For starters, the transition from daily batch payments processing to real-time workflows will require improved infrastructure. This may include stronger fraud checks, since real-time payments cannot be cancelled by the payer.
Discussing how change affects a bank’s risk profile often falls to the risk committee. And in our 24/7 world, payment innovation is one of the most rapidly evolving areas of change.
This article appears in the March-April 2024 issue of ABA Banking Journal Directors Briefing. Subscribe now.
But while many banks are exploring these solutions, they are by no means rushing into them. In all, about 7 percent of the nation’s more than 9,000 financial institutions are estimated to be participating. More are considering instant payments.
The good news is that many customers want their banks’ help. In a Federal Reserve study last year, 7 in 10 businesses and consumers said they’d prefer to access instant payment services through their primary financial institution.
Michael Barr, the Federal Reserve’s vice chairman for supervision, anticipates instant payments becoming more ubiquitous. “While current volumes on FedNow are small, I expect that participation will grow over time and be a significant addition to, and advance on, the existing payments infrastructure,” he says.
The global real-time payments market size was valued at $17.57 billion in 2022 and is expected to grow at a compound annual growth rate of 35.5 percent from 2023 to 2030, according to Grand View Research.
But there are questions for directors to consider. For starters, the transition from daily batch payments processing to real-time workflows will require improved infrastructure. This may include stronger fraud checks, since real-time payments cannot be cancelled by the payer. FedNow has built in a number of features to combat fraud. For example, financial institutions can set risk-based transaction value limits, message signing, and reporting features. Boards will need to make sure they understand these features and are comfortable with them.
Additionally, there are short-run limitations. At first, FedNow customers and businesses will only be able to send and receive payments to others whose financial institutions have also signed up to use the service. Jeff Bucher, a senior product strategy manager for Alkami, has written that smaller financial institutions may find benefits in onboarding both FedNow and RTP. This is primarily to capture opportunities that might go amiss because the two payment rails don’t currently work together. (Improving interoperability is something American Bankers Association has urged the Fed to address.)
Some observers worry that banks may fall behind if they hesitate. “Most banks have still not committed to RTP or FedNow for their commercial customers—a bank’s most significant single profit driver,” says Chris Nichols, director of capital markets for the correspondent division for SouthState Bank of Winter Haven, Florida. Nichols calls this ironic, noting that paper checks are a large and growing source of fraud, and the cost of processing them is only increasing. He urges banks to look at the immediate benefits for customers “to control cash flow like never before.” He considers this to be “the primary game-changing nature of instant payments.”
What are some of the questions boards can consider before potentially giving the green light to instant payments? A starting point is to understand supervisory risk considerations that could arise with instant payments. A paper by the Federal Reserve Bank of Atlanta identified three risk factors to consider:
Liquidity risk. The Atlanta Fed noted, “Instant payments are processed and settled individually and continuously. This means that instant payment network participants or their correspondents must maintain adequate balances to settle transactions at any time.”
Third-party risk. Financial institutions are expected to govern third-party risk management appropriately and to have internal controls needed to measure, monitor, and mitigate those risks across the organization. Using third parties to implement and operate instant payment services means scrutinizing vendors through a robust third-party risk management program and ensuring that any new risk will be escalated to the financial institution’s decision-makers.
Fraud and compliance risk. Financial institutions need a “holistic strategy” to detect and prevent fraud while complying with applicable regulations covering payment services and consumer protections. Go-to-market strategies must be aligned with the financial institution’s risk appetite, and messaging must be consistent with consumer laws.
