And now, the hard part of the Fed’s path to real-time payments

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Small institutions waited years to find out whether the Federal Reserve would build its own real-time payment system. Now that the central bank has finally announced its plans to move forward, though, the real wait is just starting.

After six years of indecision, the U.S. central bank announced plans Monday to build a real-time payment system that is meant to eventually link more than 10,000 banks and credit unions across the country.

The Fed’s slow process was a reflection of the competing demands it faced, as well as the significance of its decision. Kansas City Fed President Esther George compared Monday’s action to the birth in the 1970s of the automated clearing house network, which now accounts for roughly 15% of all U.S. payments.

“The last time the Fed offered a new service, certainly of this magnitude, would have been some 40 years ago,” she said during a question-and-answer session that was webcast by the Fed.

“This is a very, very momentous decision,” added Fed Gov. Lael Brainard.

But the Fed also said that it does not expect its real-time payment service to be available until 2023 or 2024, which means that the central bank is now back on the clock.

Below are five takeaways from the Fed’s long-awaited announcement.

The dream of connecting every bank is still a long way off.

Two years ago, a task force convened by the Fed established a goal that by 2020, everyone in the U.S. should be able to receive fast, secure payments.

It is not clear whether that goal might have been achieved if the Fed had elected to defer to the private sector, rather than making the choice it announced Monday.

The Clearing House, the big bank-owned payments company that launched a real-time system in 2017, noted Monday that it currently reaches more than 51% of demand deposit accounts in the country. But that reach is mostly a result of the megabanks’ large market share. Many smaller banks and credit unions have been reluctant to enroll in the private-sector-led service.

What is clear is that after the Fed’s announcement, the task force’s 2020 goal will not be met. And even 2023 seems unlikely.

While the Fed expects its real-time service to be available in four or five years, officials said that achieving nationwide reach will likely take longer.

The extended timeline drew barbs that the central bank’s service, which is being dubbed “FedNow,” should instead be called “Fed Five Years from Now.”

Interoperability will be hard to achieve.

The Clearing House has warned in recent months that its system is not well suited to interoperate with another real-time payment network. And on Monday the Fed was noncommittal about the likelihood that the two systems will work well with each other.

“Such interoperability is an important goal that we will pursue as standards, technology and industry practices change over time,” Brainard said in a speech, “although it is not yet clear whether it will be an initial feature.”

Cary Whaley, who works on payments policy at the Independent Community Bankers of America, said that achieving interoperability will take time. But he argued that progress can occur in incremental steps if both the Fed and The Clearing House are willing to work together.

The ICBA has long advocated the Fed operating its own real-time payment system as a counterweight to the big banks' offering.

“I think at the end of the day it’s about having choice,” said ICBA President and CEO Rebeca Romero Rainey. “It’s about having equal access to the system.”

The Fed provided few details about payment security.

The central bank said Monday that the existence of multiple real-time services will allow banks to establish backup connections in case of an operational outage.

The central bank also said that it will be in a position to promote the development and implementation of industrywide fraud mitigation standards.

But officials said little about how the Fed’s real-time system will address payment security.

A system with proper security features would eliminate the need for consumers to remember passwords when they make transactions across the internet, said Stephen Lange Ranzini, the CEO of University Bank in Ann Arbor, Mich.

Ranzini, a former member of a Fed-convened task force on payment security, called on the central bank to build a system where all data is encrypted end to end at all times. He also said that all access to data should be tightly controlled based on authentication, role, authority and the need to know.

There is still no requirement that banks accept real-time payments.

In many other countries, central banks have forced the adoption of real-time payments by imposing regulatory mandates on their nations’ banks. The Fed chose not to do this.

Brainard said Monday that there are constraints on the Fed’s legal authority that other central banks do not face.

“Historically, the way that the Fed has brought accessibility and safety and efficiency to the payment system is by operating alongside of the private sector,” she said.

But Aaron Klein, policy director of the Center on Regulation and Markets at the Brookings Institution, challenged the notion that the Fed lacks the legal authority to mandate real-time payments.

He criticized the Fed’s announcement Monday, saying that low-income consumers will spend billions of dollars on bank overdraft fees and payday loans over the next five years as a result of the persistent time lag between when payments are initiated and when they are completed.

“The banks that celebrate today’s decision by the Fed are celebrating overdraft revenue,” Klein said.

The Fed expects innovation on top of its system.

While the central bank made clear Monday that only depository institutions will have access to its real-time payment service, the announcement still drew applause from Big Tech.

“This decision is a giant step forward, and history will look back at today’s announcement as the generation’s true payment milestone,” Brian Peters, executive director of a trade group whose members include Amazon, Apple, Google, PayPal, Square and Stripe, said in an email.

Fed officials described their still-to-be-built payment system as infrastructure, on top of which private-sector companies will be able to innovate.

“The FedNow service will provide a neutral foundation for innovation and competition,” Brainard said.

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