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DECEMBER 1972 The Property Tax And School Finance . . . . . . . . . . . . page 3 The Impact of Changing Check Clearing Arrangements on the Correspondent Banking System .. page 14 INDEX OF monthly revieu Comments on the Hunt Commission Report.. ... ... September-October Commercial Bank Profitability: 1961-71 ...... .. ............... ..September-October ARTI C LES IN 1972 1972 Agricultural Outlook Under the New Economic Program .. .... .. .................... ......... ..... January The Property Tax and School Finance ... .. ... ........ .......... ... December Explaining Stock Prices ...... .... ... ... .. ... .... ... March For 1972- Phasing the Economic Future .......... ....... ... .. ........ January The Full - Employment BudgetIts Uses and Limitations ... .. ..... ... .... ........ April The Impact of Changing Check Clearing Arrangements on the Correspondent Banking System .. ... .. ..................... December International Trade PoliciesThe Problem of Nontariff Barriers .. .. ..... ....... .... ..... ..... .... ..... .... ...... May Inventory InvestmentA Volatile Component of GNP .... ...... February Japan : U.S. Agricultu re's Number One Customer ....... .... ....... .. .. ..... May Minority Owned Banks .... .... ... .......... .... February The Retirement Decision Social Pressures and Economic Trends .. ................ .. ...... Novembe r Revolution s in Am ri can Agri c ultu re .......................................... .. June The Role of Financial Management in Agriculture .. ....... ..................... July- August Ski Area Profitability .... .... ................... ...... March Skiers: Their Local Economic Impact .......... ...... .. .... ........ .... June Social Costs- The Due Bill for Progress ... ......... ....... ................. .April Sources of Money Growth in 1970 and 1971 ........... .... .... .. .... July-A ugust Who Pays the School Property Tax? .......... .. ......... .......... November Subscriptions to th e MO NT H LY R £VI EW are availab le to th e public wit hout charge. A dditiona/ copies of any iss ue may he ob tain ed from th e R esearch Departm ent . Federal R eserve Bank of Kans as City , Kans as City . Misso uri 64 198. Permission is gran ted to reproduce an y ma1 erial in this publication provided th e source is credit ed . he Property Ta And Sc ool Finance By Stephen F. l,eRor and PeKRY BrocA.schmidt We have determined that ... the California public school financing system , with its substantial dependence on local property taxes and resultant wide disparities in school revenue, . . . invidiously discriminates a~ainst the poor because it makes the quality of a child's education a function of the wealth of hi parents and neighbors .... We have concluded, therefore, that such a system cannot withstand constitutional challenge and must fall before the equal protection clause. Supreme Court of California Serrano v. Priest, 1971 ht.: Cil i rorn i;1 Su prrnit.: C ourt, hy in va lidating l hl'. e \ iS l i11 g_ S _\ S ll'. Ill Of fin a 11 Ci ng p U b Ij c edu ca ti o n in th a t sL1t e. h;1s set in motion a pro·ess th a t may rumbm e ntalh a lt er state and loca l fiscal prac ti ces throu gh~)Ut the countr . In the year sin ce the ,\'<!rrmw decision , state and Federal courts in se veral other sla tes have fo llowed C alifornia 's lead , declarin g that reliance by sc hool sys tem o n th e local propert y tax viol ate th e equal protec ti on clau se of the Fourteenth /\m endm cnt to th e U. S . Con titution and similar pro vision s or st a te co nstitution s. 1 tr the U . S . Supreme Court, which wil l make the fin . 11 lktermi11ation on the issue ... ,g rees with the m;1j orit y in Serran o. sta le governments in '-l9 or the 50 states will be legal! obligated I / On~ ~uch ~~_it , w hich 1n ~ ugu~t 1972 in va lid ated the K an~as ~ystem o f ~c hool f in arn.:e. wa~ f 1kd o n behalf o f stud ent s in the De So to schoo l d is tri ct i n John so n o unt y . Monthly R • to restructure their schoo l finance s stem s ( I Ltw;1ii uses a statewide properl tax to fin .. ,n ce puhliL· edu ·;1ti on) . Tht: ( ';II i l'orn i;1 Su pre me ·o u rl 1 ;1v · exa mplcs or the extreme disp;1rities in edu ca ti o n;d fin ance ex 1st 1ng. among v..1rious 'a lifornia schoo l districts . In 1968-69 , th e Bevt.:rly Hill s schoo l district was able to pa y for an e penditure per stud ent of $1,232 with a property tax rate of $2.38 per $100 of assessed value, whi le in the Ba ldwin Park di tri ct a tax rate of $5.48 was required to finance expendi ture of onl y $577 per tud ent. The reaso n for th e di screpa ncy is th a t the Beve rl y Hill s district, wi th its expe nsive homes and ample business property on th e ta rolls, had an assessed va lu e per stu dent o r $50,885, while in Baldwin Park the assesst.:d va lu e per st ud ent was 3,706. Equali Lati on mane from the state a nd Federal gove rn men ts had th e effect o r reduc in g so mew hat the disparity between the tw o di stri cts, but came nowhere nea r to eliminatin g it, as the expenditure a nd tax rate figures indica te. The Ca li fo rni a Supreme Court's lega l argument was that , in view of t he disparities in a sesscd va lu e per pupil, it wa impos ible as a practical matter f r the poorer di stri cts to raise proper ty tax rates so as lo ge nt.:rate the same revenue per student as the wealthier di stricts could ob tain eve n with a low ta x ra te . Wide di ·parities in e penditure per student were th e obvious result. Thu s, th e our t held, th e Californi a sc hoo l finan cing sys tem in effect cla ss ified st ud e nts acco rding to th e wealth of th e ir 3 The Property Tax parents a nd neighbors, and provided better education for those students with wea lthier pa rents and ne ig hbors. Su ch a cl assi fi ca t io n, no t being necessa ry to th e purpose of pu bli c edu cation , was viewed b th e Co urt as a deni al to th e poor of th e equ a l protecti o n of the law. Thi a rgum ent , while invalid a ting th e a li fornia school fin a nce s stem, d ocs not es tab lis h a clea r crit e rion b whi ch diffe rent sys tems ma be j ud ged to be in co nfo rm a nce wit h or in viol a tion of th e equ al pro tecti o n cla use. Presum a bl y, th e U . S . Supreme our t wi ll supply a mo re. pec ifi c g uid elin e. I loweve r the U . S . S uprem e Co urt ult ima tely reso lves th e lega l iss u ·, th e vo ters in man a reas (includin) th e Ka nsas C it y a rea) have <d read returned a ne )ali ve ve rdi ct on the local prope rt tax b reg ularl vo t in ) dow n lev in creases. Moreover, m a n obse rvers have concluded th a t exi stin g meth ods of schoo l fina nce need ba sic overh a ul. The co mm o n element of proposed changes in school fin a nce methods is th a t a ll recomm end dec reased reliance on loca l propert y ta xe . In o rde r to eva lu ate the e proposa ls a nd compa re th em to the present ys tem, it is necessa ry to ob ta in rela tively accurat e inform a ti on a bout th e na ture and e tent of fin a nc ia l di spa riti es a m ong sc hoo l districts indu ced by gen era l reli a nce o n th e local propert tax. Thi s a rticl e re po rt s th e fi ndi ngs of such a stud y for sc hoo l di stri cts in th e Ka nsas ity Stand a rd Metropo lita n S ta tis ti ca l Arca (SMSA) . THE DETERMINANTS OF FINANCIAL DIS ARITIES AMONG SCHOOL DISTRICTS 2 Th e basic meas ure o f fi na ncia l suppo rt fo r th e provi sion o f edu ca ti o na l services is curren t 2/ A s bac kgro un d. ove r half the fund~ ~pent on public education in th e Kansas it a rea aTe raised b means of the local property tax. with mo~ t of th e remainder supplied b the sta te and Federal go vern m e nt s unde r a varie t of programs. bout two- thirds of the revenue ge nera ted b t he loca l proper! tax goes to the schools. with the rest fi na ncing co unt ies. mun icipali t ies. and o ther local government units. The opera ti on of th e loca l p roper! tax is easil summari?Cd : "nhin each sc hool d is tr ic t a ll busi ness. residential. and personal propert y is assessed by th e cou nt . th eore ticall at JO per cent of its market va lu e. an d is ente red on the tax ro ll s. The tax rate to be applied agai nst these assessed values is determined by the voters of each school di str ic t. su bject to restr ict ions imposed by the state . 4 ex penditure per stud ent. Accordingly, this study will foc us on va riations among school districts in cur rent expend iture per student and its determinant . Current expenditure includes all operating costs directly related to education, but exclu de such item~ as rood services, commu nity services, student bod y activities, debt se r vice, and capital outla ~- Th e e\clusion or cap ital ou tl ays is particularl y import a nt, since otherwise the expenditure l'igurcs ¼Ould exaggerate the level of educational ~ervices provided in school districts undertakin g new construction . The relevant measure or a school district's we<ilth , and therefor· :1 major determin :1111 or curn.: nt expcnditun: per studcnl, is a~~c~~cd value pcr student. 1 This variable , whi ch i~ com puted b dividing the total a~se~~ed value or all ta ab le properties within the school district by the number or students whose education must be financed, determines the tradeoff faced by each school district between expenditure per student and the property tax rate. A school district with high assessed value per student can finance high expenditure per student with a low property tax rate, while a district with low assessed value per student must tax itself at a high rate to gencratc cvcn a cornpar<1ti vel 1 small rcvcnue per studcnl. Thc rigure~ for the Beverl Hills and Baldwin Park school districts in alifornia exemplify the tax and expenditure patterns that can n:sult from grossly unequal assessed values per student among school dis tr icts. Besides assessed value per student and the tax ra te, two other factors influence current expenditure per student: the availability of stale and Federa l money to supplement local property ta revenues, and the amount of noncurrent e pcndi turc per student. The variable u~ed to measure state and Federal aid i~ the ratio of total expenditure b a school district to the ·chool tax revenues generated in that district , J/ In fact. the magnitude of variation s in asse ~ ed va lue per student is often used as a ummary indi cator o f the extent of inequit y amon g districts in school finance . Federal Reserve Bank of Kansas City And School Finance since the difference between these two figures large ly represe nts sla te and Federa l aid .4 Th e other determinant, noncurrent ex penditure, is ex pressed as a ratio of cu rrent expenditure