Fintech Predictions Part II — Real Time Payments

What the highly anticipated FedNow launch means and areas of opportunity & challenges

Introducing RTP & FedNow

For the first time in 40 years (since ACH), an exciting new development is happening in the payments sphere: the US is launching instant payment rails!

In 2017, The Clearing House, an association owned by the largest commercial banks, created the first instant payment rails called the Real Time Payments (RTP) network. This July, another rail by the Fed Reserve is launching after its pilot, called FedNow.

About 80 countries have already implemented real time rails and the US is finally catching up to make instant payments a reality. Recent successes include Brazil’s PIX, which was launched in 2020 and is currently used by over 70% of the population, as well as India’s UPI, which was launched in 2016 and now has over 100 million monthly active users.

In the US so far, we’ve made workarounds to achieve ‘instant payments’ such as debit push payments through card networks or Same Day ACH. Now, with the creation of these two rails, financial institutions can send or receive payments at any time, 24/7, year-round.

The benefits of instant payments

Instant payments will benefit all stakeholders in the ecosystem. Consumers can gain better flexibility and transparency into their finances and payment statuses, businesses achieve smoother cash flow, and financial institutions can further service their customers’ needs.

1. 24/7 access — The RTP network is live and operates 24/7, year-round, which allows financial institutions to send or receive payments at any time, compared to standard ACH batch processing that takes 3–5 days.
2. Financial inclusion — Making instant payments technology accessible to a wider audience, including smaller community banks, will increase access and affordability for all businesses and individuals. In comparison to wires (up to $50), credit card (~3%), ACH transfers ($0.40), and checks (~$2 — $4), an instant credit transfer sent $0.045 per transaction for financial institutions across RTP and FedNow.
3. Payment Certainty — The irrevocable nature of sending a payment is a double edged sword. Not being able to recall a payment once authorized means that parties won’t have to deal with the inconveniences of NSF errors or chargebacks.
4. Data — Both rails conform to the ISO 20022, a globally accepted messaging standardization approach. Upgrading to ISO 20022 allows more flexible and detailed messaging functionality, leading to better interoperability across countries’ banks given improved data, insights, and trust for use cases such as KYC or compliance.

A deeper look at RTP and FedNow

While RTP has been known to target larger banks and FedNow for smaller financial institutions, both are similar in nature with a few varying differences:

1. Irreversible, real time funds: Both RTP and FedNow are real-time and irreversible. Within seconds of a sender initiating a transaction, it will be settled and cleared. The RTP network and FedNow are credit push only, in that the person making the payment instructs the financial institution to make the payment. However, FedNow is currently working through Request for Payment (RFP) features which can allow a business to present a bill through a customer’s mobile banking app to approve a payment in one step. This would be a huge unlock for instant bill pay services.
2. Pricing and limits: The credit transfer limit on the RTP network is currently at $1 million and costs $0.045/transfer (ACH typically costs $0.20–$1.50/transfer). In contrast, FedNow Service’s initial credit transfer transaction value limit is $500,000 with the default limit at $100,000 (The Fed will evaluate on an ongoing basis). Pricing for FedNow is $0.045/transfer, $0.01 for a request for payment, and $25 monthly participation fee.
3. Funding of Accounts/Operations: RTP is settled through a pre-funded account at the Fed that is owned by all the participating financial institutions, making instantaneous transactions through sub-ledgers and a sufficient sender balance. Unlike RTP, FedNow has settlement occurring in a financial institution’s master account, allowing for earning interest and access to borrowing for liquidity needs. The Fed has also announced providing a Liquidity Management Tool and fraud prevention tools that all participants can use.

Challenges for real time payments

Given the recent launch, there are still some open questions around how to support instant payments.

Future interoperability will need to be established. Since banks are typically connected to one or the other, the American Bankers Association (ABA) asked the Fed to strive towards achieving technical interoperability with TCH’s RTP Network. In the US, there are two different types of interoperability: message exchange interoperability and message routing interoperability. With message exchange interoperability you can initiate a payment without the receiving financial institution being on the same service. But for message routing interoperability, both senders and receivers of a payment must be on the same service. RTP and FedNow only have the latter in need of being on the same service. To send an RTP or payment, the receiver will need to be on RTP.

