The Federal Reserve Bank announced plans to create a real-time payment system to make check-cashing and other transactions faster. It would be an upgrade from the current Fed system which is slow to settle a transaction and would be run like a utility. It would also compete with a network recently launched by six big banks called The Clearing House. Critics say the Fed system would be redundant and would interfere with the private sector effort that’s already underway.
U.S. Senators Elizabeth Warren, Chris Van Hollen, and Representatives Ayanna Pressley and Jesús “Chuy” García introduced legislation called the Payment Modernization Act of 2019. (1) It calls for the development of a public round-the-clock payment system called FedNow that is not run by big banks. Instead, the lawmakers say it would provide a foundation for private sector systems, would help smaller financial institutions, entrepreneurs and individuals get fast access to their money, and be more secure in the event of a crisis.
Democrats Support Fed System
In a press release, they say that Americans are losing “billions of dollars turning to more costly financial products and paying overdraft fees because their paychecks take days to appear in their bank accounts.” (2) They say the legislation is designed to prevent those delays and give Americans a way to “safely and securely access their own money in real time.” Warren says that, “People living paycheck-to-paycheck shouldn’t have to wait up to five days for a check to clear so that they can pay their rent, cover child care, or pick up groceries.”
The legislation is a follow-up to the creation of a task force in 2015, to develop a plan for a faster payment system. The deadline is supposed to be next year to get it going, but Fed Chief Jerome Powell has said the Fed won’t make this deadline, despite the need for a modern and fast payment system. It is now expected to become available in 2023 or 2024.
In a Treasury report signed off by Secretary Steven Mnuchin last year, it said, “Payments are essential to commerce and the payments infrastructure that has been built over decades empowers consumer choice in payments. (3) This system has proven, over time, to be stable, secure, and effective.” But, it says, “New technologies, especially in commerce, have changed the way that people live, consume, and pay for goods and services.” It says they “have led to higher consumer expectations as to the speed and convenience of systems such as payments.”
That has obviously created opportunities for the private sector to fill that void, but the report suggests some important considerations in the creation of a public-run system. Among them is the need for a system that is universal, secure, and scalable. It would also need to address the complexity of evolving financial needs such as the more recent adoption of mobile technology and digital transactions. And it needs to function within the realm of banking regulations.
FedNow Task Force
The Fed’s Faster Payments Task Force has been working with private-sector stakeholders to help modernize the system. One of the solutions proposed by those stakeholders is The Clearing House, which went live in 2017. It’s a completely new payment system. The report says it connects six big U.S. banks but is open to all of them. System adoption is key to its success and the report recommends the creation of a system by the Federal Reserve that would encourage adoption by smaller institutions. The fact sheet says the Fed system would be run more like a utility and provide a foundation that could be built upon by the private sector.
This push for a public system has created a backlash from the banks that have spent a ton of money developing their own payment system. The Wall Street Journal says that banks such as Citigroup, U.S. Bancorp, and JPMorgan Chase have collectively invested about $1 billion into the Clearing House instant-payment system. (4) And, it’s already in use by some banks.
The paper also points out the drawbacks of this system. It says that smaller banks feel they may be treated unfairly by a system that’s owned by the bigger banks and that tech giants like Amazon and Google are in favor of a public option which would eliminate the middle-man approach.
In Favor of FedNow
President of the Federal Reserve Bank of Kansas City, Thomas Hoenig, and Operations Manager for the Federal Reserve System, Bruce Summers, collaborated on an opinion piece in American Banker. They say the Fed system is needed to provide an alternative, competitive interbank transaction service for real-time payments.
They also argue that it will offer stability against a payment system breakdown if there’s a financial crisis. It would be a direct extension of the payment services that are already in place by the Fed, including check clearing and electronic transfers for large wholesale and small retail transactions.
Opposed to FedNow
The president and CEO of The Clearing House responded with another opinion piece called: “Fed entry into real-time payments would do more harm than good.” He says the private-sector Clearing House payment network is already being used by 50% of the nation’s banking accounts, and is the most advanced payment system in the world. He says there is no need to worry about a monopoly because the private system already faces competition from the National Automated Clearing House Association, fintech start-ups, and others.
He also refutes the idea that the Fed system is safer, saying that The Clearing House has operated without fail for 166 years, through 9/11, natural disasters, and the financial crisis, and has settled some $2 trillion daily interbank payments, without fail. Plus, he says that the development of the Fed system may slow the progress of adoption because some institutions will want to wait for the Fed system, years from now.
And, he argues that the Fed system would not meet the requirements of the Monetary Control Act which says that the Fed would have to provide a service that can’t be provided by the private sector. In addition to fragmented adoption, he says the redundancy of the two systems would increase the cost.
FedNow supporters say that having just one payment system, such as The Clearing House, would create risks. They say it isn’t a matter of redundancy, but the need for competition to keep costs low, provide equal access, and secure the U.S. financial system in the event of a crisis or failure. As reported by the New York Times, Fed Governor Lael Brainard says the Fed system “will provide a neutral foundation for innovation and competition in end-user, faster payment services.” (5)
At this point, the balls are still in the air.
(3) Treasury Report
(5) New York Times