FedNow will have a hard time stopping fraud
The way in which we process payments here in the U.S. market has undergone significant change over the years. That said, the Automated Clearinghouse (ACH) process itself has remained fairly static, at least up until now. That’s all set to change, with the Federal Reserve’s recent announcement of its FedNow service.
According to the Fed’s official press release announcing the initiative, FedNow will be a means to “modernize the nation's payment system and establish a safe and efficient foundation for the future.” The new payments infrastructure will effectively replace the existing ACH framework. With the new system, banks of any size will have the capability of providing real-time payments. We’ll be able to resolve transactions in seconds, rather than days.
The ones pressing for this change aren’t the banks. Rather, the FedNow initiative is in reaction to an expressed desire from merchant brands for faster payments.
According to a recent study of business owners, roughly 80% of respondents are interested in the possibility of instant funds transfers. Even more (85% of respondents) are willing to change to a new acquirer if it meant receiving instant payments. And, when the Fed opened its plan for public comment, an overwhelming 90% of commenters supported the idea of round-the-clock, instantaneous payments.
It’s not hard to understand why merchants are so enthusiastic about the idea. On one hand, instant payments make for easier recordkeeping. Merchants wouldn’t have to wait days for payments to clear and for funds to be released to their accounts. After all, we have a digital-enabled, 24/7 marketplace. We need payments that operate on a 24/7 pace, too.
Second, under the current payment regime, the cardholder’s money is often tied up for several days before the transaction is finally settled. With instant payments, there’s almost no delay between the moment the money leaves the customer and when it arrives in the merchant’s account. Of course, that can create a host of other problems, too.
Despite the enthusiasm, I have some serious reservations about the FedNow system. For instance, the service will not effectively prevent fraud; in fact, we might even see fraud increase thanks to the instant payments concept.
It’s hard to predict the direct ramifications of this initiative. If experience is any indicator, uncertainty typically opens doors for fraud and abuse. Since these payments will occur in a matter of seconds, fraudsters who identify methods of abusing the system could easily commit an attack, then vanish long before anyone even notices the incident.
One of the most significant impacts of increased fraud on the market will be loss of trust. Consumers and banks will be faster to file chargebacks, assuming the chargeback process itself can still function in this new environment.
With the FedNow proposal, we aren't talking about a minor refinement or a tweak. This is a major policy overhaul. The plan requires effectively rebuilding our payments processes from the ground up. So, while the right to dispute payments is guaranteed by law as a way to preserve cardholder confidence, we don’t know yet how the chargeback system will need to change to accommodate instant payments.
The problem is that we don’t currently have a consistent way of handling chargebacks. Procedures and guidelines can change based on the card scheme, product category, billing model, etc.
Adapting this disjointed legacy dispute approach to an instant payments environment will open the door for confusion and abuse. As it stands, our data indicates between 60-80% of all chargebacks may be traced back to friendly fraud. In effect, most disputes are not filed by customers looking to recover from fraud, but rather to commit fraud.
At the same time, we can’t simply scrap the chargeback process without jeopardizing consumers’ faith in card payments. That’s why I believe the solution is to adapt the chargeback process to the needs of a modern marketplace by prescribing a single, consistent procedure.
It’s not that we shouldn’t look for ways to speed up the payments process. However, doing so can’t come at the risk of losing total public confidence in digital payments. The solution: standardization.
We need to establish consistent and fair standards for processing transactions across all card schemes. Once again using chargebacks as an example, there is a clear need for intra-scheme chargeback processes and management guidelines.
This isn't a new goal, yet progress remains slow. While we’re seeing activity with initiatives like Visa Claims Resolution and Mastercard Dispute Resolution, these are ultimately just tweaks to a broken system, rather than solutions. Standardizing fraud and dispute management protocols and giving all merchants, banks, and cardholders a level playing field is the real answer.
We can start talking seriously about instant payments once we have a universally applicable process for managing fraud and disputes. The existing processes are hopelessly out of date under the current payments regime. Thus, trying to speed up payments while ignoring faults in the system will only lead to greater losses.
The contemporary payments landscape is confusing and inconsistent. Further complicating matters, without addressing long-overdue changes, cannot be the way forward.