View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

II

(G)

JF (":6\, (e::
ff If)l 1i

CD)

December 3,1 982

Float
Even with the recent decline in interest rates,
float continues to be a major concern of
bankers and cash managers. Float constitutes
a transfer of wealth from one party to another,
and attempts to create or eliminate it require
significant real investments for the banking
and cash management industries.
Yet amid the debate over specific float-reduction methods, very little is said about the
important role that float plays in the payments
system. For example, in eliminating Fed float
as mandated, one could reduce its average
aggregate level to zero over some period such
as a month, or one could eliminate Fed float
on every individual transaction. Conceptually, either end could be accomplished, but
the effect on individual banks and the payments markets might be quite different.

Economicsof float
Float is created whenever there is a mismatch
between the time that the payor loses full use
of funds and the payee gains full use of the
same funds. Although there are many sources
of float, two are of concern here: bank float
and Federal Reserve float.
As an illustration, suppose that Corporation A
in Miami deposits at its local bank a check
that is written against a San Francisco bank
account of Corporation B. Suppose, in addition, that the Miami bank gives Corporation
A immediate credit as a normal part of its
checking account service. The fact that immediate credit (Le., "good funds") was
granted and that the paper check takes time to
clear creates "bank float." In essence, the
Miami bank has loaned funds to Corporation
A until such time that the check has cleared
and good funds are received from the San
Francisco bank.
The Miami bank may choose to send the
check directly to the San Francisco bank, or it
may route it through either a private correspondent or the Fed network. If the check does

not pass through the Fed, only "bank float" is
created; if it does, "Fed float" may also be
created. Over forty percent of the nation's
checks pass through the Fed and large dollar
transfers also are effected through the Fed's
electronic systems.
If the Miami bank presents the check to the
Miami Fed branch for clearing, the Fed by
conventioncredits the Miami bank's reserve
account on the basis of a predetermined
"availability schedule." Although the availability schedule is highly complex, two days
hence is representative for interdistrict items
of this nature. If the Fed can clear the check
and debitthe San Francisco bank's account in
two days, no Fed float is created. However, if
the Fed by chance takes three days to clear
the check, one day of Fed float is created in
addition because the Fed has extended good
funds on the second day, butdoesn'tdebitthe
San Francisco bank until the third day.
In the context of paper checks, Fed float is the
difference between the stated availability
schedule on which the Fed credits the collecting bank's reserve account and the actual
clearing time on which it debits the paying
bank's reserve account. It is analogous in
concept to bank float.
.

... asa service
Both bank and Fed float can be thought of as
constituting a part of the "service" of transacting payments. With the exception of largedenomination business transactions, deposits
of paper checks normally are credited with
good funds on a predetermined basis. The
collecting party values both the fact that
availability is predetermined and that it is
rapid. Because of its value to customers and
its simple accounting requirements, immediate (overnight) credit is the norm for most
consumer checking accounts. With known
funds availability, the account holder is reasonably sure of his daily cash receipts and
thus can gauge his disbursements accord-

reD@, CD)
liD,
1f
§

IFif

CC
11 CD)

Opinions expressed in this nevvsletter do not
necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco,
or of the Board of Covernor<, of the Federa.l
Reserve System.
ingly. Given the prevailing use of slow paper
checks and equally slow information systems, basing credit on actual clearing times
would require intricate information flows and
still would result in delayed knowledge of
funds availability.

efficient pricing structure, as the amount of
float is largely under the control of the check
writer, not the depositor.) Thus, banks charge
a "bundled" price for check-clearing services
(foregone interest and/or fees) that only on
average covers the cost of float.

Banks, and the Fed, offer not only predetermined credit, butthey also offer "premature"
(advance) credit on average. When a bank
provides advance credit and positive float is
generated, the cost of the float is borne by the
bank. As such, bank float is simply part of the
bank's cost of providing the joint checking
account/check clearing service. Two of many
attributes of that service are predetermined
credit, and often, advance credit. Since
commercial banks are in business for private
profit, we must presume that the bank is
charging the customer a price that compensates for the cost of float (even though the
charge is not linked directly to the float).