There is an opportunity to build an operating standard around real time payments. To originate an RTP transaction, you need a bank account, account number and routing number, which can be worse user experience than a card. Rules and guidelines around applying payments to customer accounts still need to be established (i.e. applying bill payments to customers’ accounts in a set period of time). Some FIs have concerns around overhead costs in supporting real time payments and infrastructure needed for any additional compliance and fraud monitoring.

RTP’s adoption to date

RTP network recently turned 5 years old last November (2022). The network currently reaches 62% of demand deposit accounts in the US with over 300 participating banks and credit unions (TCH). In terms of volumes transacted through RTP, the share is still multitudes lower compared to ACH. For context, in Q4 of 2022, RTP did 49 million transactions for $22.7 billion in value while ACH did 7.6 billion in transactions for $19.4 trillion in value (Nacha).

Integration into RTP has taken some vendors over a year and large investment (potentially ~$1M). TCH works with over 20 technology solutions providers, including Jack Henry & Associates, FIS, Fiserv, Finastra, and others to provide technical access to the RTP network (TCH) However, with the launch of FedNow, which is geared more towards smaller banks, adoption could hopefully increase, along with interoperability between the rails.

Use Cases & Opportunities

At Montage, we are looking to partner with entrepreneurs at the forefront of technological & market trends. With the adoption of real time payments, we’re excited to support new use cases and products in the following categories:

1) Consumer superapps

Real-time payments could enable the next generation of consumer financial super-apps. Imagine having a centralized bank or wallet, allowing you to better program and manage various financial accounts with others. For instance:

• Wage access — During the second quarter of 2022, instant payroll accounted for 15% of the total volume on RTP and grew 104% compared to the prior quarter. Faster payments could improve on-demand wage access, such as for gig workers to cash out to pay their bills at shorter cycles, or employees advancing their salaries.
• Bill Payments — Traditionally, credit card cycles have been in 30 day payments, causing single lump sum payments for higher stress, outstanding late fees and a drag on FICO scores. With instant payments, consumer behavior can shift towards making daily payments for better spending habits, detailed insights, and financial wellness.
• Investing — Next gen investing apps can help consumers with automated savings, liquidity, and alternative investing. Instant access to funds for investing can unlock better trading and liquidity in the market.
• Multiplayer — We see finances become increasingly social and interconnected, where consumers can split payments on transactions (ie group purchases), send payments abroad (remittances), and even group invest (ie joint accounts).

2) Merchant card alternatives

Card payments have increasingly become expensive for merchants and businesses to manage, yet consumers love the convenience and rewards of credit cards. We’ve seen a lot of interest from merchants in potentially adopting bank payments from consumers for high AOV transactions or recurring subscriptions, with the hopes of providing cost savings and potentially higher authorization rate. At the same time, consumers will need to be incentivized to pay by bank over card in the US. We expect to see a few players in the space offer pay by bank at checkout as an alternative payment option and embed account payments alongside BNP and wallets. In addition, given the plethora of payment options, orchestration layers that allow companies to aggregate, customize, and optimize successful payments will be important.

3) B2B infrastructure for real-time transactions

Historically, B2B transactions have still relied on slow moving checks and we’ve just started to see an influx of next-gen AP/AR solutions. Now, with RTP and FedNow’s ability to move rich data via ISO 20022, requests for payments can include much more relevant information. A transaction can contain actionable insights — confirmation of payment, improved control over payments timing, liquidity management, instant bill payments, and remittance data availability.

A business can send detailed billing information directly to a customer for them to approve and send the payment from their banking app in a single step. The lure of having access to funds immediately may incentivize businesses to transition from check or ACH to RTP/FedNow. There is a big opportunity for providers to build a better payment and software experience for businesses.

4) Fraud prevention

Fraudsters have become more sophisticated in recent years. Solutions addressing fraudulent transactions (false claims, modified payments, account takeovers) will need to be strengthened. In particular, real time payments have seen a rise in Authorized Push Payment (APP) scams, where fraudsters deceive users to send a payment. The UK recently saw a huge jump in losses to APP fraud, which overtook card fraud for the first time in 2021 (Finextra). P2P payments platforms like Zelle have notoriously battled scams and are in need of enhanced protocols or better platforms. We see a new generation of solutions helping fintechs verify customers, reject bad actors, and enable real-time collaboration between FIs and government bodies.

If you are building in these spaces, please reach out! Our team is eager to meet you — email us at connie@montageventures.com, matt@montageventures.com, nia@montageventures.com