FedNow Concerns: Is It Meeting Expectations & What Is It Replacing?

The Federal Reserve has touted their new real-time payment service—FedNow—as a game-changer for banks, credit unions, online merchants, and other financial institutions looking for instant payments that are available around the clock. But how has it fared during, and immediately following, launch?

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With FedNow live as of July 20th, 2023, we want to see how it’s being received and understand its impact so far. To do this, we explore some common questions about FedNow post-launch, including:

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First, we’ll look at how it’s being used, and then we’ll dive into several concerns about how FedNow will impact the financial services market, including adoption rates, whether it can compete with existing alternatives, and how safe it is for the average user.

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FedNow’s appeal comes from two core features of the real-time payment service:

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• Real-time payments: Transactions, even between different financial institutions, clear and settle instantly and in real-time.
• Full-time availability: The service is available around the clock with no downtime, meaning users can make transactions at any time they want—24 hours a day, 7 days a week, and 365 days a year.

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But these core features translate into a myriad of different potential use cases for traditional banks, credit unions, online retailers and merchants, Fintechs, and other financial institutions or money service businesses (MSBs). These include some primary use cases that the Federal Reserve directly lists on their site:

• Account-to-Account (A2A)
• Business-to-Business (B2B)
• Business-to-Consumer (B2C)
• Consumer-to-Business (C2B)
• Consumer-to-Financial Institution
• Financial Institution-to-Consumer
• Person-to-Person (P2P)

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These use cases can power a variety of applications, from consumer-facing payment solutions, to backend payment processing between merchants and financial institutions, to payment processing support for government services and initiatives.

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Now that FedNow is launched and live, we can start to look at whether some initial concerns were valid or not, and predict what’s to come based on how launch—and its first couple months—went.

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To do this, we’ll look at some of the questions that were top-of-mind leading up to FedNow’s launch, examining the relatively low adoption rates, how the costs compare to alternatives, what it threatens to replace, and whether FedNow disrupted the market as some feared it would.

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Is FedNow Being Adopted at the Expected Rate?

As is often the case with new technology, adoption was expected to be slow and incremental for major banks, but higher with Fintechs, MSBs, and other digital financial solutions looking to stand out.

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Big banks are typically slow to adopt and fully implement new solutions, instead waiting to see how the new technology performs on launch. Once they’ve seen others test it—or tested it themselves—they’ll be willing to slowly adopt it into their core offerings.

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The expectation was that smaller institutions would adopt FedNow to get a leg up on competitors by offering instant payments at any time. However, adoption has been slower than expected in the early stages, especially considering the hefty advertising push from the Federal Reserve. 

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At launch, FedNow had 35 early-adopting banks and credit unions and 16 service providers. As of August 16th, 2023, those numbers have increased to 44 and 18, respectively. Participants include some major banks—like JPMorgan Chase and Wells Fargo—and a variety of service providers that can help organizations build solutions that leverage the FedNow Service.

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It’s important to note, however, that many of the major banks are also participants in The Clearing House’s RTP Network. It’s likely that many of the major financial institutions will test FedNow, comparing it to other options on the market. So early adoption may not necessarily indicate their intention to continue to use FedNow long term.

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As more financial institutions adopt FedNow, more will follow. The main challenge is that there are competitive services on the market (such as The Clearing House’s RTP Network), and many FIs don’t see the need for instant payments with no downtime—one of the main features distinguishing FedNow from competitors.

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However, as we see in other nations (specifically in India, the United Kingdom, and parts of the European Union), as the desire for instant payments becomes more prominent from end customers, FIs will adopt these features to provide the best possible service to users and differentiate themselves from competitors.

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Are FedNow Costs & Fees Reasonable?

Currently, one of the biggest barriers to adoption for most companies is the costs and fees associated with using FedNow. Fees are similar to competitors (like The Clearing House’s RTP Network) but slightly higher than services that don’t operate around the clock—so users are paying a premium for FedNow’s promise of no downtime.

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Since this added functionality comes at a cost, this spells problems for companies looking to adopt FedNow. Unfortunately, these costs must either be absorbed by the participant institution or passed on to the end-user.

