The Federal Wire System

In the previous article, we had a closer look at the automated clearinghouse or the ACH system. ACH is not the only system for interbank payments in the United States. There is an alternative payment system called Federal Wire, which also exists. In this article, we will have a closer look at what Fed Wire is and how it is different as compared to the ACH system.

What is the Fed Wire System?

The Fed Wire system is a service that is offered by the Federal Reserve, which is the central bank of the United States. This service is provided by the main Federal Reserve bank as well as its twelve regional offices. Since this service is offered by the central banking system, it is only valid for the member banks.

The Federal Reserve System is a mechanism of real-time gross settlements that happen between member banks. These two features i.e., real-time as well as gross settlement, make it different from the ACH system.

ACH transactions are not credited to the beneficiary in real-time. They are often credited on the next business day. Also, it needs to be understood that in the case of Fed Wire, banks pay gross amounts to each other. This means that each transaction is settled individually. This is opposed to the ACH system, where several transactions between different banks are grouped together, and only the net amount has to be paid by the banks to one another.

Since the grouping of transactions takes place over the day, the ACH is settled on the next day. On the other hand, since no grouping needs to be done in the case of Fed Wire, the transactions can be settled immediately.

It also needs to be understood that in America, the Fed Wire system can only enable payments which are denominated in American dollars. If payments have to be made in other currencies, the Fed Wire system cannot enable such payments.

Finally, it needs to be understood that as soon as instructions are given by the customer, the central bank immediately debits the account at one bank and credits the account at another bank. Hence, once the payment is processed, there is no way to reverse the transaction. Therefore, payments made using the Fed Wire system are final and irrevocable. This is why Federal Wire service is only used to make payments where large amounts are involved and where time is critical.

Are International Payments Impossible Using Fed Wire System?

As mentioned above, the Fed Wire system can only make payments in US Dollars. However, businesses today need to make a lot of cross border payments. This can be done using the international Fed Wire correspondent banks.

Correspondent banks are few foreign banks that have an account with the Federal Reserve System. Hence, when a payment has to be made in a foreign location or in a foreign currency, the services of the correspondent bank are used.

Here, the Fed deducts the money from the account of the initiating party and then deposits the same in the account of the corresponding bank. This corresponding bank then uses its network to deposit the money in the beneficiary’s account.

It needs to be understood that the currency rates, as well as the fee for undertaking the transfer, differ from bank to bank. This is because each bank maintains different bid-ask spreads for different currencies based on their own network. As a result, customers have the option of suggesting which correspondent bank should be used as an intermediary to route the payment.

The messaging chain in the case of a cross border wire is quite long. The initiating party gives the instructions to their financial institution. This institution then gives instructions to the Fed, which then forwards the same to the correspondent bank.

The correspondent bank finally sends instructions to the beneficiary’s bank and then to the beneficiary. Since the chain is so long, it often takes two days to transfer the payments to the final beneficiary. If it takes longer than two days, it is not considered to be a wire payment by definition. This is the reason that in almost all cases, the beneficiary receives money in less than two days.

Fees Charged by Fed Wire

The Fed Wire service is not provided with an intent to make profits. However, the law mandates that the Federal Reserve charge a nominal fee in order to make up for the costs. It is for this reason that Fed Wire charges a nominal fee per transaction. Also, this fee is reduced drastically if the number of transactions or the dollar value of transactions increases. Since most payments made by Fed Wire are high-value transactions, the nominal cost is actually irrelevant to most users.

The bottom line is that that ACH, as well as the Fed wire system, provides complimentary services that complete the payment system. One is used for low-value payments, whereas the other is used for high-value transactions.

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