The Federal Reserve has launched FedNow, which executes instant payments 24/7. What does that mean? When I led IMF technical assistance missions to the former Soviet Union (Kazakhstan, Kyrgyzstan, and Moldova) and to post conflict countries (Afghanistan, Bosnia and Herzegovina, Iraq, Kosovo, Serbia), the payment experts on my teams referred to the Clearing and Settlement of payments. I never fully understood what that meant. “Federal Reserve FedNow Payments”
The key to understanding the meaning of “clearing and settlement” is to understand the deference between the authorization to make a payment and actually debiting and crediting bank accounts to execute the payment. When I pay from my bank account to yours, mine is debited and yours is credited. My bank executes the debt and credit if your account is also at my bank. If not, my bank debits my account and “sends” the money to you at your bank via an intermediary (usually the central bank) at which both my bank and yours have accounts that can be debited and credited. When my account has been debited and your credited, the payment has been “settled.”
The clearing part of clearing and settlement has to do with communicating the authorization to our banks to execute the debit and credit. It refers to the messaging systems that authorize the actual settlement of a payment. This is what FedNow is about (as is the well-known SWIFT messaging system for authorizing cross border payments). It will replace paper checks or electronic payments such as Venmo, Zelle, PayPal, etc. that now authorize our banks to debit our accounts and credit the accounts (somewhere) of the payees. “Econ-101-Retail Central Bank Digital Currency-CBDC”
I haven’t mentioned what it is that is being paid. If it is from my bank account, it is US dollars (ultimately a claim on the Federal Reserve Banks of the U.S.). Every currency (dollars, Euros, bitcoin) has its system of clearing and settlement. And of course, there are markets for exchanging one currency for another (FX markets).
FedNow is a messaging system that authorizes settlement in seconds 24/7 that replaces (or supplements) systems that now can take days.
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