The Fed’s new instant-payments system FedNow can be a game changer, giving people and businesses immediate access to their money and slashing fees that make it expensive to be poor in America.
But for FedNow to work, banks must use it. Unfortunately, right now they aren’t. Less than 1% of banks and credit unions have signed up, and many of these charge a lot for the service.
Sitting back and waiting for the market’s magic to work won’t do anything except turn FedNow into a Fed flop. The Fed must act now, embracing lessons from prior payments innovations both domestically and globally. The Fed should require banks to offer customers instant access to their own money, while preventing banks from adding excessive markups over what these payments cost them.
FedNow’s potential is enormous. If successful, it will give workers faster access to their pay, saving billions in fees and borrowing costs. Small businesses will get paid more quickly, helping manage cash flows. Insurers can pay claimants faster, helping people rebound from disasters. Developers will create new services, boosting innovation. Time is money; faster payments create money for everyone other than those profiting off the delay.
FedNow’s success hinges on two factors. First, whether the thousands of U.S. banks and credit unions join the Fed’s platform. Second, whether businesses, consumers and governments use FedNow to make recurring instant payments to employees and counterparties.
The Fed has worked to promote bank participation, spending decades engaging with stakeholders, facilitating equitable access for smaller banks, and encouraging banks to participate. The Fed’s pricing for banks to join the platform seeks only to recover costs over the long run. Yet despite these efforts and rising consumer expectations for instant payments, FedNow has stumbled at the start. Only a handful of banks have signed up and sometimes charge high markups to businesses to use it.
“America’s unique set of expensive workarounds for its slow payment system, including overdraft fees, are lucrative for banks. ”
The lack of immediate voluntary participation is expected. America’s unique set of expensive workarounds for its slow payment system, including overdraft fees, are lucrative for banks.
Earlier this week, U.S. Senator Chris Van Hollen (D-MD) pushed the CEOs of America’s largest banks to join and use FedNow, citing one of our pieces of research showing that if the U.S. had adopted real-time payments when the U.K. did, Americans living paycheck to paycheck would have saved more than $100 billion by now in overdraft and late fees, and check cashing and payday lending costs. This research underpins many bank’s split motives and highlights the consequence of the Fed’s inaction to use its existing authority to require banks to offer faster funds availability.
When Brazil launched its real-time payment system, PIX, for example, it mandated usage. PIX has brought millions of the country’s unbanked population into the banking system. Likewise, after the U.K. instituted real-time payments, it issued regulations to make funds available immediately. Usage soared.
Yet achieving full network effects also requires customer demand. While business leaders recognize instant payment’s benefits, their decision turns on the technology’s value proposition. Cost considerations feature prominently. The Fed’s experience running its automated clearinghouse (“ACH”) system and its more expensive progeny, Same Day ACH, is both illuminating and concerning.
Established in the 1970s, ACH processes 72% of all noncash payments in the U.S. Social security, direct deposits and online bill pay use ACH, for instance. ACH’s strength is its low cost. Banks frequently offer consumers ACH for free, while costs are in pennies for businesses. For an insurer, sending biweekly benefits may cost $4 or more per check, so ACH is an obvious choice.
By contrast, Same Day ACH use is modest. Launched in 2016, the initiative sought faster funds-settlement by eliminating the multi-day lag in ACH transactions. But bank fees have impeded use. While a bank’s origination cost for a Same Day ACH transaction is roughly a nickel, its fee for customers can range from around 30 cents to $1 or beyond.
Markups of six- to 20 times discourage businesses from switching to faster payments, even if some may ultimately do so. That includes the New York State Insurance Fund, the public-sector insurer one of us runs. Little wonder, Same Day ACH currently comprises only about 2% of ACH transactions.
Market competition should reduce Same Day ACH fees and boost utilization over time. But given the administrative challenges of changing banks, especially for large companies, let alone cash-strapped families, reality is unlikely to match theory. Witness the poor take up over the nearly seven years same-day ACH has been around.
Yet the Fed has retained for FedNow a pricing structure similar to Same Day ACH’s, leaving each bank to set its own customer fees. Since banks seek to maximize profit, not social well-being, it isn’t surprising that FedNow can cost customers multiples of what Same Day ACH costs, resulting in total cost increases of 50 times or more over traditional slow ACH. Each business will determine instant payments’ value for its bottom line, and banks will seek to generate a profit. But if the markups are excessive, FedNow could suffer like Same Day ACH, failing to achieve ubiquity or reach its potential.
American businesses and consumers have been left out of the real-time payment revolution sweeping the world. Until the Federal Reserve realizes that it must do more than build FedNow and wait for people to come, we will likely remain in the slow lane.
Gaurav Vasisht is the executive director and CEO of the New York State Insurance Fund and served as an adviser to former Federal Reserve Chairman Paul A. Volcker.
Aaron Klein is the Miriam K. Carliner Chair and Senior Fellow in Economic Studies at the Brookings Institution. He served as deputy assistant secretary of the U.S. Treasury from 2009-2012.