by Paul M. Connolly, Retail Payments Product Director , Federal Reserve Bank of Boston
Bank Administration Institute, National Payments System Symposium
Washington, D.C
October 9, 1996

     I'd like to think of my place as the middle speaker today as symbolic of the role of the Federal Reserve Banks in the payments system of the country. We are the Treasury's fiscal agent, and provide important services to the Treasury. We also provide commercial payment services to private sector depository institutions. And it's our job to serve the public interest in both capacities. We are something of a middle state between the public and private sectors. So maybe that's why I'm in the middle on our panel today.

    Larry Stout of the Treasury has given you the important features of the new legislation, and Jack Price from NationsBank will be explaining how it pertains to his bank, and to the broader banking industry. In my segment, I would like to look at three topics with you.

    First, what the Reserve Banks are doing, and will be doing, to support the Treasury's implementation of the legislation.

    Second, some key differences we see, in that middle state of ours, between the perspectives of the Treasury and the perspectives of many corporations and banks, regarding electronic payments.

    And third, a call to action, that I believe will echo much of what you have heard at this conference. We all need to move toward an electronic retail payments system for the country, with electronic payments, and with electronic check presentment, or ECP. There is a lot to be done for us to succeed with this strategic direction, and we in the Reserve Banks are eager to pitch in with the banking industry and the other stakeholders in the system to make it happen.

    Implementation of the Act will be an enormous challenge for the Treasury. Our job at the Reserve Banks is to help in every way we can, in accordance with the Treasury's needs. We will have many supporting activities going on, but here are some already underway.

    We are preparing for huge increases in the government ACH volumes that we process. Today's volume of about 420 million transactions per year could reach 700 million within a few years. A particular concern is to avoid making today's peak-volume days a lot worse when overall volumes grow so much. Social Security is working to put the monthly payments for new recipients on different cycles from today's, and that will help. We may need to work with other agencies to spread their payments somewhat more than we do today.

    While we gear up enthusiastically for many more ACH payments, we must keep the government check system running well as check volumes decline. Today all 12 Reserve Banks process government checks, which also exceed 400 million annually. We know that number will be declining dramatically, but we do not know the exact pace that change will take, and we want to provide high-quality check services to the Treasury, so that Treasury can continue to provide high-quality services to other agencies and the public, for as long as is necessary. Managing a decline in the face of uncertainty may be more complicated than managing rapid growth.

    The Treasury's need for effective support of electronic payments to all of the government's vendors will require more attention to Electronic Data Interchange, or EDI, by the Reserve Banks. To date we have found relatively low levels of interest in EDI among the banks we serve, and we have to assume that means most of the banks' corporate customers are not calling loudly for EDI support -at least not yet. But the Treasury probably will want to use EDI much more in these next few years.

    And so, the Treasury's vendors will need more EDI support from their banks. And the Reserve Banks also must become more conversant about EDI, help the banking industry to accommodate the Treasury's use of it, and determine what operational support we should provide to enable the Treasury to benefit from EDI.

    And we share in the enormous communications challenge facing the Treasury. Every depository institution in America, tens of thousands of businesses, and tens of millions of people will be affected by the legislation. How many of them do you suppose are aware of it, let alone understand it in detail?

    We will help the Treasury to get the word out in a variety of ways over time. In one collaborative effort, the Treasury, the Reserve Banks, NACHA, and regional ACH associations are going to conduct a series of public seminars to explain the law, and also to support recent Treasury and Social Security initiatives to promote electronic ACH payments. One of these seminars will take place later this month, in St. Louis, hosted by the St. Louis Reserve Bank. And more will follow.

    As we work side by side with the Treasury on these initiatives, it really strikes us that their perspectives on electronic payments are very different from what we experience with many corporations and banks.

    Before the Act ever passed, the Treasury's Financial Management Service, under Russ Morris' leadership, had half or more of its payments going electronically, instead of by check. How many businesses can say that?

    And the Treasury wanted the legislation because the the Treasury wants as close to 100 percent of its payments as possible to go electronically. Very few businesses have such a commitment to electronic payments.

    For its check payments, the Treasury converted many years ago to truncation. All 400 million of those government checks each year are truncated by the Reserve Banks. The Treasury posts its paid checks from the MICR-line data delivered by the Reserve Banks, and looks at exception items on microfilm. They very rarely look at physical checks. Again, very few companies, and not many banks have made such a commitment to breaking away from the traditional paper-bound check system.

    In recent years the Treasury has worked with us to test and prove the viability of check image technology as a successor to microfilm, for the archival storage and retrieval of truncated checks. Images can be captured immediately, with higher quality, and be retrieved and delivered electronically. Treasury helped us to learn all this because the Treasury has been committed to using technology to make its payment processes more electronic, less costly, and more responsive to the needs of its constituents.

    Moreover, we can point to commercial image products in the marketplace today and tell you that those products are of higher quality because the Treasury held to high standards during the R&D work that the manufacturers performed for the Reserve Banks, with government check as the first target application.

    The Treasury advocates electronic payments, and electronic check presentment. Both have been very slow to take off elsewhere. Why?

