FedNow, the U.S. Federal Reserve’s instant payment service went live in July of 2023. Now, 15 months later, adoption rates have been unpredictably slow, especially when it comes to banks that are able to send FedNow payments.

Before considering the challenges behind sending and receiving FedNow payments, here’s a look at some of the data behind adoption rates:

• Only around 900 financial institutions have connected to the FedNow network, a fraction of the 8,000 firms the Fed stated as its goal.
• Close to 60% of the financial institutions on board with FedNow can receive payments, while only 40% of firms have signed up to send payments.
• Banks connected to the FedNow network range in size from under $500 million to more than $3 trillion in assets.
• Of the FedNow participants, 78% are community banks and credit unions.

There are a handful of reasons why firms might be hesitant to participate in FedNow. The service faces competition with The Clearing House’s RTP platform, which was launched well before FedNow went live. Additionally, banks may be holding back because of the fees that come with participating in FedNow. Banks must pay $25 per month per routing transit number to use the service, plus a $0.045 per credit transfer fee charged to the sender and a $0.01 per RFP message, charged to the requestor. The Fed also charges a liquidity management fee of $1 per transfer.

Another reason firms may be reluctant to join FedNow is that the new payment rail comes with a set of challenges for both sending and receiving payment. Below, I’ve outlined five challenges financial institutions face for accepting FedNow payments, and five challenges they face when receiving FedNow payments, along with strategies to overcome each obstacle.

Challenges in accepting FedNow payments

1. Transaction validation in real time
Firms may have difficulty validating incoming payments instantly, especially considering the need to check for insufficient funds and fraud, plus ensure compliance, all in real time.

To combat this, firms can implement automated validation systems to check the accuracy, authenticity, and compliance of payment transactions in real time. They can also use AI tools for fraud detection to help banks validate transactions without human intervention. Additionally, they should enhance their AML compliance systems to conduct rapid checks.

2. Managing customer disputes
Customer disputes are always a headache when facilitating payments. And with instant payments, customer disputes can be even more of a challenge. That’s because instant payments reduce the time that dispute resolution can take place, since the funds are transferred immediately.

Banks should create dedicated customer service channels and clearly communicate the dispute resolution process to consumers. Additionally, banks should create robust communication procedures with other banks in the FedNow network in order to resolve reversals and other issues quickly.

3. Handling a high volume of payments
If the adoption of FedNow grows, banks will need to process higher volumes of payments as more customers use the new payment rail. This increase could strain legacy systems– especially if they are not optimized for 24/7 processing at high volumes– and ultimately lead to payment delays.

To overcome this, banks should scale their payment processing infrastructure by adopting cloud solutions and ensuring they have sufficient bandwidth to handle high transaction volumes, especially during peak times.

4. Ensuring compliance in real time
Just as they do with ACH payments, banks need to ensure they are complying with regulatory requirements, including KYC, AML, and other regulations. This is an additional challenge with FedNow payments, since the compliance checks and documentation need to be made in real time.

Banks can leverage automation for compliance checks and integrate real-time monitoring tools into their operations to ensure that incoming payments are compliant without delaying the transaction. As with all compliance training, firms should ensure that their compliance officers’ training is up-to-date. Fortunately, there are multiple regtech solutions, including ComplyAdvantage, Trulioo, and Fenergo, available to help.

5. Creating a seamless user experience
In today’s digital age, consumers are not only used to receiving things instantly, they expect it. With instant payments as the standard, any delays or issues in receiving funds could create a poor user experience and tarnish the bank’s brand.

To ensure the best user experience, banks should first invest in a user-friendly interface. Transparent and timely communication is also key. Firms should offer real-time notifications and ensure that customers have easy access to their transaction history.

Challenges in sending FedNow payments

1. Ensuring adequate liquidity
With the recent increased scrutiny on adequate liquidity, it is essential that banks ensure they have enough funds on hand. With instant payments, banks must have sufficient liquidity available at all times, even during weekends and non-business hours.

To overcome this, firms can implement real-time liquidity monitoring systems and use the Federal Reserve’s liquidity management services. Banks should also establish internal controls to maintain and managing their liquidity reserves effectively.

2. Maintaining 24/7 availability
This may be one of the biggest headaches for banks looking to send FedNow payments. Because FedNow operates 24/7, banks need to ensure they have adequate infrastructure and staffing to support continuous operations. This can be a particular headache for smaller institutions, which lack resources to support such uptime.

To keep up with availability requirements, banks can adopt automated processing systems, use cloud-based solutions to keep their operations scalable, and partner with third-party vendors who offer 24/7 payment support. Additionally, firms should conduct regular system maintenance during non-peak hours to ensure they are not disrupting operations.

3. Ensuring fraud and security protection
Just as when receiving instant payments, accepting instant payments does not leave banks much time to identify and stop fraudulent transactions. This increases the risk for loss.

