Transcript
Hi, and welcome back to another episode of the What's Going On in Banking podcast. I'm your host, Ron Shevlin, chief research officer at Cornerstone Advisors. With me today is Peter Davy, senior vice president and head of Product Innovation and Labs at The Clearing House. Peter, thanks a lot for joining me.
Absolutely, Ron. Thanks for having me.
The reason I asked you on today is the recent news around FedNow, the Federal Reserve's new instant-payments service. It was announced several years ago, made headlines again in March, and is scheduled to launch in July.
I've been covering real-time payments for the past couple of years in the annual What's Going On in Banking report. In our most recent research, about 30% of both banks and credit unions said they planned to deploy real-time payments this year, with many of them expecting to use FedNow. Yet 44% of the institutions planning to launch real-time payments said they still had not developed a strategy for doing it.
The top use cases among banks were account-to-account transfers and B2B payments. Credit unions, which tend to be more retail-focused, pointed to account-to-account transfers and expedited consumer payments.
Before we get into what banks and credit unions should be doing to prepare, I want to read you a quote from Robert F. Kennedy Jr., who had announced plans to enter the presidential race. He tweeted that the Fed had announced what he called its "FedNow central bank digital currency" and said CBDCs could lead to financial surveillance, government control over assets, and limits on where people could spend money.
Obviously, FedNow is not a CBDC. Where do you think that confusion came from, and what's your reaction to those comments?
Aside from hitting my head and wondering what these guys are smoking, I think the reality is that there is a tremendous amount of misinformation out there.
You mentioned that many financial institutions still don't fully understand what to do with real-time and instant payments. Now take that uncertainty into the political arena and try to explain the modernization of U.S. payment infrastructure. People start combining very different things.
For example, Project Hamilton was an experiment involving a central bank digital currency. FedNow is a completely different initiative. Then you have Federal Reserve governors making comments about digital currency from different perspectives, and all of those ideas get mixed together by people who don't really understand the payments space or aren't getting good guidance.
That's how you end up with a statement like this. There is simply a lot of misinformation. Anyone making policy statements in this area needs advisers who actually understand what is happening in the industry. A Payments 101 course would help.
So, in a minute or less, if you were in an elevator with RFK Jr. and had to explain what FedNow actually is, what would you tell him?
I would say that we're living in a digital era and need the ability to move money quickly and securely between financial institutions. Much of the payment infrastructure we've relied on for decades, including checks, wires, and ACH, no longer matches the customer experience people expect.
FedNow is about speeding up that process. It allows money to move between customers and financial institutions in real time, with final settlement, while still operating within the controls that have existed in the banking system for years.
We're not reinventing banking or changing the basic relationship between banks and their customers. We're modernizing the infrastructure so payments can happen at the speed customers increasingly expect.
Let's get into the real substance of this. As I mentioned earlier, nearly half of the financial institutions in our survey that planned to launch real-time payments in 2023 still hadn't developed a strategy. What should they be doing, both from a technology perspective and from a business-services perspective?
A big part of it starts with educating the C-suite and the board.
A lot of community-based financial institutions are really lending institutions first. Historically, many of them have not viewed payments as a strategic business. They've relied heavily on their core providers to tell them which payment products or networks they should participate in.
In some cases, the education coming from third-party service providers has been lackluster. If that's the only source of information your board or executive team is getting, they may not understand why instant payments should be part of the institution's strategy.
I've said for years that some community-bank boards and executive teams don't have the right mix of experience to fully understand technology modernization. That's one reason you see the more progressive institutions moving toward real-time payments and putting the infrastructure in place, while others are still waiting for something to happen.
So education is the first piece. The second is understanding what customers actually need.
One of the problems we have as payments professionals is that we talk in payment language instead of customer language. Customers generally are not asking their bank for "FedNow" or "RTP." Some businesses are beginning to use those terms because they're becoming more educated, but most customers are simply asking for an outcome.
Do they need to send money to a counterparty immediately or nearly immediately? Do they want a three- or four-day delay when they're paying a bill or transferring money between accounts? Usually, the answer is no.
So the strategic question should be: What problem is the customer trying to solve, and which payment tools help solve it?
Let's separate banks and credit unions for a moment. Banks tend to be more B2B-focused. The banking industry has functioned for a very long time without real-time payments, so is this truly an imperative on the commercial side?
You launched the RTP network at The Clearing House several years ago. What use cases have actually gained traction? What has resonated with the banks you're working with? And from the technology side, what do institutions need to do to get ready?
Let's start with the business side and then move into the technology.
When we launched the RTP network in 2017, we expected B2B payments to be the primary transactions that moved onto the network. We were wrong. A lot of the early volume turned out to be B2C payments.
What we learned was that financial institutions needed time to build the capabilities required to offer everything a new payment system can support. Whether you're talking about RTP or FedNow, the core capabilities are fairly similar. But each financial institution still has work to do on the back end to make those capabilities available to customers on both the send and receive sides.
That's one of the harder parts.
Fast-forward from 2017 to 2023, and businesses are now going through their own modernization efforts. They're looking for ways to make payments almost frictionless within the back office. They don't want to rely on manual reporting and manual reconciliation.