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The problem with passing them on to the end-user is that the customer is unlikely to choose your solution—unless they actually need instant payments available around the clock. And the problem with absorbing the additional costs is that it’s really only worth it if there is a demand from customers and you can bring in new users or improve operations based on this product offering.

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The fact is, most businesses and consumers don’t actually require immediate account settlements, especially if it comes at a premium cost to them. They may, however, be swayed to choose a solution that offers this feature if it benefits them and comes at no additional cost.

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Is FedNow More Susceptible to Fraud?

Real-time payments, as with any technology, face unique threats. And since instant payments that clear and settle in real-time are impossible to reverse, they are extremely lucrative—and popular—for fraudsters. Companies looking to adopt FedNow will certainly need to prepare their fraud detection and prevention strategy for real-time payments.

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FedNow itself doesn’t have fraud prevention or protection built in. Instead, it’s up to the organizations using FedNow to meet compliance standards and manage risk to prevent fraud and money laundering. However, this is relatively standard for the industry, and money service businesses (MSBs) are used to managing fraud protection.

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Fortunately for risk and compliance teams, real-time payments aren’t entirely new. Companies looking to adopt FedNow will just need to leverage a risk management infrastructure that is optimized to handle AML and fraud prevention for instant payments, and develop a system with clearly defined rules for this context.

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According to our recent report, where we surveyed 250+ Risk & Compliance professionals, ‘real-time monitoring’ was the second most important use case when looking for new anti-fraud and AML software—second only to ‘transaction monitoring.’ There is no doubt risk professionals see real-time monitoring being an essential component of modern fraud prevention programs.

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Fraudsters will do a significant amount of social engineering to motivate their victims to make instant payments that can’t easily be reversed. MSBs that monitor transactions and other behavioral data points will be able to identify when transactions seem out of the ordinary, allowing teams to investigate and identify future fraud. In some cases, they can even develop preventative strategies that stop risky transactions.

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FedNow isn’t just competing with other real-time payment services, they’re also competing against legacy systems to prove their faster payment service offering is more valuable to companies, merchants, and end-users.

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They compete directly with the ACH, P2P payment providers, credit cards, and other traditional banking payment services. But how well are they doing?

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We explore how FedNow stacks up against a variety of its top competitors below.

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Can FedNow Compete with Automated Clearing House (ACH)?

When it comes to competing with the Automated Clearing House, the Federal Reserve has its work cut out for itself. The fact is, the ACH has been a tried and trusted payment service for businesses for a long time now—since 1970 to be exact.

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And for many applications, batched payment professing with deferred settlements that clear periodically each day is sufficient; not all companies need real-time, instant transactions. In many cases, these solutions could actually benefit from reversible—rather than non-reversible—transactions, as it gives them an opportunity to investigate suspicious activity before it’s cleared.

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Bottom line, the ACH is a respected, reliable payment processing service for most banks, credit unions, Fintechs, and other money service businesses (MSBs). Before FedNow can truly compete, it needs to develop a similar reputation as a trustworthy, quality service. And instant payments need to be in demand.

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Does FedNow Compete with Other Real-time Payment Products?

Currently, FedNow’s real-time payment service has staunch competition from other services on the market. While FedNow is provided directly by the Federal Reserve, adding some credibility and giving users some peace of mind, other RTP products available have more robust offerings, making it hard for FedNow to compete.

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One of the major competitors is The Clearing House, which introduced its RTP Network—which offers real-time payment processing—back in 2017.

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It has been in the market longer, and it’s been able to grow a significant number of participants. To date, The Clearing House’s RTP has signed 357 banks and credit unions. In contrast, FedNow launched with 35 participating banks and 16 service providers. While this is a good sign that it can compete with its core competitor, it will certainly be challenging (and take time) for FedNow to grow its pool of participants to compete with the RTP Network.

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In its current state, it’s unlikely that FedNow can seriously compete with The Clearing House’s RTP offering for a few main reasons. Pricing is virtually identical, so organizations aren’t looking at lower costs to use FedNow. FedNow also has a max transaction value of $500,000, whereas the RTP Network has a max transaction value of $1,000,000. And finally, but possibly most importantly, FedNow is currently restricted to domestic “push payments” and cannot currently process “pull payments,” whereas the RTP Network can do both.

