Change in the National Payments System
Good morning. Welcome to the Federal Reserve Bank of Boston. And welcome to the 2007 Contactless Payment Forum, organized by the Bank's Emerging Payments Research Group.
The national payments system, on which we all depend, always has been changing. In recent years, however, the pace of change has accelerated. Moreover, the array of payment choices available to American consumers and businesses continues to expand.
Contactless payments, which you will be exploring today, promise to add more choices, with speed and convenience that would have been unimaginable not very long ago.
Change comes in many forms. One of the most dramatic changes in U.S. retail payments is the increasingly rapid electronification of the check collection system. The U.S. check system took root at about the time of the Civil War. Check-writing became increasingly popular, and increasingly accessible to the broad population, throughout the 20th century.
For all of that time, the completion of a check payment required the physical delivery of the paper check back to the check-writer's bank.
Indeed, when Congress established the Federal Reserve System in 1913, the Act charged the Reserve Banks to establish a unified national check collection system, because of the inefficiencies that had grown up around that requirement to transport and present paper.
All of that is changing now, and changing quickly. The use of digital image technology, and the federal Check 21 law that became effective in October 2004, are transforming check collection.
Now, a bank collecting checks for its business and consumer customers can capture images and send them forward electronically. If the check-writer's bank will accept check images for presentment, the payment can flow through very quickly. If not, intermediaries such as the Reserve Banks can convert an image back into paper, what we call a substitute check, and present it to the check-writer's bank. This paper-to-image-and-back-to-paper model is a transitional stage we have to move through for awhile, until all banks can send and receive images. Even so, it speeds the collection of the checks and allows significant reductions in paper-handling and transportation.
Another way in which paper checks are being collected electronically is through conversion into electronic payments after the check has been written. The Automated Clearing House, or ACH, is the electronic mechanism through which we receive direct deposit of pay, and which we can use to set up automatic payment of recurring bills.
In recent years the ACH more and more has served as the infrastructure to support new electronic payment choices, such as on-line bill payment. It also has provided options for businesses and merchants to collect check payments electronically. About two and a half billion check payments mailed by consumers each year, for credit card bill payments and the like, now are being converted into electronic ACH payments by the billers. As a result, those paper checks never hit the bank collection system, and never come back to the check-writers.
The ACH also offers merchants the means to take a check at the cash register, capture the payment information immediately, and hand the check back to the customer. The payment will be collected electronically.
Another option, just introduced in March, enables the merchant to batch the day's check payments and convert them into a batch of ACH payments for electronic collection. Here again, no paper in the banking system, and no check coming back to the check-writer.
Prior to the enactment of Check 21, and the advent of these ACH options for check conversion, the U.S. was experiencing a decline in the use of checks, particularly by consumers. That decline continues. It will be interesting to see whether these changes in how checks get collected influence consumer decisions about how to make their payments in the first place.
With respect to the decline in check writing, the 2004 Federal Reserve Payments Study revealed significant changes in consumer payment behavior. We saw for the first time that Americans were conducting more transactions electronically than by check. They have been moving away from checks, toward electronic payments, such as debit cards, credit cards, and ACH transactions. In 2000, the number of checks paid exceeded the number of electronic transactions, 42 billion to 31 billion. By 2003, the number of electronic transactions exceeded checks paid, 44 billion to 37 billion. These changes represent a 4.3 percent annual decline in checks paid, and a 13.2 percent annual increase in electronic transactions over that period, 2000 to 2003. The Federal Reserve Banks are conducting another survey now, to gather data through 2006. We will have results to share with you later in the year.
These studies help the Federal Reserve to formulate long-term plans for our own payments activities. The decline in check use has prompted the Reserve Banks to reduce by half the number of offices where we process paper checks. In 2003, the Reserve Banks had forty-five check-processing offices nationwide. We have 22 today, and we have announced plans to reduce to 18 processing locations by early 2008. Further consolidations are certain, as check volumes continue to decline, and as more checks are collected electronically. Already about a third of the checks deposited for collection at Reserve Banks are coming to us as electronic images instead of paper. We may get to 50 percent before the end of next year.
We hope our periodic studies also help financial institutions, and industry participants such as yourselves, to make better-informed decisions, including decisions about future investments in your payments technology.
Looking ahead, cash is another paper-based payment method that will experience significant shifts.
At the Federal Reserve, we want to understand the cash substitution effect, and the extent to which consumers are using alternative payment methods. In a complementary effort to the Retail Payments Study, our national Cash Product Office has been pilot-testing a survey to understand trends in cash payments. The purpose of the survey is to understand better the use of cash and other payment methods, particularly the number and value of payments executed with different choices. The pilot study was completed just last month, and the results will be shared with the public later this year.
A rapid decline in the use of cash in the near future seems unlikely. However, a number of developments, including the growing volume of low-value card payment transactions, and increasing acceptance of cards and other electronic-based instruments for purchases traditionally made with cash, have reinforced the view that the use of cash for transactions may not be as intensive as in the past. Some cash displacement is happening.
Contactless payments, today's subject, have the potential to displace cash for many lower-value payments. Around the world, contactless payments are increasing speed and convenience for consumers and merchants. In the U.S., we saw the early adoption of contactless payments in 2006 by certain merchant categories and leading financial institutions, and there will be more innovations to come.
The Federal Reserve is a proponent of fostering innovation in the payments system, and this includes reducing barriers to payments acceptance. In that regard, the Federal Reserve Board is considering an amendment to Regulation E. Under the proposal, a retailer can waive the receipt requirement for small-dollar electronic funds transfer of 15 dollars or less. On January 30 the comment period closed for the proposed amendment, and a decision will be made later this year. If adopted, this change could have a significant beneficial impact on the use of contactless and other payment cards.
Shifts in consumer behavior, technology, and rapid innovation, along with legal and regulatory changes, are reshaping the retail payments system. These shifts bring tremendous opportunities for us to innovate and pursue new directions. Successfully navigating this period of change will require collaboration. In the Federal Reserve, we want to be better at understanding the marketplace and anticipating its needs; we intend to listen to emerging market segments; we want to be adaptive, in our thinking and our activities. Holding forums such as this one helps us, and we hope it helps you.
The Federal Reserve will continue to have an important role within a more-electronic retail payments system. We will continue to monitor developments within the payments system to understand their implications and to help the public to understand them. As a policymaking body, we will continue to promote the integrity and safety of the payments system while also supporting improvements in efficiency and accessibility. When appropriate, the Federal Reserve will act as a catalyst to greater efficiency, safety, and accessibility, as we have been doing with Check 21.
The Emerging Payments Research Group here in Boston was developed to assist in this effort. We established this Group late in 2004, and in its brief existence, the Group has held two conferences on consumer payment behavior, published a paper on this subject based on a national survey of Federal Reserve employees, produced an industry reference guide from interviews with experts, and more recently published a briefing on mobile payments. All that we have published is available on our website.
One of the roles of the Group is to share information and experiences which can inform stakeholders, including financial institutions, businesses, and consumers. The Group plans to continue to conduct research and analysis, and to publish additional briefings on emerging payment types, and the demand side of payments. You will be hearing more about the initiatives of the Emerging Payments Research Group from my colleagues later in the day.
I am glad all of you are with us, and I hope you enjoy the Forum, and your time at the Bank. Thank you.