FedNow: Top 10 Facts Most Don't Know AboutJul 18, 2023
The upcoming implementation of the #FEDNOW payments settlement system has many on crypto Twitter worried it'll mean the advent of CBDCs in the United States. This is not surprising.There's been lots of misinformation from public figures on the topic this year. Most notably, @RobertKennedyJr announced back in April that the Fed would introduce its “‘FedNow’ Central Bank Digital Currency” this summer. We believe in DYOR, so let's get into it sirs! 👇
What is FedNow?
This month the Federal Reserve is set to release what many have called a "groundbreaking" payment system (FedNow) for banks. It will eliminate the need for delayed fund transfers through its instantaneous payment process, which serves as an upgrade to Fedwire and ACH. Direct access to this new system will not be made available to individuals, but people will benefit from quicker payments (as long as their financial institutions choose to join the FedNow network). The main takeaway from the implementation of the FedNow system is that it will ensure payments are no longer delayed during weekends, holidays, or outside of regular business hours.
FedNow Aims to Improve National Payments System
In addition to enabling direct, real-time settlements of interbank payments, and eliminating the need for deferred net settlements, FedNow will act as a second operator alongside the existing private sector Real-Time Payments (RTP) network operated by The Clearing House. This, according to the Federal Reserve, will provide choice and competition in payments. The hope is that FedNow will promote innovation and encourage the development of new payment services and features. Moreover, supporters argue that having multiple payment operators will enhance the resiliency of the payments system by providing redundancy, ensuring that disruptions or outages in one operator do not completely halt the flow of transactions.
Lessons From Across the Pond
To better understand the implications of FedNow and its impact, it is worthwhile to examine global developments and draw insights from the experiences of other nations. The Faster Payments Service (FPS) in the United Kingdom is a prime example of the feasibility and advantages of faster payment systems. Launched in 2008, this service operates 24/7, facilitating secure and nearly real-time transfers of funds between accounts at different financial institutions. In 2022 alone, the FPS processed over 3.9 billion payments with a total value exceeding £3.2 trillion, demonstrating its scalability and resilience. The success of the UK's FPS highlights the transformative potential of faster payment systems in enhancing transaction capabilities with speed, efficiency, and inclusivity. As emphasized in a recent report from the Treasury Department on the Future of Money and Payments, international experience suggests that expanding the range of eligible institutions that can participate in instant payment systems could help improve speed, efficiency, competition, and inclusion in payments, including for cross-border transactions.
Is FedNow a CBDC?
In short, no. However, savvy observers may notice that FedNow bears some resemblance to a retail CBDC.Their similarities lie in the fact that both would only be available to financial institutions for interbank settlements. However, the key difference between the two can be found in their design. A CBDC functions as a currency, while FedNow operates as a payment rail. If we compare dollars and cents to electricity, then FedNow acts as the wiring system that transports that electricity to its intended destination. In contrast, a CBDC would involve replacing the electricity itself in this analogy.
The Fed Says There's a Difference
Currently, interbank settlements are conducted through the Federal Reserve's payment rails, which ultimately impacts the settlement times for retail banking customers. This is why Federal Reserve Governor Michelle Bowman stated, "My expectation is that FedNow addresses the issues that some have raised about the need for a CBDC." However, it's important to note that this statement does not mean that FedNow will eliminate the possibility of CBDCs, but it does highlight the fact that the Fed views FedNow and CBDCs as distinct from one another.
5 Facts About FedNow (Pros)
Here's a list of five potential benefits of the new FedNow system 👇
#1 - Regular people will benefit.
The update to settlement of interbank payments means that consumers and businesses will be able to send and receive money instantly, 24 hours a day, 7 days a week, without having to wait for days for the transaction to clear.
#2 - Security will improve.
The system will also improve the overall security of payments, as funds will be transferred directly between banks without the need for intermediaries.
#3 - It could spur innovation in the payments industry.
FedNow will be available to all banks and financial institutions in the United States, which will help to promote competition and innovation in the payments industry.
#4 - It could benefit poor people.
The system is also expected to benefit under-served communities, who often rely on expensive and unreliable payment options.
#5 - It could negate the need for a CBDC in the United States.
Many industry experts argue that improving the speed of retail bank payments through FedNow will significantly reduce the need for a CBDC in the United States.
5 Facts About FedNow (Cons)
Here's a list of five potential drawbacks of the new FedNow system 👇
#1 - It's not as inclusive as it purports to be.
While FedNow is an exciting development in the payments industry, it's not immune to criticism. Some experts argue that the system may not be inclusive enough, as it requires banks and financial institutions to participate.This means that smaller banks and credit unions may struggle to afford the necessary technology and infrastructure to connect to FedNow, which could limit access for some consumers and businesses.
#2 - It may be a redundant, unnecessary solution.
Many experts question whether FedNow is even necessary, given the existence of other instant payment systems like Zelle and Venmo. They argue that the Federal Reserve should focus on improving existing systems rather than creating a new one.
#3 - It could exacerbate fraudulent financial activity.
There are also concerns about the potential risks of instant payments, such as fraud and money laundering. Critics argue that FedNow needs to have robust security measures in place to prevent these issues.
#4 - It keeps the Federal Reserve from seeking to improve core utilities like the National Settlement Service (NSS).
In 2019, the Fed made public its intention to explore the expansion of Fedwire Funds Service and National Settlement Service hours, up to 24x7x365, to facilitate liquidity management in private‐sector real‐time gross settlement services for faster payments and to support a wide range of payment activities, beyond those related to faster payments. However, the introduction of the new FedNow system will likely put those initiatives on the back-burner.
#5 - Adopting ISO 20022 (global messaging standard for modern payments) has drawbacks.
FedNow will adopt the ISO 20022 standard. Criticisms of this payment messaging standard include that it is overly complex and requires significant investment in technology and infrastructure, particularly for smaller financial institutions. Some also argue that it may lead to a homogenization of financial messaging and reduce innovation in the industry. Additionally, the transition to ISO 20022 may be costly and time-consuming for organizations that currently use other messaging formats.