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The Costly Late Arrival of FedNow

In a rapidly evolving digital world, where customers highly value speed and convenience, the Federal Reserve’s latest venture, FedNow, has finally made its entrance. Rolled out on July 20, FedNow promises to facilitate instant payments for both individuals and businesses through their bank accounts, providing uninterrupted service around the clock. While this may seem like a significant stride towards modernizing the payment landscape, some aspects raise questions about its timing and impact.

The reality is that FedNow is arriving at the party quite late. The Clearing House (TCH) launched its Real-Time Payment (RTP) system back in 2017. In terms of core functionality, FedNow does not offer anything that is not already provided by TCH’s RTP. And FedNow’s belated entry comes with a price — not just in terms of a burden to the banking sector but also on taxpayers.

FedNow is not compatible with RTP. Banks must choose between embracing RTP, adopting FedNow, or managing both systems. Payment systems like these thrive on network effects — the more users on a single network, the greater the benefits. Two banks on different networks cannot have real-time transfers among them. Large banks might have the financial muscle to handle both systems until one network prevails, but smaller banks face a tougher decision. Adopting either of these systems has costs, such as training personnel and adapting their IT infrastructure. If they can’t afford the cost of both networks, they risk investing in the wrong system or waiting on the sidelines, leaving their customers devoid of real-time payment advantages.

Another significant aspect to consider is the cost associated with FedNow’s development. Unlike RTP, which was spearheaded by the private sector (TCH is owned by large commercial banks worldwide), FedNow’s expenses are ultimately burdened by taxpayers. Every dollar invested in FedNow is a dollar that doesn’t contribute to the Treasury, adding to the national debt. The Fed transfers its profits – if it has any – to the Treasury. This fiscal implication raises an important question: is the introduction of FedNow justified by the benefits it brings to the market? What are those unique benefits, exactly? Or does it simply duplicate an existing network?

As of August 2023, RTP boasts a network covering 90% of US demand deposit accounts and 65% of the country’s financial institutions. In contrast, FedNow’s reach is significantly limited, counting only 38 financial institutions among its users — less than 0.5% of the market. Notably still absent are significant players like Citibank and Bank of America. The Treasury’s involvement in FedNow (given its absence in RTP) raises questions about fairness in competition from the government. More evidence of an unfair playing field is the Fed’s decision to waive FedNow’s participation fee in 2023. If FedNow solves a problem that RTP does not, why is it necessary to subsidize use at taxpayers’ expense?

The US is not falling behind on real-time payments because it lacks a private sector solution. RTP has widespread adoption already. Rather, it is because the US is a complex market that includes more than 9000 financial institutions. Other countries ahead of the US in real-time payments, such as Canada or the UK, have a more concentrated financial market.

What remains unclear is the rationale behind the Federal Reserve’s involvement in creating an unnecessary parallel network. While there isn’t any fundamental market failure that FedNow aims to rectify, the government’s intervention raises eyebrows. Some cite RTP’s pricing: a flat fee, regardless of bank size and transaction volume. But, if that were an issue, alternative approaches—such as regulating RTP’s pricing or subsidizing smaller banks—would suffice. RTP’s pricing does not warrant the development and maintenance of a parallel system.

In principle, the policy makers should ensure that the US payment landscape is efficient, accessible, and beneficial for all stakeholders involved with as little government involvement as possible. Instead of the unnecessary development of FedNow, the Fed should have encouraged adoption of RTP.

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