Thanks to contributors Matt Brazda and Sai Kailash.
Introduction
Since The Clearing House launched the RTP® Network (RTP®)in November 2017, RTP® transaction volume has increased by more than 10% each quarter.1 In Q4 2022 alone, 49 million transactions worth $22.7 billion were processed.2
RTP® is now widely adopted by businesses and consumers. With 61% of direct deposit accounts having access to RTP®, the volume of RTP® transactions is expected to reach 8.9 billion in 2026.3 Cross River alone surpassed 1 million RTP® transactions in the month of May alone.
Seeing the importance and potential of RTP®, the Federal Reserve (the Fed) will launch their own real-time payment system called the FedNowSM Service (FedNowSM). Below, we’ll dive into FedNowSM and provide an overview of the program.
What is the FedNowSM Service?
FedNowSM is a new domestic instant bank-to-bank payments network that the Fed is developing for financial institutions of every size, and in every community across the U.S.
The network will allow individuals and businesses to send and receive instant payments 24/7/365. The payment recipients will also have instant access to payouts, providing them with better flexibility in managing money.
Behind the scenes, FedNowSM will enable U.S.-domiciled banks to send and receive USD instantly from one U.S. Demand Deposit Account (DDA) to another U.S. DDA. The debits and credits to and from both DDAs, as well as the transaction settlement between banks, happen immediately.
FedNowSM works only on good funds, meaning that funds must be available in the account sending the payment for the payment to be sent.4
Use Cases of the FedNowSM Service5
FedNowSM can provide convenience and efficiency to payment activities ranging from consumers paying bills to businesses sending e-invoices. Its use cases are limitless and applied to peer-to-peer (P2P), business-to-business (B2B), consumer-to-business (C2B), business-to-consumer (B2C), consumer-to-government (C2G), government-to-consumer (G2C), and business-to-government (B2G) transactions.
Peer-to-Peer (P2P)
P2P transactions are money transfers between two individuals. These payments are linked to an individual’s bank account, debit card or credit card. The nature of these payments can be personal, business, or professional.
Example: Adam hires David, a web designer, to revamp his personal blog. To pay David for his services, Adam sends an instant payment to David through FedNowSM.
In making a P2P payment with FedNowSM, individuals can initiate a transaction on their own and the payee can receive the payment in real time.
Business-to-Business (B2B)
B2B transactions are conducted between two business entities. They include transactions between a manufacturer and a wholesaler, or a wholesaler and a retailer.
Example: Walmart purchases groceries from ABC Inc. Walmart initiates an instant payment for the purchase to ABC Inc. through FedNowSM.
In making a B2B payment with FedNowSM, Walmart can manage its working capital more efficiently with instant settlement. It does not need to withhold the capital for a prolonged period.
Consumer-to-Business (C2B)
C2B transactions are conducted between an individual and a business entity, with payment flow from the individual to the business. These transactions include purchase of goods and services.
Example: E-commerce transactions done on Amazon or eBay, or subscription payments made to Netflix.
Via FedNowSM, businesses can receive funds immediately and consumers can reduce delayed payments. Consumers can also ensure there are sufficient funds in their accounts when payments are processed, avoiding overdraft fees.
Business-to-Consumer (B2C)
B2C transactions are similar to C2B transactions – they are between an individual and a business entity. However, the payment flows from the business to the individual.
Example: Salary payments, expense reimbursements, or insurance disbursements.
In paying consumers via FedNowSM, consumers can receive their funds without delay. Businesses can also save costs by eliminating administrative expenses by setting up prepaid accounts.
In paying consumers via FedNowSM, consumers can receive their funds without delay. Businesses can also save costs by eliminating administrative expenses by setting up prepaid accounts.
Consumer-to-Government (C2G)
C2G transactions are conducted between an individual and the government. The payment flow is from an individual to a government body.
Example: Tax payments or loan repayments.
Paying taxes and loans via FedNowSM eliminates delays and inconveniences. It also reduces the risk of late payments, which usually result in penalties, interest charges, or adverse effects on credit scores.
