What is FedNow?
Introduction
FedNow is an instant payments system that the Federal Reserve launched in July 2023. Known formally as a real-time gross settlement system, FedNow allows participating financial institutions to provide their customers (businesses and individuals, alike) with the ability to conduct instant payments 24 hours a day, 7 days a week, and 365 days a year. Notably, FedNow is not mandatory. It is currently up to banks and other financial institutions whether they want to join the network and offer its services to their customers.
How does it work?
In the simplest of terms, if we think of money as water, then FedNow is the plumbing that gets that money where it needs to be. To have their money routed through this plumbing, customers need to have an account with a financial institution connected to the FedNow network.
In more technical terms, if a customer of a participating financial institution initiates a payment, then that institution will send an ISO 20022 message to FedNow through the Fedline network. From there, FedNow validates the payment and then transfers it to the recipient’s bank. After that, the FedNow system sends debit and credit signals to both parties.
FedNow vs. CBDCs: What’s the Difference?
A CBDC is a digital national currency that is a direct liability of a country’s central bank. Generally speaking, most conversations about CBDCs focus on what is technically known as a retail CBDC designed to be used by citizens for making everyday purchases. In contrast, FedNow is an instant payments system—a sort of update to Fedwire and the Automated Clearinghouse (ACH)—created by the Federal Reserve for banks to send money to one another. Unlike what would occur with a retail CBDC, individuals do not have direct access to FedNow. Furthermore, a CBDC is money whereas FedNow is the payments system that gets money where it needs to go.
Similarities to a CBDC
Although FedNow is not a CBDC, its functions do resemble the functions of what is technically known as a wholesale CBDC. Both FedNow and a wholesale CBDC are restricted to financial institutions for use during interbank settlement. In fact, officials from the Federal Reserve have said FedNow likely eliminated the need for a CBDC. For example, Federal Reserve Governo Michelle Bowman said, “My expectation is that FedNow addresses the issues that some have raised about the need for a CBDC.”
Will FedNow Create a Digital Currency?
While it’s certainly possible that FedNow could be expanded in the future to take on new initiatives, there is nothing that currently suggests FedNow would somehow create or be turned into a CBDC.
Legitimate FedNow Concerns
While FedNow is not a CBDC, that’s not to say there are no legitimate concerns with FedNow. The Federal Reserve announced its intent to launch FedNow in 2019—two years after the company known as the Clearing House introduced the Real-Time Payments Network. In moving forward with FedNow despite this development, the Federal Reserve made two errors. First, due to its legal privileges, it undermined the case for market-based solutions by occupying the payments space as both a regulator and now a competitor. Second, the Federal Reserve failed to address what market failure existed to justify its intervention in the first place. After the creation of the Real-Time Payments Network in 2017, the Federal Reserve could no longer argue that there was a market failure that the government must correct.
The problems do not end there. Rather than launch an entirely new system, the Federal Reserve could have instead simply expanded the operating hours of Fedwire and the National Settlement System to run 24 hours a week, 7 days a week, and 365 days a year. Doing so would not have created instant payments, but it would have cleared up the lags created by off-hours, weekends, and holidays. Yet, the Federal Reserve seems to have chosen to ignore this option and walk over the private sector with the creation of FedNow.