    I'm sure there are many reasons, but I'll mention two that seem important. First, the Treasury has been able over time to get to a mass of electronic payments, such that its issuance and reconcilement of electronic payments is cheaper than for checks. Banks and businesses probably are not there yet.

    When electronic volumes are small, the cost per item looks high. This a real challenge for all of us. The Treasury has shown us that electronic payments are cheaper than checks. But how do we invest in new electronic payment mechanisms, while having to support the older paper mechanisms, and without having, yet, the mass that will make electronics more cost-effective than checks?

    The second issue is check float. The Treasury focuses on real costs and real resource use. Electronic payments are less costly for the taxpayers, so the Treasury uses them to the maximum.

    Electronic check presentment reduces check collection costs, and what you might call "DDA accounting" costs, so the Treasury has adopted ECP.

    In all of this the Treasury does not try to gain any float advantages.

    By contrast, check float, and the enduring practices of many businesses to treat float as a profit opportunity, seem to be major impediments to electronic payments, and perhaps to ECP as well.

    We have to wonder. If the opportunity to profit from float, obviously at the expense of the party being paid, were eliminated, or reduced substantially, would businesses and banks focus more clearly on the real costs and real resources tied up in paper check systems, and on the savings that electronics could provide? Would many more entities act as the Treasury has acted? To move toward a more electronic payments system at a much faster pace, we will have to address the float issue.

    These differences, in mass, in costs, in approaches to float, help us to see how far away we are from an electronic retail payments system. And yet, that's where we have to go.

    We have a check system that works well, but is very costly, when we look at the all-in costs for using and processing all that paper. It's also a slow system when compared with electronics, and increasingly the system is subject to criminal exploitation.

    Well, if the check system has these liabilities, why do we have over 60 billion checks written every year, with at least some growth each year? There are a lot of reasons. Float is one of them, as I mentioned. Another is that decision to use checks usually do not have to take the full costs of the use of checks into account. Both float costs and collection costs are borne by the recipient, while the check-writer actually benefits from the float.

    The check also has a lot of appeal. It is familiar. It works well. We have standards to support its use, such as the MICR line. We have a national infrastructure for check collection, including the U.S. mail, the check processing capabilities at every depository institution or its agent, local clearings, correspondent banks, and the Reserve Banks. Most merchants accept checks, because consumers use them, and the merchants can collect them with relative ease. When consumers pay bills from the home with checks, they control the timing and the amount of each payment. And if all that isn't enough, banks compete for business by advertising free checking.

    For electronic payments to supersede check payments, we will need an array of electronic choices that collectively give consumers and businesses the combination of attributes that they enjoy with checks today. Simplicity. Universal acceptance. Convenience. Control. Low cost.

    We can see some promising signs that we did not see just a few years ago. In most parts of the country, nearly all purchases in supermarkets were paid for with cash and checks until recently. Today, a point of sale machine is literally in your face as you come through the checkout line. Debit cards and credit cards are displacing many checks, as well as many cash payments. At other points of sale, such as department stores and gas stations, debit cards also are progressing.

    A few years ago, to be a little unkind, PC banking was for nerds only. Not any more, though. PC banking and electronic bill payment still are used by a very small fraction of bank customers, but many banks will tell you that their growth rates are exceeding expectations.

    These recent successes tell us that some healthy segment of consumers is willing to change behavior, and use electronic payments, when it's easy, convenient, free or cheap, and works well. Now we need more such options. For use at the point of sale throughout the retail economy. For use in the home by the majority of households that will not be doing PC banking anytime soon. And for corporations making payments to other businesses and to consumers. We will need standards, and accessible infrastructure, to support these new electronic mechanisms, just as we have for the check mechanism.

    And let's not forget the ACH as one of the electronic options we should promote. I haven't seen any mechanism that's better for paying people their salaries, and yet, after 20 years with ACH Direct Deposit, the majority of American workers still are paid by check. We need much stronger efforts to promote direct deposit.

    The ACH also is effective for payment of some bills, and we should enhance the ACH to make it more attractive to consumers for bill payment, for instance, with options to change the payment date from month to month.

    All of this change will take time. The longer you think it will take, the stronger your case becomes for electronic check presentment, or ECP. The goal is to replace checks with electronic payments. The next best thing is to collect the checks without collecting the paper.

    If you expect today's 60 billion checks to grow for a while longer, and then to decline gradually, so that we will have tens of billions of checks annually for a very long time, then it makes sense to re-engineer the check collection system.

    With ECP we can reduce costs, mostly the banks' collection costs. We can accelerate the collection of checks. We can reduce risk in the return process by speeding up collection and return. And that speeding up also can reduce losses from fraud.

    The Reserve Banks have intensified their focus on growing ECP services, emphasizing truncation. To get significant costs out of the system, we have to cut out some of the paper-handling.

    We also are working with an advisory group of senior bankers, to think, and analyze, and test together, bankers and Reserve Banks, to find the best approaches to a national ECP system.

    One of the bankers on our group is Jack Price, and if I want him to keep working with us I'd better get out of his way now.

    I hope you agree that all of us need to cooperate to improve the country's retail payments system with electronics. The Treasury has set an ambitious course. Let's follow their lead. Thank you.