New Real-Time Federal Reserve Payment System Goes Live
Overview: On July 20, 2023, the Federal Reserve officially launched its new real-time payments system, FedNow. FedNow provides a new retail-focused, government-administered payment rail that boasts instantaneous transfers available 24 hours a day, 7 days a week, 365 days a year.
Background and Context
For a few decades, the national financial systems in most modernized countries have included three main payment rails: (i) a real-time gross settlement (“RTGS”) system for quick settlement of large value transactions, (ii) an automated clearing house (“ACH”) for lower value payments, and (iii) payment card networks. An RTGS system settles transactions on a per-transfer basis, usually in real-time (i.e., instantly), whereas an ACH system settles transactions in batches on a scheduled basis. In the US, for a long time the wire transfer system of the Federal Reserve (“Fedwire”) was the sole RTGS system. But over the past decade, evolving market drivers have pushed financial systems across the world to implement faster, cheaper, and more convenient payment systems. In this regard, the U.S. has lagged other nations.
As an RTGS system, Fedwire does provide instant settlement, though it is subject to some drawbacks. For one thing, Fedwire is not designed to operate 24/7/365. The technology that supports Fedwire does not remain operational every hour of every day; it must have downtime during which it can be updated. As a result, Fedwire is only available on business days during Fedwire’s operating hours (generally with a 5:00 PM cutoff time). For another thing, Fedwire’s technology is not designed to facilitate retail payments. The average consumer will only utilize wire transfers on an infrequent basis. Additionally, in some cases, Fedwire fees are comparatively higher than other available payment rails. And as with many RTGS systems, Fedwire does not support “pull” payments—that is, a receiving institution cannot debit (or pull) funds from the sending institution. All payments must be sent (or pushed) from the sending institution.
On the other hand, the ACH system in the U.S. is well-suited to retail payments and virtually every financial institution in the country has access to it. But ACH payments are not settled in real-time and also are not available 24/7/365. Traditionally, ACH transfers took several business days to settle. ACH transactions are bundled and processed in batches, historically only at the open and close of the business day. However, starting in 2016, the ACH system underwent a series of phased improvements to allow transactions to be processed several times per day instead of only once or twice. This change allowed for same-day processing of ACH transactions under certain circumstances. But same-day ACH still has its limits. Transactions are still processed in batches and even at their fastest, usually take hours to settle. ACH is also subject to similar operating hours to Fedwire. These limits are due in part to the fact that ACH is built on 60-year-old mainframe technology. However, unlike Fedwire, ACH supports pull payments, which allows merchants to offer auto-debit payment options.
In 2017, the Clearing House—an association and payments company operated by the largest commercial banks in the country—launched the Real Time Payments system (“RTP”) as a privately operated real-time electronic fund transfer system that operates on a 24 x 7 basis. At the time, RTP was the first new core payments infrastructure in the U.S. in 40 years. It was a market-driven initiative designed to fulfill the evolving fast payment needs of the banking industry. Like Fedwire, RTP is an RTGS system that settles transfers on a per-transaction basis. However, the main drawback to RTP is participation. Approximately 280 banks and credit unions currently use the RTP system, whereas ACH and Fedwire are each used by over 10,000 financial institutions. Also, like Fedwire, RTP does not support pull payments.
In 2019, the Federal Reserve announced that it would build and operate a new RTGS system called FedNow. Although not intended to directly compete with or replace RTP, FedNow was planned to support the Federal Reserve’s overarching policy objectives regarding the accessibility, safety, and efficiency of the nation’s payment system. In its announcement, the Federal Reserve noted that “a single private-sector provider of such services is unlikely to connect to the thousands of small and midsize banks necessary to yield nationwide reach, even in the long term.”
The Features of FedNow
The main differentiator between the existing payment rails and FedNow is that FedNow is intended to bring reliable, convenient, and efficient real-time settlement to everyday payments. As stated by the Federal Reserve in its launch announcement, “When fully available, instant payments will provide substantial benefits for consumers and businesses, such as when rapid access to funds is useful, or when just-in-time payments help manage cash flows in bank accounts.”
The technology underlying FedNow is designed for around-the-clock availability. It will operate 24/7/365 and will remain operational even during technical updates. It is also designed to be plugged into consumer-facing applications. Although consumers will not have direct access to FedNow, it was designed to give banking institutions another option for offering payment services to their customers.
