As FedNow, the second real-time payment rail, goes live, we are closely tracking the changing payment landscape in the US. This blog covers the changing market dynamics as well as areas of investment opportunity that we are excited about at Headline. Headline has invested in multiple payment companies including Pismo, Flutterwave, and Azimo.
As a consumer, how often do you wish you could instantly transfer money to a recipient, say when signing a lease? How often do you need faster access to your wages after working a shift? Consumers are conditioned to have instant access to essentially anything, and instant access to money is no different. As a vendor, do you wish you could get paid faster for goods sold? And when it comes to paying out a supplier, do you wait as long as possible until you fulfill the AP request in order to keep cash in your accounts? As a business owner, liquidity constraints are only exasperated by the time it takes to clear and settle a payment. With the rise and adoption of real-time payments across financial institutions (FIs), the speed and manner in which consumers and businesses move and access money are poised to change significantly.
What are real-time payments?
Real-time payments are payments that are instantly cleared and settled (literally seconds), can transact 24/7/365, and are guaranteed and final payments (accounts have to be pre-funded before transacting). Real-time payment rails have been live and operating with significant success in numerous countries for over a decade now (PIX in Brazil, UPI in India). In the US, these are the first payment innovations in 50 years, hence significant weight (and excitement) is being placed on the change they will drive to money movement across business and consumer use cases.
Although the US has had a rail live since 2017, operated by The Clearing House (TCH), the launch of FedNow will bring about a new rail for FIs to tap into, and is expected to significantly accelerate adoption.
TCH was the first rail to go live and is operated by a consortium of the largest banks in the US (e.g., JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup). FedNow will be the second of the two real-time payment rails in the US, built and operated by the Federal Reserve. This two-rail system is a fascinating reflection of the uniqueness (and complexity) of the US financial system and the public-private sector dynamics. For example, regional banks and credit unions (CUs) did not like that TCH rail was “owned” by this part of the financial ecosystem. Hence, as they already feel that they are in competition with the “big guys”, they have mainly waited to adopt real-time payments until the FedNow launch.
This duality between the banking sector impacts the adoption and utilization of these real-time payment rails, as where and how consumers and businesses bank will directly correlate to their ability to access these rails. In the US, ~40% of assets are controlled by the top four banks, but everyday businesses still heavily rely on regional banks and CUs (Federal Reserve System's Quarterly Banking Profile). As these two factions have historically not been the most cooperative with each other, it will be interesting to see how adoption of these rails unfold, eventual interoperability, and when institutions decide to launch abilities to both send and receive real-time payments. Interoperability is a significant concern between FedNow and TCH, as it is still unclear if FIs will utilize one or both rails, and how adoption will play out eventually.
Why is it important and will it change?
Real-time payments hold significant potential to change how and when money is being moved between businesses and consumers. Below I’ve outlined a few use cases that are starting to see more traction and are expected to see further adoption. These are instances in which keeping cash in an account significantly benefits the liquidity position. As a consumer, you may have already used real-time payments if you’ve defunded your Venmo account using instant payout. We believe we will first see consumer and SMB adoption accelerating as consumers need faster access to money and are willing to pay for that access.
Additional use cases that are rapidly emerging include:
- AP as merchants/buyers look to maximize how long they can keep cash in their accounts until they have to pay out suppliers/vendors (so businesses do not have to payout a vendor until day the payment is due, and can use cash for other needs) / AR given payments arrive faster and without delayed clawback provisions, essentially minimizing collection risk
- “Earned” wage access/ gig economy payouts (as employers look to attract/retain employees, easily accessing wages earned can attract talent); however this requires payroll provider adoption of rails and that the employees' banking institution can accept (see below)
- Immediate payouts from insurance, real estate, and other large transaction sizes to remove reliance on wire or as a consumer being able to send and settle these (even on the weekend)
- Lending (both direct and indirect via embedded solutions) as the ability to draw capital at the exact moment needed can save additional fees and make the process more efficient
Barriers to adoption and what could go wrong:
While it’s easy for us on the investing side to be excited about innovation and new applications built on top of it, there still seems to be significant apprehension from those within FIs actually responsible for implementing real-time payments. This seemed to be mainly driven by 3 areas of concern:
1) New forms of fraud
While there are varying perspectives on the potential impact of fraud rates within a FI due to real-time payments, many have concerns that fraud will increase as these payments are final, and can not be reversed. My hypothesis is in reality there will just be a shifting of fraud/scamming techniques. This is in part due to the structure of payment flow within the rails. Real-time payments follow a credit push model, meaning the payer initiates the sending of the money to the payee, and the payer has complete visibility into the transaction. Because of this, we may see an increase in ATO (account takeover) attempts and realized fraud as fraudsters either take over a send account and send money to themselves or take over a recipient account and try to convince real accounts to transfer money to the breached account.
