Dimitri Dadiomov is the cofounder and CEO of Modern Treasury.
When it comes to paying somebody, cash is as cheap and fast as it gets. You fork over the bills, and someone is paid. There are no fees, delays or waiting for the money to show up. It is palm to palm, it’s instant and it’s final.
But modern economies can’t run on cash alone. We need wires to send big amounts when we buy houses or companies. We use credit cards when we don’t want to carry cash or when we’re reserving our weekend away. We pay bills automatically each month for convenience, paying regularly out of our bank accounts via electronic ACH. Checks still account for about 80% of B2B payments—even though it can take days for the money to clear one bank to get to the next.
We use different payment methods because no payment method is perfect for every scenario. Rather, each is optimized for a specific use case.
The FedNow Service, the Federal Reserve’s recently launched instant payment network, will come as close as any existing electronic payment rail to the ease of cash (fast, easy, nonretractable) for most use cases. Over time, I believe it has the potential to vastly improve how American households and businesses send and receive money, with far-reaching impacts on the U.S. economy.
With FedNow, payments happen instantly, 24/7. The cost is less expensive than wires or credit cards. The transfer of money is faster than ACH and checks. With FedNow and instant payments, there’s no risk of bounced checks or failed ACH payments because bank accounts lack funds.
For the moment, the biggest issue with FedNow is availability. It launched in July 2023 with 35 participating banks and credit unions and 16 payment-process service providers. It is available to about 10,000 institutions but will take time to build adoption, as did the privately run Real-Time Payment (RTP) network, which launched in 2017 and is used by more than 100 financial institutions.
In the meantime, consumers and businesses will use existing payment rails and deal with the pros and cons of each. Here’s my take on them.
Checks
Checks can take one to seven days to clear and longer to be delivered by mail. That’s a downside unless the person paying needs time to gather funds. The big benefit of checks is simplicity. All you need is the name of the payee. No need to gather bank routing or credit card numbers. This level of identity simplicity is lacking in other payment types, which require long alphanumeric addressee information.
Credit Cards
Credit cards cost merchants around 3% of every dollar charged. That cost gets built into the cost of goods and services. Yet the convenience is oftentimes worth it. There is no need to carry cash. Users are largely protected against fraud. You buy immediately but don’t pay until the bill comes at the end of the month. Look for FedNow to eventually siphon payments away from larger credit card transactions—for example, a big reservation for a vacation home.
ACH
These electronic payments have a one-to-three-day settlement period. They’re a low-cost, reliable way to make larger, repeatable and predictable payments, like monthly mortgage payments or utility bills. Look for them to remain a mainstay payment rail for these types of transactions.
Payroll is one area where FedNow may take a bite from ACH. Ernst & Young estimates that about $1 trillion is held daily in payroll systems in the U.S. and the other 35 OECD countries. If companies run payroll twice a month, money may flow from company to payroll provider to employee two times a month as well.
And since each transfer takes two or three days with ACH (today’s predominant payroll method), this adds up to a lot of days where money is in transit when it could be earning interest. With instant payroll payments via FedNow, more capital would be working more of the time.
Wire
Wire transfers can be expensive, so they are mostly used for larger transactions that require reliability, like buying a house or a company. No one wants to hand over a title to a piece of property only to find out later that an ACH or check never cleared. Watch for FedNow to take a share of smaller wires because it’ll be more affordable and equally as instant and final.
When To Use What
My guess is that a lot of executives, even some in the finance department, do not know how each payment is made or whether the best payment rail is being used. When a new payment option arrives, as has just occurred with FedNow, it is a good time to review how you are doing.
Step One: Draw a flow of funds diagram. This is a diagram of where money comes from, what accounts it sits in, how it gets transferred and who gets paid. This is the literal money movement architecture of your business.
Step Two: Look at every transfer and decide the optimal payment type. Consider cost, convenience, fraud protection, how long money gets held up and whether it can be put to better use. The cash conversion cycle matters more with rates where they are; you might be able to earn significant interest by optimizing the flow of funds and speeding some transfers up.
Step Three: Talk to your bank about FedNow and what its plans are for using it. Then, you can choose whether to work it into your flow or not.
The Evolution Of Payments
Email replaced a lot of paper mail. Now, text is replacing a lot of email. But the telephone still exists, and so does letter writing. Payment rails, like modes of communication, rarely die. We just get more options as our finance ecosystems evolve. The best businesses continually evolve with the times and update their payment methods—just like their methods of communication.
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