Future of Retail payments in United States – An instantaneous exhilarating experience

Governor Lael Brainard, the distinguished Governor of Federal Bank, United States of India unveiled the acceptance by Federal Reserve Board of Fed Now Service’s proposal, a revolutionary one for enabling banks of every size and in every community in America to provide safe and efficient instant payment services around the clock, every day of the year. He connoted that Fed Now Service would facilitate end-to-end payment services for consumers, businesses, and government departments, increase competition, and ensure equitable access to banks of all sizes nationwide.

The whole speech delivered at the Fed Now Service Webinar, Washington, D.C. (via webcast) on 6^th August, 2020 heralded the beginning of Fed Now Service which was initiated a year ago after undergoing below the satisfactory level of distribution of COVID-19 emergency relief payments authorized in the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act which was intended to provide a vital lifeline for many households. The need to disperse the funds at the earliest opportunity with least delay was embarrassing all the more when after delayed receipt of funds, it was found out that the expenditure which started immediately after receipt of funds continuing for 10 days was the greatest for households with lower incomes, greater income declines, and lower liquid savings.

Let me quote the actual speech as well as the details of the scheme of 50 pages in two web sites separately.

https://www.federalreserve.gov/newsevents/speech/brainard20200806a.htm

Federal Reserve announces details of new 24x7x365 interbank settlement service with clearing functionality to support instant payments in the United States.

https://www.federalreserve.gov/newsevents/pressreleases/files/other20200806a1.pdf

The urgency with which emergency payments were spent drew the attention of authorities to develop a system for instant access to funds. The actual situation quoted by the Governor saddens the picture.

“ The Federal Reserve, acting as Fiscal Agent for the U.S. Department of the Treasury, processed most of the CARES Act payments to households using direct deposit, prepaid debit cards, and checks, which can take several days between the time the funds are sent and the time recipients get access to their funds. By contrast, the ability to disburse funds via instant payments could have helped reduce the strain for those who needed the funds quickly in order to meet financial obligations. The same is true for other payments intended to provide immediate assistance, for example, in the wake of natural disasters.”

This disastrous performance forced the authorities to evolve the Fed Now Service under which instant payments would be available to American households and small businesses rather than waiting for days to get the checks cleared.

The Governor noted with sadness that unusual delay in transfer of funds some time got the business to avail temporary overdraft from financial institutions and individuals missed their timely payments.

With detailed preamble as above, now we can indulge in meaningful deliberations.

How do the expected instant payments work and can we refer to 50 pages note from the authorities?

“The Board of Governors of the Federal Reserve System (Board) has approved the FedNowSM Service as described in this announcement. The FedNow Service is a new interbank 24x7x365 real-time gross settlement service with clearing functionality to support instant payments in the United States. The new service will support banks’ provision of end-to-end instant payment services and will provide infrastructure to promote ubiquitous, safe, and efficient instant payments in the United States.”

Let me give you an actual situation to understand from a layman’s perception.

A narration so clear and easily understandable has been given on page 22 and 23 of the webs which is a bit lengthy but just believe me, the whole process under the best technique involved, millions of exchanges among financial institutions, or others connected to them would be in a matter of seconds. Shocked!

A bit lengthy but an essential futuristic happening before your eyes.

In step 1, a sender (that is, an individual or business) initiates a payment by sending a payment message to its bank through an end-user interface outside the FedNow Service. The sender’s bank is responsible for screening the payment according to its internal processes and requirements.

• In step 2, the sender’s bank submits a payment message to the FedNow Service.
• In step 3, the FedNow Service validates the payment message, for example, by verifying that the message meets message format specifications.
• In step 4, the FedNow Service sends the contents of the payment message to the receiver’s bank to seek confirmation that the receiver’s bank intends to accept the payment message.( At this point, the receiver’s bank will have the opportunity to confirm or deny that it maintains the specified account).
• In step 5, the receiver’s bank sends a positive response to the FedNow Service, confirming that it intends to accept the payment message. Steps 4 and 5 intended to reduce the number of misdirected payments and resulting exception cases that can occur in high-volume systems.
• In step 6, the FedNow Service debits and credits the designated master accounts of the sender’s and receiver’s banks (or their correspondent banks), respectively.
• In step 7, the FedNow Service sends a payment message forward to the receiver’s bank with the advice of credit and in parallel sends an acknowledgment to the sender’s bank notifying it that settlement is complete.
• In step 8, the receiver’s bank credits the receiver’s account.

