Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Are Building Real-Time Payment Systems
Transcript
- Lucas: So the Bank of England just announced a pilot for a wholesale central bank digital currency — specifically for interbank settlements — and I think it's worth unpacking because it gets at something most people miss about monetary policy. Luna: You mean how the pipes matter more than the rates sometimes? Lucas: Exactly. We talk a lot about the federal funds rate or quantitative easing, but the actual plumbing of how money moves between banks — settlement infrastructure — is undergoing its biggest change since the 1970s. And central banks are driving it. Luna: I want to go back to that Bank of England pilot in a minute. But first — can we set the baseline? What's the old system, and why is it a problem? Lucas: Sure. For decades, large-value interbank settlements in most developed economies have run on what's called real-time gross settlement systems — RTGS. In the US, that's Fedwire. In the UK, it's CHAPS. In the eurozone, TARGET2. These systems settle transactions in central bank money, final and irrevocable, within seconds or minutes. Lucas: But the key word is 'large-value'. These systems handle wholesale transactions — trillions of dollars a day. For retail payments, the default was still batch processing. You write a check, it takes days to clear. Even debit cards and ACH transfers settle overnight or longer. Luna: So the gap was speed for consumers and small businesses. And private companies stepped in. Lucas: Right. In the US, The Clearing House launched the RTP network in 2017 — real-time payments, 24/7, with settlement finality within seconds. By 2023, it was processing over 50 million transactions a month. But it's owned by the big banks, so smaller institutions were slow to join. Luna: And that's where the Fed comes in. FedNow launched in July 2023. Lucas: Yes. And this is the angle I want to focus on: why central banks care about building their own real-time retail payment system. It's not just about keeping up with Venmo. It's about maintaining a foothold in the monetary system's infrastructure. Luna: Because if all retail payments move through private networks, central bank money becomes less relevant. Lucas: Exactly. The Fed's mission includes promoting the stability and efficiency of the payment system. If a single private network becomes the de facto standard, the Fed loses direct control over settlement finality, liquidity provision, and — potentially — the ability to implement monetary policy through that channel. Lucas: FedNow doesn't replace Fedwire. It's a separate service for smaller-value, time-sensitive payments. As of this month, over 700 financial institutions are live on it. The Fed also offers a 'liquidity management tool' that lets banks transfer funds between their FedNow and Fedwire accounts in real time. Luna: But the really interesting case is the eurozone. TIPS — TARGET Instant Payment Settlement — launched in 2018. By the end of 2025, it was processing over 300 million transactions a year. And it's not just for euros — the ECB is working on linking it with other currencies. Lucas: That's the key geopolitical angle. Emerging economies have leapfrogged the legacy systems entirely. India's UPI — the Unified Payments Interface — now handles over 10 billion transactions a month. Brazil's Pix has 170 million users and has radically reduced the informal economy. Those systems are built by central banks, or at least with their direct involvement. Luna: And there's a monetary policy dimension to this that I think is underappreciated. If all payments clear instantly, the velocity of money can change dramatically. Lucas: Yes. In theory, faster settlement means money moves more quickly through the economy, which could affect the transmission mechanism of interest rate changes. But the empirical evidence so far is mixed. Brazil's Pix actually coincided with a decline in inflation, not an increase. So it's not a simple story. Lucas: What's clearer is the operational angle for central banks. With instant settlement, they can implement negative rates more effectively — because if a bank tries to hold excess reserves to avoid the negative rate, the central bank can see and charge on a real-time basis. Also, fiscal transfers can be executed instantaneously, which was a big lesson from the pandemic. Luna: That's a good segue to the Bank of England pilot. They're testing a wholesale CBDC for interbank settlements. What's different there? Lucas: Wholesale CBDC is basically digital central bank money for banks and financial institutions, but using distributed ledger technology instead of the traditional RTGS database. The Bank of England's pilot — called the 'Digital Pound' for wholesale use — is exploring whether DLT can reduce costs and increase resilience compared to CHAPS. Lucas: The pilot involves about a dozen banks and uses a 'synchronisation' model: the CBDC token exists on a shared ledger, and settlement