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FedNow implementation: What fraud and AML professionals need to know

Mary Ellen Biery
July 25, 2023
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How offering FedNow instant payments affects fraud & AML/CFT compliance

What financial crime staff can do to prepare fraud and AML functions for implementing the FedNow Service for instant payments. 

 

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Instant payments service

What is FedNow? Benefits of implementation

The FedNow Service, which went live this month, is the new instant payments infrastructure developed by the Federal Reserve to enable real-time payments between all financial institutions on behalf of their customers or members. However, faster payments don’t necessarily mean faster fraud, according to the FedNow Service and other industry experts.

The payment rail has some built-in anti-fraud capabilities. And fraud and AML/CFT staff can take several steps during their institution’s FedNow implementation to combat and reduce fraud. This article describes what financial crime staff need to know about how the FedNow Service works and what to do now to prepare fraud and AML functions for the bank or credit union’s implementation of this service. Many of these tips are provided in the FedNow Service Readiness Guide, a good resource from FedNow to help with preparation.

Fast facts on FedNow instant payments

The Federal Reserve Banks designed the FedNow Service so financial institutions of all sizes could provide a faster, more efficient way for customers or members to send and receive money. ACH credit and debit transfers and mobile personal payment options like Venmo can take hours or days to settle between the sender and receiver’s accounts, even if information confirming transfer requests is conveyed more quickly. FedNow transactions, by contrast, allow credit transfers to complete core clearing and settlement almost immediately, within seconds.

“Lesson one ... is that implementation will come over time. Financial institutions will have different appetites, so they will have time to learn about it and learn from the activity of others.”

- Russ Chacon, VP of Product Management, Abrigo

Here are some fast facts about FedNow instant payments to help financial crime professionals get up to speed:

  • Not mandatory; no implementation deadline.
    The FedNow Service is not mandatory. Experts, however, expect FedNow instant payments will eventually be ubiquitous as financial institutions continue to try to meet their consumers’ and businesses’ expectations for convenient, fast payment methods. There’s no official deadline to implement FedNow if the financial institution chooses to offer its instant-payment service.“Lesson one in all of this is that implementation will come over time,” said Russ Chacon, Vice President of Product Management for Abrigo. “Financial institutions will have different appetites, so they will have time to learn about it and learn from the activity of others before their bank or credit union does it.”
     
  • Secure access.
    The only entities that can connect directly to the FedNow Service are financial institutions or their agent service providers (such as their core banking processors, payment hubs/payment processors, corporate credit unions, and bankers’ banks). Similarly, financial institutions can either use their own end-user interface or one from a third-party partner or service provider to offer instant payment services via FedNow to end users (consumers, merchants, and other businesses). There is no FedNow app, and FedNow’s infrastructure will not provide payment services directly to businesses and individuals. Instead, institutions serving both the payor and the payee will need to be FedNow participants to access the instant payment service. The FedNow Service has some similarities to Zelle, the private-sector instant payment service in the U.S. developed in 2017 with the backing of some of the largest banks. For example, the FedNow Service, like Zelle, requires the bank or credit union accounts of both the sender and recipient to be based in the U.S.

How FedNow processing works

Instant-payment fraud implications

Here’s a step-by-step example of how a FedNow credit push would work:

1. A business owner initiates a payment to a supplier using an app with their bank, which uses the FedNow Service.
2. The sender’s bank submits the payment information to the FedNow Service.
3. FedNow instantly validates the payment message.
4. FedNow sends a payment message to the supplier’s credit union and asks if it will accept it.
5. The supplier’s credit union tells FedNow it intends to accept the payment.
6. The FedNow Service immediately debits and credits the Federal Reserve master accounts of both financial institutions.
7. FedNow sends an advice of credit to the supplier’s credit union and an acknowledgment to the business owner’s bank that settlement is complete.
8. The supplier’s credit union credits the supplier’s account and makes the funds available. And on the sending side, the business owner’s bank debits the owner’s account.

Given the near real-time nature of settling FedNow transactions, fraudsters can receive payments quickly. Settlements mean the transaction is final, which means the payee can withdraw the funds immediately, so financial institutions need to act accordingly.

“The financial institution will need to insert AML and fraud analysis in the transaction flow,” said Chacon. “They’ll need the tools and the platforms to allow them to see these transactions as they’re made and before they flow to the FedNow Service.”

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Julie Lane, Security Officer/BSA Administrator, C&N Bank

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Optimal fraud readiness

Preparing for FedNow implementation and expected fraud

To make sure each financial institution is ready for FedNow transactions and has optimal readiness for fraud tied to the new payment rail and other instant payment platforms (Zelle, wire transfers), consider the following steps:

Understand FedNow and its differences from other payment processes.

The FedNow Service offers various educational resources, as do other industry groups. Staying attuned to these resources will help financial institutions learn more as more institutions roll it out. Among the key fraud management considerations specific to FedNow payments and other instant payments:

  • Clearing and settlement occur almost immediately rather than hours or days later, as they do with checks, ACH, and consumer-friendly applications like Venmo.
  • FedNow will operate around the clock every day of the year, so fraudsters can try to push through fraudulent transactions at any time. Fraud detection, processes, and controls must be in place to act quickly at all times.

