The launch of FedNow, an around-the-clock real-time payment network, came with liquidity management safeguards designed to help depositories protect against large, instant outflows that have the potential to exacerbate trouble at an institution that is facing stress.
The Federal Reserve Board recently announced the official launch of FedNow with 35 US banks and credit unions. The platform is aimed at enhancing customer service as the technology can settle payments instantly at any hour. It is the second real-time payment network for banks in the US, following the Clearing House's launch of the RTP network in 2017.
However, some have raised concerns that real-time payments would make large deposit outflows easier and put banks that are facing liquidity pressures in a vulnerable position. In the bank turmoil that escalated earlier this year, the industry became painfully aware of how online and digital banking have increased the velocity of transfers and helped accelerate deposit runs at Silicon Valley Bank, Signature Bank and First Republic Bank.
Adoption of FedNow has the potential to further increase the speed of transactions because major payment rails in the US such as the Automated Clearing House (ACH) or Fedwire take at least one day to settle payments and only work during business hours. While faster payments offer a better experience for consumers, FedNow's around-the-clock settlements could pose a challenge for banks in a stressed situation. FedNow could give stressed banks little time to react, whereas the longer settlement process under the old regime would give those institutions some time "to figure things out," said Jill Cetina, associate managing director covering financial institutions at Moody's Investors Service Inc.
"You might not have that same reprieve if you've got FedNow," Cetina said in an interview.
Cetina added that regulatory requirements and banks' own internal processes would likely need to evolve and adjust for the change. For instance, since FedNow processes payments during weekends, operating hours of the discount window — which can serve as a form of contingency funding for banks — may need to adjust, to give banks access to funding outside of normal business hours, she said.
Still, industry experts underscored that the Fed has taken a thoughtful approach to foster innovation, and it made tools available within FedNow for financial institutions to control the deposit flows.
"I think that there is enough thought and requirements in place today and planned for the FedNow," said Bridget Hall, leader of real-time payments of Americas at payment company ACI Worldwide Inc. "I really don't see a fundamental risk being added to the payments industry with the launch of this new rail."
Limiting the size
The FedNow program has designed features that encourage limits to the transaction size.
Limiting the size of transactions is an approach the Clearing House initially took with the RTP network, which capped a single transaction at $25,000 when it launched. RTP raised the limit several times since then, and it now can process single transactions of up to $1 million.
The smaller transaction size is aligned with FedNow's goal to facilitate
The retail nature means funds transferred on FedNow would typically fall under the FDIC's insurance cap of $250,000, and the hope is that if customers' balances are below the FDIC cap, there is less likelihood they would use FedNow to help facilitate a bank run because their deposits would be insured even in the event of a bank failure. A hallmark of the runs and bank failures in early 2023 was the high level of uninsured deposits at the institutions that were at the center of the storm.
Banks also have the option of restricting the use of FedNow to retail customers. The retail-only strategy does have the potential for growth because the convenience of real-time payment technology is often leveraged by retail customers. This is evident by the proliferation of consumer-oriented instant payment applications, such as bank-owned Zelle, Block Inc.'s Cash App and PayPal Holdings Inc.'s Venmo, said Jessica Cheney, head of product management of digital banking solutions at payment company Bottomline Technologies Inc.
Bottomline helps financial institutions to present instant payment products to their end customers, and the proper consumer awareness could help the financial institutions using FedNow focus on retail banking clients, Cheney said. "Most of the real-time and instant payments projects at the banks have started in their retail or consumer side of the bank, because the demand has been higher there," Cheney said.
Control switch
One of the policy objectives of FedNow is to make real-time payment technology available to a wide number of financial institutions large and small. FedNow allows banks to use their existing Fed master accounts to facilitate payments, and they can set up alerts internally or use outside agencies to monitor the payment flows, to ensure they do not overdraft their Fed master accounts, said Kristin Robertson, director of account management at banking software provider Finastra.
To control the flows, banks can switch to the receive-only mode at any time, so that they only receive funds immediately, and the outflows can go through the traditional rails. There are also features to control the velocity, for banks to limit the total volume of transfers during a time period, depending on the customer profiles and the bank's risk levels.
But too much risk aversion can limit growth on the network. Financial institutions eventually will have to find a balance between growth and risk controls in their real-time payment strategy, although it will take time for most institutions, said Nathan Hilt, managing director advising on payments strategy at consulting firm Protiviti.
"As banks look at what they're prioritizing, it's tough to say this is going to be prioritized above the core banking transition, or moving to the cloud, or adding features or embedding a fintech," Hilt said in an interview.
For those pursuing real-time payments, the technology adoption will prompt changes in banks' internal liquidity management and credit processes, said David Watson, the president and CEO of the Clearing House, the operator of RTP. But Watson does not think the decision to use real-time payments should come with stricter liquidity rules.
"Having more liquidity wouldn't mitigate the risk, so it wouldn't be a solution," Watson said in an interview. "The solution is to put controls in place."