Not deposit flight, but deposit shift

Earlier this month, The Wall Street Journal published a?piece?centered on banks’ questions regarding potential deposit flight following the launch of the FedNow Service. While we are not a bank, ACI works with nine of the top 10 global banks and helped the Federal Reserve develop and test FedNow as part of its pilot program. We were among the first in the industry to complete testing and certification for the FedNow service, including fulfilling a checklist of requirements to confirm ability to send, receive and process ISO 20022 messages and meet the requirements to successfully operate in a 24x7x365 instant payments environment. More importantly, we have helped countries and banks implement real time payments rails for 17 years. This leaves us in a unique position to share our perspective on what FedNow is and is not, and what it means for banks.

FedNow is not the first real-time payments solution in the U.S.?Backed by big banks?in 2017, The Clearing House ’s RTP was established to support instant payments. FedNow is intended to act as an equalizer, increasing financial inclusion for smaller banks and underserved communities while facilitating the nationwide reach of instant payment services. We anticipate FedNow will have a significant impact on accelerating the adoption of real-time payments globally; according to our Prime Time for Real-Time annual report, more than 1.8 billion real-time transactions were recorded in the U.S. in 2021. This resulted in estimated cost savings of $648 million for businesses and consumers, which in turn helped to unlock $1.4 billion of additional economic output.

Some wonder whether transitioning to real-time payments could destabilize banks’ reliance on customer cash, creating concerns around deposit flight following a challenging spring for U.S. mid-size and regional banks. The recent bank failures highlighted the myriad flaws in trying to adapt a century-old business model to contemporary needs. Historically, the Federal Reserve encouraged banks to borrow short and lend long, where the bank has an opportunity to make money in the middle. To limit risk if the equation becomes unbalanced, the Federal Reserve implemented regulation that requires banks to hold a buffer of assets that can be sold over 30 days. This protects both customer and bank funds alike. Instant transfers create more asset volatility for banks, which is not reflected in a business model meant to process in days or weeks.?

Banks that rely on these legacy systems for much of their revenue are justified in their concern; however, a deposit shift is more likely than a deposit flight. This can be substantiated by monitoring the correlation between account openings and deposits. An increase in account openings justifies the theory of a broader distribution of deposits across institutions. To that point, we are seeing a reallocation of deposits in the U.S. as a result of the regional bank collapses that occurred earlier this year. Essentially, this means that accounts with balances above the FDIC insured amount of $250,000 are split between more than one account as a safeguard. We expect that to be a growing trend as consumers look for stability and safety. The bottom line is that money will be coming in as fast as it is going out. And it can’t go out if it doesn’t come in.

It’s also worth noting that the U.S. is not the first market to launch more robust real-time payments systems; globally, FedNow is relatively late to the market. Markets with more advanced real-time payments systems (India and Brazil, for example) that adopted real-time payments infrastructure earlier did not experience bank runs or changes in liquidity requirements. Rather, real-time payments helped modernize payments infrastructure and enabled more liquidity and interoperability. Moreover, real-time payments and FedNow will provide improved cashflow management for small businesses and enable employers to pay workers in real time, helping millions of Americans gain more control over their finances. It supports better credit between banks, decreases financial system complexity and increases business, bank, and consumer confidence and certainty. Big picture, FedNow is an overdue step in the right direction for U.S. payments, and will deliver significant value to consumers, businesses, and the industry at-large.?

There are a few ways for banks to grow their liquidity and limit their exposure to deposit flight risk. The two prevailing approaches we’ve seen – and helped banks implement around the world – are limiting volatility with internal protocols and creating additional revenue streams to hedge against revenue loss. Examples of successful internal protocols include limiting transaction sizes and volumes, configuring per day or per transaction limits, and implementing vertical-specific protocols to manage withdrawals. This is already widely practiced with TCH’s RTP transactions, which have?a one million dollar limit?and enable participants to set lower value limits for payments they originate.?

Most banks around the world have also focused on creating new revenue streams. Instant payments have now moved from being just P2P focused to expanding into C2B, B2B, G2C, C2G, etc., which enables banks to save on costs and create new tailored services. Some examples of these include generating commissions through brand placement fees, charging small transaction fees or subscription revenues, creating expedited loan processing systems and co-branded credit cards, etc.

ACI has supported hundreds of banks globally as they field these challenges and create new opportunities. Replacing any legacy system carries risk, but the consequences of stalling are even more severe. The real determining factor of success will be how quickly and effectively banks can adapt to a real-time payments world.