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FEDERAL RESERVE BANK OF RICHMOND MONTHLY REVIEW The Evolving Payments System The Federal Reserve's Communications Center and the Payments System The Washington-Baltimore Regional Check Clearing Center N o t e : This issue of the M o n t h l y R e v i e w is devoted to the nations internal payments mechanism. The feature article examines some aspects of the present system, noting recent improvements that have managed to keep it from being engulfed by the rising flood of checks. It also describes recent progress toward a more efficient payments system of the future— one in which paper checks will likely give way to an electronic transfer system possibly employing some variation of the giro principle. Two major developments in the Fifth District this year could represent important milestones on the road to a new payments system and are discussed in separate articles. These are the completion of the Federal Reserve’s new Communications and Records Center at Culpeper, Virginia, and the establishment of a Regional Check Clearing Center for the Washington-Baltimore area. E d i t o r ’s THE EVOLVING PAYMENTS SYSTEM Businesses and banks in the United States are of paper, and by the large investment in expensive in danger of being drowned in a flood of paper machinery and equipment that is needed to keep the generated by the operation of the country’s payments system operating. system. arising from inefficiencies and delays in processing The accompanying chart, which shows the Not so obvious are the costs number and dollar amounts of checks handled in the daily flood of checks. recent years by the Federal Reserve Banks, gives lays in collecting checks, by altering the reserve some indication of the rate at which this flood has grown. The number of checks handled in 1969, for position of the banking system, may complicate the monetary policymaking process. example, was almost six times the number processed in 1941, and almost twice the number handled only ten years ago. And these figures tell only part of the story. A great many checks are collected through clearing houses or correspondent banks without pass ing through a Federal Reserve Bank. In addition, checks passing through a Reserve Bank may be handled, on the average, by five or six individuals, businesses, or commercial banks before reaching a Reserve Bank. Thus, the approximately seven billion checks processed by Federal Reserve Banks in 1969 may have involved 40 to 50 billion processings before finally returning to their drawers to be stored away in their files. The costs of operating this payments mechanism are enormous. The most obvious real cost is measured by the number of man-hours involved in the sorting, proofing, and shipping of this huge flow Digitized2for FRASER Moreover, unforeseen de Criticisms of the Present System A lth ou gh the Federal Reserve System and the commercial banks have made a number of changes to improve the check payments system in recent years, the efficiencies realized have hardly more than offset the increase in volume. (T h e number of checks handled by Federal Reserve Banks increased 9.6 per cent last year, and the average annual growth over the past five years was in excess of 8 per cent.) Those who advocate a fundamental change in our payments system claim that we have gone about as far as we can go in im proving the present system. They say that the real need is for a new payments system, one that would make full use of the fantastic technology of the computer age. What is under attack is the basic nature of the check payments system itself. In this system, pay ment is made by transferring ownership of a deposit claim against a commercial bank. But the payment A Future Payments System? The paym ents is not made by means of an order presented directly system of the future is usually seen as one that com to the bank on which it is drawn. Instead, the order (a check) is presented to the person to whom pay bines modern electronic technology with what is known as the giro transfer system.1 The giro system ment is being made. He examines and endorses it. perhaps sorts it and puts it together with other is one that has been widely used in continental European countries for years but which has been checks, and passes it along to another individual, largely untried in the United States. business, or bank. istics make it especially suitable for the use of com There the whole process is re Its character peated. And so it goes, until finally the check is presented to the bank upon which it is drawn and puters, although it does not require their use. final payment is made by reducing the account of involves deposit balances held by individuals and the maker of the check and increasing the account businesses at a financial or governmental institution, of (or paying cash to) the party presenting the check. and some systematic arrangement for the transfer of Each transfer of the check in this chain represents ownership of these balances from payer to payee. a conditional payment. The major difference between the giro and the check That is, each holder in due course has a claim against the party from whom he received the check (or any previous endorser) in the event that it is not honored by the bank upon which it is drawn. A typical check may pass through numerous hands, and through two or more banks and/or a clearing house, before being presented to the drawee bank. Thus, payment by check is a round-about, time-con suming process that, by its very nature, generates a great deal of costly paper handling. Critics of the system compare its problems with those of the se curities business, where an excess of paper handling has at times threatened to bring the m achinery for transferring securities to a grin din g halt. Like the check payments system, the giro system system is in the method for effecting the transfer of ownership. Unlike the check system, in the typical giro transaction the payer delivers to the drawee in stitution an order directing it to transfer a specified sum from the payer’s account to that of the payee. The institution is also required to advise the payee and to supply the payer with a record of the trans action. Thus, giro transfers are more direct and in volve less time and less paper handling than ordinary