. .. as a subsidy
The mechanics of Fed float are similar to
those of bank float. When banks bring checks
to the Fed for clearing, it grants predetermined credit, aJbeit normally with a lag. On
average, it also gives some advance credit,
generating positive Fed float. The
daily variability of Fed float comes from many
sources: unexpected processing delays and
equipment malfunctions within Fed offices,
transportation delays, and computer or communications breakdowns. The positive level
on average results from an availability schedu Ie that is somewhat ambitious relative to
these factors. While the availability schedule
is based on actual historical data, the Fed
tends to round fractions of a day down to the
nearest whole number. (Advance credit turns
out to average only a fraction of a day per
transaction.)

The dollar value of float on large-denomination items suggeststhat advance cred it may
be a significant part of the value of checkclearing services. For example, the value of
three-day float on a $1 0,000 check is roughly
$8 at present interest rates, far in excess of the
perhaps 2Si average total handling cost of a
check. (With large-denomination checks, the
2Si figure may be a substantial underestimate, given that processors may have an
incentive to employ costly handling procedures in order to reduce the cost of float.)

Although the mechanics of bank float and
Fed float are comparable, the interpretation
of a positive average level of float differs. In
the case of a private commercial bank, float
cost is borne internally and must be passedon
to the bank's customers if the bank is to
remain in business. In the case of the Fed,
however, the cost of Fed float historically has
been borne by the U.S. Treasury in that the
Treasury's revenues from the reserve tax have
been reduced by the interest-value of the
float.

Since predetermined credit and advance
credit both are valued by depositors, we cannot be certain that float ought to be reduced
to zero, or that a bank would eliminate float
even if-it cou Id. In theory, bank customers are
willing to pay explicitly for float. A practical
problem arises, however, because direct and
explicit charges for float would require prohibitively costly information systems under
today's technology. Charging the depositor
for each float item would require information
on the ultimate clearing time of every check.
(Even then, charging the depositor explicitly
for the float would not necessarily lead to an

When Fed float is positive (negative), total
bank reserves are created (extinguished) temporarily because of the mismatch between
when one bank's reserve account atthe Fed is
credited and another bank's is debited. Such
reserves have a market value that is determined by the Federal funds rate. (The Fed
funds rate is the interest rate that banks charge
each other for overn ight reserve loans.) Whi Ie
2

$Blilions

FEDERAL RESERVE FLOAT

10.0

$ Millions

Annual Value ,...
(at Fed funds rate)

"I',

8·0

"

6.0
4.0

.\

2.0

1 000
800
600
400
200

O.

1965

1970
1975
Last date plotted: Jan.- Aug., 1 982

0
1 980

/'

imposed in part for monetary control purposes, (non-interest-bearing) required reserves may be likened to a tax imposed by
government on the banking system (and indirectly, its customers). Positive Fed float represents a "subsidy" that partially offsets the
much larger tax imposed through required
reserves. Even at its annual peak in 1979, the
$6.5 billion of Fed float still represented only
a partial offset to' the $41 billion in sterile
reserves required of member banks.

hours-the deadlines within the day by
which the Fed accepts checks from depositing banks and presents checks to paying
banks. (By altering availability schedules, the
Fed would be changing only the accounting
conventions. In contrast, by altering deposit
and presentment hours, the Fed would require that checks actually move according to
different deadlines.) Most of the reduction in
Fed float since 1979 is the direct consequence of investments the Fed has made to
move checks faster. But to reduce float
further, the Fed is considering both of the
other possibilities.

In the years preceding passage of the Monetary Contro I Act (MCA) of 1980, Fed float and
free Fed services were used as partial offsets
to the cost of holding idle reserves at the Fed.
Despite these offsets, Fed membership was
declining as banks increasingly sought to
escape the rising cost of required reserves.
The M C A of 1980 addressed the issues of
required reserves, Fed services, and float
simultaneously. It made required reserves
universal and independent of Fed membership; it required the Fed to price its nongovernmental services at full cost plus a margin
for taxes and cost of capital (presently 16
percent); and it required the Fed to eliminate
or price its float.

