Improving the National Check Collection System Improving the National Check Collection System

February 1, 1996
Bank Administration Institute, Float Management Conference Orlando, Florida

Thank you for having me on your program this morning. I'm looking forward to learning about current developments from several of the sessions today and tomorrow, and I hope I will be informative for you also.

I have been giving a lot of talks about check and retail payments issues during the past year. I see this as a big part of what I should be doing in my assignment as the Federal Reserve's product director for retail payments. My colleagues in Boston and I, working for all the Reserve Banks, are supposed to focus on the retail payments market, and the strategic issues of importance to the payments system. And to do that we need to learn as much as we can, and work interactively with the banking industry as much as we can. Conferences such as this one help us to do both.

Of course, you can't give a talk unless you're invited, and I'd like to think it's a compliment to be invited as often as I have been recently. I'm not sure, though, because usually the conference organizers get around to asking, "you people aren't allowed to get reimbursed for expenses, are you?"

And it may simply be that people think I hold the ashtray for Jay Simmons. Jay is on every program, so these conferences may assume we go around together.

Being at this year's Float Management Conference has a special significance for me, though, because it was my privilege to speak at this conference ten years ago yesterday. First and foremost, it's nice still to be welcome after ten years. Beyond that, my return to this agenda gives me a reason and a chance to do something I wish I could do much more often: reflect. Reflect on what was happening ten years ago, how the world of payments looked to us then, and how things have changed.

I believe history can help us to learn. I also believe we make a mistake when we assume that the future will be like the past. If we look at some aspects of today's payments system against the background of the past, we might see what is likely to be different in the future. We might also see more clearly the need to take new, greater, bolder initiatives to make important changes happen.

So, if you will indulge me, I want to take a backward glance, at the 1986 BAI Float Conference.

Then I will share some perspectives on today's retail payments system, and forces for change that are at work.

I hope you will share a sense of urgency, that we must pursue as future directions the electronic origination of more payments, and the electronic collection of checks. And in closing I will give you an update on the Federal Reserve's joint efforts with some banking industry leaders to chart a course for electronic check presentment, or ECP.

Here's where we were in 1986. The best estimates of annual check volumes in the United States were 40 to 45 billion. Annual rates of growth were estimated at 4 to 5 percent.

Developments during the early 1980's had spurred some of the increases in check volume. NOW accounts had begun in New England in the early 1970's, and had been authorized nationwide in 1981. These accounts gave check-writers a new, interest-paying option for their checking accounts. They also bought in some new check-writers, from among the customers of thrift institutions.

We had the break-up of AT&T, which continues to reverberate through the market for telecommunications services, but impacted the payments system as well. Many households had new checks to write, for long-distance services and equipment rental. And the seven "baby Bell" companies all had hundreds of millions of new dividend checks to issue each year.

An emerging trend was lifeline banking, or "no frills" banking. These services sometimes were coming forward as new product initiatives of the banks. In other cases they were being required by state law. They brought a swath of new users of banking services, including check-writing, into the system.

And ten years ago we were seeing clearly the trend toward a service economy that continues today. The term "service economy" includes all sorts of activities, some of which look more like manufacturing than service. However, it is unmistakably clear that more and more we pay other people and businesses to do things for us. So we have more payments to make each year. And we make many of them with checks.

All of these trends, and others that supported an outlook for continued growth in check volumes, were evident in 1986. And yet, there still were widespread expectations that checks were on the verge of a decline. We had had predictions of a checkless society since the 1960's, from many directions. In the Federal Reserve, a study by economists in Atlanta in late 1983 had foreseen a decline in check use by the late 1980's. I hasten to note that my colleague Jim McKee from the Atlanta Fed, who helped to organize this conference, had absolutely nothing to do with that study. And many experts shared such expectations. Electronic payments had arrived, and the old-fashioned check would decline rapidly.

It did not look that way to me. Honestly, I may just have made a lucky guess. But in my talk here in 1986, I stated my own guess, that "annual growth in check volumes would continue for another 10 years, and perhaps longer".

After my presentation, we had a break. I've noticed that after I make a speech, everyone seems to need a break.

Well, during the break, several people, from banks and companies serving banks, came up to me and asked about that prediction. I was surprised that they were so surprised. They wanted to know how sure I was. They wanted to know if they could quote me to their bosses. They said they had not heard such good news about the outlook for their check operations anywhere else. They asked why the Federal Reserve was changing its predictions about the checkless society.

Frankly, their reactions were so strong that I started to think I had put my foot in my mouth -again. I wondered if I'd gone too far in pretending to have any ideas about the world of 1996.

Well, that was January 31, 1986. So, as of today, I think I've made it.

As you listen to this now, you might wonder what the big deal was then. Our perspectives of today have been influenced by 10 more years of check growth, and by a lot of false starts, pratfalls, and disappointments with electronic payments. Many people in banking now see continued growth for check volume indefinitely.

And this is my point. The wisdom in the air ten years ago was wrong. The wisdom in the air today also can be wrong. I think the future will be different from the past, although change will come slowly. Moreover, all of us in banking should want it to be different. We should be working to make changes for the better, and to make the changes happen sooner rather than later.

