Plumbing

Prompt funds lastly attain America

America’s financial assets are overdue and maintenance is overdue. Built by a group of the country’s largest banks to replace paper checks, the current payment rails are more than half a century old and based on outdated code. While robust, the system is painfully slow. American payments are less sophisticated than those in the rest of the rich world, and indeed much of the poor world as well.

It’s a problem the Federal Reserve is trying to solve with a centralized instant payments system. Aptly named FedNow will soon allow Americans to send money to their countrymen through their existing financial institutions and settle payments instantly. The Fed is preparing to launch its new program at the end of July. 41 banks and 15 payment providers will use the service once it goes live.

Currently, bank transfers are inexpensive but are processed in batches, often taking days to complete. Peer-to-peer networks like Cash App seem much faster to customers, but under the surface they are based on the old system. Regulators have warned that funds held in such apps may not be eligible for deposit insurance in the event of a failure. Credit cards that offer hefty bonuses for even heftier fees also use existing rails. According to the San Francisco Fed, almost a third of payments last year were made with plastic.

Typically, Americans use different methods for different types of payment: a water bill is paid by bank transfer; $100 owed to a friend is sent through a payment app. A purchase on Amazon is made with a credit card. A single real-time payment solution could improve the quality of all payments.

JPMorgan Chase and Wells Fargo, two heavyweight banks, have signed on to FedNow. But Wall Street isn’t quite on board: A longer list of institutions, including Bank of America, Citigroup, and Goldman Sachs, are missing. Although the current system is slow, it is still profitable for those involved. Financial institutions can take advantage of slow settlements to park cash overnight in interest-bearing short-term securities or simply leave the money with the Fed to earn interest. They also collect late payment fees, and some make money from their own instant payment schemes, such as The Clearing House, which is operated by a group of banks.

The story goes on

Some observers, remembering this spring’s banking turmoil, worry that FedNow could destabilize the financial system. A report by rating agency Moody’s warns that the new system could increase the likelihood of bank runs by making it easier for depositors to flee. However, such worries may prove to be overblown. The current system, with weekends closed for business, brought little relief to Silicon Valley Bank and others a few months ago. Also, since FedNow is a back-end system, participating institutions can set limits based on their risk appetite. For example, you can limit payments or limit transactions.

Other countries are also light years ahead of America – and don’t seem any more vulnerable to bank runs. In India, for example, instant payments are the norm and accounted for 81% of domestic electronic transactions last year (see chart). In Thailand and Brazil they accounted for 64% and 37%, respectively. Emerging markets have embraced instant payments, partly for demographic reasons (consumers are younger and more open to change), partly because of strict cash policies (policymakers are keen to shrink the size of gray markets and increase the tax burden), and partly because it’s different than in America, new payment systems did not have to crowd out the existing ones and those who benefited from them.

FedNow is unlikely to switch payments immediately. The system will only support “push” transfers, i.e. those that consumers initiate themselves. In contrast, FedNow’s counterparts in Europe and India also have “pull” capabilities that businesses can use if they get permission (allowing for regular payments for electricity, for example). Fed officials claim they have no plans to expand the system for such purposes, but bankers suspect this is the next step.

There will still be one hurdle to mass adoption: the American consumer, on whom paper-based payments are having a particular impact. According to aci Worldwide, a payments company, around a fifth of all cash transfers in the country are made by check. Still, just like the rest of the world, it will be nice for them to have the option.

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© 2023 The Economist Newspaper Limited. All rights reserved.

From The Economist, published under license. The original content can be found at https://www.economist.com/finance-and-economics/2023/07/20/instant-payments-finally-reach-america

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