FedNow’s potential pitfalls for B2B payments

In the next six to eight months, the Federal Reserve will start rolling out FedNow, its newest instant payment service. Unlike its pending CBDC project, FedNow services will use the existing financial infrastructure to help FIs enable real-time payments (RTP).  

Right now, over a hundred banks and payment processors are participating in FedNow's pilot program. Upon release, the Fed’s country-wide RTP network initiative is expected to become one of the biggest payment and clearance settlement systems in the world.

Poised to play a pivotal role in the future of payment transactions, the initial rollout, as with any new tech, has a few wrinkles that need ironing out. Tearsheet sat with payments solution veteran Balaji Devarasetty, CIO of Paya, to discuss the benefits and potential pitfalls of implementing FedNow's RTP for B2B clients. In addition, Devarasetty shared how Paya, a B2B payments solution provider, is actively planning for the upcoming rollout.

“FedNow is an alternative to other real-time payment solutions such as ACH, credit cards, and debit cards. The Federal Reserve is creating an internet-based infrastructure using ISO 2022, an international standard for money transmission,” says Devarasetty.

According to him, FedNow is an alternative to Automated Clearing House (ACH), which has been around since the early 70s. ACH is currently the preferred B2B payment method because of its cost-effectiveness. Although it moves close to $50 trillion annually within the United States, the system is over 50 years old. 

In essence, ACH is a ‘file-based’ system - modeled after paper-based filing systems - which explains why it takes three to five working days to process transactions. It is not instantaneous and is thus considered cumbersome.

The benefits of FedNow services

FedNow would address the pitfalls of a file-based system by incorporating the clearing functionality into the payments settling process. Using the existing traditional payment rails, it aims to increase accessibility and efficiency in payment transactions. 

Its mission is to boost the economy by enabling FIs of every size and in every town in the US to offer secure and effective instant payment services.  

Instant transactions will help businesses manage their cash flow, and consumers will benefit in times of emergency expenses, amongst other things. But most compellingly, it will operate 365 days of the year, including on weekends and bank holidays. 

FedNow’s B2B pain points

In reality, however, execution can make or break the perfect tech solution. Thinking months ahead, Devarasetty identifies the potential problems around implementing FedNow services in B2B transactions.  

The first issue is that only a few banks are currently involved in the FedNow pilot program. Only 121 banks have joined out of the 4,236 FDIC-insured commercial banks in the US. That means adoption could take some time – Devarasetty suggests it could take well over two years post-launch to onboard all the banks into the new system.  

The second issue is that FedNow will only roll out to registered banks. In other words, merchants, consumers, or non-bank payment service providers will have to access the service through bank partnerships. And that means fintechs will have to jump through technical hoops to enable FedNow as a payment alternative for their customers.  

Finally, the most challenging aspect of FedNow for B2B payment providers is the initial $100,000 credit limit set by the Fed, adjustable up to $500,000. “Today, when you look at B2B payments, the average transaction is about $1,500. And then our [Paya] highest tickets are as high as a million dollars per transaction,” says Devarasetty.

Having thought through some of these issues, reserve banks will offer a liquidity management tool alongside the FedNow Service. This will allow non-banks and consumers to transfer funds instantly amongst each other. In addition they will also waive customer credit transfer fees for the year 2023. 

Paya’s path to enabling FedNow services

Paya started as a spin-off of Sage Payments. As the company grew, it expanded its services and built its own ACH network. It now works with software providers to offer payment solutions to various professional services, including nonprofits, and the healthcare sectors. “Last but not least, we are a dominant player in government payments. We serve about 2000 municipalities, cities, and townships,” says Devarasetty. 

Paya processes over a billion dollars in payments for the government sector. Therefore, the company is compelled to provide FedNow as a payment alternative to its long list of clients.

“So we are right now evaluating what we need infrastructure-wise. Do we want to go direct? Do we want to go through a partner?” says Devarati.

Looking six to eight months into the future, Paya is exercising caution, careful not to jump head-first into the race. It is working closely with its current banking partners and evaluating whether to partner with another bank from the pilot program, to first learn how the new system works, before setting out to build. 

When it comes to enabling FedNow payments, the company aims to be a very 'fast follower,' in an effort to avoid the blows often absorbed by first movers.  

In closing, when considering the mandatory nature of FedNow’s rollout in 2023, it seems fintech companies that plan ahead and adapt to the new changes will continue to thrive in the payments space.