So where are we with retail payments today?

By our best guess, those check volumes have grown to 60 billion or more annually.

The rate of growth seems to have slowed, to perhaps 1 or 2 percent. I am hearing some knowledgeable people say that the growth has stopped, but I think we need more evidence before we can say so.

For the past twenty years the principal electronic alternative to the check has been the automated clearing house, or ACH. Ten years ago there were about 500 million ACH payments. Last year there were about 3 billion. That's still only 5 percent of check volume, but that's impressive growth.

And the ACH has lots of room for further growth. Getting our pay through ACH Direct Deposit is a great convenience, yet fewer than half of all American workers get paid this way today. And only a tiny fraction of bill payments are made via ACH.

The ACH can replace many more checks, and there is a new focus now on enhancing the ACH and promoting its use.

We in the Federal Reserve certainly are emphasizing these directions, as are NACHA, other ACH service providers, and other entities, notably in the government. The Federal Reserve and NACHA conducted a Direct Payment campaign during 1995, which will extend into 1996. NACHA has had over one thousand inquiries as a result of this campaign, from corporations and depository institutions, saying "tell me more" about how to use the ACH in place of checks. This year you will see a new push from the Social Security Administration on direct deposit, and an effort led by the U.S. Treasury to promote ACH direct payment.

After years of slow growth, point-of-sale (POS) transactions are estimated to have come close to 1 billion in 1995, spurred by wider acceptance by merchants, and the option to use ATM cards as "debit cards" in stores.

All of this leaves aside the huge volumes and continued growth for credit card transactions, which, strictly speaking, are extensions of credit rather than payments, but functionally are used in place of checks, cash or debit cards. Credit cards now are accepted in new places, most notably in supermarkets. And we are offered all sorts of new incentives to use them more, including frequent flier miles, credits toward buying a car, and other purchase credits.

Besides the ongoing growth in these familiar alternatives to the check, we can see some new or intensifying forces for change. One of these forces is the array of new electronic payment options.

Stored-value cards, smart cards, home banking systems, and services available through the Internet promise new choices and added convenience for consumers and businesses. It is too early to tell how these options will progress, but some of them are likely to flourish. In some cases they will displace cash payments more than check payments, though some impact on check volume should also be expected.

The home banking option gets at consumer check-writing in the home more directly than the other options. It is happening at pretty low levels now, but it will be growing. The upside of home banking is that it gets consumers used to initiating payments electronically.

An interesting twist is that most of these payments, initiated electronically, are completed with checks. And these checks have no signatures in most cases. They are pre-authorized drafts, and their prevalence presents new risks for consumers and banks. How do we tell the good checks with no signatures from the fraudulent or erroneous ones? In the push for home banking, banks and other providers need to address this issue.

Another force for change is the ever more sophisticated consumer, ever more willing to use electronics, when the electronics provide greater convenience. Close to 40 percent of households have PC's. We are using automated telephone services for more purposes. One notable trend, on college campuses, is the rapid growth in proprietary electronic card systems to pay for meals, books, and other purchases. Soon we will have millions of young people in the workforce who are accustomed to making payments electronically, providing a critical mass for more widespread adoption of new payment options.

The new systems, along with the growth and enhancement of the more familiar ACH and POS systems, could provide the array of features, choices and convenience needed to make substantial inroads into the use of checks. As I say that, though I believe that in any scenario we are likely to have many billions of checks to handle each year for many years to come.

And another force for change, with which all of you are quite familiar, is competition. Corporations, large and small, really are competing with international firms in a global marketplace. Firms in many nations enjoy cost advantages and governmental support which make it difficult for American firms to compete successfully. The ongoing pressure in all businesses to improve efficiency and reduce overhead will only intensify. All facets of business are being scrutinized, including how payments are made and received. The larger a business' volume of payments handled, the greater the incentive to move away from the paper-bound check system to some electronic alternative.

Float benefits, real or perceived, sometimes stand in the way of this movement, but the real resources and real costs tied up with the use of checks cannot be covered up or explained away in the long run. And electronic payments can reduce float costs on the collection side even if they take away float benefits on the paying side.

No industry is more competitive than banking these days, and here also we can only expect current forces to intensify. If banks did not already have enough competitors within the industry, they now face non-bank competition for an ever-increasing portion of what had been the "business of banking." Certainly this stands to be true in the payments arena, where new providers are in the wings.

These non-bank providers of payment services may have cost advantages over banks for a variety of reasons. One particular advantage is that they will confine themselves to electronic options.

Take a look at all the new payment options and all the new players. Nobody is pushing a new paper-based system. Nobody wants to process paper. Nobody has to process paper -except the banks. The banks alone will be stuck with the expenses and inefficiencies of paper payments, putting them at a competitive disadvantage, unless the banks themselves become a force for change.

What kind of change? Well, one future direction we should welcome and support is to accelerate the adoption of electronic payments. We should try to make the evolution from checks to electronics, however gradual it is destined to be, happen more rapidly than it would without the efforts of all of us.