Financial institutions increasingly have to support that by creating API interfaces for ERP systems and third-party integrators, helping businesses create a more seamless payment environment.
For years, though, we've found ways to approximate some of these benefits without actually modernizing the underlying payment rails. There are concepts such as guaranteed ACH, which we've seen especially in bill payment. Large corporations may outsource the payment risk to another provider and feel as though they already have a guaranteed transaction.
So when you're making the case for RTP, you have to explain the additional benefit. A big part of that is the customer experience. And now that interest rates are no longer near zero, there can also be a financial benefit to businesses receiving funds in real time.
On the technology side, one thing The Clearing House did early was partner with third-party service providers and bank technology providers to connect them to the RTP rails.
When we talk about the reach of the RTP network, more than 65% of deposit accounts are covered. That's not necessarily the perfect way to measure who can receive an RTP payment, but from a technical-capability standpoint, we've integrated with providers that represent a very large share of the market.
That work also helps the Federal Reserve. Many providers have already developed the ISO messaging capabilities needed to connect to RTP, which makes it easier for them to connect to FedNow and offer both services.
There is still a major hurdle, though. A lot of the existing connectivity is focused on receiving payments. If an institution can only receive an instant payment, it hasn't fully modernized its payment operation. It also needs the ability to send.
What we've found is that many third-party service providers have not yet enabled that final mile for send-side products. That makes it harder to drive real adoption and transaction volume on either RTP or FedNow.
If customers don't have access to tools that let them send transactions, the institution becomes a net receiver. You're not modernizing the full procure-to-pay process on the B2B side.
I'm glad you brought up send versus receive because that's something I hear constantly. A lot of institutions seem to be planning for receive-only. What's the downside of doing that? Why should they care as much about sending as receiving?
The send-side products are where customers can really begin using the capability for their own needs.
Imagine I receive an insurance payout in real time after a loss. That's useful, but the next question is: How do I use the money?
Take a flood at your house. You receive an insurance payment to cover repairs, and now you have plumbers, flooring contractors, and other people doing work who may not accept credit cards. How do you get that money to them immediately?
You could write a check, but many customers don't want to do that. Some contractors aren't set up for ACH. So the industry needs tools that allow the recipient of an instant payment to turn around and make another instant payment.
Products like Zelle or the CHUCK network can help in certain situations, and there are other options as well. But the important thing is enabling the payment to happen in real time.
If I'm a plumber or flooring contractor, I want immediate access to the funds too. That makes it easier for me to serve the customer. The send-side opportunity is really about meeting customer demand so both parties can complete the transaction without one side waiting days for money to clear and settle.
That's a great point. There are also plenty of commercial use cases. Construction is an obvious example. Payments may be held until work is complete and then take additional time to reach the contractor. Instant payments could address some of that friction.
Looking ahead a few years, our research suggests many institutions expect to use both The Clearing House's RTP network and FedNow. Do you think they will use one network for certain use cases and the other for different ones? How do you see the two systems coexisting?
There are several ways it could evolve.
The Federal Reserve and The Clearing House have been both competitors and collaborators in payments for a long time. We both operate check-image systems, high-dollar transfer systems, and ACH systems. Those systems already coexist and interoperate in different ways.
I expect a similar dynamic between RTP and FedNow. A third-party or software provider may give the financial institution access to both networks. Then, in real time, the provider can make a smart routing decision about which network to use.
Sometimes that decision may be simple: the recipient endpoint exists on only one network. In other cases, economics may matter. One network may offer a better price or another operational advantage for a particular transaction.
So I think institutions will increasingly connect to both, and the routing decision will happen behind the scenes.
A lot will depend on endpoints. The RTP network has been operating for several years, so it already has established endpoints. When FedNow launches, the question will be how many endpoints it has on day one and how quickly that grows.
If providers such as Fiserv, FIS, and Jack Henry can make it easy for financial institutions to turn on both networks, I think you'll see both systems grow at the same time rather than one simply replacing the other. Then the decision comes down to economics, reach, and the specifics of the transaction.
Last question, Peter. When FedNow goes live in July, what could go wrong? Are there things banks should be watching closely?
When we launched RTP in November 2017, we started with two financial institutions, then four, then six, and grew from there. Operating a new payment system is something you learn by doing.
The Fed has had a testing environment with participating institutions, but there are things you don't really understand until the system is live and you're connecting institutions in production.
I think the hardest part may be onboarding. How do you get financial institutions connected efficiently?
The technology itself may be relatively straightforward for many institutions because so much integration work has already been done by the industry. The harder part can be signing agreements, getting operations ready, and making sure the back office is prepared.
The Fed also has to scale carefully. You probably don't want to bring 25 institutions live on day one. That's asking for trouble. Start with a manageable group, make sure the system works as expected, and then grow.
The institutions connecting to the network also have to be ready operationally to support the payments. So the early fits and starts are likely to involve whether the Fed has all of the technical capabilities operating as expected, whether the service behaves correctly in a live environment, and how efficiently they can scale the onboarding process.
Awesome. Peter Davy, senior vice president and head of Product Innovation and Labs at The Clearing House, thanks a lot for being on the What's Going On in Banking podcast.
And everybody listening, thanks for joining us. We look forward to seeing you on another episode.
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