to total expe nditure. Differences among sc hoo l di stri cts in the c urrent/to ta l expe nditure ratio largely represent varyi ng rates of co nstru cti o n, sin ce cap it a l o utla y is th e most impor ta nt item of noncurrent expenditure. The reason for expressing the determinants in ratio form , as formu lated above. is that under thi s spec ifi cation the product o r the determina nts is exact ly equ:.d to c urrent expenditu re per st ud ent. lkc:.1usc or this c4u:.1lity, ttny va riation :1rnon I schoo l distri cts in c urren t expe nditure per stud e nt c: 111 e:.1sil y h · tr :tced h.tck to v:1r it1 ti ons in ( I ) :.1sscsscd valuc per student. (2) the school ta x rat e, (3) the r:.1lio or sc hoo l district expenditure to sc hool tax revenues, a nd (4) the rati o of current to to tal school distric t expenditure. Analysis of th ese variables alone, though revealing, does not yield an adequate understanding of the dete rmin ants of curre nt expen diture per stud ent, as th e discussion in the fo ll ow ing sec ti on will make clear. /\ further brea kd ow n of one of these variables. :.1ssessed value per st ud ent, int o thr ee other dctcrminants will be parti cu lu rly useful. The determinants o r assessed va lu e per st ud ent arc median hous in g va lu e, th e si1e or the schoo l-age population, and the a mount of business property on th e tax roll s. Med ia n hou sin g val ue is a major determinant of assessed value per stud ent. sin ce 4 / Loca l sou rces of school di stri ct revenue other than the property tax . such as proceeds from bond issues and intangibles taxes. are thu s implicitl y grouped with state and Federal rayments . 5/ To see th is. it is noted that the school tax rate equa ls the rat io of schoo l tax reve nu es lo total assc:ssed value . Mak in g this change . the relati on between c urrent exrend iturc per st ud ent and its determina nt s becomes urrenl E,pend11ure u111hcrof'S1u drn1s 6 / Personal propert y is included wi th business property in the no nresidential portion of th e tax base. 7 / If median hous ing va lu e is a pproxi ma tely equ a l to ave ra ge housin g va lu e. th e relat ion etween assessed va lu e per stud ent and it s determin a nts ma y be expressed as (I) m (I) ( 'i ) I 01.il \ "c"cd \ .due S e huo l I .1, Re1enue um her of S1udcn1s I llldl l\ "e"ed Value I ol:tl /\ sse"ed V;iluc Number ol Siuclcnl\ -, otal R esiden11al Value Number ol I l ou,eho ld s (1) (4) T o 1,il l· ,pcnu11ure Sd1ool I .1, R e i cnue l urre 111 I· ,pendilure I ,>I .ii I ,rend11ure (6) · By ob. erving the cancc: ll ation or terms. it is apparc:nt th a t current expenditure per stu dent equals th e product of the determinants. Th e va ri ab le numbers are th ose of Table I. Monthly Review res identi al propert y accounts fo r a large proportio n of the total lax base in most sc hoo l d istricts. Th e rela tive size of th e stud ent popul ati on is al o importa nt, as eve n a sc hool di stri ct with hi g h medi a n hou sin g va lu e may find its advantage o ffset if the sc hoo l-age popul a ti on is relativel y la rge. Fina ll y, the va lu e of bu siness propert,y mu st be co nsidered becau se the am pi e ava il ab ility of such property ca n raise total assessed va lu e per stud en t to seve ra l times the residential assessed va lu e per stud ent. 6 /\ s before, it is usefu l to formulate th ese determinants so that th e var iabl e lo be explained in thi s case, assessed value per student equal s th e product o f th e determinants . The relative si1.e or the sc hoo l-.t )c popu lation is measured hy th e ra tio or the number or househo ld s to th e number of stud ents (o r, e4 ui va lently, th e inve rse of the average number of stu dents per househo ld ). The mea sure of th e avai la bility of bu sin ess property is specifi ed as the rati o of tot a l assessed va lu e to tota l res idential va lue. The three dete rmin a nts of assessed va lue per stud ent , th en, are median hou sing va lu e (variable 5), the average number of hou sehold s per student (variab le 6), and th e ra ti o of tot al assessed value lo total residenti a l value (vari ab le 7). 7 In order lo ca lcu late the numeri ca l ma :1nitudes or a ll th e determinants o r current expenditu re per student in th e Kan as ity S MSA , it was necessa ry lo ob tain measures of the following variables for eac h sc hoo l di stri ct: current sc hoo l di strict expendit ure, total sc hool district expenditure, the number • December 1972 Number or I t o u~e ho ld, umba or S1udents (7) T ota l Assessed Valu e Tota l R eside nti a l Value · /\gain. the ca ncellation proves th at assessed va lu e per stud ent equals the product of its determinants. The va riable numbers a re those of Table I. 5 The Property Tox of students, total assessed value, the sc hool tax rate, the median value of homes in the school district, and the total number of hou eholds in the district. Duta were co ll ected for th e 38 sc hool districts in the Kansas City SMSA which huve high sc hools (the 16 districts without hi gh schools were exc luded because severa l or the compu ted vuriab les proved to be ina ccurate for small schoo l districts) . The first five variables li sted above were supplied by stat e and co unty authorities in Kansas and Mi sso uri, while the last two were ca lcu lated from data contained in the 1970 Census of Housin g. These va riables arc ge neral! co mparable to those used in an ea rlier study or the burden or the properly t,1x by in co me cl:1ss. KThe cfola mc:1surin I current expenditure per student :111d its determinants, as specified above, arc shown in Table I. DISPARITIES IN SCHOOL FIMANCE The figure s in Table I show that there is considerable variation in curren t expenditure per student and its determinants among schoo l districts in the Kan sas City area . C urrent expenditure per student ranges from $459 to $8 17, and th e tu x rate varies between 0.700 per cent an d 1.850 p<.:r cent. Th<.: range or v<1riation in ass<.:sscd va lu<.: per student, $ 19,700 to $9J,J00, is co nsiderabl y wider. The disparit y hctw<.:en the latt<.:r figures , however, is much less 8/ Set: LeRoy and Brot:kschmidt. " Wh o Pa ys the School Prorcr ty Tax?" th is R e ,·iew. November 1972. where the method o r estimating median h0tJsing va lue by sc hoo l di stri ct is brien y summariLt:d . One_ minor modification or the d ata, co ncerning the vari able mea suring th e rati o of tot a l to residential assessed va lu e, was required . The dat a measuring tota l assessed value relfect on ly a small propo rti o n of the m arket value o f the properties on the tax rolls, due to the practice prevailing in Missouri and Ka nsa s (and most states) of assess ing property at a fr ac ti on of its estimated market va lue . However. the measure o r th e va lu e of residcnti a l property. drawn from the Census of I lousing. is a n estimate or th e full market valuc or hous in g (it was necess;1r y to use C\:ns us data to estima lt: housin g values bt:caust: avai lab le asst:sscd va lu e d ata a rt: not brokcn down by n:s idenl ia l and non rt:s id t: nt i:il proJ1t:rl it:s) . Ir no :ii lowan ce for thi , clist:rt:pancy wt:rc madt:, the ra ti o o r tht:sc two var ia bles would I t: a serio usly dist ort t:d mt: as ure o r the :1vailahilit y o r hu sin t:ss propt:rty to supplemt:nt rcsidt:ntial propt:rty on th<.: ta x rol ls. To corr_t:c t tht: discrt:pancy. lht: meas urt:s or asscssL:d v<duL: wcrt: put on a full valu..: basis by multiplying by fi ve. sin ce thc pr<.:vail in g as,css..:d lo- market ratio in th<.: Kan sas ' it y ar<.:a is approximately 20 Jlt:r c<.:nl. In orcler lo avoid di,tortion in th<.: cstimat<.: or tota l prop..:rt v laxc, col lect..:d . th<.: <.:ffct:tiv..: property tax rate was th<.:n com putec.! by d1v 1d1n g th<.: actual rat<.: by fi vt: . 6 than that between assessed va lu e per student in Bever ly Hill s and Baldwin Park, the California schoo l districts used in the Serrano decision to exemp lify disparities in sc hoo l finan ce. The richest Kan sas City area district has approximate ly four times more assessed value per student than the poor<.:st, comr,ared with the 14 to I ratio bctw<.:<.:n assessed value per student in Beverl y Hill s and Baldwin Par k. '1 The ratio b<.:twe<.:n the larg<.:s l and smallest assessed va lu <.:s per stud<.:nt , howcv<.:r , is not a very efficient mea sure or va riati o n sin ce it makes use ol' only two observations. /\ better meas ure of th e dcg rt:t: or va riati on in a set o r data is the coefficien t or dispersion , with hi gher v<tlu cs or thi s sL1 tistic indi ca tin 1 µrc; 1t cr v:1ri;1tion ;1rou11d the avcr;1gc. 11 ' Coclli cic nl s or disp<.:rsi on or assessed va lu <.: per student, the l;1x rate, and currL:nl expenditure per studt:nl for the Kan sas City area are ca lcu la Led from Table I and di spla yed in Table 2. Also shown for co mparison arc similar figure s for sc hoo l di stricts in th e six New England states, drawn from a study of disparities in school finan ce in New England. 11 With one exception, th e coefficients of di spersion in Kan sas City for a ll three va ri ab ks arc as low as or low<.:r than in any or thL: New Eng land st<1tes, indicatin g that ass<.:sscd va lue p<.:r studen t, th<.: school ta x rate, and current <.:xpcnditurc per student arc more nearl y <.:qual in Kansas City school distri cts than in New England sc hoo l distri cts. 9/ The Pleasan t Valley School Di stri ct. with an assessed value per student of a lm ost $6 million (at full valuation). is not considered in this stud y because it is a n element a ry district. 10 / The coefficien t of dispersion is defined as the sta nd a rd deviati on di vided by th e mean . The si mplest int erpreta ti on of the standa rd devia ti on. which is the most fr equentl y used measu re o f di spersion. is that in a norma l stat isti ca l samr le about 68 pcr ce nt o f th<.: ob~crvati ons li e within one stand ard d..:vi :1ti on of the mt:an . 1lcr..:. howevcr , th <.: standard d..:viatinn i~ di vidt:d by th e me:1n ht:cause a mt:asur<.: or r<.:lati vc r:1thcr than abso lute di sp<.: rsio n is dL:s ired . /\~ an ..:xa rnple or this ca lc ulati on. th <.: mean a nd st:1ndard cleviation o r <.: urr<.:nt exp<.:n ditur<.: JlL:r stu d<.:n t in Kans :1s Ci ty area st: hoo ls ;1r<.: $597 and $94 . respec ti ve ly. implyin g a t:odTiciL:nt o r di spt: rsion o r 0. 16. Th..:s<.: stati sti cs indica te th a t in abou t 68 per c<.:n t or th t: sc hoo l di stri t:ts curr<.:n t cxp..:n ditur<.: p<.:r stud ..: nt dilfrrs from th <.: overa ll 111c:1n h1 less th an $9-l. which is 16 p<.: r <.:<.:nt or th<.: mean . 11 / Stcv..:n J. Wciss. Lristing Disparities in Puhlic School Fi11u11 ce and Proposals fo r R eform . Rcst:a rch Rep ort No . 