Banks can add a layer of protection by deploying real-time fraud monitoring systems to detect suspicious activities using AI and machine learning. Also, firms can implement advanced consumer authentication methods and mandate ongoing fraud prevention training for staff to further mitigate risks.

4. Managing customer payment errors
With instant payments, there is not much time to correct mistakes. When consumers fat-finger the payment amount or send the funds to the wrong recipient, they lose the opportunity to correct errors. This could not only create customer dissatisfaction, but also lead to financial losses.

Fortunately, there are ways to mitigate such mistakes. Banks can add confirmation steps into the user interface that require users to verify payment details before the transaction is sent for processing. It is equally as important to educate customers about the finality of real-time payments and provide them with a clear process for dealing with errors.

5. Creating interoperability with other payment networks
As with other payment rails, banks need to ensure their systems are compatible across other systems. Banks should create a system that is not only compatible with FedNow, but also with other real-time payment systems, including The Clearing House’s RTP.

To ensure compatibility, banks can invest in unified payment platforms that integrate multiple payment rails. Additionally, firms may find it helpful to participate in industry-standard development efforts to help shape the conversation around compatibility and functionality.

Photo by David Clarke on Unsplash

You’ve likely been following the fallout from Synapse’s bankruptcy earlier this year. BaaS provider Synapse filed for Chapter 11 bankruptcy in April, leaving its clients, including Evolve Bank & Trust and multiple others, unable to verify and manage funds. In all, around $85 million in consumer funds are missing due to discrepancies in Synapse’s records.

Adding to the confusion, the dispute is ongoing in court, and because Synapse is a fintech and is thus unregulated, regulatory bodies are unable to protect consumers, many of whom are still missing their funds.

As a result of this nightmare, the FDIC has advanced a notice of proposed rulemaking for what it is calling Requirements for Custodial Deposit Accounts with Transactional Features and Prompt Payment of Deposit Insurance to Depositors. The regulatory body is currently taking public comment on the rule.

As it currently stands, the rule applies to bank accounts that fit into three categories:

• The account is established for the benefit of beneficial owners
• The account holds commingled deposits of multiple beneficial owners
• A beneficial owner may authorize or direct a transfer through the account holder from the account to a party other than the account holder or beneficial owner

Here are five things banks with accounts that fit these categories should know about potential implications the rule may have on them.

Strengthened recordkeeping requirements

Advanced recordkeeping should already be part of a bank’s routine. However, the proposed rule is specific in its requirements, stipulating that banks working with non-bank entities (as in a BaaS partnership) must maintain accurate records that identify the beneficial owners of custodial deposit accounts that are held on behalf of consumers, which is typical in a BaaS agreement. Maintaining records of custodial accounts will help regulators ensure that deposit insurance can be quickly and accurately provided in the event of a bank failure.

Continuous third-party records access

The proposed rule states that if banks rely on non-bank companies to manage custodial deposits and their records, the bank must have continuous, direct access to records held at the third party organization. This requirement aims to prevent disruptions to operations, as what we saw in the Synapse bankruptcy case earlier this year. Ultimately, if banks have transparent access to third party records, they can help customers maintain access to their funds.

Annual compliance and validation

Under the new rule, FDIC-insured, BaaS-enabled banks will be required to conduct an annual, independent validation to verify that their third party partners are maintaining accurate deposit records. Banks will send the records, which must be accurate and compliant with the FDIC’s standards, to the FDIC and to the bank’s primary federal regulator. The purpose of this stipulation is to ensure consumers are able to access their funds without delays and to increase the reliability of custodial funds arrangements.

Consumer protection and transparency

Consumer protection is the underlying reason behind the new proposed rule. A large piece of this provides clarity about FDIC insurance. As such, BaaS-enabled banks will be expected to ensure that their consumers fully understand the coverage and protections of their deposited funds, particularly when dealing with non-bank custodians​.

Heightened money laundering

The document also emphasizes that banks must exercise strengthened internal controls and anti-money laundering (AML) compliance requirements. Notably, the ruling also emphasizes that banks must ensure that their third-party partners do not facilitate financial crimes.

This week’s proposed rulemaking highlights two truths in financial services. First, the additional requirements can potentially add burdens on banks that are already weighed down by multiple reporting responsibilities. Yesterday, Vice Chairman Travis Hill voiced his concern, saying, “I recognize that certain types of pass-through arrangements have become much more complex in recent years, exacerbating the potential risks…” Hill said, however, that he is voting in favor of the proposal, explaining that, “improving recordkeeping and reconciliation practices (1) can reduce the likelihood of another Synapse-like disaster in the event of a third-party failure, and (2) may result in a more orderly resolution in the event the bank fails.”