check transfers. Giro transfers are extremely simple when both the payer and the payee have accounts with the same institution, but they can function with equal ef ficiency where the payer and the payee use different institutions. Some European systems, for example, provide for a central institution for making transfers C H EC K S H A N D LED BY FED ERA L R ESER VE 5 Bil. BANKS Bil. C h eck s between member institutions as well as for transfers between customers of those institutions. In fact, it is possible for depositors in some European systems to make payment to individuals or businesses in other European countries. Most descriptions of a future electronic payments system incorporate some sort of giro arrangement because the giro system possesses characteristics which make it particularly suitable for the use of electronic data processing equipment. Transactions in the giro system take place entirely within the in dividual institution, or if more than one institution is involved, entirely within the giro system. Thus, when a depositor instructs the institution holding his account to make payment to another account holder. Sou rce: B oard of G o v e rn o rs, F ed era l Reserve System . 'F or a more detailed description of the giro system, see “ The Giro, the Computer, and Checkless B anking,” in the April 1966 issue of this M onthly R eview , reprinted in Lawrence F. Ritter (e d .), M oney and Econom ic A c tivity, 3rd. ed. (B oston: Houghton M ifflin ), pp. 34-38. he provides the institution with all the information it needs to complete the transaction— the identification of both the payer and the payee, the amount to be paid, and the time at which payment is to be made. Computers could handle the entire transfer process almost instantaneously. Banks of the future undoubtedly will provide their customers with some sort of automatic loan plan, somewhat along the lines of the credit extended today through the use of bank credit cards. If the house wife described above were shopping for new furniture The payer’s instructions or a television set and the amount of the purchase could be fed into his bank’s computer, for example, exceeded her current balance, the bank’s computer and if both payer and payee are depositors of that might make an instantaneous loan, up to some pre bank the computer could perform all of the operations arranged amount. necessary to make the transfer, including the printing loan by authorizing her bank to have the computer out of confirmation to the payer and advice of pay transfer money from her deposit account, either the ment to the payee. entire amount at the end of the month or in instal If the two have accounts at dif ferent banks, the computer at the payer’s bank could perform the operations necessary for its records and transmit the information to the second bank’s com puter, perhaps through a central institution. Settle ment between the two institutions could be made through entries in the records of the central institution. Numerous articles have been written in recent years describing various features of an electronic payments system, and it is not difficult to think of many ways in which such a system could function. The housewife of the future, for example, could pay the family bills by simply inserting a card into a special telephone device and giving the necessary in structions to her bank’s computer. She could pay all of her bills at one time by giving the computer a list of her creditors, the amount to be transferred to each, and the date at which transfer is to be made. The housewife might pay for her groceries at the supermarket by handing the cashier the same little plastic card. The cashier would insert the card into a telephone-like terminal and instruct the bank’s com puter to transfer the amount owed from the house wife’s account to that of the supermarket. In addition to the use of the electronic payments system for retailing purposes, business firms of the future may also use it for processing payrolls. Rather than issuing a check to each employee, for those de siring it the employer could have the employee’s pay credited to his deposit account at regular intervals, monthly, weekly, or even daily. The employer would furnish the bank the necessary information in ma chine-usable form, or he might instruct his computer to instruct the bank’s computer to reduce his account and to credit his employees’ accounts in the proper amounts. If his employees banked at several banks, his computer might transmit the payroll data to a central bank switching center, whence it would be transmitted to the various banks concerned. Digitized 4 for FRASER She might arrange to pay off the ments over a period of time. Making the Old System W ork Better M ost o f the changes in the payments mechanism in recent years have served to improve the functioning of the present system. The more important of these changes have made it possible for people to write more and more checks, year after year, without causing the entire system to collapse. Others have made modest contributions toward reducing the need for checks. Finally, there have been some tentative steps toward the development of a new and different payments mechanism. The development of the Magnetic Ink Character Recognition System (M IC R ) in the 1950’s was un doubtedly one of the most important improvements in the present system. By putting certain essential information on checks in a form that can be read by electronic data processing equipment, the process of reading, sorting, and tabulating checks is greatly speeded up at certain points of congestion along the circuitous route followed by the typical check. A large percentage of the checks that are written every day are now being processed on electronic equipment. One of the most spectacular changes in recent years has been the growth in the use of credit cards. And, although this was not the reason for their introduc tion, credit cards have served to reduce the number of checks used. The individual cardholder, by writing one check at the end of the month, may settle for a number of transactions that occurred over the course of the month. Arrangements designed to reduce the handling and use of checks include the use of a “ lock b o x ” and the preauthorization of payments. The lock box technique may be employed by