The Future of FedNow

It’s been over a year since the launch of FedNow, a real-time payment system developed by the Federal Reserve. As businesses, consumers, and financial institutions increasingly seek faster, more efficient ways to manage transactions, FedNow aims to fill this role by enabling immediate fund transfers between U.S. financial institutions. Let’s take a look at where FedNow stands one year in and what the future may hold for FedNow specifically and real-time payments in general.

What is FedNow?

FedNow is a real-time payment platform introduced by the Federal Reserve in 2023. Unlike traditional bank transfers like ACH payments or wire transfers, which can take days to process, FedNow facilitates immediate clearing and settlement between banks, making funds available to recipients in seconds.

The Current State of FedNow Adoption

To date, over 900 banks and credit unions have joined FedNow, a significant achievement for a system that is still in its infancy. These institutions are largely community banks and credit unions that were previously hesitant to adopt private-sector real-time payment networks like RTP.

Some of the largest U.S. banks, such as Bank of America, Citigroup, and Capital One, have yet to join FedNow. These institutions have taken a more cautious approach, citing competing priorities for technology investment. However, J.P. Morgan Chase has joined the FedNow network, and both Capital One and Citigroup have announced plans to follow suit in the near future.

FedNow has successfully onboarded financial institutions from all 50 U.S. states, ensuring broad national coverage. However, the actual usage of FedNow services and integration into everyday banking processes remain in the early stages. Most financial institutions are still in the process of figuring out how best to integrate FedNow with their existing payment systems.

FedNow’s early use cases have focused on transactions like person-to-person (P2P) payments, account-to-account (A2A) transfers, and funding of digital wallets. Some business-related payments, such as insurance payouts, emergency relief payments, and earned wage access, are also gaining traction.

The Federal Reserve’s long-term goal is to connect 8,000 of the nation’s 10,000 banks and credit unions to the FedNow network. However, this process is expected to take several years, as many institutions are still in the early stages of adoption or waiting to see how the system evolves.

Obstacles Facing Wider Adoption of FedNow

Challenges for Banks

• Cost and Complexity: Implementing FedNow requires significant infrastructure upgrades. Many banks are concerned about the costs involved in overhauling their payment systems to support real-time transactions. Nearly one-third of financial institutions report concerns about the difficulty and expense of updating their core systems to accommodate FedNow. Smaller banks, in particular, may struggle with the financial and technological resources required.
• Fear of Cannibalization: Some banks worry that offering real-time payments could cannibalize revenue from traditional payment services like wires, ACH, and credit card processing. Credit card interchange fees are a significant source of revenue for many banks, and the adoption of real-time payments could reduce the use of credit cards, impacting these revenue streams.
• Fraud Concerns: Faster payments also mean faster fraud. Banks are particularly concerned about managing fraud risks with FedNow’s instant, irrevocable transactions. Once a payment is sent through FedNow, it cannot be reversed, unlike ACH or credit card payments, which can be disputed and reversed. This puts pressure on banks to focus on fraud prevention rather than relying on post-transaction resolutions.

• Interoperability Issues: FedNow and RTP, its main competitor, are not interoperable. This lack of seamless integration between the two real-time payment systems creates a hurdle for broader adoption, as transactions between financial institutions on different networks cannot be completed easily.
  

Challenges for Consumers

• Lack of Awareness: Despite FedNow’s potential, many consumers remain unaware of the system and how it can benefit them. As a result, consumer demand for real-time payments has remained relatively low, partly because banks have been slow to offer these services to their retail customers.
• Competing Payment Options: Consumers have become accustomed to platforms like Venmo, Zelle, and PayPal, which offer similar features for P2P payments and have established user bases. Convincing consumers to switch to bank-based real-time payments via FedNow could take time, as they may not immediately see the added value compared to these popular alternatives.
• No Direct Consumer Access: Consumers cannot access FedNow directly. Instead, they must rely on participating financial institutions to offer the service. This means that consumer adoption is largely dependent on the bank or credit union they use, and not all institutions have adopted FedNow yet.

Potential Benefits for Merchants

FedNow’s instant payment capabilities allow merchants to access funds immediately after a transaction is completed. This eliminates the waiting period associated with traditional payment methods like ACH transfers or credit card settlements, where payments can take days to clear.

For businesses, particularly those with tight cash flows, this immediate access to funds can be a game-changer. FedNow’s real-time capabilities ensure that merchants know exactly when funds will be available, enabling more efficient business operations.

One of the most appealing features of FedNow for merchants is the lack of a chargeback process. Chargebacks are a significant pain point for many businesses, leading to lost revenue and additional fees. Since FedNow does not currently have a system for payment disputes, payments made through the system are final and cannot be reversed.

Addressing Merchant Challenges with FedNow

Recurring Payments

FedNow only supports push payments, meaning the customer must initiate each transaction. This model complicates recurring payments and subscriptions, where merchant-initiated pulls are common. However, FedNow offers a workaround through its Request for Payment (RFP) feature, which allows merchants to send payment requests to customers. Customers can manually approve the payment or set up autopay if their financial institution supports it.

Adoption Barriers

Not all banks support FedNow, which means merchants may face limitations if their acquiring bank or customers’ banks are not part of the network. Additionally, small to medium-sized businesses may encounter technological challenges in integrating FedNow into their existing payment systems. These businesses may need to invest in new software or partnerships with third-party fintech providers to facilitate integration.

Security and Fraud Concerns

While real-time payments offer numerous advantages, they also introduce new security challenges. The speed of FedNow transactions means that fraudulent payments could be completed before they are detected, leaving merchants and banks vulnerable.

Unlike ACH or credit card transactions, FedNow payments are irrevocable, meaning once funds are sent, they cannot be recalled easily. This makes fraud prevention even more critical, as there is no safety net for reversing fraudulent transactions.

FedNow includes several fraud prevention tools to help mitigate risk, including:

• Value limits: Banks can set transaction limits to reduce the risk of large-scale fraud.
• Negative lists: Financial institutions can block payments to known fraudulent accounts.
• Real-time reporting: Merchants can use reporting features to monitor transaction activity and detect suspicious behavior quickly.

Preparing Your Business for FedNow

Merchants should assess their current payment solutions to determine how FedNow could enhance their operations. Merchants can reach out to their financial institutions or payment acquirers to determine whether they are part of the FedNow network and what features they plan to support.

As with any new payment system, FedNow will require changes to existing workflows. Merchants adopting FedNow will need to invest in staff training to ensure they can handle real-time payments, update fraud prevention measures, and educate customers on new payment options.

As more financial institutions adopt FedNow and build services on top of its infrastructure, merchants will have opportunities to leverage these capabilities to enhance their operations. By preparing now and engaging with financial institutions, merchants can stay ahead of the curve and position themselves to thrive in the real-time payments future.