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Over time, FedNow has a good chance to be another core player in the real-time payment space, but they have a long road ahead of them to strongly compete with existing alternatives like The Clearing House’s RTP Network.

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Will FedNow Replace P2P Payment Services and Banking-as-a-Service Solutions for Consumers?

With the launch of FedNow complete, many are wondering how it will impact the success of other peer-to-peer (P2P) payment services like PayPal, Venmo, CashApp, and Zelle. Namely, people are concerned that FedNow will replace a variety of these existing services.

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This concern is understandable, as FedNow empowers money service businesses (MSBs) to offer their customers the same core features as these P2P payment services—instant payment capabilities and around-the-clock availability.  And frankly, they can do it better.

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Most P2P payment services are able to offer instant payments at any time by having customers use a digital wallet they’ve already transferred funds into. With the funds already available, companies like Venmo and PayPal can make transactions in real-time, because the credit is already there—they can settle and clear the transaction instantly.

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FedNow allows banks to offer this same quality of service, all within the end-users’ bank account. Customers, whether they’re individuals or companies, get access to instant payment clearing. In the hands of traditional banks and credit unions—where customers already have existing financial products—FedNow could arguably make these P2P payment services obsolete.

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However, with costs currently at a premium, most of these solutions aren’t at risk of being replaced any time soon. And they have the advantage of having to sell themselves directly to consumers, rather than having to sell themselves to banks, credit unions, merchants, and other financial institutions. After all, end-consumers don’t have the same vetting process as multi-million dollar corporations.

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Over time, digital MSBs have attracted a large following of loyal users by offering convenience and low costs. Many customers will still choose to use these solutions rather than switch back to using a FedNow-powered product through their traditional bank.

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The fact is, FedNow is not a directly competing service, as it is not itself a peer-to-peer payment service that is directly available to customers, but instead an instant payment rail available to banks, credit unions, merchants, and other financial institutions.

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Will FedNow Replace Cash?

No. Currently, FedNow simply facilitates the settling and clearing of transactions between financial institutions. It isn’t a digital currency, nor is it directly related to digital currency markets.

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According to the Fed itself, the “FedNow Service is neither a form of currency nor a step toward eliminating any form of payment, including cash.” They’ve also said that they’ve made no decision on issuing a central bank digital currency (CBDC) and would only proceed with the issuance of a CBDC with an authorizing law.”

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Since FedNow empowers immediate virtual transactions, it could reduce the need for paper currency by providing access to instant virtual payments. But it poses no threat when it comes to replacing cash. Since FedNow actually supports cash transactions, it could be argued that it encourages the use of cash more than it discourages it.

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Will FedNow Impact the Use of Debit or Credit Cards?

There is speculation that FedNow-powered products could replace—or at least reduce—the use of debit and credit cards. But credit card companies aren’t worried; Vasant Prabhu, CFO of Visa, said that Visa doesn’t fear competition from not only the FedNow Service, but any real-time payment system.

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New products developed using the FedNow Service are a far cry from credit cards, a widely-used and long-trusted payment method. And frankly, they don’t offer many of the hallmarks that make credit cards so popular.

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For one, credit cards actually give customers the ability to make purchases on credit, without needing the funds at the time of purchase. While solutions could certainly be developed using FedNow that enable users to make purchases on credit, FedNow itself doesn’t facilitate transactions on credit. Credit cards also often provide the consumer with additional benefits for using them, like cash back or rewards points.

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Another major difference is that both debit and credit cards offer protection to consumers, making it extremely easy to dispute charges. Customers can use these products with confidence because they know they are protected from any unauthorized use of their card. Alternatively, customers could be held partially—or fully—responsible for payments made using real-time payment services.

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People are creatures of habit, and making payments using debit and credit cards is certainly a habit that has been developed by most consumers. Moreover, consumers are extremely protective of their finances and are not easily swayed into using different financial products that could put their hard-earned cash at risk. It would be extremely challenging to convince consumers to change the way they make payments, and frankly, traditional banks don’t have much incentive to actually convince users to make that switch.