As a condition of the FedNow Service, the receiver’s bank must agree to make funds available to the receiver almost immediately after step 7.

This crediting to the receiver’s account as well as the debiting of the sender’s account by their respective banks happens outside the FedNow Service.

In a lay man’s language, the sender’s bank, Fed Now, receiver’s bank, the customer, or business are involved in the transaction but without explaining in a lengthy or elaborate scale the process can’t be understood thoroughly.

Further interesting information

• FedNow Service has a team of over 100 people working on the program, including experts drawn from across the Federal Reserve System and key external experts, some of the best in the world.
• Apart from the core interbank clearing and settlement functionality that will enable consumers and businesses to send and receive instant payments through participating banks, FedNow Service will include special features that enhance the usability of the service.
• Starting with core features to inaugurate the scheme, and provide available features over time in response to changes in technology and market needs. This is not an unexpected statement.
• What additional requirements were received from 400 commenters and other stakeholders who interacted with Fed authorities over the last one year?
• Safety and integrity of the payment system set the tone. Some newer payment services while giving feel good instant service advocated settling the transactions on a deferred basis, creating risk for consumers, banks, and the payment system overall.
• In contrast, the FedNow Service will offer a real-time gross settlement of transactions, an approach that involves each transaction being processed individually and immediately, which avoids interbank credit risk.
• The banks wanted FedNow to incorporate strong fraud tools in its scheme of installment payments which would have an additional advantage of refinement by banks with their knowledge of their own customers.
• Second, banks told Fed authorities that they expect in future to have adequate funds in their Federal Reserve accounts on a 24x7x365 basis to cover outflows related to instant payments, especially during hours when existing payment services are not open and funds cannot be transferred into Federal Reserve accounts to cover intraday overdrafts.
• Accordingly, Fed would develop a liquidity management tool that would entitle a participant with excess funds in its Federal Reserve account to transfer funds to another participant who needs the funds on weekends, holidays, and after hours.
• Banks that do not participate in the instant scheme or participants from private-sector instant payment service will be able to use the tool to transfer funds from their Federal Reserve accounts to the joint account at a Reserve Bank that backs settlement in that service.

The Road Ahead

Fed Governor promised to continue their engagements with a broad set of stake holders to gain input from them, work with banks and service providers on preparations to adopt the service, and also announced in May the formation of Fed community of 500 members from all segments of payment ecosystem. Engagement with fintech and software providers who work on providing the top-notch tools to banks and other involved institutions has started so that they would take care of the needs of their customers.

I am producing his concluding observations showing optimism and commanding tone to lead the future.

“We are committed to building an instant payment system that delivers the payment speed that users want without bypassing the legal and regulatory protections they have come to expect from banking relationships.

Ultimately, the FedNow Service can be a catalyst for innovation in the market by providing a neutral platform on which the private sector can build to offer safe, efficient instant payment services to users across the country. The promise of the FedNow Service is that it will provide a modern payment infrastructure for the future, bringing the benefits of instant payments to communities across America.”

Conclusion

Being enamored by the introduction of the most sophisticated system of instant payments elaborated by the respected Governor of Federal Bank, United States, I described the whole scheme with passion.

I am also impressed with the experience of India in providing financial/material relief to 800 million people affected by the suspension of the whole economy that raised the bar of the world higher to help its people. India established the systems, educated its vast multitude of its even illiterate people the utility of a banking account, and ensured the benefits reach them at the earliest time in the world.

But as an admirer of the latest systems and disbursal of either economic benefits or scientific knowledge to the common man, India like the U.S.A., needs to have an instant payment system for all banks or other stakeholders like NBFCs, Postal banks or other private remittance giants liked with RBI so that 24*7*365 services could be given in the near future.

RBI is already showing enormous willingness to change with time at an alarming scale.

Disclaimer: These are my personal views. Neither taxguru.in nor Federal bank, U.S.A. is responsible for my views. Any stakeholder can view the web sites quoted above and also contact fed authorities for guidance.