The second truth today’s proposed rulemaking underscores is that the financial services industry needs a national fintech charter that can monitor, regulate, and enforce third parties that manage and handle consumer funds. Banks have long been subject to strict regulations and reporting requirements. But should banks that have conducted the proper due diligence be held responsible for the actions (or inaction) of their third party partners? It is time for fintechs to step up and share the responsibility.

Photo by Maksym Kaharlytskyi on Unsplash

There was a time when robo-advisory represented the peak of fintech’s contribution to the wealth management industry. And these services continue to be popular options for a new generation of savers and investors. The Statista Market Forecast indicates that the robo-advisor market worldwide is expected to grow by more than 6% by 2028, with more than 34 million investors relying on robo-advisors.

At the same time, enabling technologies like machine learning and AI are generating new ways for fintechs to bring the benefits of technological innovation to the wealth management industry. But it is important for fintechs to avoid building solutions in search of problems. What are some of the real trends and true pain points in the industry that fintechs may be able to help solve?

Democratization

One major theme in wealth management is democratization. For generations, wealth management has been the province of, to put it bluntly, the wealthy. Services were often expensive and opaque for the growing number of upper-middle class and middle-class investors of the 1980s and 1990s.

There is still a healthy market for high net worth investors, of course. But we have seen a major trend toward leveraging technology to make some wealth management services that were previously available only to the elites accessible to investors of lesser means.

There is also another way of looking at democratization in wealth management. In the same way that technology is enabling average investors to access increasingly sophisticated wealth management services, so is technology making it possible for smaller providers to compete with larger wealth management rivals. Fintechs that can help smaller firms and family offices do more with less may find significant opportunities among the growing group of wealth management entrepreneurs.

Personalization

Personalization has increasingly been seen as table stakes in financial services, and with good reason. Whether you are involved in payments or lending or ecommerce, the ability to get relevant products and services in front of your customers is paramount. Not just knowing what customers might want but also being able to deliver is what separates those businesses that gain new customers and keep the ones they’ve got, from those who struggle to do so.

Fintechs can enhance the customer experience by, for example, ensuring that wealth managers can communicate with clients in their channels of choice – and are able to bring significant functionality to those interactions in those channels with video or co-browsing. Knowing which customers are more likely to respond positively to new or alternative investment strategies, for example, or to other complementary products or services can go a long way toward building better engagement and loyalty.

Operations

One of the less flashy areas where fintech technologies can help drive innovation in wealth management is in back-office operations. This is also where enabling technologies like artificial intelligence (AI) and machine learning are delivering Automation 2.0 to intelligently streamline manual tasks and complex procedures. This trend, which has brought speed, accuracy, and cost-cutting to industries throughout financial services, is one that will benefit wealth management service providers significantly.

Moreover, many of the other trends in wealth management – such as the challenges of managing (and securing) ever-growing volumes of data, keeping up with evolving regulatory changes – are made possible by operations teams that have these powerful, enabling technologies at their disposal. For wealth management service providers who are not yet maximizing their teams or these technologies, fintechs can help them close the gap.

Decisioning

From buy-and-sell decisions to strategic portfolio allocations, wealth management is about making good, consistent decisions. Not only do wealth management service providers constantly seek to improve their investing strategies – one area where fintechs can provide specific expertise – but also these firms need to think about more than just maximizing returns. Keeping portfolio volatility at an acceptable level based on the risk tolerance and profile of the individual investor is just one example of another important function of the successful wealth manager.

Making good decisions is also about accountability. Having systems in place that ensure that processes are explainable and auditable is critical to accountability. It is also vital to an institution’s ability to learn, adapt, grow, and improve.

Compliance

Keeping up with the latest regulations is important for all financial service providers – and wealth management companies are no different.

As mentioned previously, one of the biggest benefits of enabling technologies like machine learning, AI, and Automation 2.0 is the ability for firms to track regulatory changes and ensure that their operations are able to meet new standards. An article earlier this year in Financial Planning listed 10 separate regulatory issues that wealth management firms are likely to face this year, from regulations on marketing language to rules governing digital assets. Moreover, many wealth management firms have internal rules and mandates based on the type of investments they offer and to whom. As such, remaining compliant with an institution’s own governing policies is also a challenge for which regtechs in our industry can provide assistance.

Growth

One of the most exciting ways that fintechs can bring innovation to wealth management services providers is to enable them to grow and expand their businesses by offering services that, while complementary, could be difficult to offer (much less integrate) without technology partners.

Whether through APIs or embedded finance, there are a range of complementary services that fintechs can provide to wealth managers. From insurance to estate planning to secure document digitization and storage, fintechs are able to provide services that wealth management customers often need, but are inclined to get elsewhere. By adding these solutions and services to their product mix, wealth managers can dramatically increase their capacity to grow.