46, F..:dcral Rcsc rv..: Bank or Boston. February 1970. Federal Reserve Bank of Kansas City And School Finance Table 1 D ITS DETERMINANTS, 1970-71 CURRENT EXPENDITURE PER STU (1) (2) (3) Total ExCurrent School pendlture/ Expendl- Assessed Tax Rate• School ture Per Value Per (In per Tax Student Student* ~ Revenue School District and Enrollment (4) Current Expenditure/Total Expenditure (5) (6) (7) Median Housing Value Households Per Student Total/ Residential Value Cass County, Mo. 1. Belton - 5,131 2. Raymore- Peculiar - 1,390 3. Pleasant Hill - 1,420 4. Westline - 619 5. Harrisonville - 2,009 6. Drexel - 351 7. Archie - 503 $459 490 546 524 571 579 515 $19,685 30,908 37,589 36,135 39,353 43,629 46,816 0.970 0.970 0.790 0.900 0.930 0.850 0.700 2.84 2.14 2.21 2.13 2.07 2.02 2.05 0.85 0.76 0.83 0.75 0.75 0.77 0.77 $14,459 13,494 12,420 9,237 13,185 8,574 8,497 0.63 1.06 1.14 0.89 1.14 0.78 1.10 2.17 2.17 2.66 4.39 2.63 6.54 5.00 Clay County, Mo. 8. Smlthvlll - 959 9. Kearn y - 1,024 10. North Kansas Ci ly - 23 ,889 11 . Excel sior S pr ings - 3,531 12. Liberty - 4,049 589 553 607 520 554 46,922 41 ,040 53 ,447 34,617 36,202 0.906 0.910 0.940 0.800 1.160 1.89 2.45 1.90 2.33 1.63 0.74 0.60 0.64 0.81 0.81 13, 759 13, "146 16,610 11 ,050 15,179 1.27 0.76 1.17 1.05 0.78 2. 8 4.10 2.76 2.99 3.06 Jackson County, Mo. 13. Fort Osage - 4,987 14. Blue Springs - 3,867 15. Grain Valley - 616 16. OakGrove - 1,128 17. Lee's Summit - 6,378 18. Hickman Mills - 15,419 19. Raytown - 16,576 20. Grandview - 6,546 21 . Lone Jack - 322 22. Center - 6,087 23. Independence - 17,494 24. Kansas City - 73,656 496 477 528 486 576 523 549 536 558 685 513 739 24,632 34,786 32 ,124 24,552 46,105 29,311 33,059 35,547 35 ,438 69 ,054 31 ,548 65,438 0.960 1.090 0.976 0.960 1.040 1.198 1.150 1.162 0.910 0.890 0.940 0.846 2.81 1.99 2.63 2.87 1.74 2.02 1.81 1.73 2.16 1.40 2.39 1.70 0.75 0.63 0.64 0.72 0.69 0.74 0.80 0.75 0.80 0.80 0.72 0.78 15,082 19,384 13,966 12,136 17,150 17,543 17,627 16,580 16 085 18,573 1S, 260 10,388 1.04 0.76 1.51 1.00 1.06 0.90 1.13 0 .83 1.82 1.62 1.30 1.83 1.57 2.32 1.52 2.02 2.54 1.85 1.65 2.59 1.21 2.30 1.59 3.44 Platte County, Mo. 25. North Platte - 855 26. West Platte - 1,035 27 . Platte City - 1,410 28. Park Hill - 6 ,256 585 586 673 589 47,897 50,009 52,670 43,948 0.862 0.870 0.858 1.020 2.60 1.67 1.80 1.65 0.55 0.81 0.83 0.80 10,279 9,495 16,060 19,439 1.13 0.99 1.39 0.90 4.11 5.35 2.37 2.51 29. 30 . 31 . 32 . Wyandotte County, Kans. Kansas City - 32 ,872 Turner - 5,305 Piper - 529 Bonner Springs - 2,259 613 614 817 807 43 ,125 28,987 42 ,318 35,917 1.280 1.486 1.388 1.850 1.38 1.71 1.59 1.49 0.81 0.84 0.88 0.81 10,809 12,106 13,359 12,025 1.62 0.68 1.48 1.12 2.47 3.51 2.14 2.68 Johnson County, Kans. 33 . Stanley - 832 34 . Spring Hill - 744 35. Gardner - 1,329 36 . De Soto - 1,798 37 . Shawnee Mission - 43 ,694 38 . Olathe - 4,477 739 684 761 652 726 680 93 ,357 41 ,938 44,602 26,695 50,871 47 ,990 1.256 1.366 1.482 1.706 1.532 1.468 1.00 1.46 1.28 1.80 1.21 1.25 0.63 0.82 0.90 0.80 0.75 0.77 14,446 13,527 12,003 11 ,100 21,934 14,831 1.17 1.08 1.32 0.94 1.25 1.12 5.53 2.87 2.82 2.56 1.85 2.89 • Adjusted to full valuation . SOURCES : Median value of housing and number of households were calculated from U. S. Bureau of the Census; U. S. Census of Housing, 1970. Second Count Summary Tape - Kansas City SMSA Census Tracts. The other data were obtained from state and county authorities. Monthly Review • December 1972 7 The Property Tax Table 2 COEFFICIENTS DI PERSION Current Expenditure Per Student Assessed Value Per Student Maine Massachusetts Vermont New Hampshire Rhode Island Connecticut .18 .21 .16 .21 .13 .16 1.07 .94 .75 .69 .52 .38 .44 .31 .39 .44 .28 .31 Kansas City SMSA .16 .33 .25 Tax Rate SOURCES: Weiss , Existing Disparities in Public School Finance and Proposals for Reform , p . 17, and Table 1. Table 2 a lso shows lh al in both Kan sas City and New Eng land sc hool di stri cts thL: di spL:rsio n or asscssL:d va lu L: pL:r slu(kn t is mu ch ,rL::tt a than the di spersion or current L::<. 1xnditurL: per student. he ncccssa r impli cation is th at variation s in as ·cssed va lue per st ud en t a rc at leas t partly co unt erba lan ced by var ia ti ons in th e o th er de terminants or current expe nditure per stud ent. One po ss ibl e offset lo va ri a ti ons in assessed va lu e per stud ent is th e tax rate. Th e cor relation coefficient, a sta ti st ica l measu re of the direction a nd deg ree of association between two var iables, was used to determine whether the tax rate plays thi s rolc . c To do thi s, the correlation coe ffi cient s between assessed va lue per student , th e ta x rate, and current expe nditure per stud ent were calc ulated for Kansa s C it y area school di stricts. These co rrelati on coe ffi cien ts are di splayed against simil a r data for New Eng land sc hoo l di stri cts in Table 3. Assessed va lu e per student is seen to be positi ve ly correlated with expenditure per st ud ent in both Ka nsas City a nd ew England, as expected. Except for thi s similarity, however, th ere i a sharp co nlrasl between th e Ka nsa. it y sc hoo l di tr_ict s and cw Eng la nd di stri cts. 1 _12 / If two va ri ab k s usuall y bch avc si mil a rl y. wi th onc va riablc typica ll y hi gh (low) whcn th c other is hi g h ( low). t hcn th e co rrcl ati on coe fficicnt wi ll bc posi ti vc. reac hing a possiblc maximum of+ 1.00 ifthc two va ri ab les a lwa ys var cxac tl y in propo rt ion . lf a hi g h va lu c for o ne var iabl e is typicall y associa tcd with a low va lu e fo r the oth cr va ri ab lc. th e co rr ela ti on coe ffi cie nt will be nega ti ve. reac hing - 1.00 in the c:1sc o r a pe rfect inv..:rs..: rc.:l a ti o nship . If thcrc is no pcrccptiblc rc la tio n b..:twccn two va ria blcs. thc co rrcla ti on codf'i cicnt will b..: approx imatel y zero . 8 In New England, assessed value per student is inversely relat ed to th e ta x rale while in th e Kan sas Ci ty di stri cts, lhe co rrelation coefficient is approximately zero. Th ese fi gures demonstrate that th e lax rale tend s to offset variati ons in assessed value in N ew England school di tri ct , but d oes so onl y to a sli ght ex tent in lhe Kan sas City area . The co ntra st be tw een New England sc ho ol di stri cts an d Ka nsas it y a rea sc hool districts ca rri es ove r lo the co rrela ti on between th e lax ralc and c urre nt expenditur e per stud ent. In New Eng land, the corre lati on coe ffi cient s arc sca llered around zero, while in Kansas il y th en.: is a strong pos1ll vc co rrelation hclwL:en the lax r;1t e an d c urrL: nt L:xpcn diturL: ( 0 .60) . ThL: key to th L: inta prc lali on or th ese di vl'.rge nt patt erns o r be hav ior is th at , as not ed, v~1rialions in assessed va lu e per student arc low in Kansas City re lative lo New Eng land. Beca use the varia ti ons in assessed va lu e per stud ent in ew England are rela ti ve ly wide, sc hoo l districts with lo w assessed va lu e per stud ent are virtua ll y compel led to levy tax es at a high rate in order to finance eve n low levels of ex penditure per stud ent, whil e di stri cts with hi gh assessed va lu e per stude nt ca n afford hi gh expenditure pe r slud en l withou t sac rifi ci ng a low Lax rnl e. In Kansas ' it y, by co nlra sl, lh c lowe r Table 3 CORRELATIONS BETWEEN ASSESSED VALUE PER STUDENT, CURRENT EXPENDITURE PER STUD NT, AND THE TAX RATE Assessed Value Per Student and Current Expenditure Per Student Assessed Value Per Student and Tax Rate Tax Rate and Current Expenditure Per Student Maine Massachusetts Ver mont New Hampshire Rhode Island Connecticut .54 .56 .40 .57 .55 .54 - .58 .60 .56 .69 .56 .68 - .06 .04 .11 .00 .10 .10 Kansas City SMSA .57 - .08 .60 SOURCES : Weiss , Existing Disparities in Public School Finance and Proposals for Reform, p. 21 , and Table 1. Federal Reserve Bank of Kansas City And School Finance Ta ble 4 CORRELATIONS BETWEEN CURRENT EXPENDI URE PER STUDENT AND ITS DETERMINANTS Assessed Value Pe r Student School Tax Rate .60 -. 08 .57 Total Ex p./ Tax Revenu e Current Exp./ Total Ex p. -.75 -. 61 -. 57 .30 -. 20 .28 -. 3 1 Med ian Hou sing Valu e Household s Pe r Stude nt Total / Resid e ntial Val ue .00 .06 .16 -. 21 -. 12 .44 .42 - .08 -. 23 .12 .03 .11 .4 6 -. 19 -. 18 -. 16 - .61 -.31 di srersion in .i~scssed va lue pe r stud en t mea ns that -; ·hool di-;tricts do not have to use th e school r;1ll.: primarily to offset varia ti ons in ;1ssesscd value per stude nt. Sc hoo l di stri ct:-- in Kansa~ Cit \\ith high tax rate:-- ;1re lik e! to be those which prdt.:r a high level o r expe nditure per st udent, rather than t hose with low assessed va lue per student. This would explain th e hig h co rrelation or the tax ra te with current expendit ure and its low correlation wit h asses ed va lue. 11 1;,, DETERMINANTS OF CURRENT EXPENDITURE In interpreting the magnitude of fi na ncial di sr a riti cs among school di:--tricts, it was fou nd usefu l in the preceding section to exa mi ne the co rrela tions betwern current t.:xpend iturc pe r stu dent and two or its determinants tht.: tax rat e a nd assessed val uc per student. It was see n th a t if th e determinants or current expe ndit ure per stu dent arc negatively correlated wi th eac h 13 / Differences between school finance practices in Missouri and Kansas may be partly responsible for the high positive correlation between the tax rate and expenditure per student. The data in Table I support the conclusion that. compared to Missourians. Kansans ( I) prefe r higher expenditure per student (average expenditure per student in the Kansas districts lying within the Kansas City SMSA was 703 . compared to $5 54 in the Missouri districts). and (2) rely rcla tiv<.: I mor<.: on th..: local prop.:rty tax (th..: total expend11ur<.:/ to ta l pro perl y tax revenu..: ratio av..:rag<.:d I 40 111 Kansas and 2.06 in M issou ri ) s a r<.:sult of (I) and (2). th..: prop..:rty tax rat..: av..:rages <.:ons1lkrahl) h1gh..:r 111 Kans.is th .111 M "souri ( I -1 72 p..:r <.:..:nt com pa red to 0.9.:t I per cent) Thus the scall..:r hdw..:..:n Kansas and Mi ssou r i data would indu ce a pos111ve corr..:lation hctw..:cn th..: lax ra te and cxpend ll ur..: per stud..:nl. Such inferences .iboul differenc<.:s h..:tw..:cn th..: Kansas and Misso uri schoo l financ..: systems should h..: regarded as ver y tentative. howeve r. si ne..: the portions of Kansas and Missouri 111 the Kansas Ci ty S MSA may no t he representative of the two states . Also . there a re institu tional and .1ccoun11np. difference~ b..:tween the two states. Monthly Review • December 19/2 Curre nt Exp . Per Stud ent Assessed Valu e Per Student