2) Not being ready for the launch (be that technologically, personnel, etc)
Another risk to adoption is the ability for existing banking cores to accept/send real-time payments (i.e. plug into the rails). At the time of writing, ~250 banks in the US can receive real-time payments through The Clearing House, but only ~30 can send them. The readiness appears to vary quite a bit between cores, with sentiment suggesting that Q2 and Fiserv are very much at the forefront of being ready, or already supported. This is both a barrier to adoption, as well as a chicken-egg problem for users, as some transactions could be sent from a FI that supports real-time payments but the recipient may not bank with an institution that has the capacity to accept them.
For banks and FIs to access these rails they can connect directly as an institution (technical expertise required in-house) or use a 3rd party service provider (Fiserv NOW product). Regardless, in a competitive banking environment being able to offer and enable real-time payments as a way to compete and differentiate yourself as a banking provider seems to be the common opportunistic narrative.
3) FIs concerns about revenue degradation from rail adoption
Some institutions are concerned that adopting FedNow/TCH will eat into existing revenue streams from other payment methods (e.g., wire, ACH, interchange). Concerns about degradation in revenue should be looked at from a different lens: the make-up of payment revenue will change, and in many cases perhaps grow significantly, and increased efficiencies within a business unit may be a bi-product. This has been the case in other countries where real-time payment adoption is more mature. Furthermore, there are limits on the size of a transaction ($1M via TCH) so payments of those sizes will still flow through alternative existing rails, further supporting the thesis that there will be a shift in revenue makeup not a degradation of it.
The slow adoption of TCH in the US to date has resulted in uncertainty around which predominant use cases will emerge for real-time payments, resulting in relatively low rates of innovation and company build on these new rails. Given that the rails are being built by major governing bodies (FedNow)/consortium of institutions (TCH), the infrastructure layer has proven to be a commodity across payments, as well as in other real-time payment rails in other geographies. We are interested in the applications that will be built on top as well as the orchestration layer. We think adoption across use cases will also vary as businesses weigh the cost of access to capital – i.e. is it worth to pay XX for real-time vs wait XX days and only pay XX for ACH/wire, and this will in turn dictate the business built around real-time payments. We believe that as FedNow launches and more institutions sign up to offer these rails, the rate of innovation will change and we will see more companies building to serve the needs of real-time payments.
The main areas of opportunity we’re seeing in the real-time payments space are:
- Fraud detection and AML solutions: given that there will be “faster” fraud, how do we detect and prevent this as well as run a payment, its sender, and recipient through AML screening
- Companies building here include: Incognia that uses device ID for onboarding + monitoring, Nivelo which handles instant risk monitoring coupled with end-to-end payments orchestration, and Effectiv who is building a modular wholistic risk infrastructure stack
- Value added services utilizing the nonpayment messages: real-time payments are ‘chatty’, as a significant amount of data can be exchanged between parties (e.g., real-time reconciliation, liquidity management)
- Connectivity layer from banks/FIs into FedNow/TCH (like Trice) to enable other institutions to offer real-time payments
- Crossborder real-time payments would be a large opportunity to unlock, however this is probably something that will take at least another few years in the US (other countries are already making progress). Companies building here: Payall and Buckzy
If you’re building anything in this space, whether in the categories mentioned or something else related to real-time payments, please reach out to firstname.lastname@example.org. We'd love to connect and learn more!