a company whose customers are distributed over a wide area. Rather than have the customers pay their bills by sending a check to the head office, the company may rent post office boxes at strategic locations in the area and customers mail their payments to this box. The company maintains an account with a bank near each Finally, the development of regional clearing centers has been encouraged as a means of reducing of these locations, and authorizes the bank to collect the length of the journey of the typical check and cutting down on the number of times it is handled. the checks from the box at frequent intervals. The bank credits the company’s account in the amount of The interest of the Federal Reserve System in this type of arrangement is evidenced by the establish the checks received, advises the company of the pay ment at the Baltimore Branch of the Federal Reserve ments, and sends the checks through regular chan Bank of Richmond of a Regional Clearing Center to nels for collection. The use of lock boxes does not serve banks in a 40-mile radius of Washington, D. C. reduce the number of checks, but it does reduce the round-about collection process and the number of In its present stage of development the Baltimore Clearing Center represents an attempt to improve times each check is handled. the functioning of the existing payments system, but Preauthorized payments involve the periodic trans it should be remembered that the electronic payments fer of money from one account to another with the system of tomorrow will require the establishment of expressed agreement of the parties concerned. Many a number of highly automated regional clearing preauthorized payments arrangements are internal to centers. the bank, involving such things as the transfer of article elsewhere in this issue of the Monthly Review. funds from a checking account to a savings account, a Christmas or vacation club, or in payment for U. S. Savings Bonds. Preauthorized payments external to The Baltimore center is discussed in an Steps Along the W a y A press release b y the Board of Governors of the Federal Reserve System, dated September 20, 1968, began with these w o rd s: the bank have included such things as payments of insurance premiums, utility bills, taxes, and rental or mortgage payments. Both types of preauthorized payments have reduced the number of checks in cir culation, but more important, perhaps, preauthorized In a m a jor preparatory step tow a rd an electron ic transfer system for bank deposits and financial data in the 1970’s, the Federal R eserve System a nn oun ced tod ay it has entered in to a con tra ct fo r a key segm en t o f a com p u terized n etw ork to speed up the m ov em en t o f m on ey, securities, and e co n o m ic statistics. payments would be a significant element in any future In these words the Federal Reserve System of electronic payments system. Some form of payroll servicing is another way of ficially called attention to a project which may rep reducing the number of checks used and one that resent the beginning of a giant leap toward an en also would be an important element in an electronic tirely new payments mechanism. payments system. be noted that the new Culpeper facility referred to Corporations and governments And yet, it should issue a large number of checks for salaries and wages, in the release is nothing more than a broadening and and anything to short-circuit this process could re duce significantly the number of checks in circula Some companies and governmental agencies an extension of a wire transfer facility the System has operated since 1922. This facility, which is used mainly for the transfer of funds and securities be have entered into agreements with banks to have em tween member banks, has many of the features of ployees’ wages deposited automatically to each em the European giro systems. p loyee’s ch ecking account. In som e instances, by one bank authorizing the Federal Reserve to firms relate this kind of program to the automated credit the account of another bank or some account tion. Transfers are effected payroll service provided by their banks. The Federal in that bank. Reserve Bank of Richmond permits each employee when and from whom payments have been received. Payees are advised by their banks to designate the bank in which his check will be The scope and significance of the new facility, and deposited. The Payroll Department then makes a list for each bank designated, showing for each employee of the specialized equipment employed in it, are dis cussed in an accompanying article in this Monthly the amount to be deposited. A single check is issued Review. to each bank covering the total amount of deposits the development and testing of a facility of this type It is sufficient to our purposes to note that for that bank. A t the head office of the Federal R e is an essential first step in the transformation of the serve Bank of Richmond, all 35 officers and more payments system. than 200 other employees have salary checks de Mitchell, Member, Board of Governors of the Fed posited under this plan. eral Reserve System, “ By its planning and action in In the words of George W . 5 putting into place a sizable electronic transfer plant noted earlier, the establishment of clearing centers to and related staff the Federal Reserve System is demonstrating its preparedness to accommodate an permit electronic transfers of funds among member institutions is an essential element in the creation of automated payment system as rapidly as it earns the payments system of the future. Public acceptance is a major prerequisite to any public acceptance.” The establishment of the Culpeper switching center far-reaching change in the payments mechanism, and is the most important single step toward an electronic payments system, but there have been many others. way toward creating the proper climate for such Some of these have been mentioned in the section changes. dealing with improvements in the old system. One major changes are inevitable is found in the example interesting recent development was the action of the cited above, and in the announcement by the Am eri Home Loan Bank Board in publishing a proposed can Bankers Association that a top-level committee developments over the last decade have gone a long Evidence that