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Financial institutions earn money every time a customer makes a credit card purchase through interchange fees. In contrast, they have to pay the FedNow Service per transaction. Because of this, banks are not only not motivated to develop their own products using FedNow, but they are likely motivated to make sure consumers don’t see a need to use real-time payment solutions at all.

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Certainly, even if FedNow does lead to solutions that pull users away from debit and credit cards, this process will be gradual and require consumer demand for alternative services.

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Will FedNow Impact the Use of Buy Now, Pay Later (BNPL) Services?

The short answer is no.

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The reason customers find BNPL options so appealing is because they are able to make purchases on credit, paying them back later. Real-time payment offerings facilitated through FIs don’t really do that—as they instead facilitate real-time settling and clearing. Unless paired with available credit (an entirely other product offering from the FI to the consumer), FedNow simply doesn’t threaten BNPL services.

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While BNPL products can certainly be built using the FedNow Service, the FedNow real-time payment rail doesn’t itself power BNPL products or services. Since the FedNow Service in no way facilitates the BNPL portion of the interaction, it doesn’t actually compete with BNPL services. Instead, the FedNow Service would be the background settlement clearing service used for facilitating payments, but a BNPL service would still need to be involved in some way.

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What Does FedNow Mean for Crypto?

Many are concerned that the introduction of FedNow will impact the popularity of cryptocurrency. After all, it would power instant payments that are available any time—a feature that has made crypto extremely popular.

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But FedNow doesn’t offer other features that crypto is known for—specifically, its affinity for anonymity and its use of a distributed ledger. FedNow is managed by a central authority (the Federal Reserve) rather than a distributed network. It is also tied directly to US currency, as opposed to deriving its value based on popularity and product applications.

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FedNow’s payment processing is fundamentally too different from cryptocurrency to be a direct competitor, and should have little impact on crypto markets. While FedNow may draw some users away from crypto in favor of using more traditional banking options, it doesn’t offer most of what crypto users and investors love.

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Real-time Payment Services Are Just Around the Corner

Prior to launch, there were concerns that FedNow would disrupt the market, drastically impacting P2P payment services (and other alternatives) to thrive. But it was also anticipated to disrupt traditional payment services that customers know and love, like debit cards, credit cards, and other money services businesses.

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Given the popularity of legacy systems like the ACH, and the lack of demand for instant payments from consumers, this market disruption isn’t likely to come any time soon. And, if it does, it’s likely to be very gradual.

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While banks, credit unions, and other financial institutions can certainly benefit from using the FedNow service, its use will only grow as demand grows for instant payments that are available around the clock.

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Adoption is slow—slower than expected—but it’s likely to grow as demand increases. Many nations have had success rolling out similar RTP solutions, specifically in India, the United Kingdom, and the European Union.

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Brazil’s monetary authority, the Central Bank of Brazil (BCB), has had rapid success with its instant payment platform—Pix. Officially launched in November of 2020, by the same time the following year, it had “already made more than 6 billion transactions.” According to BCB Statistics, in 2022, Pix facilitated a total of 24 billion transactions; by the end of August 2023, they’ve already passed that number, closing in on 25 billion. At the end of 2021, they had 117 million users (individuals and companies); by the end of the next year, they’d grown that number to 141 million.

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As more US customers demand instant payments from their service providers, more organizations will adopt—and find ways of innovatively integrating service offerings built on FedNow’s RTP service.

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While FedNow certainly has the ability to disrupt the way finance is conducted in the United States, it’s unlikely for this change to be rapid or drastic. It’s more likely to grow as an alternative to current MSBs slowly, but won’t eliminate existing options—and certainly not overnight. Most MSBs don’t have to worry about being replaced anytime soon, nor do some of FedNow’s major competitors, namely The Clearing House’s RTP Network.

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That said, real-time payment solutions are on (the very near) horizon, and teams will likely want to be prepared to adopt RTP options for customers as they want them. For fraud prevention professionals, real-time transaction monitoring will be more important than ever, allowing teams to analyze transactions for abnormalities and suspicious behavior.

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