Financial institutions can expect to reap some benefits as well. For many retail payment scenarios (which typically settle through ACH), banks often have agreements among themselves to allow for a receiving bank to extend credit to a sending bank, so the recipient of a transfer can have access to the transferred funds before they actually settle into the recipient’s account. From the consumer’s perspective, the payment appears to settle very quickly, but because the funds must settle from the sending bank to the receiving bank during the scheduled batch processing windows, it creates risk exposure for the receiving bank that has given credit for funds before they settle. Managing such exposures on a large scale can be costly for many banks. But with FedNow, there is no such exposure because the funds settle immediately to the receiving bank. This should allow thousands of banks to provide instant funds availability to their retail customers without having to accept such substantial exposure.
However, the road to fast retail payment Nirvana will not be instant or without concerns. FedNow rolled out on July 20, 2023, and not all financial institutions are using it yet. According to the announcement, only 35 early adopting banks and credit unions (as well as the U.S. Treasury’s Fiscal Service) and 16 service providers are ready with instant payment capabilities via FedNow. No financial institution will be required to participate in FedNow. Its usefulness for everyday payments will therefore depend greatly on how quickly FedNow is adopted across the banking industry.
Also, at the outset, FedNow will only support push payments, not pull payments, meaning that transactions can only be initiated by the sending bank, not the receiving bank. This will limit certain use cases for retail payments such as auto-debit transactions until the Federal Reserve implements pull payments. The Federal Reserve has not announced a clear timeline for that implementation.
Like wire transfers, FedNow transfers are essentially irreversible because the funds are immediately transferred out of the sending account. FedNow currently does not have a technical mechanism to reverse erroneous or fraudulent payments. According to FedNow's “Fraud at a Glance” pamphlet, the platform has a return request option, which allows a financial institution to submit a message requesting that another FedNow participant return the amount of a transaction identified as fraudulent. But this mechanism does not appear to be guaranteed like a credit card chargeback or ACH reversal. FedNow provides some fraud mitigation tools to participating financial institutions, but such tools are dependent on the institutions’ own policies and procedures, such as creating their own blacklists and transaction limits. The pamphlet notes that “Future releases of the service will add even more capabilities,” but for now the speed and irreversibility of FedNow will make it a higher risk option than payment channels with slower clearing and settlement processes.
Lastly, it should be noted that financial institutions that use FedNow to provide 24/7 real-time payment services to consumers will, themselves, need to have systems that can operate around the clock with no downtime, and will likely need to build new IT systems to connect their customer-facing banking applications to FedNow services.
Outlook: FedNow is not likely to kill or replace retail money transfer services already in the market, such as Venmo or Cash App. Rather, it will provide financial institutions with additional options to support retail money transfer services that are faster and more efficient than current alternatives. It may take some time before ubiquitous adoption makes it as useful as the Federal Reserve hopes, but FedNow appears to be an important step toward catching the U.S. financial systems up to the rest of the world.
Department of Justice Expands Scope of Bank Merger Antitrust Review
Overview: On June 20, 2023, the Assistant Attorney General in charge of the Antitrust Division of the Department of Justice (“DOJ”) delivered remarks outlining DOJ’s new approach to assessing the competitive effects of potential bank mergers. DOJ’s new approach will shift the focus of its merger analysis from purely local considerations to an expanded analysis of factors potentially impacting competition. In practice, this new approach will likely result in less predictability and a more complex bank merger process.
Federal banking regulators and the DOJ have shared authority to evaluate potential bank mergers. Although the banking regulators have the primary responsibility to evaluate whether to approve bank mergers, DOJ also has jurisdiction to challenge potential mergers in court and has a statutory responsibility to provide the banking regulators with a report on the competitive factors in a bank merger. The DOJ’s analyses often lead to the regulators or DOJ imposing conditions banks must meet to secure regulatory approval for a merger, including potential divestiture of branches.
The agencies’ current analysis of bank mergers is based in large part on joint guidelines the DOJ, the Office of the Comptroller of the Currency (“OCC”), and the Federal Reserve Board (“FRB”) jointly issued in 1995 (the “1995 Guidelines”). The 1995 Guidelines rely primarily on an assessment of local branch deposit concentrations to assess the competitive impact of proposed bank mergers and have provided standardized benchmarks banks may use to assess the likelihood that the agencies will ultimately approve a given merger.
