Faster Payments – Considerations for Community Financial Institutions

With the completion of ACBB’s recent survey across its client base on readiness for FedNow^SM Service and “faster payments” overall, what stood out the most was the need for more information. Over two-thirds of survey participants recognized the importance of these new payment networks, but also acknowledged the need for more information.

ACBB has invested significant resources in the development of its infrastructure to accommodate access to faster payment networks for its community Financial Institutions. In doing so, expertise has been gained, and perhaps more importantly, many observations have been made based on exposure to the new systems as well as direct experience participating in the networks via our clients that have adopted the technology.

This piece is intended to provide some foundation for understanding the networks as well as key considerations community Financial Institutions should factor into decisions on if and how they should plan to adopt.

Faster Payments: What? Why? Which? How? Risk? Cost?

What Are Faster Payments?

The term “faster payments” is a bit ambiguous, but it has become the general term referring to what are actually “instant” payments. Yes, an ACH payment is generally faster clearing than a check, and indeed “same-day ACH” is faster than traditionally settled ACH payments, but it’s really the “instant” nature of payments that define the more transformative aspect of the payments space today. Instant payment networks began decades ago in other countries (typically those with less efficient payment systems where the need for modernization was much more urgent). In the U.S., The Clearing House (TCH), launched the first “public” instant payment network, Real-Time Payments (RTP®), in 2017. The Federal Reserve’s “central bank”-based solution, The FedNow^SM Service, launched in late July 2023.

What exactly are “instant payments”? Here are a few characteristics that define them (regardless of the network):

– Credit “push” transactions (no pre-authorized debits allowed)

– Settlement occurs in seconds (recipient has use of good funds immediately)

– Transactions are irrevocable (returns can only be done voluntarily at the discretion of the receiving Financial Institution)

– Message standards are based on the ISO 20022 format

Overall Commitment Considerations

ACBB views the development of these instant payment networks as part of the “evolution” of the overall payments infrastructure. We believe that it is critical to adopt and embrace these new networks and related technologies – no different than when our predecessors considered the migration to ACH payments in 1973 or, more recently, Check 21 in 2001. Checks, ACH, and wire transfers will not necessarily go away – as we’ve learned, but changing patterns, new use cases, and user behaviors will dramatically impact the way payments move. Over 52 million payments occurred over the RTP® rails in the first quarter of 2023 alone.

Adoption is particularly important for community Financial Institutions. As consumer and business behaviors change, so do their expectations. Your customers may take for granted that they can access funds immediately at your institution – until they cannot. For some demographics, e.g., Gen Z, instant payments are a way of life. Today, if a Financial Institution is not part of one of these networks, funds received will either remain in the “app” (e.g., Venmo, PayPal, Apple Pay, etc.) where the customer access to the funds is more restricted, or the funds move through more traditional payment channels (ACH or Debit Card) eventually making it into accounts at your Financial Institution (not instantly available). Customers will eventually recognize this inconvenience and question their relationships. Further, when customer funds sit in an “app,” they are not on your balance sheet either. Retention of relationships and growth in important demographics are key considerations we believe justify pursuing participation in instant payments.

Network Participation Considerations

ACBB recommends that Financial Institutions consider joining BOTH networks. Not necessarily both at once, but we believe that there are compelling reasons that justify some evaluation of the pros and cons of both networks.

Some factors relating to both RTP® and FedNow^SM Service:

RTP®:

– Operating experience – over five years in production

– “Big Banks” = access to over 65% of U.S. households

– Higher overall transaction limits (more use cases)

– Testing international transactions

– Integrated document management for payment information

FedNow^SM Service:

– Targeting community Financial Institutions

– Larger messaging capacity within the ISO format

– “Power User” in the U.S. Bureau of Fiscal Services (Government Payments?)

– No sponsor-imposed impressed balance requirements

– Some synergies with FedLine® platform

ACBB has observed some bias around the RTP® network from The Clearing House due to its ownership by the “big banks,” while true and while there is and always has been a competitive “conflict” there, it should be pointed out that there are now over 300 regional and community Financial Institutions participating in the RTP® system. Also, as a reminder, TCH operates other payment clearing channels such as ECCHO and CHIPS, and it plays significant clearing positions within the ACH network as well – solutions relied upon by most banks.

Finally, it is the opinion of most experts that ultimately there will be interoperability between the two networks. However, neither operator has indicated an intent or time frame to make this a reality. Good news, both rely on the ISO 20022 message formats (however both have pursued unique adaptations thereof). Understandably, both providers have prioritized the development and roll out of each unique platform as a priority vs. planning and investing in the ubiquity factor.

Network Functionality Considerations

The choices here are fairly simple: participants in the networks have to define if they want to receive incoming payments only (receive only) or if they want to send and receive instant payments (send and receive).

Again, both networks are similarly configured when it comes to broad capabilities. At a minimum, many, if not most, Financial Institutions considering participation indicate that their preference, at least initially, is to receive only. As noted earlier, customer experience is evolving, and expectations are increasing that certain transactions are immediately available.

