds at all times, potentially benefitting credit card users.
Announcing its recent acquisition of Nets, a European payment technology company, Mastercard’s chief product and innovation officer, Michael Miebach, said, in a news release, “The global opportunity for real-time payments is accelerating.”
Visa, too, offers real-time transfer of funds to financial accounts using debit cards through its Visa Direct system.
Kim Ford, executive director at the Faster Payments Council, an organization that aims to advance the U.S. payment system, noted in emailed comments that the credit card networks that also operate debit platforms would likely say their debit cards have provided access to fast payments for many years through their PIN debit transactions.
“But as we look to faster payment solutions that use real-time settlement, I think the market is just getting started, and as an industry, we still don’t know how the systems will evolve to a point where, say, the credit card networks ultimately interoperate with The Clearing House’s real-time payment system (RTP) or the Federal Reserve’s upcoming FedNow service,” she said.
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Fed gearing up to provide real-time payments service
FedNow, a real-time payments system that the Federal Reserve is working on, is expected to be functional in the 2023-2024 time frame, with the ultimate aim of providing services nationwide.
The central bank’s new system will usher in payments that can be processed in mere seconds. It will do so by debiting and crediting banks’ accounts with the Federal Reserve system, with the accounts of the banks’ customers reflecting their transactions. The system will also provide a messaging service that would allow, for instance, a receiver of funds to prompt a sender for payment.
In a news release, the Fed noted, “The rapid evolution of technology presents a pivotal opportunity for the Federal Reserve and the payment industry to modernize the nation’s payment system and establish a safe and efficient foundation for the future.”
The new Fed system will draw on the central bank’s existing capabilities to provide payment and settlement services to financial institutions nationwide. It will enable banks of all sizes to provide real-time payments services (initially limited to amounts of up to $25,000) to their customers.
In a comment letter to the Fed on the proposed system, the American Bankers Association noted, “FedNow has the opportunity to encourage the adoption of faster payments across the country.”
Instant access to funds
One fundamental advantage of real-time payments is they allow consumers instant access to funds received. With other modes of payment, such as bank payments, debit cards and bank checks, it could take a few days for the moneys to clear and be available.
Real-time payments would especially benefit consumers who are living paycheck-to-paycheck and small businesses. When paying your credit card balance, for instance, you need not incur a late payment fee, or bank overdraft fee, just because your funds are not immediately credited.
Tom Feltner, director of research at the Center for Responsible Lending, said, “Consumers benefit from a robust, safe, and diversified payments ecosystem with increased speed, low costs and clear rules of the road to prevent abusive overdraft fees and detect and prevent fraud.”
In Congressional testimony at a hearing on the future of real-time payments, Harsh Sinha, chief technology officer at TransferWise, noted that although both Visa and Mastercard have developed fast payment systems, and banks have adopted fast payments through clearXchange’s Zelle system and The ClearingHouse’s RTP system, “the market and customer’s access to real-time payment rails are still very fragmented.”
“Moving money should be like sending an email – instant. It’s simply the digital movement of data,” Sinha said.
Payments can’t be recalled
Instant access to funds also comes with some risks.
“Credit card users that have come to expect consumer protections like the ability to reverse payments, fraud protection and error resolution may not realize that not all of these protections are available when sending money through other payment networks for purchases,” Feltner said.
This means you could lose your money if you accidentally send a real-time payment to the wrong person.
According to Matt Friend, Visa’s vice president of global faster payments, real-time payments don’t offer the peace of mind that credit card payments provide.
He said, “The transaction is essentially the same as wiring funds or handing over cash, whether you are funding the payment from a checking account or a credit line. A credit card payment comes with a lot of assurance that inspires a lot of confidence in whoever is making the payment.”
However, the Fed system’s direct messaging capabilities can help cut down on transfer of funds to the wrong party, since funds transfers could be made by responding to a direct message from payees asking for money.
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Higher potential for fraud
Another concern is that the Fed proposal contemplates providing system access to nonbank institutions through participating banks, which could also elevate system risks, according to the American Bankers Association.
And Christina Tetreault, policy counsel at Consumer Reports, noted in an email, “Instant, irrevocable payments are an inviting target for scammers. When the United Kingdom launched its real-time payment system, fraud spiked. Everyone should be concerned that faster payments may mean faster fraud here.”
That’s why, in order to encourage the use of real-time payments systems, it’s important to have strong protections against errors in place.
In its public notice asking for comment on the proposed system, the Federal Reserve noted that banks would continue to watch for fraudulent transactions, and the Fed would also monitor payments and warn banks about any unusual transactions.
Could the Fed crowd out private players?
There is also some concern about whether the Fed system could impede the growth of private sector real-time payments providers. The ClearingHouse’s RTP system, which is owned by some big banks and started operating in late 2017, is currently the only private system the Fed considers comparable to its own planned system.
The Fed is weighing the benefits to the public of a government real-time payments service, versus any potential adverse impact in terms of stifling the growth of private operators, and the market.
Possibly impeding the competition, the Fed offering would enjoy certain systemic financial advantages over similar private-sector ventures. For instance, depositing funds with the Fed would be essentially risk-free for participating banks, whereas depositing funds with a private system comes with risks.
A government system could have more reach
On the other hand, a government-sponsored real-time payments system would lower costs and hike up efficiency by consolidating the market and making it less fragmented, while reducing the vulnerability of the overall financial system (by providing service during times of crisis).
And having just one dominant private player in real-time payments could also lead to less innovation in the niche, although it could respond faster to market needs than a slower, rules-bound government system. Another positive is that the Fed could use its dominant position to develop industrywide standards to combat fraud.
According to Tetreault, “Only the Federal Reserve can build a faster payments system available to all and focused on the diverse needs of all stakeholders.”
And Esther George, president of the Federal Reserve Bank of Kansas City, pointed out at the congressional hearing that the Fed can connect with more than 10,000 financial institutions.
“Through these connections, the Federal Reserve’s existing payment services allow banks of every size to serve the needs of thousands of communities across the United States with competitive, fair and transparent access,” she said in a prepared statement. “Providing this degree of comprehensive nationwide reach is something that we believe will present significant challenges to other providers in the current market landscape.”
There still remain some challenges to be met before the Fed system really takes off.
For one, the long time frame for the government to recover costs associated with setting up the system could be a constraint. There’s also the issue of being vigilant about fraud.
And Visa’s Friend believes that medium and small banks, in particular, could face challenges “to scale and compete in developing customer-friendly, efficient and secure tools for consumers to conduct payments,” such as bank websites and mobile phone applications.
In any event, the U.S. has some catching up to do with other countries in terms of real-time payments capabilities. In a public speech, Lael Brainard, a member of the Federal Reserve System’s Board of Governors, noted that the U.S. infrastructure for retail payments lags behind that of many other countries. For instance, Europe, Mexico and Australia already have real-time payments capabilities in their banking systems. The Federal Reserve is now weighing public comments it received to its FedNow plan before proceeding further.
As for how the market might evolve, the Faster Payments Council’s Ford noted, “We don’t view faster payments as a zero-sum proposition where if faster payments systems ‘win,’ then other forms of payments lose. We envision a future where there will continue to be a robust market of consumers in the U.S. who want to use their credit cards, and some of those same consumers and more will want to transact using faster payment solutions.”