To keep up with customer expectations, institutions must modernize their payments strategy and ensure security, speed and ubiquity. Real-time payments (RTP) meet all three of these expectations as a critical facet of a modern payment hub model.
Naturally, banking executives named real-time payments as their second-highest payments priority in CSI’s 2021 Banking Priorities Executive Report, after P2P, a related technology. And as the FedNow pilot program continues, the future looks bright for RTP and the often-overlooked possibilities it will open.
Modernizing with Real-Time Payments
Real-time payments go by various names, including instant payments, immediate payments and real-time gross settlements. They operate on a separate network from ACH and wire to enable consumers and businesses to conveniently send and receive immediate fund transfers, 24×7.
Real-time payments follow ISO 20022, an international standard for financial business process communications. These data-rich payments process on an open-loop system, with an inter-bank or account-to-account payment posted and confirmed in moments. And unlike PayPal, Venmo and other platforms, RTP immediately moves money from Bank A to Bank B.
“Financial institutions have real-time and faster payments as a key element to their payment modernization roadmap. It’s about staying competitive and retaining key clients, but it’s also about creating money movement efficiencies and driving new revenue streams,” said Sarah Grotta, director of Debit and Alternative Products Advisory Service at Mercator Advisory Group. “Currently, most activity is centered around person-to-person transactions, payroll and gig economy disbursements and account-to-account transfers. Bill payments and business-to-business activity are just beginning to see traction.”
Looking Ahead to the FedNow Service
In 2019, the Federal Reserve announced that it would enter the payments arena to ensure a nationwide infrastructure for instant payments that encourages competition and innovation and avoids a single point of failure. Its FedNow Service aims to provide secure, fast and ubiquitous payments that all financial institutions can easily access 24×7.
The FedNow pilot program kicked off in Jan. 2021, with many institutions and stakeholders like CSI joining the effort to support the development, testing and adoption of the service. As proposed, FedNow will offer uninterrupted, immediate payments with enhanced security features by 2023.
At launch, FedNow will only process domestic credit transfers and require adequate funds or credit to settle accounts. However, the Federal Reserve has also made clear that banks can leverage the FedNow Liquidity Management Tool (LMT) as needed.
The request, approval and settlement of payments should all occur within moments. To the consumer, it will seem as simple as initiating payment that either processes or doesn’t. As a result, real-time will simplify B2B transactions, P2P, payroll, AR/AP processes and more.
The Federal Reserve’s FAQ states that the initial release will also offer “fraud prevention tools, the ability to join initially as a receive-only participant, request for payment capability, and tools to support participants in their handling of payment inquiries.”
Managing Risk with the FedNow Service
But as with other forms of payment, there are some caveats. Due to the instant nature of these payments, they are irrevocable. Once the settlement message goes out, the transaction is final.
Institutions must therefore stay vigilant and leverage either FedNow’s optional fraud prevention features or other fraud mitigation tools and techniques. Only a good faith request can resolve an error, but even with that request, institutions risk damaging both their credibility and the user experience.
Since funds move in real time, institutions must stop fraud beforehand by authorizing only the right ones, because once a fraudulent transaction is processed, it’s already too late. An enterprise fraud approach with a complete picture of customers and their behaviors can help guide this screening process.
The silver lining to this risk is that real-time payments can find system weaknesses more quickly. Fraud will often become evident faster, which will illuminate when to shore up defenses.
Transforming Real-Time Payments with Directories
Although the Fed will first focus on the service’s core functionality for a speedy and efficient rollout, the Federal Reserve is phasing in features and functionality over time. FedNow’s phased approach opens the door to exciting possibilities, like alias-based payments that list consumers by more approachable “lookup criteria.”
With directories, customers don’t need to know specific account information to search for someone and securely process payments. Directories leverage APIs to enable customers to self-enroll and identify recipients by searching for their user IDs, email, phone number, alias and picture.
The process is old hat to consumers who have used closed-loop directories through third-party P2P apps. However, these new directories would revolutionize the user experience with their financial institution’s digital banking platform, and offer the convenience that many expect.
The Federal Reserve must first weigh a host of legal and operational considerations regarding alias-based transactions. But its statements on their possibility are promising. In fact, the Fed has gone so far as to express interest in connecting one or more existing directories or building its own directory to facilitate nationwide reach.
Directories will likely be a primary focus for future releases and serve as a driver of an improved user experience. Until then, the Federal Reserve will not preclude participants from “using alias-based payment services that are unaffiliated with the FedNow Service.”
Continuing the Real-Time Payments Journey
Effective implementation and incorporation of real-time payments into institutions’ payments portfolios will require a careful watch of the industry. Upon the FedNow’s launch and beyond, real-time payments will symbiotically grow alongside innovations in core banking, digital technologies and security. Institutions that haven’t already should plan for how they will exist alongside their existing payment portfolios.
For a deeper dive into real-time payments and CSI’s take on a modern payments model, refer to this on-demand webinar.