Involve the right people at the bank or credit union to create a retail solution tailored for your risk tolerance and your customers or members.

As they do when offering any new product or service, financial institutions will control certain aspects of their FedNow instant payments offering, and several of those controls can reduce fraud risk. Here are some fraud risk management options that FedNow will give participants some control over:

  • When to begin using FedNow. Each bank and credit union can set its own implementation timeline. 
  • How the institution wants to use FedNow. One bank could decide to initially use the network solely for allowing businesses to make instant payments for payrolls. Another may allow credit transfers to be sent and received.
  • How much money can be sent. The FedNow Service is setting network-level transaction limits, which will cap the amount per transaction that a financial institution can send. However, each financial institution participating in the FedNow Service will be also able to configure a lower transaction value limit, which they may adjust over time, using their institution’s risk policies as a guide.
  • How to accept. FedNow participants will be able to submit an “accept without posting” status. This would indicate to the originating institution that more information is needed for compliance or fraud considerations before payment will be accepted. Financial institutions will be able to request information such as more details about the sender. This is similar to how FedLine allows financial institutions executing wire transfers to ask for more information about the source of funds before completing the transaction.
  • Who can send or receive. Each financial institution can set its own rules and limits regarding FedNow payments. 

Peter Tapling, a board advisor with the U.S. Faster Payments Council, encourages financial institutions to carefully design their FedNow offerings to control how customers or members use them.

“Even if a bank signs up to be a sending institution with FedNow, they have the ability to control how they offer that send capability to customers,” he said during a recent video interview with Information Security Media Group. “So from a fraud and risk perspective, a lot of thought needs to be put into who am I going to offer this product to, under what conditions, and during what times. Even though FedNow is available 24x7x365, at the end of the day, the product being offered to the customer is a bank product, it’s not FedNow, and so the bank gets to control how they’re going to offer that product.”

Including fraud and AML/CFT staff among those involved in product and capability planning, technology planning, and treasury planning can support FedNow implementation that is designed with anti-fraud measures in place.

Talk to your technology partners.

Financial institutions must be able to connect to the FedNow Service, either through their core or another service provider. They will also need front-end services for customers or members to initiate payments and receive requests for payments, either through their own online capabilities or an app. And they will need a fraud detection partner capable of security measures such as cross-channel detection so they can evaluate transaction patterns across all payment types. Fraud prevention efforts for senders will also benefit from building in the capability to pause a transaction if it hits a certain trigger (such as a value limit). The ability to analyze incoming transactional data is vital.

Review the institution’s current tactics to fight fraud.

Do you have robust user authentication methods? According to Staci Shatsoff, Assistant Vice President for secure payments with the Fed Bank of Boston, “The ability to stop the fraud as far upstream as possible is crucial to minimizing downstream impact.”

Do you already understand normal client behavior? Understanding normal client transaction behavior across channels and payment types helps fight fraud of all types. It’s also essential to collect and assess behavioral data continuously and to continually verify customer contact information.

Consider taking steps to boost anti-fraud and AML/CFT protection.

These could include:

  • Adding suspicious accounts and aliases to a watch list to block potentially fraudulent transactions before affected funds leave or enter your institution.
  • Reviewing and considering a boost to security controls for account enrollment ahead of FedNow implementation. If a financial institution is going to support sending requests for payments, having the controls in place to ensure it’s a legitimate company or individual sending a legitimate request is critical. Similarly, financial institutions can either use their own end-user interface or one from a third-party partner or service provider to offer instant payment services via the FedNow Service to consumers, merchants, and other businesses.
  • Boosting security controls around how payments are initiated. FedNow officials have said such controls can include a pop-up message asking “Are you sure?” of customers or members before they execute the request to transfer funds.
  • Educating consumers and businesses on measures they can take to prevent fraud when using instant payments such as the FedNow Service. Remind them of best practices for handling suspicious emails and the importance of strong, secure passwords. Encourage them to enable account alerts and verify their contact information. Reiterate that the institution staff will never ask for login information over the phone, via email, or text, and encourage them to take a “zero trust” policy when someone asks for such information. Urge businesses to have two-step approval processes for certain types of payments so they can pause and validate before sending funds. Explain the importance of having employees verify the legitimacy of someone claiming to be a supplier or biller who asks for a payment or a change to payment accounts.

Conclusion

The FedNow Service will allow banks and institutions to meet customers’ needs better and perhaps differentiate their offerings to attract more depositors. It can also improve efficiency in the transaction process. However, AML and fraud leaders must plan carefully to minimize AML/CFT and fraud risks.

Learn about some of the important considerations for financial institutions to remember when combining fraud and AML departments.

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About the Author

Mary Ellen Biery

Senior Strategist & Content Manager
Mary Ellen Biery is Senior Strategist & Content Manager at Abrigo, where she works with advisors and other experts to develop whitepapers, original research, and other resources that help financial institutions drive growth and manage risk. A former equities reporter for Dow Jones Newswires whose work has been published in

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About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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