This article is aimed at looking at how FedNow will grow using various non-Fed related sources and from essentially a different point of view.
On a company called PYMNTS’s website, what strikes one is how close to the Fed’s pilot program they’re running now and then how big it could be, whenever it launches in mid-2023.
There are more organizations than originally suggested after reading just the Fed-related documentation and reports. We don’t know how the FED is defining financial institutions and it appears broader in scope than payments appear to be.
What is FedNow?
The nationwide introduction of the federal reserve’s FedNowSM service will offer 24/7/365 funds availability to help all types of financial institutions move beyond the person-to-person use cases that fintech’s popularized. This would be similar to your Venmo, your cash app on your phone, or other similar services in use right now.
The FedNow service will broaden access to instant payment features and use cases by clearing and settling payments between financial institutions around the clock, every day in a Federal Reserve Bank master account, allowing instant payments functionality, which reduces interbank credit risk and liquidity risk for participant institutions, thereby increasing the appeal of current and new use cases.
This is similar to instant settlement before transactions and all participants have a sort of “Federal Reserve Bank master account “, but this is not a reserve account at the FED. We don’t want to give the implication that they’re trading Bank Reserves and settling it that way.
The difficulty appears to be defining exactly what the difference is between the FedNow master accounts and the reserve accounts of depository institutions.
FedNow Master Accounts
The FedNow master accounts are dollar-denominated but it can be assumed that they cannot be bank reserves since some of the participants are not depository institutions at the Fed. In the pilot program, there are more than 120 organizations that form a part of the FedNow pilot program, including Square financial services and other fintech’s and processors. So, we assume that other fintech and payments system institution like PayPal are in there as well.
An interesting concept to ponder is, even though these FedNow master accounts do not consist of bank reserves, do they essentially function as if they were. It would depend on whether or not the Fed can introduce funds into these Master accounts as they can with Reserve accounts. Even if this is the case, FedNow is essentially just a settlement system, and it does not seem that if the amount of settlement “currency”, if you want to call it that, is increased that it would significantly change the outcome of the system, much like the increase in bank reserves has been the past decade or so.
To continue this line of reasoning, we need to touch on ISO 20 022. It’s described as a global standard for payment message specifications, and this was a strategic decision when building the FedNow service and a foundation for broad interoperability across the domestic ecosystem and across borders in the future.
The FedNow service will leverage The FedLine Network for secure connectivity, which today connects seven thousand financial institutions and processors to the Fed’s critical payment and information infrastructure services and applications, such as ACH wire payments and Federal Reserve accounts.
One thing to note about this messaging system is, it’s not necessarily that FedNow is the introduction of a CBDC. But it could be seen as building the initial infrastructure. When one talks about FedNow with respect to CBDCs, there seem to be a lot of similarities between what the FedNow service is doing or will do and then what was discussed on how a possible CBDC could be implemented.
Benefits of FedNow
One of the benefits is not just the person-to-person application but also C to B, B to C, and B to B. A big difference for businesses would be instant payments applied to invoices. This can be of immeasurable benefit to companies that want to pay their suppliers in real-time, get paid in real-time, and operate more efficiently by associating funds with the correct invoice.
These functionalities will improve efficiencies and cash flow in the opinion of the Boston Fed Senior Vice President.
Early feedback indicates payroll may be an early adoption use case for pay-on-demand models. It will also place less demand on batch processes. So, daily paychecks are an option as opposed to having to wait two weeks for a paycheck.
A final concept is the fraud angle, as it comes up often in any terms of payment systems and is mentioned often throughout the Fed’s discussion papers. Faster funds come with the threat of faster fraud.
Concerns are that as consumers initiate payments, those instant transactions might not make their way to the right receiver. People make mistakes all the time and so a strong set of multi-layered controls and capabilities in the initial version of FedNow should include support of fraud management, mitigation of risk and assistance for financial institutions as they battle bad actors.
The FedNow service features will help participating financial institutions conduct investigations and provide returned funds connected to fraud and errors.
Basically, you’d get your money back if you accidentally sent it to the wrong person.
How FedNow will grow by more than 50 times
The main concept is that by connecting FedNow to FedLine, they’re basically multiplying the number of organizations from around 120-130 currently, to about 7,000, which is more than 50 times the current participants in the pilot program.
So, the volume of transactions appears not to be a problem for how fast will FedNow grow, because it would leverage the FedLine Network, which seems like it’s already established. There is no indication of how well the system functions, but that’s something that can be looked into at a later date.
For More on FedNow
https://jamesdforsythe.com/key-features-of-fednow-birth-of-a-new-payments-system/
https://jamesdforsythe.com/the-7-use-cases-for-fednow-utilizing-revolutionary-systems/
https://jamesdforsythe.com/how-fednow-started-the-commanding-of-the-u-s-payments-system/
https://jamesdforsythe.com/is-this-the-beginning-of-the-end-of-financial-privacy/
