Thursday, March 23, 2023

Does FedNow mean quicker bank runs?

The Federal Reserve is introducing its first instant retail payments system this summer, FedNow. Retail is a catch-all term for small payments made by (and to) regular folks like you and me. Think bill payments, transfers to friends and family, salary, and more. Up till now, the retail crowd hasn't had a Fed-provided instant payments options.

The U.S. is also in the middle of a banking crisis.

Putting a banking crisis together with instant payments, some commentators fear that future U.S. bank runs will proceed even quicker than before.

I don't think so.

A bit of background. Up till now, the Fed's flagship retail payments system has been FedACH. (ACH stands for automated clearinghouse). FedACH is not a real-time system. Historically it has taken a day or two for ACH payments to settle, but even with the recent addition of a "same-day" ACH option, it still takes several hours for funds to land in a recipient's account.

Now that the Fed is building an instant system, the fear is that banking customers can presumably execute a run on their banks much faster than before.

One of the big gaps in this argument is that retail customers are generally sticky. The types of customers most likely to run on their bank are large depositors such as corporations, funds, and wealthy individuals. But these actors have always had Fedwire at their disposal, the Fed's large-value payments system. And Fedwire is already a real-time system; the moment a transaction request is sent to Fedwire, it gets settled. 

So the addition of FedNow to the arsenal of Fed instant payments systems doesn't add much in terms of runnability. Large U.S. depositors have always been able to execute rapid bank exits.

Fedwire closes at nights and on the weekends, though, whereas FedNow will be open 365/24/7. Won't this offer more temporal scope for runs?

I still don't think so. As a payments option for retail customers, FedNow payments will likely be capped, say at $25,000. Limits on the weekend and at night will likely be even lower than that. This is how other real-time systems like UK's Faster Payments have been managed, the idea being to cut down on fraud. If you're a large business with millions deposited in the banking system, a tiny $25,000 aperture isn't going to cut it.

So long story short, FedNow won't speed up bank runs. And that's because it won't serve as an additional exit for the most run-prone bank depositors, who already have Fedwire at their disposal.

The threat of a weekend or midnight bank run only begins when Fedwire itself starts to operate on a 365/24/7 basis. That's just a matter of time. India's large value payments system switched over in 2020; and the U.S. is generally a few years behind India when it comes to payments.