Mobile apps mentioned earlier are the driver of this type of activity. Person-to-person (P-2-P) payments as they are known have proliferated over the last decade and have increased notably over the past two to three years for obvious reasons. What’s also increased is the acceptance of mobile payments by businesses (POS for retailers, Business-to-Business payments within certain industries, [e.g., hospitality, etc.]). This trend makes the acceptance of instant payments valuable for retention of both consumer and business relationships.

The “send” capability may be a bit more complex, in that with activity flowing both ways, a Financial Institution could find itself in a negative/deficit position periodically over a 24-hour period. This mandates that considerations for 24×7 liquidity are in place, and frankly, this is where the bankers bank “funding agent” or “settlement provider” capability comes into play nicely.

For Financial Institutions, the send feature is less “crucial,” it seems. Generally, use cases for businesses dictate the urgency to go to market with this feature. In both networks, Financial Institutions may change their status as new opportunities present themselves – so, a Financial Institution can agree to Send and Receive when the need arises, or as products are developed to support customer needs. Certain underwriting requirements may come into play within the network or with the correspondent/bankers bank as the level of adoption changes.

Connectivity and Liquidity Considerations?

With respect to connecting to the networks – probably the most important step is to review the options with your Core provider. Here, it has been our observation that Core providers’ ability to support faster payments varies tremendously. Some are ready, willing, and able, others have murky strategies and uncertain time frames – not to mention inconsistent costs. The size and relative sophistication of the Core may not be an indicator of their prowess here.

Regardless – the cooperation of the Core is essential to validate accounts and post transactions in an instant fashion. Many Cores can accommodate directly with the networks, others may have to cooperate in terms of supporting APIs to the account data for “enablers” like third-party service providers (TPSP) or correspondents like ACBB.

Also, connectivity directly with the Fed is an important consideration. For settlement, Financial Institutions that have existing FedLine connections (including routers and MQ middleware), may not require the support of a correspondent for settlement. If, however, the Financial Institution contemplates Send and Receive status – and liquidity could be a factor, then the connectivity through a correspondent like ACBB could be a logical and prudent option.

What about liquidity? As noted earlier, the netting of incoming and outgoing funds could lead to an intraday deficit position – which, if after hours, can be problematic. The RTP® and the FedNow^SM Service networks have taken slightly different approaches to managing liquidity on a 24×7 basis. The RTP® network requires an impressed balance to be maintained in a joint account at the New York Federal Reserve Bank. The value of the funds to be maintained is tied to a table based on your Financial Institution’s level of “transaction account balances.” In the FedNow^SM Service model, no impressed balance is required at the Fed, but rather, a similar formula is applied by the settlement provider (correspondent like ACBB), or deficits can be covered through LMTs (liquidity management transfers) between participants – but this presumably relies on 24×7 management. Of course, if a deficit position exceeds the impressed balance or target maintained by your correspondent, then most correspondents will have a backup borrowing facility in place to ensure coverage so that no transactions will be returned.

Risk Considerations

Good news… The incidence of fraud within the current faster payment network is statistically much lower than in other established channels like checks, ACH, and wires. However, with any new infrastructure, there are risks.

Financial Institutions considering participation must take a hard look at how their current BSA/AML, regulatory, and compliance regiments might be impacted by the addition of a new payment channel – after all, faster payments may equal faster fraud.

The RTP® and FedNow^SM Service networks are evolving with respect to fraud controls that are part of the system. Transaction monitoring, e.g., velocity and value abnormalities, are flagged within the process. New enhancements are being made as experience is gained and as technology evolves.

As with other payments, the Financial Institution is primarily responsible for its compliance requirements. KYC programs take on increased importance with faster payments since fraud might be targeted at vulnerable demographics and where funds are deceptively sent to perpetrators that may have exploited a Financial Institution account opening process to secure illicit funds.

The networks do allow participants to establish transaction limits at the institutional level. So, while the FedNow^SM Service may allow transactions up to $500,000, a community Financial Institution can set that limit for its customers to an appropriate level, say $50,000, for example. In addition, ACBB as a correspondent will offer the ability for Financial Institutions to “block” certain accounts based on the institution’s internal risk assessment.

Costs Considerations

While both networks have very comparable pricing at the transaction level (e.g., $0.045 per transaction) paid by the originating institution (sender), other partners within the network, e.g., correspondent, TPSP, or Core provider) are likely to pass along costs.

It’s ACBB’s observation that probably much like the roll-out of the ACH network, significant investments are being made across the providers to enable the processing. As a result, significant expense is being accumulated – and all the players want to start to recoup these costs.

As a Financial Institution considering participation in faster payments, you should be diligent about understanding the costs across the options presented. Consider, too, opportunities within certain segments of your client base, ways to pass along costs, and/or generate a new source of non-interest income.

Just because the network-imposed fees are generally “low” does not mean that faster payment adoption is not going to require a potentially significant investment.

Remember, the payback is a long-term endeavor, marked by client retention and continued relevance to new client demographics, development and support of new services, and the potential for new deposit and non-interest income streams.

William J. Booth, SVP Head of Product Strategy & Innovation

Atlantic Community Bankers Bank