Sc hool Ta x Rate Total Exp ./Tax Reve nu e C urre nt Exp ./ Total E. .p. M edian Housing Value Household s Per Stud ent oth er, th e di sr,c rsinn o r c urrent ex r enditure per stud ent will h · low reL11 ive to th e di -; persio n o f th · deter mi11 ;111t s. l·or C\:1 111p h.:, in New h i gland sc hoo l di stri cts, ;111d to a m uc h lesse r extent in Ka nsas C it y sc hoo l di str ic ts, it was see n that th e nega ti ve t.:o rrcla tio n betwee n assessed value per stud ent a nd th e tax ra te impli ed th a t variati ons in th e tax rate acted to offset va ria tions in assessed va lue per stud ent , res ultin g in lower di spe rsio n in cur re nt ex penditure per stu dent th a n in assessed va lu e pe r stud ent or th e tax rat e. On th e oth er ha nd , if two de termin a nt s a re pos iti ve ly co rrela ted they will re in fo rce each other and prom ote hi gh di spersion in current ex penditure per stud ent. Th ese co nside rati ons suggest that th e stu dy or di spariti es in curre nt ex pend iture r,cr stud ent may usc f'ull y be pursued by exa minin g th e correla ti ons between current ex penditure per stu dent a nd all it. determin a nt s. Th e co rrel a tion ma tri x in T a ble 4, whi ch shows the co rr elation coe ffici ent between current expenditure per student a nd eac h o f its determ ina nt s, and a lso th e co rrela ti on between each pa ir o f determinant s, is co nve ni ent for thi s purp ose. Each row a nd co lumn o f th e ma tri shows the correlati on coeffi cient s between a pa rticu lar vari a ble and eac h of th e oth er vari a bl es. For exa mrl e, th e fi rst row co n ta in s the co rrela tion coeffi cien ts betwee n curren t ex penditure per stud ent a nd eac h of it s dete rminant s. By ex amin ing the co rrela ti on coe ffi c ients in thi s row, it is possib le to determin e wh eth er sc hoo l di stri cts with hi gh 9 The Property Tax Ja ckson County M1ssour1 Johnson County 35 Kansas Coss County Missouri SCHOOL DISTRICTS IN THE KANSAS CITY SMSA D Urban School D1stric1s Suburban School D1str1cts D Rural School Districts Districts Without High Schools KANSAS current expenditure per student typically also have high assessed value per student, tax rate, and so forth for all the variables. 14 Similarly, the row and column associated with assessed value per student show the correlations of that variable with each of the other variables. The same pattern follows for the other variable . The: coefficients of correlation shown in the l'irst row of Table 4 allow identil'ication or the t pica! finan ·ial characteri tics or school dis1-1 / The finan cial characteristics of school district ~ with low current expenditure per student will typically be the oppo~ite of th ose with high current expenditure per student . a nd the sa me applies for the other variables. 10 MISSOURI tricts with high expenditure per student. As noted previously, school districts with high expenditure per student tend to have both high assessed values per student and high tax rates. This is indicated in Table 4 by correlation coefficients of +0.57 and +0.60, re pectively . In addition , the correlation coefficient of -0.75 between current expenditure per student and the ratio or total ex penditurc to property tax rev enue implies that school districts with high current expenditure per student typically generate a high proportion of their total revenue from the property tax, receiving a corresponding! mall proportion of their budget from state F-ederal Reserve Bank of Kansas City And School Finance Table 5 URBAN, SUBURBAN, AND RURAL AVERAGES FOR CURRENT EXPENDITURE AND ITS DETERMINANTS Current Expenditure/ Total Expenditure Current Expenditure Per Student Assessed Value Per Student ($ thousands) $613 574 593 42.4 36 .3 40.5 1.073 1.155 1.017 1.79 1.78 1.91 0.75 0.77 0.75 591 39.6 1.059 1.86 0.76 Urban Average Suburban Average Rural Averag e Overall Average X School Tax Rate (In per cent) X Total Expenditure / Tax Revenue X SOURCE: Table 1. and Federal :-.ources. /\nolher finuing is lh . ,l such district:-. do not tend to h . 1ve high median lwu :-.in_i v. tlue:-. . In 1';1ct , the co rrebtion coelli cienl bet vvce11 c111-re11 l e:--.pcnd it 11 re per sl uden I and media II ltou:-.in g v. tluc i:-. (l.00, i11d ic . 1lin g lh . 1t th ere i:-. no a:-.:-.oc1a tio11 wh . 1tevcr between the t\,\, 0 variable:-.. 1 hi:-. rc:-.ull ma appear surprisin g, :-.incc it might be cxpccleu lhat residents of school districts with high median housing values would be able to afford a grcate r-lhanavcrage invcstmcnl in education. The other rows or Table 4, which show the corrclalion coefficients among the delerminants or current cxprnditurc rcr student, help lo explain the 1cm correla tion between currenl expenditure per -;tudent and median housing v. tl uc. It is seen th . 1t school districts with high mcdian housin g va lues typically have rclativdy liltlc busincss propert y on the Ltx rolls (lhis is indicated by the -0.61 correlation coefficicnt between median hou sing va lue and the ratio of total to residential assessed value). As a result or this offset, school districts with high median housing values have only a slight advantage in assessed value per student (as evidenced by a corre lati on coefficient of only +0.06 between these two variablcs. 11 ' Table 4 shows also that schoo l districts with high median housing va lues characteristicall ha ve high tnx rales (r, the corrdalion coefficicnl, equals +0 . 16), but re1 ' 15/ This does not imrl v th at slate and l·edcral payments have an e4uali,ing impa ct when measured 111 .ihsolutc.: terms. si nce raymcnl or a fixc.:d sum per student would constitute .i sma ller proportion of th e.: tota l budget in a school district v. ith high exrc.:nditurc.: per student than in one with low expenditu re.: per student. Monthly Review • December 1912 cc ivc a sma llcr proportion or their budgets from thc stale and 1:eder,tl µovcrnm ·nl:-. (r = - 0 .2 1). Urban, Suburban , and Rural Differences The currel..ttiun:-. di:-.cu:-.:-.cd in the preceding sec ti on can be identified to a considerable ex tent wilh differences between urban , suburban, and rural sc hool di slricts . Table 5, calculated f'rom the dala in Table I, shows the average figures for currenl expenditure and its determinants in urban, suburban, and rural chool districts in the Kansas City SMSA. 11 The classification of the schoo l districts is as shown on the map . Despite the fact lhat the average currenl expcndilure per student or each grour is approximately eciual to the over:tll aver,1ge ( w ilh urban d islricts sligh ll y a bovc ..1vcrage and suburban districts somew hat below average), the delerminants or current expenditure per student va ry widely. Assessed va lu e rer sludenl is considerably higher than average in urban districts, slightly higher in rural di stricts, and lower in sub urban di strict s. In order 16 / Thi~ positive co rrelation between median hou sing va lue and the ta x rate is expected in light of the positive coefficients in regress ions of the tax rate on median income noted in LeRoy and Brockschmidt. "Who Pays the Sc hoo l Propert y Tax''" sin ce median housing va lu e.: and median income.: are th emselvc.:s highl y corrc.:latc.:d (r = +0 .92) . Beca use.: of the.: link between median housin!! value.: and mc.:dian in come. the rre,c.:nl analysi~ ca n he u,c.:d lo interpret th e.: rc.:sults of the.: e.irlier .irt1ele. l· or ..:,ample. the dat ,1 presc.:nted in th1, article ,hov. that the hi!!h tax ratc.:s in ,choo l di,tri eb wllh high mc.:dian incomc.:s are nc.:edc.:d to offst.:l low nonrc.:sidc.:ntial assessc.:d valuc.:s and low state and Fc.:deral aid. and not lo finan ce high ra tes of cxpc.:nd iturc.: per stud ent. 17 / Gc.:omc.:tric rathc.:r than arithmc.:tic avc.:ra!!C.:S arc.: sho\\n in Tables 5 and 6 in ordc.:r to presc.:rve the.: c.:4ualitic.:s hetwc.:en current c.:xpcnditurc.: pc.:r student and assc.:ssed value.: per studc.:nt and their respc.:etive dc.:terminants for the.: averaged data . 11 The Property Tax Table 6 URBAN, SUBURBAN, AND RURAL AVERAGES FOR ASSESSED VALUE AND ITS DETERMINANTS Hou sehold s Per Student Total/Resi dential Value As sessed Value Per Student ($ thousands) Median Housing Value ($ thousand s) Urban Average Suburban Average Rural Average 42.4 36.3 40.5 12.8 16.8 12.5 1.25 0.99 1.10 2.65 2.18 2.93 Overall Ave rage 39.6 13.6 1.09 2.68 X X SOURCE: Table 1. to offset thei r rela tively low assessed values per student, suburban districts levy property taxes at a higher rate than urban or rural districts . Statc ;rnd federal aid forms a somewhat high cr proportion or total cxpenditun..: in rural school districts than in urban or suburban districts . On the othcr hand, thc ratio or currcnt cxpcnditure to tota l cxpenditurc shows no significant differences among urban, suburban, and rural districts. The most st riking result here is that suburban sc hool districts have considerably lower assessed values per student than either urban or rural school districts. This conclusion may seem surprising in view of the greater affluence of suburban residents. To determine the reason for the lower asscsscd values per student in suburban school districts, the dctcrminants of assessed va lue per student were averaged for urban, suhurban, and rural areas (Table 6) . /\s expected, suburban school di . tricts have much higher median housing va lue than either urban or rural districts. However, this advantage is offset by a total-to-residentia l assessed value ratio that is lower than that for either urban or rural districts. Despite the much-publicized nigh t of business and industry to the suburbs, urban districts are seen to maintain greater co ncentrations _of business property on the tax rolls than suburban districts. The total -to-re_sidcntial assessed value estimate is even higher in rural distr icts than in urban distric ts, probably due to the amp le avai lability of business property in the fo rm of farms_ 1x In additio n to a relative lack of business 12 property on the tax ro ll s, subu rbs arc disadvantaged by a low households-to-students ra tio, particularly compared with urban districts. The reason is that a disproportionatcly largc numhcr or ramilies with school -agc childrrn locatc i11 thc suburbs, whilc young couples with out childrcn, single pcoplc, and older adults arc more likely to remain in urban areas. Also, a higher proportion of students in urban districts attend nonpublic schools. These factors operate to the advantage of urban schools and the disadvantage of suburban schools, which accounts for the lower-than-average assessed value per student of suburban school districts. CONCLUSION The California Supreme Court