bankers are convinced that change in its regulations which would permit savings of leading bank executives has been created to study and loan associations to pay, at a shareholder’s re various aspects— economic, legal, technological, and quest, amounts from the shareholder’s account to marketing— of any modification of the payments third parties. W hile this action in itself is a far cry mechanism. W hile the general public is probably from the payments system of the future, it does less aware than bankers are of the necessity for constitute a limited recognition of the giro principle. changing the present system, most people are prob The New Y ork Clearing House Association is en ably more receptive to change today than they would gaged in setting up a network to transfer funds have been ten years ago. The proliferation of credit cards, among other things, has conditioned the public electronically between major clearing house banks. The first phase of the project, which will be used to checkless and cashless purchases. only for large-denomination international transac great deal remains to be done in the way of educating N o doubt a tions, is expected to become operational in the near the public to the idea of a checkless society, but the future. The system, which will make use of a central task seems much less formidable than it did just computer located at the Clearing House, is expected a few years ago. to eliminate as many as 40 thousand checks a week. The technological know-how required for an elec The second phase will bring other New York in tronic payments system already exists. stitutions into the system, and it is expected that extensive use of electronic data-processing equipment eventually it will be expanded to include banks in other major U. S. cities.2 SC O P E (Special Committee on Paperless Entries) is made up of representatives of banks in the Los Angeles and San Francisco Clearing House Associa tions. Its purpose is to study and recommend ar rangements to enable California banks to transfer debits and credits electronically between banks. A recent news story indicates that commercial banks in Seattle are considering a similar project3. A s was in their operations, and a push-button type of tele phone has been developed which would permit a de positor to communicate directly with his bank’s com -Am erican Banker, March 13, 1970, p. 1. 3A m erican Banker, A p ril 6, 1970, p. 1. Digitized6for FRASER puter. Banks make The Federal Reserve facility at Culpeper represents the kind of switching center that would be an integral part of any such system. W hile there would be problems, both legal and technological, in the establishment of an electronic system, the limita tions of the check-payments system make it im perative that these problems be solved. Aubrey N. Snellings The Federal Reserve’s Communications Center and the Payments System Fortunately for the American payments system, the growth of knowledge in the field of information technology has kept pace with the growth of paper generated by the ever expanding volume of economic and financial transactions. W hile the paper jam has on numerous occasions impaired the orderly flow of economic activity, and probably will again, it is en couraging that steps are being taken which should practically rid the payments system of the future of this costly burden. One such step is that taken re cently by the Federal Reserve System in opening its new Communications and Records Center at Cul peper, Virginia. The communications aspect of the center is now in the testing stage and is expected to be fully operational by July 1970. In view of the Federal Reserve’s central role in the handling of economic and financial data— particularly banking statistics— the communications facility is expected to have a significant bearing upon the speed and ac curacy with which the payments system operates as well as upon the capacity of the system to handle the increased volume of information. Officially dedicated in December 1969, the Com munications and Records Center, built largely under ground, serves several roles. It provides vault space for storage of money and duplicate records for use in the event of a national emergency. Also, it will house a computer to serve the data processing needs of the Federal Reserve Board, and to supplement the Board’s existing computer located in Washington. O f most significance to the payments mechanism, however, is the fact that the Culpeper facility con tains the Federal Reserve System’s new communica tions center, consisting of four large, high-speed, special-purpose, com m unications sw itch in g co m puters. The Culpeper facility, including the com The Federal Reserve Bank of Richmond's C ulpeper facility. The facility houses the Federal Reserve System 's new com m unications center, and provides vault space for the storage of m oney and duplicate records. 7 munications center, is operated by the staff of the Federal Reserve Bank of Richmond for the entire Federal Reserve System. When it goes into full operation in about July of this year, the new com munications system will replace the existing Tele graph and Switching Center, which has been in operation at the Richmond Bank’s head office since 1953. The Federal Reserve System has operated a wire transfer system since 1922, but the Board of Governors decided to move the center which handled this operation from Washington to Richmond in 1953, to make it less vulnerable to nuclear attack. The decision to move to Culpeper was predicated partially on the same motive, but of equal importance was the desire to establish a modern facility with a capability for growth commensurate with that ex pected in the Federal Reserve System’s communica tions needs. office has the capability to send and receive messages, although specialized equipment to receive or send only is provided additionally at some locations. These units handle the frequent and important low-content messages involving transfers of funds and adminis trative transmissions, but usually not those messages transmitting large quantities of data. A t present, the system is equipped to handle mes sages to or from the Model 37 terminals at the speed of 150 words per minute. The transmission speed is constrained by the lines rather than by the mes sage exchange at Culpeper. The