The Federal Reserve launched its new FedNow service on July 20th, a surprise early launch to this new program which allows individuals and businesses to (finally) send instant payments through their banks. The announcement has been met with a mixture of celebration and suspicion, largely due to a misunderstanding of what FedNow really is. To clear up any confusion, let’s walk through what the FedNow program is, what it is not, and why I think this is a good thing for the US banking system.
The most surprising part of the FedNow announcement is that the system did not already exist. Currently, and for the past 60 years, interbank transfers have been handled through two systems that were costly or time consuming (or sometimes both). The most common system is the Fed’s Automated Clearing House (ACH), which takes two to three days. If you receive direct deposit of your paycheck, then you are familiar with ACH deposits. What you may not know is that your employer had to send the funds for your check a couple of days before it hit your account. You may also not be aware that ACH deposits (other than paychecks) can be held by the receiving bank for up to 10 days depending on the size of the deposit. This makes ACH transfers terribly cumbersome for people who want to transfer funds quickly. The second system is the FedWire program, which allows for same-day transfer of funds, but at a significant cost, usually around $25 per wire, not something you would want to pay for everyday transfers. If you have ever purchased a home, then you may have ‘wired’ funds into escrow and used this system. The FedNow system promises to combine the speed of the wire system with the low cost and ease of use of the ACH system, while also adding new fraud prevention tools.
Even though the United States has the largest and (arguably) most sophisticated banking system in the world, we did not have the ability to transfer funds instantly, something that most other countries have had for decades. The FedNow system brings the US to the 21st century and makes the US banking system more competitive. I believe this will significantly improve our ability to serve our clients and am glad of the update.
So why would FedNow be controversial? It seems that FedNow, which allows transfers between banks, is being confused with a Central Bank Digital Currency (CBDC). To be clear FedNow is not a Central Bank Digital Currency. Transactions will still be handled in regular dollars through your existing bank. CBDC’s are controversial due to the power and control they give to the government, but this is a different topic. Some argue that FedNow provides the platform for a CBDC, which could be true, but only in the sense that it improves the banking system. The likely result of FedNow is increasing offerings of bank-sponsored payment programs, like Venmo. Yes, FedNow is likely to increase the number of digital transactions, but there are still many more steps to a CBDC.
FedNow is still being rolled out, and we will keep you updated as our custodians and banks begin to offer instant transfers. If you have ever had to wait days for your funds to arrive, FedNow is good news. Your days of waiting could be over.
You can learn more about FedNow on the Federal Reserve website: https://www.federalreserve.gov/paymentsystems/fednow_about.htm