held that the substantial dependencc or California public schools on the local property tax illegally discriminates against the poor. The Beverly l lills and Ba ldwin Park school d istricts, cited in the Serrano case, exemplify the disparities in educational finance that can result from extreme variations among school dist ricts in assessed value per student. The general pattern of low tax rates with high expenditure per student in "rich" school districts and high tax rates with low expenditure per student in .. poor" districts was round to violate the Constitu tiona l guarantee of equal protection, since the qua lity of public education is made a funct ion of wea lth. 18 / The statistical procedure adopted to calculate the total / residen tial assessed value ratios invo lved imputing lo farms a residential value equal Lo the value of the average nonfarm residence in the school distri c t and t reating the remainder of the farm 's va lue as business property. Federal Reserve Bank of Kansas City And School Finance The pattern was see n to be substan ti a ll y different in the Kansas C it y area. To be sure , there are considerable variations in cur rent expenditure per st udent among sc hool districts , with these variations being related to diffcrcnces in assessed value per student, as in California and also New England. I lowc vcr, the varia t ions or both variables arc much less in the Kansas C it y area than New England , indicating that di sparities among districts in school finance arc not as great in the Kansas Ci ty area. Examination or the correlations among cur rent expe ndi ture rcr student, assessed va lue per stud ent, and the tax rate sugges ted a major co nsequence or th· lower v;1riation or ;1sscsscd va lue p ·r stu dent i11 the Kansas Cit .irc:1. 111 the Ka ns:1s Cit SMSA , school districts wit h high tax rates arc likel y to he those desiring high c pcnditurc per student; whereas in the New Eng land stat es, wit.h their higher variation or assessed va lu e per student, schoo l districts arc virtual ly required to use the tax rate to offset var iations in assessed value per student. Thus, because of the difference in the variation of assessed va lue per student, school districts in cw England charactcristica lly con form lo the Beverly HillsBaldwin Park pattern , while school di stricts in the Kansas City are;1 do not. The ;1 nal ysis or this article, then, attributeu the major contras ts between schoo l l"inancc patterns in the Kansas City area, on one hand, and New England and California , on the other, to the lower variation of assessed val ue per student in the Kansas City area. By examining th e determin ants of assessed value per student it was possible to isolate some of the spec ific factors promoting low variation in assessed va lu e per student in the Kansas Ci ty ;_trea . Generall y, va ria ti ons in the detcrm in;1 n ls we re seen to offset one another. so that if one determinant ravorcd a school district another determinant was likcl to cancel the advan ta ge . The most striking instance of this offsetting behavior is that school districts with high median hous in g values primarily suburban districts Monthly Review • De(ember 1972 char ac teristica ll y ha ve less nonres idential property on the ta x rolls than urban or rural sc hoo l districts . Also, suburban districts have la rge schoo l-age populations rclJtive to the numb er or hou se hold s, further offset tin g their higher median house va lue . As a result of these offsets, variations in assessed value a re more modera te than wou ld otherwise be th e case. Th....:s....: conclus ions impl y th at reliance on th e local property tax to finance schools docs not systema ti ca ll y discriminate agains t the roor. The urban and rural schoo l districts , where most of the low-i ncome familie s in the Kans ;1s Cit) metrop o lit :111 :1rc;i li,·c. :,re fovorcd hy rcl :1t iv ·h high nonrcsid ·n ti :tl :1sscsscd v: tlucs , rclat1v ·I; i<m sc lwol -iigc popu l:1tions , ;_ ind rcLttivcly more ;1hundant slctt c and Federal support. ;\s a consequence, the urban and rura l districts arc ab le to afford higher expenditure per stud ent and lower tax rales than the more ar!luent suburban disLricts. These findings do not impl y that the local propert y tax is beyond criticism, since it has adverse effects not indicated by the dala on disparit ies in sc hool finance. Reliance on the loca l f)rof)ert y tax gives municipaliLies an incentive to adopt ri 1 id cons tru ction codes ;1nd 1011i ng restrictions in orda to e:-..cludc the poor, who con trihut . . : rcl<1tivcl y little to the tax base . The resulting impcdimcnls to mobility con tribule to the con tinuin g deca y 01· urban areas in the Uni ted States. For thi s reason alone any proposal to lessen reliance on the local property tax should receive a sympathet ic hearing. However, care shou Id be taken not to overstate th e case for reform . Elimina tion of di sparities in school finance wil l not automa ti ca ll y bring relief" to those schoo l districts which may need it most. For examp le, the Kans;_ts Ci ty, Mi ssouri, schoo l district dra¼s on a relative ly high assess....:d va lue per student and might not benefit from reform. These considc ra lions sugges t that, while reform of schoo l finance meth ods is needed , any a ttempt to jettison th e loca l property tax shou ld be preceded by care ful planning. 13 The Impact of Changing Check Clearing Arrangements On the Corres ondent Banki g ystem By Robert E. Knight n recent years the traditional methods or effectin I payments have come under increa sing examination. harges that banks will be smothered under a mountain of paperwork unless drastic cha nges are made have become almost commonplace. Strong stimulus ha been given the use of wire and paperless transfers with the completion of the Federal Reserve's Culpeper center and the experiments with a variety of electronic payments systems in various sections of the country. The speed and efficiency of check collections arc being in creased with the development by the Federal Re erve of regional check processing centers (R PC's), and the requirement that banks pay for cash letters received from the Federal Reserve in immediately availab le funds. Some correspondent banks have discovered that by developing their own networks for clearing checks a nd bypassing the more traditional avenues, substantially earlier collection can be obtained. Thi s article considers some of the more rece nt and significant changes in check clearing a rran gements with the main focus on th e development of R PC's and the implication s for th e correspondent banking sys tem. ROLE OF CORRESPONDENT BANKS It- C F I C- r An important co nsideration in founding the Federal Reserv e was the de ire to establish a 14 comprehensive and economic~il system for ckarin I checks. The Federal Reserve Act provides that the ' stem's check clca rin g services arc to be available both to member banks and to nonmembers maintaining clearing accounts with the System. Nevertheless, comparatively few banks have chosen to send checks directly to Reserve Banks. The imposition of sorting, encoding, and com put er processing requirements has discouraged many smaller member banks from making direct deposits with Reserve Bank s. Nonmember banks, on the other hand, have frequently found clearing checks through correspondents advantageous. All states with reserve requirements permit nonmember banks to count balances due from other banks as reserves . incc correspondent banks normally give immediate ledger credit for cash letters received, nonmember banks are often able to meet a substantial proportion of state reserve requirements with uncollected funds and with compensating balances maintained with correspo nd ents for other purposcs . 1 1/ The immediate credit provided hy corrc~po ndcnt s 1~ frequently misunders tood . Even thoug h immediate lc.:dgcr credi t may he given for cas h letters, depositing banks arc not fn:c to draw on these funds until they arc co llected . M oreove r, in determining the earnings value of an acco unt , co rrespondent hanks make a deduction from the ledger balance for um:o llccted funds to determine collected and invcstable funds . As a result , the provision of im mediate credit for cash lctcrs is of value primarily to nonmember banks in meeting state reserve requirements, but it docs not represent ava ilable fund s. f-ederal Reserve Bank of Kansac; City The Impact of Changing Check Clearing Arrangements on the Correspondent Banking System Recent urveys have indicated the significance of the correspondent network in clearing c heck s. A 1969 survey by the Federal Reserve Bank of Kan a ity cove ring banks in Tenth District states revealed that over 90 per cent of the survey bank and 87 per cent of the member banks preferred to send checks drawn on nonlocal banks to correspondents. 2 Only bank· with deposits in excess of $ I00 mill ion normally cleared checks directly with the Federal Reserve. Although estimates of the percentage or nonlocal check ent to correspondents by banks with total deposits le~s than $100 mill ion vary from 70 to 95 per ce nt , these l"igures tend to overstate th e role or thl: correspondent network in cle~tring checb. Many correspondents send checks received from smaller bank!'> to the Federal Reserve. The number or checks cleared through the Federal Reserve, consequen tly , is greater than the figures might suggest. However, even large correspondents clear about one-fo urth of their checks through other corre pondents. The most important reason su rvey banks listed for sending checks to correspondents relates to the immediate credit correspo ndents offer. A. noteworthy number of banks also indicated that the "saving of sorts" and "more prompt clearance" were advantages . The most common "other" reasons g iven were that banks were not members or the Federal Reserve or that check clearing pattern s were based on tradition. A rough indication or the balances ge nerated for cor respondent banks by providing check clearing services can be obtained from another survey conducted by the Kansas City Reserve Bank in 1971 . This survey exa mined the procedures used by correspondent banks to analy1e the accounts or smaller banks to determine whether the balances held to co mpensate for services are adc4uate. In the analysis, the charges for various services arc re2/ R e~ults or this ~urve} were rdea~ed 1n the ovember and Dece mber 1970 Monthly Rniews of the Fedc.:ral Re~erve Bani,. of Kansa s ity. Monthly Review • December 1?