lines presently available for use with the Model 37 terminals are 150 “ baud,” where “ baud” is defined as a unit of signalling speed. T he term is, for practical pur poses, almost synonymous with “ bits per second.” W ith the A S C II code, there are eight bits per character, and six characters per word. Allowing for additional characters that are transmitted in order Technical Features of the Com munications to check the internal accuracy of the message, the Center term “ baud” U nder a $2^4 m illion contract, Marshall becomes approximately synonymous Communications, Inc., now a division of Control with words per minute. Data Corporation, has installed a M-1000 Quad potential speed in this respect, it should be noted that Communications Culpeper. the message exchange computers at Culpeper are M-1000 computers capable of transmitting messages to distant points which are designed to handle in very rapid fashion at speeds of 9,600 bits per second. A t present, there the receiving and relaying of messages among the fore, constraints are imposed by the lines as well as 12 Federal Reserve Banks, their 24 branches, the by the types of terminals in use at the various end Federal Reserve Board, and the U. S. Treasury. locations. The system operates as a message exchange or the maximum utilization of the capacity available at the Culpeper message exchange. Switching System This system is actually four at switch, and it communicates with the 38 locations, each of which has one or more terminal units, by means of telephone lines capable of high data transmission. speed Any type of message, whether T o compare present with Present needs, however, do not require The lines used with the Model 37 terminals are “ full-duplex,” which means that messages can be received and sent simultaneously between any given quantitative or narrative, can be transmitted by the points, each at the designated speed. system. A n important feature of the system is that the a terminal is in the process of sending a message does not preclude its receiving another message at The fact that kinds of terminal units located at each of the Federal the same time. Reserve offices can vary considerably. by the message exchange computers at Culpeper. Standardiza Whether this is done is determined tion is achieved through the use of a universally The Culpeper computers continuously poll all ter adopted code in which all messages are phrased and minals to determine whether a message is waiting to transmitted. be transmitted. This code, which can be handled by The complete polling cycle takes several types of terminal gear, is A S C II, American about 45 seconds. Standard Code for Information Interchange, known by a waiting terminal, the Culpeper exchange receives as “ asky.” The code is a communications language which, in addition to actually transmitting informa the message and notifies the terminal of the mes tion, executes its own internal check on the accuracy been received by the Culpeper exchange for delivery of the information transmitted. elsewhere, the Culpeper exchange notifies the ter Most Federal Reserve offices have been equipped If a positive signal is indicated sage’s arrival. In a similar fashion, if a message has minal at the destination (or destinations) that a mes with Model 37 terminal units— slightly modernized sage is to be delivered. versions of conventional teletype equipment. signal, the message is sent to its destination, and the Digitized8 for FRASER Each Upon receipt of the proper M-1000 com m unications switching computers and related equipm ent at the Federal Reserve's Com m unications and Records Center in C u l peper, V irg in ia . Equipm ent in this room links all offices of the Federal Reserve, and w ill play a central role in facilitating the nation's paym ents system. Culpeper computer awaits a signal from the terminal terminals, is regarded as temporary at several of the that the message was received. Federal All messages are Reserve offices. A number of Reserve then stored at the Culpeper center on disks or tapes Banks and branches are in the process of upgrading for a predetermined period of time. their data processing and research computer equip In addition to the Model 37 terminals, the 12 Federal Reserve head offices and the Federal R e ment. In doing this, they have taken into considera tion the coming potential of the Culpeper center. serve Board are being equipped with I.B.M . Model Thus, some of them intend to use large third-genera- 2968 tape units for transmitting and receiving large tion computers as terminals to communicate with the quantities of data through the Culpeper exchange. These units utilize magnetic tape which is readable Culpeper exchange in addition to performing other data processing or research functions for the R e by the data processing computers at each of the lo serve Banks. cations. Thus, tapes of economic information gen erated by the Banks’ computers can be immediately transmitted to other Reserve Banks or to the Board The Federal Reserve Bank of New Y ork has planned from the outset to do this, and will therefore begin its communication with the Cul peper exchange via a computer. The Federal R e through the Culpeper exchange, or conversely, can be serve Banks of Chicago and San Francisco have received by a given Reserve Bank for immediate plans to follow a similar approach in the near future, processing on its own computer. and will probably replace or at least supplement Lines available for transmission by this method are 2400 “ baud,” i.e., their existing terminal gear with computer-to-com- approximately 2400 words per minute. puter communications. are “ half-duplex,” These lines however, which means that a Other Reserve Banks, in cluding the Federal Reserve Bank of Richmond, have terminal can either receive or send at a given time, similar plans under consideration. but not both. Since the Culpeper message exchange is capable of of this approach are considerable in that all messages The advantages flowing to or from the Culpeper exchange at a given communicating with a wide variety of terminal equip Reserve Bank can be examined by that Bank’s com ment, the use of the Model 37 terminals, and to a puter for informational content relevant to other com lesser extent even the use of the Model 2968 tape puter related