The various Anti-CBDC bills by various states might have been a complete shot in the wrong direction. At first glance, the new FedNow system delivers central control over instant payments delivered as “instant messages” by participating institutional servers to be a much better system to control the citizen’s spending. A digital coin was never needed to accomplish the same chilling outcome in a world where the dollar, for the most part, is already just a digital (central) ledger entry.
In this article, we take a closer look at the FedNow system from a technical perspective and try to understand how it actually works “under the hood.”
Understanding the FedNow System: Key Considerations and Options for Financial Institutions
As the Federal Reserve, with a 20-year delay, finally joins the instant payment space with its FedNow Service, financial institutions nationwide find themselves in a position to reassess their connection capabilities and align their operations with the new framework. The service, promising round-the-clock, real-time payment services, provides flexible and familiar connectivity options that cater to diverse business objectives and customer needs – under the close supervision of the federal reserve system.
The Payment Process
The payment process within the FedNow Service consists of ten key steps. Initially, a sender-an individual or a business initiates a payment with their financial institution via an interface independent of the FedNow Service. The sender’s financial institution is then responsible for validating the payment according to internal processes and requirements.
Once the validation process is complete, the sender’s financial institution submits a credit transfer message to the FedNow Service, which validates the payment message. It ensures the statement adheres to the required format specifications and complies with relevant controls.
Next, the FedNow Service transmits the payment message to the receiver’s financial institution for confirmation of acceptance. The receiver’s institution then decides whether to accept, reject, or accept the payment message without posting (ACWP).
If the receiver’s financial institution decides to accept the payment message, it sends a positive response back to the FedNow Service. This response triggers the FedNow Service to settle the payment, debiting and crediting the respective accounts of the sender and receiver’s institutions. Steps 2 through 6 are complete within seconds, with a maximum time limit of 20 seconds – benefits of a central architecture.
Upon settling the payment, the FedNow Service sends notifications to both the sender and receiver’s financial institutions, informing them that the Federal Reserve Banks have settled the credit transfer. The receiver’s institution then makes the funds available to the recipient immediately. The receiver’s institution can optionally send a confirmation message through the FedNow Service to the sender’s institution, indicating that the payment posts to the recipient’s account. Finally, the sender’s institution can notify its customer that the funds have been made available to the recipient.
Essential Functions of the FedNow Service
Primarily, the FedNow system allows organizations to send and receive messages, including ISO 20022 messages, via an application interfacing with an IBM MQ client. To enable this functionality, connecting parties are required to install this client.
In addition to message handling, the system enables financial institutions to access participant profiles in the FedNow interface. Using FedLine Solutions, participants can manage configurations, view reports, and run ad-hoc queries.
The Role of IBM MQ in the FedNow System
IBM MQ is integral to the FedNow system, handling message queuing for applications. Institutions are required to develop IBM MQ applications that interact with a queue or a topic hosted on a queue manager – a server that hosts queues and topics.
Institutions need MQ client libraries and a queue manager to develop these applications. The queue manager can run on various environments, including different cloud platforms. For this purpose, IBM offers the MQ Advanced for Developers, which includes a queue manager with default queues and topics for a quick start.
Financial institutions can choose to connect directly using a FedLine Solutions connection to send and receive FedNow ISO 20022 messages and perform its Service profile administration. Alternatively, they may choose to connect through a third-party service provider such as a payment processor, bankers’ bank, or corporate credit union.
Institutions that currently do not connect to the Federal Reserve must establish a new WAN (FedLine Direct) or VPN (FedLine Advantage or FedLine Command) connection to support the FedNow Service. Meanwhile, those with an established connection will need to configure it to support the service or install a new one exclusively for FedNow.
Key Considerations for Financial Institutions
Before making a decision, it’s essential to evaluate various factors, including resiliency and contingency plans, anticipated volume and bandwidth needs, monitoring and alerting capabilities, and the possibility of having a dedicated connection for the FedNow Service.
Institutions will also need to purchase or build a payment application that interfaces with the IBM MQ client and can handle FedNow ISO messages to the core banking system.
Service providers assisting financial institutions in implementing the FedNow Service can connect via a FedLine Solution. They can process for multiple financial institutions through the same connection, given that the participating institutions authorize the service provider to send or receive FedNow Service messages.
Meanwhile, fintech companies or other providers offering instant payment solutions to consumers and businesses must partner with a FedNow-participating financial institution. They cannot leverage a connection from another service provider to access the FedNow Service directly on behalf of their end customers.
Ensuring Security and Fraud Protection
However, this technological innovation isn’t without potential risks. As with any payment system, there’s a risk of fraud with instant payments. Recognizing this, FedNow offers fraud management capabilities to support and complement the individual security measures of financial institutions.
At the outset, FedNow will provide transaction limit settings and participant-defined negative lists, which will help guard against unauthorized transactions. Each financial institution can set a lower transaction limit based on their risk policies and specify suspicious accounts that their organizations can’t send to or receive from.
To further bolster security, FedNow employs cryptographic signatures for message integrity and authenticity, encryption for data in transit and at rest, and multifactor authentication for user interface access via FedLine Solutions. The system also leverages role-based access controls and the separation of duties to enforce least privilege principles.
It’s worth noting that FedNow also urges the education of end customers on identifying fraud attempts and protecting their data, advocating for a combined effort to safeguard the system.
The new age of instant payments delivered by the universally trusted “Fed” promises a host of benefits for traditional banks but raises tons of privacy issues for regular citizens. It will be interesting to see how the adoption of FedNow will impact the digital payment space in general.
