aamerican finance Plumbing maintenance is delayed. The current payment “Rail”, built by the country’s largest banking group to replace paper checks, is more than half a century old and runs on outdated code. This system is robust, but very slow. American payments are less sophisticated than those of the rest of the rich world, and indeed many of the poor world are as well.
That’s the problem the Federal Reserve is trying to solve with its centralized real-time payments system that it introduced on July 20th. The service, aptly called “FedNow,” will allow Americans to send money to their fellow countrymen through their existing financial institutions and have their payments cleared instantly. Overall, 35 banks and 16 payment providers have registered to use the service.
Most U.S. bank transfers are cheap, but they are batched and often take several days to clear. Peer-to-peer networks like Cash App seem much faster to customers, but underneath the surface they rely on older systems. Regulators have warned that funds held in such apps may not be covered by deposit insurance in the event of a failure. Credit cards that pay even more attractive fees and offer attractive perks also use existing rails. Nearly a third of payments last year were made using plastic, according to the San Francisco Fed.
Americans typically use different methods depending on the type of payment. Water charges are paid by bank transfer. $100 due to a friend is sent through a payment app. Amazon purchases are made with a credit card. A single real-time payment solution should improve the quality of everything.
Two major banks, JPMorgan Chase and Wells Fargo, have signed up for FedNow. But Wall Street isn’t fully on board. It did not join a longer list of financial institutions that included Bank of America, Citigroup and Goldman Sachs. The old system is slow, but it also benefits those involved. Financial institutions can take advantage of slow settlements by depositing cash overnight in short-term interest-bearing bills, or simply holding funds at the Fed to accrue interest. They also pocket late fees, and some banks generate revenue from their own instant payment systems, such as clearing houses operated by banking groups.
Some observers, recalling the banking turmoil this spring, fear that FedNow will destabilize the financial system. A report from credit rating agency Moody’s warned that the new scheme could increase the likelihood of runs by making it easier for depositors to flee. However, such concerns are likely to prove excessive. A few months ago, the current system of closed weekends offered little relief to Silicon Valley banks and others. Additionally, because FedNow is a backend system, participants can set limits based on their risk appetite. For example, you can cap payments or limit transactions.
Other countries are also light-years ahead of America and do not appear to be as vulnerable to a bank run. Instant payments are the norm in India, for example, which accounted for 81% of electronic transactions in the country last year (see graph). Thailand and Brazil accounted for 64% and 37% respectively. Emerging markets have embraced instant payments partly because of demographics (consumers are young and tolerant of change), partly because of the crackdown on cash (policymakers are keen to scale back the gray market and raise taxes), and partly because unlike the US, new payment systems didn’t have to push out existing payment systems and those who benefited from them.
FedNow is unlikely to transform payments anytime soon. This scheme only supports consumer-initiated “push” transfers. In contrast, FedNow-enabled companies in Europe and India also have a “pull” feature that companies can use if they get permission (which allows them to pay their electricity bills on a regular basis, for example). Fed officials say they have no plans to extend the system for such uses, but bankers suspect this is the next step.
There is another hurdle to mass adoption. It’s the American consumer where paper-based payments still have a strong influence.according to Reed A global payments company, about one-fifth of domestic cash transfers are made via check. Still, it would be nice for them to have options, just like the rest of the world. ■
Editor’s note: This article has been updated to incorporate FedNow launch news.
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https://www.economist.com/finance-and-economics/2023/07/20/instant-payments-finally-reach-america-with-fednow Instant Payments Finally Arrive in the US with FedNow