Now, for people who view ourselves as "check people," dependent on the paper check system for our jobs, this is very hard to accept. However, for people who want our banks, and our banks' customers, both businesses and consumers, to be more competitive, and be able to use a less costly, more reliable means to collect their money, we should try to make it happen.

We should support the evolution of safe, convenient new payment options. And when it comes to the safety issues, such as contingency backup, and settlement, and credit judgment, nobody has as much to contribute to the design and implementation of new systems as bankers have. I see no reason at all to cede the field of efficient electronic payment options to non-bank players. Bankers can learn a lot from these players, but they can learn a lot from bankers, too.

Even if we all get behind electronic payments, change is more likely to come slowly than swiftly. As I mentioned, I expect we will have many billions of checks to process each year for a long time. And while we have made the check collection system work pretty well, it is costly, slow relative to electronic alternatives, prone to delays and errors, and increasingly subject to criminal exploitation. The more we believe the check will endure as a popular means of payment, the more we should commit to changing the check system for the better, with electronics. This is our second important future direction: to collect checks electronically.

Electronics can accelerate the collection process, making funds available faster for banks and their customers. And it can accelerate the return process. It can reduce costs, and reduce risks. It can get us out of the sitting duck posture we have now with respect to check fraud. It can reduce the cost burden on banks when only they are supporting paper payment systems, and other providers are competing with electronic payment systems.

During these past 10 years, the Federal Reserve and the banking industry have taken numerous initiatives to implement ECP in various forms. The Federal Reserve offers a variety of electronic check services that encourage paying banks to use the payment information in electronic form to post payments to their customers' accounts, and to prepare account statements. Members of the Electronic Check Clearing House Organization, ECCHO, send the electronic payment information to one another hours in advance of the checks, so accounts can be updated and potential return items identified earlier. The New York Clearing House is implementing in phases the electronic exchange of check payments among its members. Other banks are also exchanging check payment information electronically with one another.

All of these initiatives bring benefits to the participants. However, most checks in the country still are collected without the benefit of electronic communication. Moreover, most of today's ECP initiatives still require paper checks to be handled and delivered all the way through the collection process, in addition to the electronic information. In these models, the check payment is not deemed to be completed, or "presented," until the check gets to the check-writer's bank, so the uncertainties and costs of the paper-bound process remain.

In an ideal ECP environment, the paper check would be stopped as early as possible in the collection process, be that at the bank of first deposit, or at an intermediary such as a Reserve Bank or correspondent bank, or even at the point of sale. The check payment information would flow to the check-writer's bank, but the check would not. The check collection process would be all-electronic, as the ACH process is today.

In this ideal model, the costs for check collection would be reduced. Payments would be collected faster, with every check presented electronically to the check-writer's bank on the same day or within one business day of entering the bank collection system. Payments would be collected more reliably, without delays due to weather or errors due to repetitive efforts to read the paper. Losses due to returned check would be reduced by a swifter collection and return process. Fraud would be deterred by closing the gap between collection times and funds availability schedules for depositors. And banks could reduce their costs by reducing the resources needed to process and collect deposited checks, and process and return the checks written by their customers.

What will it take for us to get there? What are the obstacles? What can be done to overcome them and achieve the ideal?

To address these issues comprehensively, the Federal Reserve and banking industry leaders have formed an Advisory Group on Electronic Check Presentment. This group, with participants from a national cross-section of banks, large and small, as well as representatives from industry groups pursuing ECP initiatives, wants to establish ECP without paper collection as its common goal. We want to pursue tests and studies that can help the banking industry chart a course to get from the present to the ideal system.

Our group has significant issues to address, including:

  • Standards for electronic exchange of check payment information;
  • Systems and standards for banks collecting the checks electronically to be able to provide sufficient information from each check to meet the needs of the paying bank and the check-writer;
  • Safeguards and services to protect consumers' funds and provide timely, high-quality access to particular checks, or representations of checks, when needed; and
  • Legal and regulatory actions to allow for electronics rather than paper to constitute presentment, and to address risk and liability issues such as signature verification. 

During this year, the Advisory Group will be analyzing legal and cost/benefit issues, and also conducting "hands-on" tests to explore approaches to ECP, such as beginning with low-value checks, and the potential for image technology to support an electronic return item process. We will also develop more specifics on how ECP without paper might work in the longer run, and consider how today's forms of ECP might help the banking industry move in stages toward an ideal system.

Getting from today's check system to an ideal system will be an enormous challenge. The good news is that bankers and the Federal Reserve are working together to chart the course. And we need your help.

In your material for this session I have included the summary of our Advisory Group's first meeting. It lets you see some of our thinking and the "next steps" we are pursuing now. Please look it over when you can, give it some thought, and share with us your ideas, your experiences, your data, your best input on how we can chart this course, and get from here to there.

We welcome your help, and we hope you see this as a great opportunity to be agents for change, and to make important improvements happen.

And maybe, God willing, we will have a lot to be proud of when we gather again in the year 2006 to take another backward glance together. Thanks very much.

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