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JuIy 31, 1981

PricingFedServices
On August 1, the Federal Reserve begins
charging users for clearing and collecting
checks, and for transferring funds electronically via automated clearinghouses (ACHs).
Pricing of these Reserve Bank services will
significantly affect the nation's payments
mechanism, because Reserve Banks process
nearly half of all paper checks, and also operate most of the cou ntry' s automated cleari ng-.
houses. The Federal Reserve System ultimately will price a number of correspondentbanking services under the terms of the
Depository Institutions Deregulation and
Monetary Control Act of 1980 (MCA). Check
processing is the System's major banking
service, however, so that charging for check
and ACH services-which are close'
substitutes-represents a major step in the
implementation of the Act's pricing and
access provisions.

encoding or microfilming services. Also, they
typically require all but the smallest
institutions to presort checks by
predeterm i ned processi ng categories.

Check-clearingservices

The Fed's ACH services provide financial
institutions with the ability to transfer debits
and credits automatically between institutions and account holders. A central ACH
computer accepts and executes electronic
messages necessary to complete a "paperless" transfer of funds. (Governments and
financial institutions provide most of these
inputs, primarily in the form of magnetic
tapes.) The ACH takes the inputs, processes
them, sorts debits and credits to the appropriate accounts, and then clears and settles
the clearinghouse members' accounts.

Reserve Banks clear and collect checks in
order to facilitate the paper transfer of funds.
Last year, for example, the Fed handled 15.7
billion checks at its 48 check-processing
offices. Operation of this network of check
facilities cost the System almost $280 million
in 1980, or nearly two-thirds of the entire cost
of all the correspondent-type banking
services it provides.
The swift and reliable transfer of funds via a
bank-checking account (or thrift-institution
N OW or share draft) entails a number of
processing stages. The process involves
encoding transaction information on each
check, microfilming for records purposes,
sorti ng by check type and desti nation,
transporting the checks, sorting by institution
for payment and settlement-and finally,
crediting or debiting institutions' or clearinghouse members' accounts. Private banks
(correspondents) also sell check-processing
services to other financial institutions
(respondents). Unlike such correspondents,
however, Reserve Banks do not provide

Automated clearinghouses
ACHs are the computer-age equivalents
of-as well as direct competitors with-the
check clearinghouses operated by the
Federal Reserve and by the private sector.
Last year,.38 Reserve Bank facilities handled
227 million ACH transfers, although at a
much smaller cost ($18 million) than the cost
of its check-handling facilities. Ever since
ACHs began operating a decade ago, the
Federal Reserve has supported the
development of a national ACH network, asa
means of utilizing computer technology to
reduce the nation's reliance on paper checks
for the transfer of funds.

Pricing services...
Under the MeA, Reserve Banks must set
service fees to reflect the "full cost" of
producing these services at a mature volume
of output. Full-cost prices should include all
of the costs that a private competitor wou Id
have to cover in the long-run in order to
remain in operation. In compliance with the
Act, Reserve Banks now add production costs
to allocated overhead expenses for each
service from available Federal Reserve
accounting data, and then add a 16-percent

In this nevvsielter do not
(efleer the:,
of the rnanagement
of the Fc-dcral Ri:".'serve r:'ank of San Franci':;'(:(j,
or of the
of CO\'("frlCHS
i)t
i hI:" Federal
Reserve SYsten1.

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- - - - - - - - - -

, ----

Reserve Bank check services and fees may
vary by type of check and by region. Each
check type-generally determined by the
type of processing it requires, and the
location of the paying'and depositing
institution -wi II be priced separately. Th is
reflects actual differences in the costs of
processing cash letters (bundles of similar
checks). While all districts will offer a similar
package of services, in some cases Reserve
Bank charges will vary because of inter-office
differences in services and/or costs. Thus,
fees will differ between districts, and in some
cases, even between Reserve Bank faci Iities
(although not in the San Francisco District).

Pricing and open access to Reserve Bank
check services, as called for under the M CA,
will directly affect the correspondent banks
selling check services 'in competition with
Reserve Bank services. First, correspondents
will no longer be able to rely on "free"
Federal Reserve check services to lower their
cost of producing services for resale to respondents. Thus, pricing should increase the
cost of privately supplied check-processing
services, as well as the price correspondents
charge respondent institutions purchasing
services. Second, the elimination of free
check services will allow correspondents to
compete with the Fed both on price and
service quality, instead of simply on service
quality alone. Finally, open access should
mean increased competition in the sale of
check services to nonmember banks and
thrifts-institutions which previously had
only limited access to Reserve Bank check
services.

Reserve Bank fees for check services (see
table) compare favorably with previously
reported prices charged by large
correspondent banks for similar services. For
example, the average charge per encoded
check in the San Francisco (Twelfth) Federal
ReserveDistrict in 1 979 was 2.1 cents, with a
range from 1 .4 to 3.0 cents for individual
banks-according to the Account Analysis
Survey of Charges for Selected Correspondent Banking Services conducted by Robert
Knight Associates. These prices of course do
not include any increase in costs that
correspondents may face because of Reserve
Bank pricing, which may boost correspondent prices after the August 1 shift by the Fed.