/2 lated to th e imputed earnings represe nted by the balance maintained. At the time of th e su rvey, 42 per cent of the total ledger balances due to other banks were uncollected funds. These balances represent th e dollar amoun t of cash a nd noncash items correspondents have received for clearing but for which they arc un able to obtain immediate credit. The survey revealed that thL: major proportion of analysis expense for most survey banks was related to check clcarings. 3 The largest single entry in th e account analy is is often the charge for the number of items depo sited . rban banks in particular tend to have high analysis charges for check clearing . A.mong the banks in the sample, urban respondents typ1c~tll y sent I 1/2 to J times as man y checks to co rrespo ndents as did rural bank s of similar si,e . Despite relativel y high analysis charges, total fee s for ledger en tries and returned items were generally quite sma ll. While large variances were evident, the number of returned items and ledger entries, respectively, amounted to less than .08 per cen t and .76 per cent of the items deposited. Nevertheless, the total balances required to compensate correspondents for tran it services were subs tantial. For all but small rural bank s, the sum or uncollected balances and balances required for transit services averaged over 70 J/ To ob tain an cs11mate of the compensa tin g balances requ ired for check clearing serv ices, it was necessary to obtai n a relative1} aecurate coun l or th e number or e hec ks banks o n the average c lear through cor respondent s along with the related counts on returned items a nd ledger entry credits a nd debits . Since most small banks do no t maintain reco rd s of item counts, a number of co rresp o nd ents in different sec ti o ns of the country were asked to provide copies of their analysis statements for individual banks cove ring the month of Jul y 197 1. Correspondent banks were requested to select on ly th ose banks believed to be se nding esse ntia ll y all of their tran s it items to the correspondent. A total of 344 analysis forms were rece ived . Al the sa m e time a n o ther s urvey was conducted of m ajo r co rrespondent banks thr oug h out the cou ntry to determine the ty pical eharges for serv ices a nd lhc methods of analy1ing the profitabil11) of the .1ccounts or respondent ban ks. A co mplete descripti o n or account analys is procedure~ a nd the re~ulb of this latter surve} is contained in th e Decembe r 1971 M onthly R e ,•iew o r the l· edc.:ral Reserve Bank of Kan sas City . To reduce lhe potential bia s which wou ld result from the fact that th e banks providing co pies or the monthl y accoun t analysis ,latements for speulic respondents might lend to have above or helo\\ average collec ted balance requirements for tran s it services. the item counts ob tained from the forms were multiplied b} the median co llec ted balance requirements determined from the broader survey o r c harges. 15 The Impact of Changing Check Clearing Arrangements Table 1 COMPENSATING BALANC. D BY CORRESPONDENTS FOR PERFORMING TRANSIT SERVICES BANK DEPOSIT SIZE (In millions of dollars) Less than $5 $5 to $10 $10 to $15 $15 to $20 $20 to $25 $25 to $30 1. Average demand balances held with banks in the United States in thou sands of dollars· (June 30, 1971) 259 533 795 1,356 1,370 1,606 153 104 343 222 428 208 756 388 1,063 283 1,567 103 NA 305 192 473 314 807 443 1,062 574 1,020 373 64 .72 62 .85 48 51 66 .45 51 .30 54 .88 26.58 54 .03 6 .56 36 56 15,802 41 ,387 27 ,351 62 ,154 42 ,985 63, 196 50,662 69 ,330 81 ,500 100,411 19 18 22 19 26 10 31 16 NA 60 94 64 87 86 109 104 132 171 195 116 91 209 85 205 168 344 129 151 170.22 2.25 2.47 4.43 179.37 200.62 2.69 2.98 7 .43 213.72 - 274.55 1.39 3.79 2.79 397 .63 1.99 5 .59 3.26 282.51 408.48 2. Average demand balances held with primary correspondent by sample banks in thousands of dollars (July 1971) RURAL BANKS Average ledg er balance Average collected balance URBAN BANKS Av rag alanc Av rag d ba lance 3. Coll ct d balanc s as a per c nt of I dger ba lanc NA 68 .27 RURAL BANKS URBAN BANKS NA EC EDCO 4. Average number of items deposited RURAL BANKS URBAN BANKS 5 . Average number of returned items RURAL BANKS URBAN BANKS 6,934 NA 13 NA 23 6. Average number of ledger entry credits RURAL BANKS URBAN BANKS 43 NA 7. Average number of ledger entry debits RURAL BANKS URBAN BANKS 91 NA NA R 8. Collected balance requirements in thou sand s of dollars RURAL BANKS Item s deposited Returned items Ledger en try credits Ledger entry debits Total URBAN BANKS Item s deposited Returned items Ledger entry credits Ledger entry debits Total 9 . Per cent of ledger balances attributable to fl oat or held to compensate for check clearings RURAL BANKS URBAN BANKS 10. Per cent of collected balances necessa ry to compen sa te correspondents for transi t servi ces RURAL BANKS URBAN BANKS 27.46 1. 13 1.23 1.97 62 .58 1.65 1.72 2.5 1 108.31 1.91 1.84 4.51 31 .78 68.45 116.57 - 163.89 1.56 2.70 1.97 170.1 1 246.13 1.65 2.50 1.84 252.11 250.26 0.87 3.13 3.63 257.88 55 .23 92.82 78 .64 86.92 72 .40 77 .06 93 .48 72 .55 103.48 30.83 88 .60 56 .04 80 .29 46.23 58 .21 75 .52 49.22 109.58 52 .80 30.56 - 322.74 4.90 - - *Excludes balances at U.S. branches of foreign banks. NA- Not available due to small sample size . 16 deral Re rv Bonk of Kansas City On the Correspondent Banking System per cent of gross ledger balances of respondents at principal cor respondents. For rural banks with deposits und er $IO million , the comparable percentage wa slightly over 50 per cent. (The basic data underlying these conclusions arc hown in Table I.) These figure. provide a guide to the maximum reducti on in co rrespondent balances whi ch mi ght occu r ii" sma ll banks were to utili1.e the clearing serv ices of the Federal Rese rve exclu sively. Assuming remaining correspondent balances arc necessa ry to com pensate for other services, the maximum decline in prin cipal correspo ndent accou nts of small b;1nk s would average about 50 per cent for rural han ks wit h tkposits under $ 10 million and over 70 rer ·ent for other banks . While these potential losses arc la rgc, two important qu alifications m ust be recog nized . First, with th e except ion or mall urban banks, abo ut 60 per cent of th e loss in eac h deposit ize ca tegory would be attribu tab le to a reduction in uncoll ected funds or noat. For urban banks with deposits under 15 million, the proportion attributable to no at would app roximate 40 per cent. Losses or such funds would affect corresrondent bank deposit totals, but would not influen ce their loanable funds or earn ings. Second , the lo ss l"igu res refer on l to balances maintain ed a t prin cipal corresrondents and not to total co rres pondent balances mainta in ed by respondents . Since th e balances held a t prin cipal co rrespondents by the survey banks with less than $20 millio n in deposits average only 60 per cent of the total correspondent balances maintai ned by th ese banks, th e potential redu ction for these respo ndents would range between 30 a nd 40 per cent of total cor re pondcnt balan ces held . The reducti on for la rge r rcsrondcnt s wou ld he somewhat greater. Propo sa ls for modifying the check co llecti on system arc not new . In 1954 the Wurts ommittee, composed or rep resentatives of Monthly Review • Dcc.cmbc>r 1972 the American Bankers Association, the Association of Reserve City Bankers, and the Conference of Reserve Bank Presidents, was organized . At that time the Wurts Committee found th a t over 90 per cent of the dollar amo unt of mon ey payments in the United States were made by check, that check collection problems arose primarily from the volume of check , and that the average check pa ed through 2.3 bank s in th e co llection process. Recognizing that the volume problem could be allev iated by reducing the number of handling of individual chec ks, the ommittee recommended increa sed use of regional clea rin ghou ses. It also proposed that nonmember bank s be permitted to pn:sent chec ks directly to the Reserve Bank s for cred it to the acco unts of member banks, if those items othcrwi e would be sent by th e nonmember lo members and th en cleared by the members through the Federal Re erve Sy tern. The A BA approved the recommendations with the understanding that they would not be used by the Federal Reserve to stimulate membership. However, reserve city banks voiced strong opposition to th e report. Th e principle of more efficient and speedi er check collection s was acce pted, "but not where this acceptance might pos ibl y endan ge r co rrespondent banking rel a tion hips." Despite minor modification , th e check collecti on system experienced littl e change until recently. A study of check clea rin g practices in the late 1960's found that check volume had been increasing at an average rate of 7 to 8 per cent per year,4 suggesting that the number of checks written annua ll y is likely to double during the current decade. Approximately half of all check received by banks were tran it item s not drawn on loca l bank s. However th e study found that nationally about 35 per cent of a ll tran 1t item were drawn on bank within 75 mile of the bank 4/ Linda M . Fe nn er a nd Robert H. Lon g, Th e Ch eck Collection System : A Quantitatil'e Description (Park Rid ge, Ill. : Bank Administra ti on In stitute, 1970). 17 The Impact of Changing Check Clearing Arrangements Table 2 CHECK COLLECTION SCHEDUL ~ A D AVAILABILITY OF FUNDS Midnight 1. Check deposited In a FR city bank and drawn on another bank in the city. (Typical clearinghouse arrangement.) 2. Check deposited in a bank and drawn on a country bank In a dlff rent FR district or In different zone of the same FR district. Midnight Midnight Midnight Midnight DAY1 DAY2 DAY3 DAY4 DAYS (Noon) (Noon) (Noon) (Noon) (Noon) Early morning deposit at FRB Morning presentment to drawee bank I Funds available to depositing bank, opening of business Late afternoon deposit at commercial bank R ceipt by FR Branch Afternoon deposit with FRB Dispatch to FR Branch Late afternoon deposit at commercial bank Under change in Regulation J , drawee bank charged for check . Funds availab le to depositing bank, opening of business Under former schedu le. drawee bank charged for check . Morning presentm nt to drawee bank I 3. Check deposited In a bank and drawn on a FR city bank In a different FR district or in a Late afternoon different zone of same deposit at commercial bank FR district. Afternoon deposit with FRB 4. Check deposited In a bank and drawn on a country bank In same FR zone. Receipt by FR Branch I Dispatch to FR Branch I Late afternoon deposit at commercial bank Funds available to depositing bank, opening of business Afternoon deposit with FRB Morning presentment to drawee bank I Morning presentment to drawee bank Under former sch ed ule, fund s available to depositing bank , openin g of business. Drawee bank charged for check . I I Under change in Reg ulation J, funds available to depositing bank , opening of business. Drawee bank charged for check . 