Photo by Charles DeLoye on Unsplash

We’re more than halfway through 2024 so there’s no better time for a trends temperature check to determine what we should be paying attention to throughout the second half of the year. Learning about the newest trends is crucial to understanding how your firm can better compete and ultimately succeed in the crowded fintech and banking arena.

Funding

Late last year, we were still in the metaphorical trenches of funding. As of mid-2024, fintech funding trends are mixed. For the most part, venture capital investment is still quite slow because of high interest rates and economic uncertainty. We may see a more positive shift after the U.S. election, as many investors have cited political uncertainty as a factor in delaying major strategic and investment initiatives.

There is, however, another aspect of the current funding scene. Startups in targeted subsectors that are leveraging generative AI in unique ways are still garnering attention and funding from investors, though not quite at the high levels we saw in 2021 and early 2022. These shifts have caused companies to focus on sustainable growth and profitability, rather than the aggressive growth-at-all-costs mentality that was common from 2010 to 2019.

Regulation

As expected, the regulatory landscape has tightened significantly so far this year. Regulators have intensified their scrutiny not only of financial institutions, but also of specific issues. In the U.K., the Basel III framework brought forth new regulations focusing on capital adequacy, liquidity, and operational risk. In the U.S., there has been increased scrutiny of banking-as-a-service partnerships. This has brought a pulse of new consent orders on a regular basis. On top of all of this, we’ve seen the CFPB take measures to further consumer protection, such as last week’s proposed interpretive ruling stating that some earned wage access tools should be considered loans.

Embedded finance and open banking

Predictably, the conversation around embedded finance and open banking has escalated in 2024 as consumers continue to seek digital experiences that offer seamless financial integration. Banks’ open banking initiatives have expanded, which is crucial given that the CFPB is expected to release the final ruling of Section 1033 of the Dodd-Frank Wall Street Reform, which will stipulate rules surrounding rules governing personal financial data rights.

Generative AI

It will not come as a surprise that both the use and mentions of generative AI technology in fintech and banking has increased. The use of the technology experienced major expansion after the general release of ChatGPT in late 2022. Now that both banks and fintechs have been able to see and experience first-hand the potential of generative AI, there has been a large spike in demand for integrating the technology into existing operations to help improve efficiency, personalize customer interactions, and enhance risk management.

Photo by Tara Winstead

CrowdStrike’s update to its flagship cybersecurity product, Falcon Sensor, late last week caused an impressive amount of panic across a wide swath of industries. Many computers running Microsoft were stuck on the “blue screen of death” (BSoD), which would not allow users’ computers to load.

Immediately, the update caused flight cancellations, train delays, broadcasting problems, hospital issues, and disruptions at businesses across all sectors that could not log into their computers for the day. But aside from these fleeting, yet major, problems the botched software update will have lasting implications.

Opportunity for competitors

Impacting the cybersecurity industry as a whole, many organizations will see last week’s update failure as an opportunity to market their own fraud fighting technology to organizations big and small that were impacted by last Friday’s events. We may even see a slight increase in new cybersecurity company launches. According to TechCrunch, as of last year, CrowdStrike enjoyed a 14.7% share of global revenue from security software sales. This may decrease as some clients seek alternative technologies. It is unlikely, however, that we will see a mass exodus from CrowdStrike.

Information for hackers

Perhaps one of the biggest concerns for CrowdStrike clients is that the update failure offered hackers all over the globe a visual of which companies use CrowdStrike as a vendor to fight fraud. Cybersecurity companies rarely disclose client names, especially in banking and finance, and for good reason. When hackers know which security software vendors a firm is using, they are able to gather a lot of information they can use to try to circumvent the software for nefarious purposes.

In addition to offering visibility into which banks are working with CrowdStrike as a security vendor, the fallout of the update also offers fraudsters an open door to send consumers phishing emails and phone calls to exploit the situation by asking consumers to divulge passwords and sensitive codes.

Loss of consumer trust

End consumers, especially in the banking and airline industries, will likely lose some amount of trust in the security of online businesses. Many saw firsthand how far reaching and potentially catastrophic software disruptions can be, and unfortunately, many consumers incorrectly assumed that the BSoD was the result of a cyberattack rather than an update glitch. As a result, consumers may be more wary of sharing their sensitive details online and may be less willing to trust the security of their financial institution, even if it was not impacted by Friday’s events.

Heightened regulatory concern

Regulators are consistently being challenged by today’s fast-moving technological environment. Now, they have a new worry to add to their list. Regulators have a responsibility to ensure that they are not only retroactively responding to IT outages, but also actively working to help prevent them from occurring in the first place. This will likely lead to more stringent regulatory guidelines for cybersecurity measures, mandatory incident response protocols, and regular stress testing of critical IT systems to ensure their resilience.

Photo by Patrick Tomasso on Unsplash