The Federal Reserve has adopted uniform
pricing for ACH services-except for New
York. Those services are provided on a
standardized basis nationwide (except for
New York, where Fed-provided ACH services
are limited to settlement of clearing balances
among institutions). Also, the cost of
computer-processing facilities, the major
ACH category, essentially is determined in
the national market. In addition, advances in
ACH technology are likely to lead to a
national ACH market linked by on-line
computer-communications facilities, which
would reduce the locational importance of
both clearinghouses and ACH users. Thus,

markup to cover imputed taxes and returns to
capital. The Fed includes this private-sector
markup to offset the fact that Reserve Banks,
unlike private suppliers, are neither taxed nor
required to earn a market return on capital.

. . . for checks

. .. andACHs

Pricesof Selected
CheckServices-San Frandsco

District
Centsper item

Machine readable items deposited locally
City checks
Regional Check Processing Center (RCPC)
Package sort (presorted by paying institution)
Mixed items (unsorted items)
Other Fed (items payable at other ReserveBank facilities)

0.58
1.71
4.12

Non-machine readable items deposited locally

7.99

2

1.54
1.71

---_.

__

__
._-----_._-_.. .-_ .... ---_
_

_---------------_.

•. ....
_

_-_ .., ---------_.

_---

dampen the growth of the developi ng market
for ACH transfers and increase the bu rden on
the nation's check-payments system. Setting
fees too low wou Id also create problems,
even while promoting faster ACH growth to
take advantage of scale economies and
alleviate pressure on the check-clearing'
system. Low fees could act as a barrier to
competition from the private sector and resu It
in a long-run ACH subsidy that would run
cou nter to the Monetary Control Act's pri ci ng
and access provisions. Indeed,
intended just the reverse-to improve the
efficiency of the payments mechanism by
eliminating Reserve Bank subsidies and
barriers to competition.

the Federal Reserve has set prices for
intra-ACH transfers at 1.0 cents per item,
except in New York where the charge will be
0.3 cents per item-while
transfers between
clearinghouses will cost 1.5 cents per item,
except in New York where the fee will be 1.2
cents per item.
Rapid expansion of ACH volume and the
evidence of scale economies in such
operations complicate the task of pricing
ACH transfers. Both factors i nd icate that ACH
facilities have yet to reach a mature volume of
services as called for underthe M CA's pricing
provisions. ACH volume, for example, has
not leveled off -rather, it has more than
doubled in'the lastthreeyears-and
itcari be
expected to continue growing even with the
advent of pricing. In addition, Federal
Reserve cost and output data indicate the
existence of sizable economies of scale in
ACH processing. Thus, the continued
expansion of ACH facilities should lead to
further reductions in "full cost" as output
rises. Therefore, the Federal Reserve has set
fees for ACH transfers based on an estimate of
"full cost" at an estimated mature volume
that takes both potential growth and scale
economies into consideration.

In sum, August 1 represents the dawn of a
new era in correspondent banking. Reserve
Bank implementation of explicit charges for
check and ACH services wi II strongly affect
the future markets for these two services.
Pricing will increase the cost to institutions
using check and ACH services, but it wi II also
increase the efficiency of Reserve Bank
production and distribution. Uriderthe M CA,
Reserve Bank check-clearing faci Iities shou Id
be able to compete, both on price and service
quality, with the private sector. At the same
time, the ACH fee schedule should leave
ACH-transfer prices competitive with check
fees, while encouraging the continued
development and use of ACH faci Iities.
Gary C. Zimmerman

Advertised ACH fees are below the price of
comparable paper-check transfers. Because
of possible substitutability, setting the ACH
price too high relative to checks could

Publication-Monetary PolicyObjectives
Copies are now available of the publication, Monetary Policy Objectives for 7987
-Midyear Review. This is a summary of
the report made by Federal Reserve Chairman Volcker to Congress on July 21, 1 981.

Free copies of this publication can be
obtained by calling or writing the Public
Information Section, Federal Reserve Bank
of San Francisco, P. O. Box 7702, San
Francisco 941 20. Phone (415) 544-21 84.

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BANKIN G DATA-TWELF TH FEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)
SelectedAssetsand Liabilities
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.
(LargenegotiableCD's)
Weekly Averages
of Daily Figures
Member Bank ReservePosition
ExcessReserves + )/Deficiency (- )
(
Borrowings
Net free reserves(+)/Net borrowed(- )

Amount
Outstanding
7/15/81

150,188
129,084
38,643
53,130
22,939
1,579
6,190
14,914
43,196
29,875
30,327
82,813
74,575
33,825
Weekended
7/15/81
n.a.
72
n.a.

Change
from
7/8/81

Changefrom
year ago
Dollar
Percent

9.1
239
12,522
11.3
13,120
23
- 254
5,309
15.9
13.0
201
6,132
- 3.8
915
15
60.1
145
593
1.7
8
108
- 3.2
270
486
2.8
1,099
1,262
- 2,328
7.2
363
5.0
346
lA40
33.8
906
20,912
1)75
20,985
39.2
52.9
1,070
llJOl
Comparable
Weekended
year-agoperiod
7/8/81

-

n.a.
39
n.a.

- 65
47
-112

* Excludestrading account securities.
# Includes items not shown separately.
Editorial comments may beaddressedto the editor (William Burke) or to the author . ... Freecopiesof this
and other FederalReserve
publications can beobtained by calling or writing ..he Public Information Section,
Federal ReserveBank of SanFrancisco,P.O. Box 7702, SanFrancisco94120. Phone(415) 544-2184.

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