functions— accounting, reserve account 9 ing, research and statistics, fiscal agency operations, Banks play an obviously critical role in the Am eri discount and credit, etc. The terminal computer can thus automatically update files or perform necessary processing of the data it receives from the message can payments system as it presently exists. They provide the mechanism through which the over flows. Thus, the efficiency of communications among banks Several Reserve Banks have further plans to establish computer-to-computer communications with largely determines the efficiency with which the pay member commercial banks in their districts. Such central bank, in turn plays a critical role in the set arrangements will make possible direct electronic communication via the Culpeper exchange of com tling of payments among banks, both member and mercial banks throughout the nation. Messages in whelming preponderance of payments are made. ments system operates. The Federal Reserve, as the nonmember. Therefore, the Federal Reserve’s com munications center at Culpeper, the nerve center of volving funds transfers, for example, will be com the central pleted almost instantaneously. become a core element in the nation’s payments Human intervention in the transaction will be minimized thus reducing banking system, will unquestionably mechanism. the possibility of error, and automatic updating of The significance of the Culpeper center is yet to all relevant reserve accounts will be achieved as a by-product of the communication. be seen, since its contribution to the Federal R e The technical capability exists for still other com serve and to the payments system does not begin until mid-year. Its potential impact, however, is munications linkages, of a bank or non-bank nature, more clearly revealed by its technical characteristics either directly to the Culpeper exchange or to it via than by the nature of the jobs that it will be required a computer-type terminal at a Reserve Bank or to perform in its initial stages. branch. The existence of the Culpeper facility makes that will be put through the Culpeper exchange at feasible, for example, the sharing among Federal the outset are conventional tasks that will be trans Reserve offices of a large centralized data bank of ferred from the existing Telegraph and Switching national economic information. Implications for the Payments System T o obtain maximum efficiency in the operation of any payments system would require the instantaneous communica tion of transactions data. Realistically, however, constraints are imposed by the complexity of the economy and its institutions, as well as by the distances which separate individuals and organiza tions— not to mention many other natural barriers. There is presumably some maximum speed at which it is physically possible to sort checks, to move pieces of paper from one location to another, or to ship currency and coin. W hile numerous advances have been made in all these areas, progress to date is still considered far short of adequate. Modern technology does not seem to promise an ultimate solution where by maximum efficiency of the payments system can be achieved. Since all economic units are not elec tronically interfaced with one another, it is not feasible to consider this kind of efficiency— nor would such a system necessarily be desirable. Nevertheless, the limits of feasibility have been greatly expanded. The establishment of the Culpeper exchange is a re minder of the technological possibility of alternative payments systems, which might feasibly include an economy without checks. Digitized 10 for FRASER Most of the work Center— e.g., funds transfers among banks, adminis trative messages, transmissions of economic infor mation among Reserve Banks, etc. However, as the Federal Reserve Banks and branches begin to install more sophisticated terminal equipment, as communi cations via computers are established with com mercial banks, and as rapid data transmission among Reserve Banks gets underway, the impact of the center upon the operations of these institutions should be striking. Significant departures from existing customs of communication will be quick to follow. Technological progress in the communications field has exceeded present levels of ability and readiness to take maximum advantage of its potential. H ow ever, there is little doubt that the Culpeper center represents one of the early steps leading invariably to an electronic payments system. The Culpeper facility was a necessary develop ment because improvement in the timeliness of eco nomic information is necessary. development is impressive. But, even so, the Its impressiveness lies not in any immediate revamping of existing methods of communication, but in the opportunity which it offers for significant future accomplishments in the communications field. William H . Wallace The Washington-Baltimore Regional Check Clearing Center Since its inception the Federal Reserve System has worked with bankers to improve the check col lection process on which the nation’s payments system is based. The opening of the Washington-Baltimore Regional Clearing Center on January 2, 1970, repre sents a major step in that direction. Regional clearing centers are perhaps the best immediate answer to the check collection problem. Moreover, a series of such centers, connected by wire with each other and with their participating banks, could well bridge the gap between the present payments system and the “ checkless society” of the future. Background In virtually all large cities, clearing houses have existed for many years for the exchange of checks among large city banks, but rarely have these arrangements included smaller banks in the surrounding areas. The Nassau County Clearing Bureau, organized by about 80 banks on Long Island in 1952, is a notable exception. Checks are picked up each evening from the participating banks, sorted, and delivered to the drawee banks early the next morning. The Federal Reserve Bank of New York, however, was not and still is not a direct par ticipant ; that is, it does not send checks to, nor receive them from, the Clearing Bureau. The success of this effort resulted in a similar clearing system established later in Bergen County, New Jersey. This Bureau began operations on O c tober 20, 