Let’s Get Real: Perspectives on the Fed’s Real-Time Payment Processing Initiative

Kim Wilson, MPP Staff Writer, Brief Policy Perspectives

The Federal Reserve Board of Governors recently announced plans to develop a real-time gross settlement (RTGS) system. FedNow ServiceSM will facilitate the instantaneous transfer of funds between financial institutions, businesses, and individuals. Currently, the process of transferring funds from an originator to a recipient can take several days, leaving consumers hanging in the balance while deposits from relatives or employers clear. While a 2015 Fed rule change enabled same-day settlement capability, both consumers and financial institutions continue to advocate for even faster payment processing. Calls to facilitate real-time payments in the U.S. follow the implementation of RTGS platforms abroad, which began several decades ago.

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History of Real-Time Payments

As early as 1973, Japan launched the world’s first national real-time payment system, Zengin. The central banks of 54 countries across the world have developed real-time systems as of 2019, including the Czech Republic, Romania, Saudi Arabia, Malaysia, and Hong Kong within the past year. Acknowledging the United States’ need to establish its own national real-time payment system, the Fed launched a stakeholder collaborative in 2013 to collect feedback and develop plans for an RGTS system that is broadly accessible by financial institutions and integrated with private-sector platforms.

The Fed Payments Improvement Community synthesized stakeholder feedback into three reports that shaped the path forward for real-time payments. In Sept. 2013, the Fed published initial findings on payment-system improvement needs and the Fed’s potential solutions. A 2015 paper followed, outlining goals and strategies developed in response to the feedback received since 2013. The Fed, in consultation with the stakeholder collaborative, released its final paper in Sept. 2017, offering nine strategies to enable the central bank to accelerate payment processing.

The 2017 paper suggested that the Fed pursue real-time payment processing enhancements based on recommendations developed by the Fed’s Faster Payments Task Force, a subset of the Fed Payments Improvement Community, that includes a range of stakeholders (illustrated below). The Task Force also issued reports, concluding with a July 2017 call to action to implement payment speed enhancements by 2020.

Progress and Next Steps

The Fed acknowledged the Task Force call to action with a Nov. 2018 proposed rule requesting comments on the best way to implement a faster payment system that is “ubiquitous, safe, and efficient.” Almost 800 organizations responded to the proposed rule, with an overwhelming majority in favor of the Fed implementing an RTGS system. In response to overwhelming support, on Aug. 9, 2019, the Fed announced its decision to create the FedNow ServiceSM and accepted comments until Nov. 7.

The latest notice explains the need for a public-sector RTGS system. Currently, only one private-sector service provider offers real-time payment processing. The Clearing House operates an RTGS platform, which is owned and operated by the 25 largest banks (see below graphic). The Fed acknowledges concerns that the Clearing House platform may be inaccessible by smaller banks, harming consumers, and preventing ubiquitous participation by all financial institutions.

In the Aug. 9 notice, the Fed suggests that the simultaneous availability of private and public-sector real-time payment service providers will encourage competition and, therefore, better price and quality outcomes. They indicate that high fixed costs and coordination challenges associated with developing an RGTS platform serve as barriers to entry for any potential private-sector competitors to the Clearing House. The Fed also explains that marginal costs associated with onboarding smaller financial institutions will likely exceed marginal revenue, disincentivizing the private sector alone from enabling ubiquitous RTGS participation. For this reason, the Fed argues that a public-sector provider is necessary to ensure the widespread adoption of RTGS capabilities.

The Fed expects to launch FedNow by 2023 or 2024 after continuing stakeholder engagement on the design and implementation of the new service. The American Bankers Association (ABA), a critical stakeholder which represents both small and large banks, issued the following statement of support for FedNow: “ABA will continue to encourage all banks to embrace the future and consider whether to connect to the existing Real-Time Payments network offered by the Clearing House.” The trade association representing community banks, the Independent Community Bankers of America (ICBA), registered strong support for the Fed establishing an RTGS system.

Several major stakeholders oppose FedNow’s implementation. The Clearing House, which currently has a monopoly over real-time settlement servicing, stated that FedNow is “not needed” and is likely to harm cost and quality overall. In its 2018 comment letter, the Bank Policy Institute (BPI) indicated strong opposition: “…we urge the Federal reserve not only to defer any further work on its own ‘24x7x365’ RTGS system but to explicitly and publicly affirm that it has no plans to do so.” The creation of BPI was a result of a merger of the Clearing House Association and Financial Services Roundtable. Within the Federal Reserve Board of Governors, Vice Chair for Supervision Randal Quarles voted against the recent decision to proceed with FedNow.

Conclusion

According to representatives of smaller financial institutions, the implementation of FedNow will enable all account holders to access their deposits immediately. The Fed must continue working with stakeholders to ensure that system enhancements assist consumers and adequately address issues with accessibility, costs, risk, and the private sector’s ability to offer competing RTGS services. The comment period that closed Nov. 7 requested stakeholder feedback on the best design strategy for FedNow and a competitive impact analysis to enable additional private-sector entrants to the market.

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