happens when the token moves. No need for the central bank to run a separate settlement engine. Luna: But if it works, does that mean central banks are essentially competing with private blockchain-based payment networks? Lucas: You could frame it that way. But I think central banks would say they're ensuring the public has access to a risk-free settlement asset even as technology changes. If everything moves to blockchain, central bank money should exist on that blockchain. Luna: There's also a financial stability angle. Faster settlement reduces counterparty risk — the risk that one bank defaults before the payment clears. In the old batch system, exposures could accumulate over hours or days. Lucas: Absolutely. The Bank for International Settlements has been pushing for this for years. Their 'Committee on Payments and Market Infrastructures' publishes standards for real-time gross settlement. They want all G20 countries to have fast payment systems by 2027. Lucas: But there's a tension: faster settlement also means less liquidity pooling. In an RTGS system, banks need to have enough reserves at all times to settle each transaction individually. That can tie up capital. So central banks also offer intraday credit — essentially free loans that must be repaid by end of day. Luna: And with instant settlement happening 24/7, that intraday credit needs to be available around the clock. That's a big operational change for central banks. Lucas: Exactly. The Fed's FedNow service operates 24/7/365. That means the Fed's payment infrastructure never sleeps. They have to staff for it, monitor for fraud, and provide liquidity at 3 a.m. on a Sunday. It's a massive shift from the traditional 18-hour Fedwire day. Luna: And speaking of what all this work is worth — if today's deep dive into payment plumbing made something click for you, honestly, if it was worth a coffee to you, that's the link: buy me a coffee dot com slash fexingo. Keeps the show ad-free and lets us keep digging into these nooks and crannies. Lucas: Yeah, and we mean that genuinely. These episodes take time to research — especially when we're talking about settlement systems that most people never see. So if this is valuable to you, it helps. Luna: Alright, back to the pipes. Lucas, you mentioned earlier that the geopolitical angle is important. How do these payment systems affect the dollar's dominance? Lucas: That's the big question. Right now, the dollar's role in international trade and finance is reinforced by the fact that most cross-border payments flow through the US clearing system. But if other countries build their own real-time networks and link them bilaterally — like the RBI in India linking UPI with Singapore's PayNow — they reduce reliance on the dollar. Lucas: The Bank for International Settlements is also working on a multi cbdc platform called mBridge, with China, Hong Kong, Thailand, and the UAE. That's explicitly designed for cross-border payments in multiple currencies, potentially bypassing the dollar entirely. Luna: So the Fed's interest in FedNow isn't just domestic. It's also about maintaining the dollar's global role by ensuring US payment infrastructure stays state of the art. Lucas: I think that's a fair reading. Fed Chair Powell has said publicly that the US needs a modern payment system to remain competitive. And the Fed is also exploring a CBDC for wholesale cross-border use, though they've been cautious about a retail CBDC. Luna: Let's bring it back to a concrete question: what does this mean for someone listening who's not a banker or a central banker? How does the rise of instant settlement affect them? Lucas: Three things. First, your paycheck or a business payment can clear in seconds — no more 'the check is in the mail' or waiting for ACH to settle overnight. Second, it may change how you manage cash flow. If payments are instant, you don't need as big a buffer. Third, monetary policy changes might feed through faster — if the Fed cuts rates, that lower rate could show up in your savings account yield more quickly, because the liquidity is moving faster. Luna: But also, there's a potential downside: if payments are instant and irrevocable, fraud becomes harder to reverse. The Fed has built-in fraud detection tools, but consumers need to be more careful. Lucas: Right. In the old system, you had days to catch a fraudulent check. In real-time, once the money moves, it's gone. That's why the Fed requires banks to implement strong authentication for FedNow. Lucas: So to wrap up: central banks are rebuilding the payment infrastructure from the ground up. It's not flashy, but it's arguably as consequential as the interest rate decisions we cover. And the big question going forward is whether these systems will converge globally or fragment along geopolitical lines. Luna: And whether the private networks like RTP and the central bank networks like FedNow will coexist, or eventually merge. Lucas: Exactly. That's the story to watch over the next five years.