1959, serving 31 banks with 70 offices. By the end of 1969, the area served by the Bergen County Clearing Bureau had been expanded to in clude nearby counties, with participation by 39 banks with 185 offices. As in the case of the Nassau Bureau, the Federal Reserve Bank of New York does not participate directly. Meanwhile, the American Bankers Association, more than 90 per cent of the dollar value of pay ments in the United States was being made by check. A n efficient collection system is thus of key importance in facilitating the flow of such payments. The committee noted that check collection problems arise primarily out of the volume of checks and esti mated that the average check passes through 2 banks in the process of collection. The volume prob lem, furthermore, could be alleviated by reducing the number of check handlings. The committee recommended that, where volume warrants, checks drawn on nearby out-of-town banks “ should be presented to drawees through a central clearing arrangement serving all banks in the area, with settlements being made on the books of a correspondent bank or on the books of the Federal Reserve Bank.” Some of the proposals made by the committee, however, met with strong opposition, and there was little support for establishing regional clearing arrangements until the middle 1960’s. The Washington-Baltimore Situation T he W a s h ington-Baltimore area provided a striking example of the inefficiencies possible under existing check clearing arrangements. Delays resulted partly from the fact that the Federal Reserve Bank of Richmond served Washington and Northern Virginia while its Baltimore Branch served Baltimore and surrounding Maryland counties. A check drawn on a suburban Maryland bank and deposited with a bank in Northern Virginia might take as long as four days to clear even though the banks were only a few miles apart. If this check were deposited on Monday, and sent to Richmond that night, the Richmond Fed would send it on to Baltimore on Tuesday. The Baltimore Branch, in turn, would forward the check to the drawee bank on Wednesday and receive pay the Association of Reserve City Bankers, and the ment on Thursday. A return item would have to Conference of Reserve Bank Presidents appointed a follow this route back to the bank with which it was joint committee to make a comprehensive study of deposited. The entire process could take up to eight the nation’s system of collecting checks. or nine business days from the date of original de The com mittee in its report dated June 15, 1954, found that posit. A s a result, area banks were understandably 11 reluctant to collect checks through the Federal Reserve. Instead they resorted to one of several arrange ments for local clearing. These included clearing houses in Washington, Baltimore, and Frederick, Maryland. There were also two informal exchanges, one made up of two banks in the Maryland suburbs of Washington and the other with limited participa tion of five Northern Virginia banks. No provisions had been made, however, for exchanging checks among these five groups. Banking Characteristics of the Area T he ac companying table summarizes some of the banking characteristics of the area that was under considera tion for a new regional collection system. It con firms that the area within a 40-mile radius of W ash ington had a very heavy concentration of the Fifth District’s total banking activity. In 1967, there were 94 banks with 666 banking offices, representing 11.7 per cent and 22.2 per cent respectively of the totals for the entire Fifth District. The deposits of these banks totaled about $6 billion, or 32 per cent of the District total. The population of the area represented about a quarter of the total District population. Development of the Plan Bankers in the area have long been aware of the need for a better clearing procedure. During the 1960’s many of these bankers approached representatives of the Federal Reserve Bank of Richmond about the possibility of establish ing some type of clearing center. They did suggest, however, that the Federal Reserve should take the initiative in setting up such a facility. The Richmond Reserve Bank decided to initiate efforts to establish a better collection system early in 1967. Accordingly, in March it invited the banks belonging to the Washington and Baltimore clearing houses, the Northern Virginia Bankers Association, and the various banking associations in nearby M ary 2. The formation of a six-man committee of area bankers to advise the Reserve Bank on the operation of the center. 3. The location of the center at a point con venient to participating banks, airports, and beltways. 4. The extension of participation privileges to all banks within a 40-mile radius of Washington and to any others near enough to make participa tion feasible. Federal Reserve offices wrould also be allowed to send items directly to the center. 5. The settlement of clearing balances through the reserve accounts of member banks. 6. The establishment of pickup and delivery service so as to effect presentation of items to drawee banks by 10 a.m. Establishment of the Center A fter a lengthy dis cussion within the Federal R eserve System, the Federal Reserve Bank of Richmond agreed to establish a regional check collection center, the first operation of its kind to be established by a Federal Reserve Bank. The Washington-Baltimore Regional Check Clearing Center officially began operations on January 2, 1970. The Clearing Center initially serves 90 banks within a 40-mile radius of Washington (see m ap). Included in the service area are the city of W ash ington ; the city of Baltimore and the counties of Anne A rundel, Baltim ore, Calvert, Charles, H ow ard, Montgomery, and Prince Georges in Maryland; and the cities of Alexandria, Falls Church, and Fairfax and the counties of Arlington, Fairfax, Loudoun, and Prince William in Virginia. For operational reasons the Center is located at the Baltimore Branch of the Richmond Reserve Bank, with a relay station in downtown Washington for use by participating banks that may find it more convenient. Banks depositing their items at the land counties to participate in a check clearing relay station are subject to the same cut-off hours survey of the Washington-Baltimore area. This led as those sending directly to the Center in Baltimore. to the appointment of a team of area bankers and The Federal Reserve Bank bears the expense of representatives of the Richmond Reserve Bank to transporting checks from the station to the Baltimore conduct a survey and develop plans for a regional Branch. Participating banks, both member and non check clearing center if one seemed desirable. member, and The survey team studied check movements in the Federal Reserve Banks may send checks, unsorted, drawn on other banks in the region area during June 1967 and concluded that a clearing to the Center by 1 a.m. center definitely was needed. Its report to the Rich sires, it may fine sort its checks by drawee bank mond Reserve Bank contained the following recom and deliver them to the Center by 5 a.m. for inclusion mendations : 1. The establishment of a regional check clear ing center to be owned and operated by the Rich mond Bank without cost to participating banks. 