President Biden has made review of existing antitrust policy across industries a priority of his administration. In July 2021, the President issued a broad Executive Order on Promoting Competition in the American Economy that, among other things, directed DOJ to coordinate with the OCC, FRB, and the Federal Deposit Insurance Corporation (“FDIC”) to revisit current bank merger policy and adopt a new plan to assess bank mergers. The DOJ has now outlined a new approach to its bank merger analysis, and is continuing to work with the banking regulators to formally issue new joint bank merger guidelines.
The DOJ’s Revised Approach to Bank Merger Analysis
Assistant Attorney General Jonathan Kanter, the head of DOJ’s Antitrust Division, delivered remarks on June 20, 2023 outlining the Department’s revised approach to analyzing the impact on competition of proposed bank mergers. Assistant Attorney General Kanter maintained in his remarks that the agencies’ approach to analyzing bank mergers must be updated to reflect changes in the banking industry and the economy as a whole since 1995, including interstate banking, online banking, mobile banking, and the overall digital transformation of the U.S. economy. Kanter stated that, because banks now compete in many more geographic markets and business lines, the 1995 Guidelines’ focus on local market deposit concentration alone may no longer be sufficient to assess the complete competitive impact of a bank merger. Kanter also noted that the emergence of fintech and other nonbank financial services companies may be an appropriate factor to incorporate into the competition analysis.
Going forward, DOJ will expand its merger analysis beyond local market deposit concentration in several ways. For example, DOJ will also incorporate a review of a merger’s potential impact on fees, interest rates, product variety, and customer service. The Department will also specifically assess a potential merger’s competitive impact on different aspects of the banks’ business, including retail banking, small business banking, and large- and mid-sized business banking. The likely result of this expanded analysis is that DOJ will give less deference to pure market share metrics, and instead rely more on an analysis of qualitative and potentially more subjective effects.
Assistant Attorney General Kanter highlighted two key areas in which DOJ will focus its merger analysis. First, DOJ will closely examine the extent to which a potential merger may entrench the market power of the largest banks by potentially excluding existing and new competitors. This signifies that it is likely that mergers involving the largest banks will receive particular scrutiny. Second, DOJ will specifically analyze the impact of a proposed merger across different segments of a customer base, and the extent to which a merger would impact whether customers have access to a meaningful choice of the type of bank with which they do business.
DOJ and the Banking Regulators Work Toward Formal Updates to Merger Guidelines
DOJ and the banking regulators are continuing to work on formal updates to the 1995 Guidelines. Acting Comptroller of the Currency Hsu has also recently stated that it is a priority of the OCC to update its merger analysis to reflect the changes in the banking environment since 1995, and similarly noted that it may be appropriate to revisit the extent to which local market concentration drives merger analysis. In connection with collaborating on updated guidelines, DOJ and the banking regulators are also working on developing new data sources to supplement the current concentration metrics.
Outlook: DOJ’s revised analysis of the competitive effects of bank mergers is likely to make bank merger analysis more complex and less predictable. This new approach will also likely lead to heightened scrutiny of certain mergers, particularly those involving large banks and those that may reduce customers’ ability to choose among banks serving different customer needs.
Craig Saperstein, a member of Nacha’s Government Relations Advisory Group, is a partner in the Public Policy practice of Pillsbury Winthrop Shaw Pittman LLP in Washington, D.C. In this capacity, he provides legal analysis for clients on legislative and regulatory developments and lobbies congressional and Executive Branch officials on behalf of companies in the payments industry. Deborah Thoren-Peden is a partner and member of the Financial Institutions Team at Pillsbury Winthrop Shaw Pittman LLP. She provides advice to financial institutions, bank and non-bank, and financial services companies. Daniel Wood is a Counsel and member of the Financial Services Regulatory Team. He provides analysis for financial institutions, technology companies, and clients that offer consumer financial products. Brian Montgomery is a Senior Counsel and member of the Financial Services Regulatory Team. He provides analysis for financial institutions, technology companies, and clients that offer consumer financial products. The information contained in this update does not constitute legal advice and no attorney-client relationship is formed based upon the provision thereof.