5. Check deposited In a country bank and drawn on a FR city bank In same FR Late afternoon deposit at commercial bank Afternoon deposit with FRB I I Funds available to depositing bank, opening of business l zone. 6. Check deposited In a bank served by an RCPC and drawn on another bank served by same RCPC . Late afternoon deposit at commercial bank Funcfs available to depositing bank , opening of business I Late P.M. or early A.M . deposit at RCPC or relay point I 18 I Morning presentment to drawee bank I I Morning presentment to drawee bank 1 I Federal Reserve Bank of Kansas City On the Correspondent Banking System of depo si t, 50 per cent within 150 mil es, a nd 63 per cen t within 300 mil es. The average c heck was processed by 2. 6 institutions befo re being paid, a sli g ht though probab ly not significant increase from the average of 2.3 found in the early I 950's. Based on thi finding, th e study concl ud ed that the average item wa s in th e di stribu ti o n and processi ng stream abo ut 2.6 days. J\ continuing force for c han ge has been Cong ressiona l crit icism of th e grow th in Federal Reserve float, which has been viewed as an interest free loan to banks. Wh e n c hec ks arc ck.ir ed through the Federa l Rese rve, banks ;_ ir e given credit for the c hecks accordin lo a set schedule r: 1thcr than when p;_1y111e nt is recciveu hy the 1-'cd . 1:10:11 represents the aggregate amount or checks in process or co llect ion ror whic h credit has been gra nted by the Federal Reserve without the receip t of paym e nt , minus th e amou nt of c hec ks ( if any) for which payment has been received but no t g iven. From around $1 billion in the ea rl y I 950's, Federal Reserve float rose to ove r $3 billion prio r to the recent change in Regulatio n J . About two-thirds of this floa t was attribut ab le lo the fact that the maximum period for which credit was dckrred under the Fed' s sc hedule was 2 days, but until rece ntl y Reserve Ba nk s, even under ideal circumsta nces, were normall y un able to col lect items drawn on co untry banks in other Federa l Rese rve di s tri c ts o r in ot her Lones of the same Federa l Reserve di strict in less than 3 days . (See Item 2, Table 2.) The recent change in Regulation J requires a ll bank s to pay for cash letters received from R eserve Banks on the da of receipt in immed ia tely available funds. Since banks already se rved by an R P (Item 6) and most in ci ti es with Federal Reserve Banks (Items I , 3, 5) we re previously pa ing on the da of rece ipt, these bank s were not required to pa more ra pidly . Howeve r, out) ing bank generally have not been required to pa until the day following receipt of the cash letter (Item 2, 4) . The d e lay has been permitted beca u. e these banks, unlik e c it banks, ha c ften been un ;_ 1hlc to ge t their transit c heck: to the R eserve Ba nk for co ll ec ti on on th e <.la of orig in a l dcrosit. Under the modification in Reg ul a ti on J , th e Federal R eserve grant arli e r availability of funds to ba nk s onl for those item s drawn on banks served by the same Federal R ese rve office as the d epositing bank. Co nsequ ently, Federal Reserve noat has been reduced by the amount of items dra n o n co untry banks in other di stricts and zone which a mounts to over $2 billion on average. Under the c han ge in R eg ul atio n J , ba nk s in Federal Rese rve c iti es arc not required to pay more rromrtly , but receive earlier credit fo r ite m s in their outgoing cas h letters dra\! n on co untry bank s in the same Federal Reser e zo ne. Th e effect, therefore, is to tra nsfer collected fund s from outlying banks, which pa a NOTE: City banks in the chart are those which prior to the recen t change in Regulation J paid for Federal Reserve cash let ters in imm edia tely avai lc1ble funds . These banks would include most in cit ies with Federal Reserve Banks and a lso those receiving cas h letters from RC PC's. /\ II o th ers arc refer red to as count ry ba nk s. If the deposi ti ng hank receives fund, at the same time as the drawee hank i, required to pay for the check. a separate en tr y indi ca tin g the actual payment for the chcd has not been shown . I lowevc r. ii' lhc two tim e, differ. rc,ulting in 1:cdcra l Rese rve noa t. a separate cn tr ha s hecn includcd for each . Simi lar ly. if thc change in Regulation J \.\Ould affect paymcn t or collection schedule,. these mod1fica110n, arc sho,, n in the chart. Although thc tim es indicated in th e chart arc rcprcscnta tivc of the clear ing schcdulcs for mos t hanks. cxccp tions arc 11 01 un u,ual. Thc schedules. consequent I) . ,hou ld not hc app li ed to specific si tu ations "'ithou t fir,t ascertaining the va lidity of the times show n. 5/ In additi on to " tim e schedule" noat, described abo e. there are at least three o ther types of Federal Reserve Ooa t. .. Holdove r" noat, comprising abo ut IOJJer cent of the total , represent the do ll a r a mount of item s the Federal Reserve is unable to process in time to meet dispatch deadlines. Such noat arises primarily du ring periods whe n mecha ni ca l failures occur with check sorting and encodin g equipment or when check volumes are unusually la rge. "Transpo rta tion" noa t, averaging over 20 per cent of th e tota l. occu rs from un expected or unusual del ays in the movement of c hecks be tween Federa l Reserve offi ces. "Remittance" fl oat. whi ch amoun ts to less than 5 per cent of the total. develop, when banks fa il 10 remit to the Federal Rese rve for cash le tt ers a t th e a ppropri a te: tim e. With th e Federal Rese rve no making a utoma tic dedu cti ons from reserve acco unts for cash letter, sent to ban ks. remi ttance noa t wi ll tend to disa ppea r. /\I I Federal Rese rve noa t co uld be eliminated if th e Reserve B.111ks we re to g ra nt c red it to clearin g banks o nl y as the checks a rc ac tu a ll y co ll ected . However. len gth ening the payment schedule from its cur rent ma xim um of 2 da ys has ge nera lly been viewed as a step bac kwa rd s. The Federa l Reserve. co nsequently. has emphasized speedin g co ll ect ion. Monthly Review • December 1972 19 The Impact of Changing Check Clearing Arrangements d ay sooner th a n previously, to c it y bank s. Estim a tes s ugges t c it y banks on th e average sh o uld ga in funds equa l to abo ut 3 pe r ce nt o f th e ir net d emand deposits . In mo st in s tan ces thi transfer cou ld be avoided if co untr y ba nk s were ab le to d epos it item s with Rese rve B·tnk s for co llecti o n on the da y of origin a l rece ipt, as c ity banks often ca n .6 Deman d for ch a nge have also co m e from bank in a reas whe re locat iona l factors made pr o mpt co ll ection of c hecks diffi c ult. The most pronounced problem s have occ urred for banks located co ns id e rable distances from cdera l Rese rv e o ffi ces a nd in metrorolitan reg ions served hy diffe ren t offices or Federn l Reserve Bank s. S in ce the situ ~1ti o n h~ts va ri ed from pl ace to pl ace, two exa mples m ay help to d esc ribe th e na tur e of the difficultics .7 Example 1: The Washington, D. . metropolit a n a rea, w hi ch is co mp osed of Wa shington , D. C. a nd it s s uburbs in Virgi ni a a nd Maryla nd , is in the Ric hm o nd Federal R eserve District. Prior to th e creation of the W as hington-Baltimore Region a l Clearing Center in 1970, how eve r , W as hin g ton a nd th e Virg ini a suburb s were served by the Ri c hmond o ffice of th e Federal R ese r ve, while the M a ryla nd s uburb s were e r ved by th e Baltimore Bra nch of th e Federal R e e rve. on equentl y, if a c hec k drawn on a ban k in a Virg inia uburb we re d e po sited in a bank in a Maryland suburb on Mond ay, a nd the c hec k were cleared through th e Fed , c redit would not have been received by the M a ryland bank until Thursday. More specifically, the Maryl a nd bank could deposit the check at the Baltimore Branch on Tuesd ay, where it would be forwarded to the Richmond office on Wednesda y. The Richmond office would present the check 6/ If countr y ba nks ma king ea rli er payment fo r cash lett ers wae form erl y un a bl e to deposit item s fo r coll ecti on wit h Reserve Ban ks on th e day of origin a l receipt, ea rlier deposit wo uld prevent the tran sfer. These bank s would be required to pay for in co min g cash letters a da y ea rlier, but co uld star t co llection o f outgo ing cash letters a day ooner. oun try banks previously depos iting it ems with Reserve Ba nk s on th e day received , however , would not have an opportunit y to initiate coll ecti on of outgoi ng cash letter sooner and could not avoid th e lo s of funds lo city banks. 7/ The first example corresponds lo Item 2 of T able 2. an d the second lo Item 4. 20 to th e Virgini a ba nk on Thursd ay a nd would receive payment on F rid ay. Since th e maximum defe rm ent und er th e Fed's ava il abi lit y c hedul e was 2 days, the Fed would g ive c redit to th e M a ry la nd bank on Thursday a nd no a t for I day would be c rea ted. nd cr the recent modil'ication in R eg ulation J , the availability of fund s to the M a ryla nd bank would not have c h a nged , but the Federa l R eserve's noat would be e limin ated. With the creat ion of the W ashin gtonBa ltim ore Reg iona l C learing e nte r, the check ca n now be deposited by th e Maryland bank a t the Ba ltim o re office for rrcsentment and co llecti on on Tuesday . A co llectio n pcriod o r 4 da ys has been shor te ncd to ovcrn i 1 ht av ,1ilabi lity o f funds a nd Fed era l R escrve rl oa t e limin ated. Example 2: Prior to the opening of the Miami R egio n a l Check Clearing Center in late 1971 , so uth e rn Florida wa s served by th e J ac ksonville Branc h of the Atlanta Reserve Ba nk . Under th at a rrange ment, if a suburban bank in the Mia mi a rea received a check drawn o n another ba nk in Mi a mi on Mond ay a nd the c heck were cleared through th e Federal Reserve System, the s uburb a n ba nk would deposit th e check with th e J ac kso nvill e Bran ch o n Tuesday. The Branch would forward the c hec k to th e d rawee ba nk on W edn esd ay and would rece ive pay m e nt on Thursd ay. Under th e 2-day deferm e nt schedule, c redit would also hav e been granted the suburban ba nk o n Thursd ay. As a res ult, no Federal Rese rve float would h ave been created . With the recent change in collection schedules, the suburba n ba nk would collect the