The FedNow Dilemma: Why Banks can't afford to miss the Real-time Payments Revolution

As the FedNow network continues to evolve, a critical question lingers in financial institutions' (FIs) minds: What is in it for a bank to actively participate in real-time payments? The answer to this could be the make-or-break factor for the widespread adoption of the FedNow Service.

The Federal Reserve launched the FedNow Service in July 2023. This introduced a new set of instant payment rails to provide real-time payment access to banks and credit unions of all sizes. Despite being newer than The Clearing House's RTP Network, the FedNow Service has gained significant traction, with over nine hundred financial institutions already connected. This adoption rate surpasses that of the RTP Network during a similar period.

However, despite these promising statistics, the question remains: Why should banks invest resources in adopting real-time payment capabilities beyond the “receive-only” mode? The answer lies in the potential commercial benefits and the risk of being left behind in a rapidly digitizing world.

Unlocking New Revenue Streams and Customer Loyalty

Banks have a strong incentive to fully engage in the FedNow network because it presents an opportunity to access new revenue streams. With the growing demand for faster payment solutions from businesses and consumers, banks that can provide these services have the potential to earn fee income, improve customer acquisition and retention, and upgrade their current offerings, including loan disbursements.

Moreover, providing real-time payments can drive operational efficiencies. The detailed transaction data offered by instant payment systems simplifies reconciliation, reduces error rates, and enables more efficient liquidity management. In a world where time is money, the ability to process payments in real-time reduces the need for manual intervention, lowering labor costs and improving overall operational efficiency.

Realities of Scale

• The Federal Reserve Financial Services reports more than 900 financial institutions connected to the FedNow Service
• To date, many of these early adopters remain in receive-only mode, limiting their ability to fully participate in the economic benefits available (approximately 375 FIs have activated Send & Receive services)
• Roughly 8,100 of the 9,310 US banks and credit unions remain on the sidelines and yet to fully participate

The Competitive Imperative

From a competitive standpoint, banks that do not offer real-time payment capabilities risk losing customers to more agile competitors. The US Treasury's plan to implement FedNow for distributing government payments adds a sense of urgency. Banks that are not part of the FedNow network may find themselves in a precarious position. Customers could receive messages stating that they cannot access funds rapidly because their bank is not a participant.

Moreover, instant payments are no longer a novelty but are quickly becoming a standard expectation. The increase in use cases such as earned wage access(EWA), immediate fund availability from online gaming, and digital wallets indicates that the market is evolving rapidly. Banks that take a "wait-and-see" approach may find themselves at a significant disadvantage, unable to catch up with early adopters who have already established a foothold in this space.

Navigating Barriers: Fraud, Operational Complexity, and Market Demand

Despite the clear advantages, several barriers still impede the full-scale adoption of instant payments. Concerns around fraud, operational complexity, and market demand are often cited by financial institutions as reasons for their hesitance. However, these challenges are not insurmountable.

The perception of heightened fraud risk associated with instant payments is understandable but misguided. According to data from both The Clearing House and Federal Reserve Financial Services, current fraud rates on RTP and FedNow transactions are lower than those for other payment instruments such as ACH, wires, and checks. As banks become more comfortable with the risk management and operational adjustments required for real-time payments, these concerns are likely to diminish.

Operational complexity, while a valid concern, should not be a deterrent. The implementation of real-time payments necessitates certain adjustments, such as client and staff education, responsive client support, and enhanced business continuity efforts. However, these are initiatives that banks should be pursuing regardless, as part of their continuous improvement efforts.

Finally, the argument that market demand for instant payments has yet to materialize is flawed. Volumes and growth rates for instant payments and related services like Same Day ACH indicate a foundational level of demand that is only set to increase. The rapid adoption of services such as earned wage access and real-time withdrawals in sectors like online gaming and digital wallets further underscores the growing demand for faster payment solutions.

Drawing from my numerous conversations with senior executives, it’s clear that they are grappling with a series of critical questions.

1. Enable which (one or both) instant payment networks and how quickly?
2. Identify the client segments that would gain the most from these capabilities, and assess which existing processes require updates to support 24/7 operations.
3. Evaluate how these new payment options will impact the transaction volumes in their current channels.

The Time to Act is Now

As we approach the two-year mark since the launch of FedNow, it's important to recognize that the adoption of instant payments is more than just a trend. It represents a fundamental shift in the payments landscape. Banks that embrace this change and actively participate in the FedNow network can gain a competitive edge, unlock new revenue streams, and better serve their customers. On the other hand, those who remain on the sidelines risk falling behind in an increasingly digital world.

 The commercialization strategy for banks in the FedNow network is straightforward: The benefits of active participation far outweigh the challenges. The time to act is now, as the coming months will be a test of agility, innovation, and foresight for financial institutions across the U.S. As FedNow continues to gain traction, it will not only reshape the payments landscape but also set a new standard for how money moves in America. The question is no longer if instant payments will become ubiquitous, but when. For those who move quickly, the rewards will be significant.

To Conclude, the question is no longer whether banks should adopt real-time payments, but how quickly they can embrace this transformative shift. The FedNow network provides a unique opportunity for financial institutions to exceed, customer expectations, unlocking new revenue streams and strengthening their competitive position. The time to act is now - those who hesitate risk being left behind in a rapidly evolving financial landscape. Embrace the future of payments or watch as others seize the opportunity. The choice is clear, and the stakes have never been higher.

The views and perspective expressed in this article are my own and do not necessarily reflect the official policy or position of my current or previous employers. The information provided is accurate to the best of my knowledge at the time of publication, but the rapidly evolving nature of the payments industry may render some details outdated or subject to change.

What do you think? I'd love to hear your thoughts in the comment below.