It is no secret that the United States is late to the instant payments party. While there are longstanding reasons, what matters now is that the market needs and expectations for real-time payments continues to grow, brought into stark focusby the COVID-19 pandemic. The accelerated shift to digital and remote payments, as well as the need for immediate access to emergency funds disbursements, present ideal use cases for this functionality.
While real-time payments have existed in the US in the form of RTP, the new set of payments rails launched by The Clearing House (TCH) in late 2017, adoption has been incremental to date. RTP is currently being used primarily for business payments and centered on the nation’s largest banks that jointly own TCH.
Additionally, the Federal Reserve has now entered the field with last year’s announcement of its upcoming FedNow network.This was cheered by most community banks and credit unions, who, despite assurances from TCH, have expressed reservations with relying on a system owned and operated by their largest competitors. However, the Fed’s projected timeline of a 2023 or 2024 FedNow launch reflects a lengthy wait for functionality that has become increasingly relevant.
Are Real-time Payments a Necessity?
Ultimately, every bank and credit union management team will need to determine whether offering real-time payments capabilities makes sense for theirinstitution. Implementation will not be an easy lift, requiring changes to several foundational operations. In our view, however, it is a necessary move for smaller institutions to remain competitive with their much larger rivals. This will also allow them to serve their customers and membersmore effectively in an evolving payments landscape.
Along with the immediacy that their names convey, another key feature of both the RTP and FedNow models is irrevocability. Unlike ACH transactions (or to a lesser extent, credit/debit card charges), once a payment is made it cannot be recalled. This makes them better suited for certain uses, e.g., for established relationships between known counterparties. Instant payments also tend to be cheaper for merchants than debit/credit transactions, a natural appeal to merchants facing a greater inflow of digital sales. On one level this might be viewed by some FIs as cannibalizing existing revenue streams. However, with transaction volumesrising, it remains a revenue growth opportunity overall. More importantly, it will allow banks and credit unionsto provide of a full suite of payments options– a capability that nonbanks will happily devise ways to fulfill.
How FIs are Leveraging RTP
So far, early use of RTP has been dominated by B2B transactions. Going forward, easier to implement processes offering quicker and less costly ways to fulfill existing needs are likely to be next in line. TCH is already working with Zelle to enable P2P payments for the simple and instant transfer of funds between individuals. B2C disbursements are also likely to have appeal for situations where certainty of immediate funds transfer is essential, while also enablingthe payer to retain the funds until the last minute. Examples include payroll distribution (including gig economy workers often in need of daily remittance), insurance payouts, expense reimbursements, and disaster relief.The addition of “request to pay” messaging to solicit instant payments (foritems like bills, daily work, etc.) will create further value in many instances. Finally, “Venmo‑like”C2B retail transactions based on irrevocable instant payments will attract merchants looking for contactless options at a lower price point than credit cards.
The list of FIs signed on for RTP to date is heavily weighted toward those with TCH ownership stakes. Since these are also the nation’s largest banks, in theory over half of U.S. deposit accounts are already covered by the network. Actual usage is a different story, however. Even these large banks have been deliberate in their rollouts, focusing first on business accounts and B2B opportunities. The expectation is thatmost of these FIs will continue todeploy gradually, fine-tuning the processes as the market evolves.
For most consumer-facing uses to resonate and gain traction, ubiquity is a prerequisite. That is where the roughly 10,000 credit unions and regional/community banks serving the other half of U.S. consumers can effectively enter the picture. However, it is also where things get complicated.
Real-time Challenges to Consider
Unlike the case with ACH’s typical daily payment settlement, supporting real-time payments requires 24x7x365 staffing – a dramatic shift from traditional “banker’s hours.” This includes monitoring reserves on handand having someone on duty authorized to replenish themso that the FI does not fall into an overdraft position based on after-hours outflows. Given that funds settlement is immediate and irrevocable, fraud must be monitored in real-time as well. FIs may look to outsource this task, but thatwill carry an added cost. There is also the question of whether to extend customer service hours to address related issues.
Based on recent Fed announcements, FedNow is being designed to deliver on its initial promise – an instant payments platform allowing users to transfer irrevocable funds within seconds. Despite exhortations made in numerous public comment letters to move faster, it appears on track to launch in the original 2023/24 timeframe.
The operational aspects credit unions and banks must consider before rolling out FedNow largely mirror the considerations for RTP. However, the decision is more than an either/or choice between RTP and FedNow. There is also the option of standing pat, despite the accompanying risks of competitive disadvantage, particularly for business customers. As Nacha continues to add same-day settlement windows to the ACH network, some smaller banks and credit unions may determine that such “faster payments,” while short of real-time, are fast enoughfor now.
Two other major and somewhat related issues are interoperability and the adoption curve. As of now, RTP and FedNow are not designed to be compatible. This means the account holders of FIs implementing one service will be unable to transact in real-time with customers of FIs using the other. The laws of market efficiency dictate that this hurdle will be overcome (much as the parallel ACH rails run by TCH and the Fed have been interoperable for decades), but pending further negotiations, it remains a significant risk.
Adopting for Real-time – Looking Forward
This disconnect also remains one of the biggest barriers to mass adoption. Both the Federal Reserve and TCH have stated that they see their role as providers of the underlying payment rails. It will be other players – whether banks or fintech firms – that will develop innovative solutions atop these platforms. Investment in such solutions is less attractive if they stand to reach only a fraction of U.S. bank accounts. Perhaps one of these third parties will step up and design a product allowingusers to transact across the two rails. In the case of FedNow, it is also critical that these third parties have early access to the system so that their solutions can be ready for the launch. If not, this would ultimately further postpone the rollout of the ancillary services that will actually drive volume.
Credit unions and community banks positioning themselves as service leaders or innovators may approach real-time payments as a competitive advantage. They will promotethis as a feature that either distinguishes them in their local markets or at minimum, enables parity with large bank rivals. However, more conservative FIsmay choose a watch and wait attitude. This group will likely onlyembrace real-time payments when customers/members demand the service. In either case, it is almost certainly a matter of “when” rather than “if.” At a minimum, FI leaders should closely monitor the progress of both RTP and FedNow and be prepared with plans to act when appropriate for their institutions.
Dr. Jack Baldwin is Chairman and CEO of BHMI, a leading provider of product-based software solutions focused on the back office processing of electronic payment transactions and creator of the Concourse Financial Software Suite®.