When Federal Reserve Chairman Jerome Powell is in the news, it’s primarily for his clash with President Trump over interest rates. While vociferously defending the independence of the Fed in the face of political demands for lower interest rates, he has been less critical of the Fed’s meddling in other markets. In fact, the Fed recently announced its new FedNow Service, a real-time settlement program that has the potential to override a thriving electronic payments sector where private companies have invested heavily in electronic payments and already provide these services in a fiercely competitive setting.
The digital economy and the ability to transact online have brought fundamental changes to financial institutions and the way that settlements are handled. Prior to electronic transfers, some of these transactions could be cumbersome, with banks and other institutions required to clear thousands of transactions, primarily by checks. To facilitate this process, the Federal Reserve and some in the private sector created the Automated Clearing House (ACH) which eliminated the need for paper checks in a host of transactions, from direct deposits for paychecks to recurring payments such as mortgages and utility bills. Over time this was also expanded to handle one-time, single transactions as well. Currently, the Federal Reserve along with the privately run Electronic Payments Network are ACH operators. The size of the operations is substantial: In 2018 the ACH network cleared over 23 billion payments totaling more than $50 trillion.
Yet beyond the ACH, private payments networks exist, typically to clear debit and credit card transactions. Competing networks are available and consumers and retailers can choose among several competing payment systems. The market continues to grow at a substantial pace: Visa, MasterCard, American Express, and other card networks compete vigorously among themselves and with other payment networks (STAR, NYCE, and so forth) and online networks such as PayPal and Stripe.
And it’s not as if these private networks have not responded to the demand for real-time payments. As paperless and digital transactions have outpaced traditional checking transactions, the market responded. In 2017 the Clearing House—a newly created group of banks and tech companies—launched its Real-Time Payment network. Adoption has been quick, and by the end of 2019, more than half of the demand deposit accounts in the United States are projected to be able to send and receive real time transactions through this private network. Nonetheless, the Fed is moving forward with its FedNow Service, which will affect everything from depository institutions to payment networks to nonbank service providers.
The proposed FedNow Service raises several concerns. There are real questions about interoperability and the Fed’s impact on the existing ecosystem for electronic payments. Introducing a new electronic payments system controlled by the Fed may require current networks to retool and adapt to the Fed’s payment system rather than continuing to develop their own. And lacking the same competitive pressures as private networks, it is not obvious that the priority on innovation will continue.
This may be exacerbated should the Payments Modernization Act become law. Introduced by Sen. Chris Van Hollen (D-Md.) and co-sponsored by Sen. Elizabeth Warren (D-Mass.), the bill would put further pressure on the Fed by adding new mandates on how the system would operate. Once specific concern is a ban on the use of volume discounts, which would make it almost impossible for the Fed to provide services based at market-rates, as required by the Monetary Control Act of 1980.
Questions surrounding the FedNow Service demonstrate the important need for cost-benefit analysis when promulgating new regulations. A careful assessment of proposed regulations helps ensure that new regulations do more good than harm. To that end, the Office of Management and Budget issued a memorandum last spring suggesting that OMB can flag any major rule—from any agency—for further analysis under the Congressional Review Act. Given the potential impact of FedNow Service on the thriving market for electronic payments, the Federal Reserve’s new rule is ripe for this new call for cost-benefit analysis.
From an economic perspective, government intervention is a response to a market failure that yields suboptimal outcomes. Yet with respect to real-time payments, there is little evidence of a market failure that needs to be solved. Private payments systems have evolved to expedite digital commerce and electronic transfers while expanding the relevant size of the market for all participants. Sound policy should promote such innovations and expansions, not compete with them through new public programs.