Government-To-Consumer (G2C)
G2C transactions are conducted between an individual and the government, same as C2G transactions. However, the payment flow is from the government to the consumer.
Example: Financial assistance after a disaster or tax refunds.
With the use of FedNowSM, consumers can easily verify receipt of tax refunds and governments can track the disbursement process more efficiently. Providing financial assistance after a disaster via real-time payment networks can also be helpful because people often need immediate access to funds.
Business-To-Government (B2G)
B2G transactions are conducted between a business and the government. The payment flow is from a business to the government.
Example: Businesses paying state and federal taxes, or visa fees for businesses employing foreign workers.
By processing fees and taxes via FedNowSM, businesses can benefit from quicker confirmation of payment, reduce administrative burdens, and improve their cash flow management.
The Flow of a FedNowSM Transaction6
Before we discuss the payment flow of a FedNowSM transaction, we will introduce key stakeholders in the process. They include:
Payer – The person who pays money, a.k.a. the debtor.
Payee – The person due to receive money, a.k.a. creditor.
FedNowSM Participant – A FedNowSM participant is a financial institution or a service provider that engages with FedNowSM. Some of the primary functions of these participants include:
From Payer’s End | From Payee’s End |
|---|---|
Payer’s agent - Holds payer’s account | Payee’s agent – Holds payee’s account |
Instructing agent – Sends payment through FedNowSM | Instructed agent – Receives payment through FedNowSM |
FedNowSM Service – The system that processes FedNowSM messages between participants. This will be operated by the Fed.
The flow of a FedNowSM transaction can be traced below:
The payer initiates a payment with its financial institution.
The payer’s financial institution submits a payment message to FedNowSM.
FedNowSM validates the message received from payer’s financial institution against its format and controls.
FedNowSM sends a payment message to payee’s financial institution to confirm whether payee’s financial institution intends to accept the payment message.
Payee’s financial institution accepts or rejects the payment message received from FedNowSM.
FedNowSM settles the payment by debiting payer’s financial institution’s master account and crediting payee’s financial institution’s master account.
FedNowSM sends advice to the payee’s financial institution and acknowledgement to the payer’s financial institution notifying that the Federal Reserve Banks have settled the payment.
Respective financial institutions inform the payer and payee about the settlement of the transaction. Payee’s financial institution enables access to funds to the payee.
Payee’s financial institution sends a confirmation message to payer’s financial institution through FedNowSM, that payment has been made available to the payee.
Payer’s financial institution relays the same confirmation to the payer.
When will FedNowSM Services launch?7
FedNowSM is planned to commence in July 2023.
In April, the financial institutions participating in FedNow SM started a customer testing and certification program to ensure operational readiness and network experience. These participants can go live in July if the testing is completed and the product is validated.
More than 110 financial institutions, including Cross River Bank, have shown enthusiasm for the early adoption of the FedNowSM services.8
Conclusion
FedNowSM could bring a new era of instant payments to individuals and businesses.
Real-time transactions in the U.S. are expected to grow from 3.9 billion in 2022 to 13 billion by 2027.9 By enabling instant settlement via the Federal Reserve network, FedNowSM can realize the potential of instant payments and improve the banking industry’s overall efficiency.
Footnotes
1 Real-Time Payments In U.S. Marks Fifth Year — FedNow Coming In July (forbes.com)
2 FedNow vs RTP: Can two real-time payments systems coexist in the US market? (redcompasslabs.com)
4 Note that this is different from the no prefunding requirement of the Federal Reserve Bank master account held by banks. Banks are not required to prefund their master accounts under FedNowSM, but customer accounts’ balance need to be available when money is sent.
5 https://explore.FedNowSM.org/explore-the-city?id=7&building=instant-payments-university&resource=2&role=fi_sp-eu_spe&resourceTitle=faster-payment-types, https://www.frbservices.org/binaries/content/assets/crsocms/financial-services/FedNowSM/general-use-case.pdf
6 https://explore.FedNowSM.org/resources/customer-payment-flow.pdf (FedNow Service Banks)
8 Announcing the FedNow Pilot Program participants (frbservices.org)
9 Real-Time FedNow Expected To Boost Instant Payments (forbes.com)