- What is FedNow?
- How will it work?
- Why is it so badly needed?
- Can the US financial system finally enter the 21st century?
In yesterday’s FOMC presser Fed Chair Powell, in responding to a question about central bank digital currencies, made an offhand remark about a new program that could change the financial services industry as we know it.
Chair Powell noted:
” I am really concerned about getting it right. It is a tricky set of questions that we have to navigate in a world where we already have, remember, a highly evolved payment system. We have FedNow and other immediately available funds. Pretty soon everybody will be able to do what people do in other parts of the world, which is just use their phone to make immediately available payments all the time. It’ll be normal. And what would be the role of a central bank digital currency in that kind of an environment? Far more important to get it right than it is to do it fast or feel that we need to rush to reach conclusions because other countries are moving ahead.
I mean, the currency that’s being used in China is not one that would work here. It’s one that really allows the government to see every payment for which it is used, in real time. It’s much more to do with things that are happening within their own financial system than it is, I think to do with the sort of global competition.”
What is FedNow?
So what exactly is FedNow?. The FedNow Service is a new instant payment service that the Federal Reserve Banks are developing to enable financial institutions of every size, and in every community across the U.S., to provide safe and efficient instant payment services in real time, around the clock, every day of the year. The service is expected to rollout in stages starting 2023 enabling all sorts of new use cases for both businesses and consumers.
The basic schematic of the payment flow will look like this
The system is designed to be secure, robust and as error-proof as possible and could effectively eliminate the need for digital currency by creating an evolutionary rather revolutionary change.
How will it work?
The Fed envisions a variety of use cases including Account to Account ability – where the user can instantly transfer his or her own funds between two different institutions. An investor for example can transfer funds from their bank to their brokerage account in a matter of seconds. The second most obvious use case would be to instantly settle bills with vendors such as utilities and credit card companies. Finally the third most common use case that the Fed envisions is E-voicing allowing billers to send requests for payment that could be settled instantly.
Why is it so badly needed?
There are of course a plethora of instant settlement choices that already exist in the marketplace with PayPal(NASDAQ:PYPL) and its subsidiary Venmo dominating the space while Zelle – a consortium of banks offers a similar service for banking customers. Although the private market choices work well they require enrollment and adoption that is far from universal in scope. The current system runs into massive bottlenecks when either the vendor or the customer does not have one of the services which forces a return back to physical settlement of transactions that is both highly inefficient and far more costly.
Furthermore, because systems such as Zelle are private they are subject to bizantine rules of each member bank with some banks putting widely varying limit caps on daily settlement transactions and some banks offering the service to consumers but not to businesses which effectively defeats the whole purpose of universal digital payments.
Can the US financial system finally enter the 21st century?
If FedNow solves these issues by first creating a universal standard for instant payment settlement and then enacting regulations that would force every financial institution to comply with those standards the implications for commerce could be massive. The current Balkanized state of e-payments in the US has put the country at a major disadvantage to the rest of the world where instant digital payment settlements are the norm. A physical check is the 21st century equivalent of the horse and buggy and it is not only an embarrassment but a true economic risk for the US economy to function in this manner for any longer than necessary. The FedNow project is designed to address this critical weakness in the US financial system. Let’s hope it succeeds.