To The Moon

It is important to note that FedNow, the Federal Reserve's upcoming instant-payment tool, is a major innovation in electronic payments, as well as speeding up savers' ability to move money out of their bank accounts to higher-yielding alternatives during a time of financial turmoil.

Banks may be under increasing pressure to stem outflows as a result of these trends. This is especially true if they need to be forced to take down assets that have yet to realize losses.

1.What is the FedNow Service?

FedNow is an instant payments service being developed by the United States Federal Reserve Bank (Fed). The FedNow Service, or FedNow for short, is designed to offer uninterrupted 24/7/365 processing and will feature integrated clearing functionality, enabling financial institutions to deliver end-to-end instant payment services to their customers.

The Federal Reserve issued a press release announcing its plans for a July debut of FedNow, its service “to facilitate nationwide reach of instant payment services by financial institutions.” As previously discussed here, the FedNow service will provide individuals and businesses the ability to send and receive instant payments through the Federal Reserve’s Fedline® network at any time of day seven days a week. Fedline® currently serves 10,000 financial institutions and their agents. Recipients of payments using FedNow will have immediate full access to funds which will enable greater flexibility and opportunity for immediate use of money sent and received.

In April, the Federal Reserve will begin certifying participants so that when the launch occurs, those institutions will be prepared to send live transactions through the system. In June, the Federal Reserve and those certified participants will engage in production validation activities to prepare for the launch.

Ken Montgomery, first vice president of the Federal Reserve Bank of Boston and FedNow executive, said “[w]e couldn’t be more excited about the forthcoming FedNow launch, which will enable every participating financial institution, the smallest to the largest and from all corners of the country, to offer a modern instant payment solution, With the launch drawing near, we urge financial institutions and their industry partners to move full steam ahead with preparations to join the FedNow Service.”

The press release stated the U.S. Treasury and various financial institutions have declared their intent to use FedNow after the launch. Currently, over 120 organizations participate in the FedNow pilot program, including companies such as $Bank of America(BAC)$ $Block(SQ)$ $Exchange Bankshares, Inc.(EXCH)$

2.Why is the Federal Reserve Bank developing FedNow?

Instant payments are one of the fastest-growing forms of digital payments, with a projected compound annual growth rate of 23.6 percent from 2020 to 2025. Central banks in more than 50 countries have already implemented instant payment networks that support the immediate posting and settlement of funds.

U.S. consumers and corporations can already access instant payments via Zelle and the RTP® Network; these are both privately held systems, owned and operated by Early Warning Services, LLC and The Clearing House, respectively. The Fed first began to explore the possibility of introducing a centrally owned and operated instant payments network in 2013 and formed the Faster Payments Task Force (FPTF) in 2015 to identify opportunities to implement instant payments.

In its final report, published in 2017, the FPTF overwhelmingly ruled in favor of establishing a network and issued recommendations to support successful implementation. In 2018, the U.S. Treasury offered its official support for an instant payments network, and in 2019, the Federal Reserve Board announced that it would begin developing the FedNow Service.

Ultimately, the Fed is developing FedNow in the interest of enabling financial institutions of all sizes across the U.S. to provide safe and efficient instant payment services to customers.

3.What does a FedNow payments flow look like?

A FedNow payments flow is similar to any other instant payments flow, starting with the parties involved: a payer, the payer’s financial institution, the FedNow network, a payee and the payee’s financial institution.

4.Will FedNow Enable Greater Deposit Flight from Troubled Banks?

The failures of Silvergate Bank, Silicon Valley Bank, Signature Bank, and the current struggles of First Republic and Pacific West Bank have seen bank deposits flee to the perceived safety of large banks. In the chart below, one can see the flight of deposits from small banks into large.

To make matters worse for banks, rising interest rates and easily accessible higher yielding alternatives exist like money market funds (MMF) or US Treasury ETFs. These alternatives are now a few thumb taps and swipes away from depositors, making the near-zero rate of return on bank deposits much less attractive for many consumers and businesses. In the chart below one can see the drop in bank deposits and increase in MMFs.

Here we can see the significant premium 3-month US Treasury yields command over bank certificates of deposit (CDs).

These issues, plus the new FedNow service which is set to begin trial runs in July, could represent an uphill battle for banks to retain deposits. The Federal Reserve’s new FedNow program will allow bank customers at 10,000 financial institutions to instantaneously transfer funds in and out of bank accounts on a 24/7/365 basis. This is probably the biggest innovation since mobile banking and investment apps and will allow customers greater access to their money than ever before.

“We reiterate our view that FedNow will represent a material change in how consumers use electronic money,” said TD Cowen analyst Jaret Seiberg in a recent Marketwatch report. FedNow may accelerate the ability of depositors to remove money from banks accounts and reroute it to higher yield alternatives. With banks under increasing pressure to stem outflows, these trends could add to their troubles, especially if banks are forced to sell even more assets which currently have unrealized losses.

VIA:

https://www.frbservices.org/financial-services/fednow

https://www.aciworldwide.com/fednow

https://www.advisorperspectives.com/commentaries/2023/03/29/will-fednow-enable-greater-deposit-flight-from-troubled-banks