It is possible that both the average level of
float and its day-to-day volatility could be
reduced Simultaneously ifthe Fed were to
move towards a real-time electronics payments system-i.e., one in which debits,
credits, and information flows (confirmations) are effected simultaneously. (If the
commercial banking system were to adopt
real-time electronic payments, bank float
could be eliminated similarly.) Wire transfers
and automated clearing house (ACH) transfers with simultaneous confirmation constitute such a system.

The float issue was no small part of the package. At passageof the M CA, the implicit value
of Fed float (see chart) exceeded the $400$500 million combined annual cost of all Fed
services that were mandated to be priced!

In a world in which it is difficultto charge the
depositor directly fo rfl oat, and nearly impossible to charge the initial check writer, there is
considerable merit to moving toward electronic systems that hold the ultimate promise
of eliminating float altogether. They also
would eliminate the credit risk associated
with delays between credits and debits.

EliminatingFedfloat
Random elements and uncertainties such as
transportation delays and equipment malfunctions make both bank float and Fed float
extremely volatile on a day-to-day basis.
Although the volatility and aggregate level of
float often are related, the issue regarding the
subsidy value of Fed float does not necessarily center on eliminating its daily variance,
but rather on reducing its average aggregate
level to approximately zero. One could
achieve this end by (1) moving paper checks
through the Fed at a faster average rate, (2)
extending the availability schedules slightly,
or (3) altering "deposit" and IIpresentment"

But despite their ultimate promise, fully electronic payments systems are still some distance in the future. In the meantime, the Fed
must eliminate or price its float. In the context
of Fed float as a subsidy and a political issue,
it is the average level of Fed float that is
central, not necessarily its daily volatility.
There are many ways to reduce or eliminate
this average level while still retaining the
system of predetermined credit that is of
value to depositing banks.

JackH. Beebe
3

d

1006

UOl8U!4Sl?M 4l?ln • uo8aJO Ii l?pl?i\ar'-l" 04l?PI
Ii
!!l?Ml?H • l?!UJoJ"l?:) • l?UOZPV • l?>jSl?IV

CD)

:{l

BANKING DATA-TWELFTH FEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)

Selected
Assets Liabilities
and
Large
Commercial
Banks
Loans(gross,adjusted)and investments*
Loans(gross,adjusted)-:- total#
Commercial and industrial
Realestate
Loansto individuals
Securitiesloans
U.s. Treasurysecurities*
Other securities*
Demand deposits - total#
Demand deposits - adjusted
Savingsdeposits - total
Time deposits - total#
Individuals, part. & corp.
(Largenegotiable CD's)

Weekly
Averages
of DailyFigures
MemberBankReserve
Position
Excess
Reserves )/Deficiency (-)
(+
Borrowings
Net free reserves(+ )/Net borrowed(- )
* Excludestrading account securities.
# Includes items not shown separately.

Change
from
11/10/82

. Amount
Outstanding
11/17/82

161,402
141,845
45,466
57,490
23,386 ...
2,060
6,507
.13,050
41,205
28,049
32,440
98,894
88,787
35,865
Weekended
11/17/82

3H
234
44
8
9
151
- 121
41
418
- 825
87
- 773 .
670
- 797

c-

-

Weekended
1-1/10/82

96
14
82

139
39
100

Changefrom
yearago
Dollar
Percent

7,47"1
8,753
5,497
2,082
87
11
1,060
2,342
590
-187
2,714
12,468
10,824
2,764

4.9
6.6
B.8
3.8
.4
.1
19.5
- 15.2
1.5
.7
9.1
14.4
B.9
8.9
Comparable
year-agoperiod
33
16
17

_

Editorial
comments beaddressed the.editor to theauthor, .. . Free
may
to
or
copies thisandotherFederal
of
Reserve
publications beobtained callingor writingthePublicInformation
can
by
Section,
Federal
Reserve
.
Bankof SanFrancisco, Box7702,San
P.O.
Francisco
94120.
Phone
(415)544-2184.

4I