12 in the daily shipment. If a participating bank de Nonparticipating member banks from outside the area may also send to the Center, but for them the cut-off hour is 4 p.m. of the previous day. Spotsylvania A re a served by the W ashington-Baltim ore C learin g Center. Regional Clearing Center personnel using high The circle has a radius of 40 miles around W ashington. Am ong other features of the Regional Clearing speed computer equipment sort the checks by drawee Center a re : bank, make up the shipments and dispatch them by 1. motor carrier in time to reach each bank by 10 a.m. Member banks settle through their reserve ac counts and nonmembers through the reserve account of member correspondents. Thus, participating banks A requirement that participating banks that are members of the Washington or Baltimore Clearing House sort and package clearing house items separately. 2. A requirement that all items sent to the each morning receive credit for all deposits made Center must be amount encoded if a sending bank prior to the cut-off hours and likewise are debited averages more than 100 items per day in its de for all items presented to them. posit. 13 3. The establishment of an Advisory Group made up of two commercial bankers from Northern Virginia, twro from Washington, and two from Maryland. Advantages of the Center The R egional Clear ing Center has now been in operation more than four months and has already produced a significant improvement in the check collection system for the Washington-Baltimore area. Am ong the ad vantages a re : 1. Earlier Collection of Items A regional center of this type enables both participating banks and banks outside the area to present and collect many checks more promptly. Checks now clear in one day, rather than up to four days as was pre viously the case. 2. Earlier Credit on Checks Because of the faster process, participating banks collecting through the Center receive earlier credit on their checks in most instances. 3. Earlier Return of Unpaid Items The faster check collection process generally enables participating banks to receive their return items two or three business days sooner. 4. Reduction in Check Kiting The general public had become increasingly aware of the length of time required to collect checks in the W ashing ton-Baltimore area, and this had given rise to a number of check kiting schemes. By reducing col lection time significantly, the Center greatly re duces the opportunities for such kiting operations. 5. Reduction in Commercial Bank Float By reducing collection time on checks the Center reduces commercial bank float on both intra-area items and those presented from outside the area by direct-sending banks and Federal Reserve Banks. 6. Fewer Check Handlings In terms of the payments system, the most significant advantage is the reduction in the number of times each check is processed. The Clearing Center is now functioning smoothly, although some start-up problems were experienced by the Federal Reserve Bank and participating banks. Probably the most difficult situation resulted from significantly higher volume than expected. Forecasts of check volume, based on the 1968 survey, had in dicated that the Center would be processing about 600,000 items per day. Actual volume for the first quarter of 1970. however, averaged 874,000 items per day and necessitated diverting some of the checks to Richmond for processing. W ith the installation of additional computer equipment scheduled for this month, the Center should be able to handle present volume and its projected growth. It is now evident that a regional clearing center can provide a significant improvement in the check collection process. If the idea spreads throughout the country, both the banking system and the general public should benefit. The Federal Reserve’s new communications network could conceivably provide an electronic link between such centers. In any case, both these innovations represent considerable progress toward an improved payments system of the future. H. L ee Boatwright, III C. P. Kahler BAN KIN G CHARACTERISTICS OF THE W ASH IN GTON -BALTIM ORE AREA PO PU LATION (July 1, 1967) NUMBER OF BAN KS (July 1, 1967) NUMBER O F B A N K IN G O FFIC ES (July 1, 1967) BANK DEPOSITS (June 30, 1966) Northern V irg in ia 1 846,500 35 170 W ashington, D. C. 809,000 14 108 2,004,600 38 276 1,391,370,000 913,000 7 112 1,485,245,000 4,573,000 94 666 $6,030,004,000 Suburban M arylan d ' Baltim ore, M aryland TOTAL SU RVEY AREA Survey A rea as a Percentage of Fifth District 24.8 11.7 22.2 $ 842,429,000 2,310,960,000 31.7 1 Cities: A le x a n d ria , Falls Church, and Fairfax. Counties or parts thereof: Arlington, Fa irfax , Loudoun, and Prince W illiam . J Counties or parts thereof: Source: Anne Arundel, Baltim ore, C alvert, C h arles, H ow ard, Montgom ery, and Prince G eorg es. Bureau of the Census, Current Population Reports, Series P. 25 No. 373, Septem ber 5, Division of Statistics, Population Estim ates of M arylan d, August 30, 1967; University Economic Research, Estim ates of the Population of Virgin ia Counties and Cities, July surance Corporation, N ational Sum m ary of Accounts and Deposits in All Com m ercial Digitized 14 for FRASER 1967; M arylan d State Departm ent of Health, of V irg in ia, The Bureau of Population and 1, 1967, O ctober 1967; Federal Deposit In Banks, June 30, 1966.
@FedFRASER