check on Wednesday . Howeve r, by u ing the Mi a mi Clearing Cente r, co ll ecti o n of th e check ca n now occ ur on Tuesday . I f the chec k is d e po sited with th e Center on Mond ay e ve nin g, it is prese nted and co llec ted on Tuesday mornin g. T hese exampl es dem o nstrate th e d e la ys in collection which ca n occ ur if checks a re routed in a c irc uit o us fas hi o n . As mi g ht be anti c ipat ed und e r th ese ci rc um st a nces, few Federal Reserve Bank of Kansas City On the Correspondent Banking System checks drawn on regio na l ba nks we re co llected thro ugh Federa l Reserve fac iliti es . The largest banks in bo th the Was hin gton and Miami areas performed reg iona l chec k co llection serv ices for area banks and prese nted as many chec ks as possib le on an ove rni ght basis. Nevertheless , simi lar pro blems a re likely to ex i t whenever banks a re itu ated close lo the bord ers of Federa l Re erve territories, or a city in one Federal Reserve zo ne is located in th e economic and trade a rea of ano th er Federal Reserve zone. T he indirec t routing of checks in uch cases de lays their co lkction . In th ese instances, fu rth er probkm s arise hec:.1u se returned items can take 8 to 10 wo rl-. in 1 da ys to return to the ba nk or original depos it , thus creating greater tha n norm a l uncertain ty for banks in the ma nagement of funds. Following the genera l exa mpl es of th e Miam i and Washington-Ba ltimo re Reg ional Clearing Centers, the Federal Reserve made plans to establish a pproximately three dozen additional chec k processing centers at central locations about the country. T he goal of th ese R PC's is to permit all participating ba nk s8 to route virtua ll y all items drawn on oth er particirating banks to the clearing ce nter on th e day or origina l deposit. At the clea rin g center th e itcm s arc processed and returned to th e drawee banks for payment early the following mornin g. Presentl y, larger banks in Federal Reserve cities a re able to do this, bu t distant bank s are typicall y un a ble to process all item s on the day of rece ipt before dispatch must be made. To give equali ty to all participating banks reg ardless of locatio n, drop boxes or relay points where pa rti cipating bank s may depo sit items have freq uentl y been located at major population centers wi thin the geographical area se rved by the R P . Th e cu toff time for receipt of items at th ese 8/ Throughout th e balance of this article. ··pa rt icipa tin g banks" refer to th ose that receive cash let ters from regio nal check processing cent e rs a nd pay fo r th ese cash lellers in immediately available fund s. '" Membe r ba nk s' " are th ose which are members of the Federal Reserv e System. Monthly Review • Dec.ember 1912 loca tion s is usuall y identical to th e deadline at the clearing center . In some in stances all ba nk s within Federal Reserve di stri cts are ched ul ed to be se rved by RC PC' . In oth er cases onl y th o e bank s within a give n radiu s of th e chec k process ing center or onl y th ose loca ted a long major tr ansportation lin es or co rr idors leadi ng to th e center a re includ ed. To ensure uni fo rmity, th e Bo ard of Govern ors issued a et of bas ic guidelin e coverin g th e operatin g prin cipl es of RC PC's in Fe bru a ry 1972 . T hose prov i ions of importance to co rre po nd en t ba nk relate to th e condit ion und er wh ich ba nk s may depos it il <.:m s with th e R P . U nder th <.: guid di n<.: . a ll par ti cipa tin g ba nks ar<.: to b<.: pe rm ill cd to send items draw n on other part icipa ting banks, U. . Governmen t check s, p stal mo ney ord ers, and oth er items paya bl e at a Federal Rese rve offi ce, direc tl y to th e RC PC. Onl y Federa l Rese rve member bank s, howeve r, are to be permitted to deposit checks dr aw n on ba nk s no t directly serviced by th e RCPC. When full y operatio na l, an RCPC will accept items from all Federal Reser ve offi ces, dir ec t sendin g membe r bank s, and oth er RC P 's on th e same term s as fr om part icipa tin g ba nk . Pa rtic ipat in g Federa l Rese rve member ba nk s with average dail y depos its und er 2, 000 items may se nd th e e to th e ce nter un so rted. In ge nera l, all items deposited hould be amount encoded and full y qu ali fied. Region a l chec k process ing centers orga nized since th e guidelin es were iss ued have tended to follo w th e broad pro vision s, although the sorting and encoding requirements have frequ entl y been relaxed. However, the oper atin g rul es for ch ec k clearing ce nter in stituted ea rli er occas ion all y differ in ignifica nt ways. Ju t a th e req uireme nt th at all bank s pay for cas h letters in imm edi ately avail a bl e fun d ca n crea te difficulti es for bank un abl e to get all of th eir trans it work to th e Reserve Ba nk on the day of initi a l depos it, th e development of RC PC's has crea ted a related 21 The Impact of Changing Check Clearing Arrangements problem for part1c1pating banks. Due to the late cutoff hour for the receipt of item s at RCPC' s, banks located outside the region served by an R PC can often clear checks drawn on participating banks overnight, either by sending cash leLLers directly to the RCPC or by depositing items with participating correspondent banks which in turn channel the items to the R PC. Such an effort, of course, would be feasible and economical only if the dollar amounts were substantial. However, participating banks clearing checks on banks not served by an R P must accept the normal delay in the Fed's availability schedule. The effect, consequently, is to transfer funds from banks p.irticipating in RCPC arr;111g ·men ts to nonparti cipatin I hank s. Both th e im mediate pa nH.: nt and RCP ' problems wou ld be elimin ated if all banks were able to obtain overnight collection of all items on the day of initial deposit. In any event, the development of RCPC' s offers numerous advantages Lo the banking ystem as a whole. By speeding check co llection and reducing the number of handlings and transportation costs, check processing centers improve the efficiency of the check clearing mechanism . In some areas served by RCP "s, as many as 70 per cent of all checks deposited in banks will be collected on an overnight basis. Moreover, by returning unpaid items more promptly, potential losses to the public and the banking community are reduced. Looking to the future, these centers may serve as the nucleus for the ultimate development of an electronic payments system. sition a l difficulties have been resolved, correspondent banks are likely to find that ledger balances due to other banks average somewhat less than initially because the uncollected portion of those balances will have been reduced . A large reduction in collected balances due sma ll respondents, however, is unlikel y. /\s long as smaller banks continue to clear checks through correspondents, account ana lysis procedures will require maintenance or collected balances near present levds .'' The impact of the change on individual banks will depend on their location and type or business, how they collect checks, and the dollar si1e or their cas h ktt ·rs. Since most memb ·r h;111l--s ;i nd nonrncrnha hank:-. lo ·.i t ·d in 1:ctkral Rcsavc citics will hen ·l"it l"rom thc changcs in Regulations D and .I , the problem arca for correspondents is likely to be with country nonmember banks. Thcsc banks have been asked to make earlier payment for cash letters, but will not in many in lance have the benefit of reduced reserve requirements. Nonmember banks, on the average, hold considerably larger balances with correspondents than do member banks of similar siLe; yet, they frequently do not demand proportionatcly more in services. While some reduction ma y occur in thesc accounts, it should be remembered that nonmember banks will still be required to meet reserve requirements and that for nonmember banks, reserve requirements arc a primary determinant of correspondent balances. As the uncollected funds in these accounts are reduced, correspondent banks may find that th e collected funds increase and that these accounts be- EFFECTS ON THE CORRESPONDENT BANKING V TEM 9 / The corresponden t hanks which are most susceptible to deposit losses arc tho se located in c ities without Federal Reserve offices . Thc~c banks have occasio nall y obtained balances from other large hanb which wish to ob tain overnight collection of i1 c m s drawn on hank s in lhcsc nonrcscrvc ci ties . If th e cas h lctlcrs were scnl instead lo lh c Federal Reserve for co llcclion , availability would have been dcfcm.:d 2 da)s Since the change 1n Regulati o n J permits hanks w11h1n a 1-cdcral Reserve ,one to obtain overnight co lk:clion of item s drawn o n all other banks in thal tone, quicker co llecti on will no longer he oh1a1ned by sending cash let ter s to co rrespondent s loca ted in the same Federa l Reserve t o ne . Consequently , co rrespondents in such cities as Milwaukee, In dianapolis, Rochester , Phoenix , Orlando, and Co lum bus may experience so me permanent reduction in collected deposits . Change in Regulation J Although correspondent banks have been apprehensive about the possible implications of the change in Regulation J, the long-run effect on the collected balances of most correspondents shou ld not be great. After tran22 F-ederal Reserve Bank of Kansas City On the Correspondent Banking System come more profitable. In any event, the cha nges will make it more difficult for nonmember banks to meet a substantia l proportion of reserve requirements with un co ll ected funds. Since the collection schedule on out-oftcrrit ory items is not altered, the change in Regulation J presents an opport un ity for correspondent banks to increase their transit business. In many locations correspondents can promise earlier collection o r chec ks if those checks arc cleared through the correspondent net work rather than th e Federal Reserve. For examp le, if a bank receives items on Monday drawn on a bank loca ted a t a 2day h,;(kral Reserve point , the checks co uld he clc . ,red through 1:ec.kral Reserve channel s for cn.:dit on Wednt.:sd . ,y or Thursday . llowevt.:r, by sending the items lo a cor res pondent in that city on Monday night, T uesda y funds frequently can be obtained. Whil e this opportunity is not new, the increasing emphasis on the speed of c heck co ll ec tion s is likel y to increase its importance. Dev elopment of Regional Check Processing Centers /\ much more se rious chal lenge to th e corresponuent banking system is the development of regional check processing ce nters. /\bout 32 per cent or al l checks received by large banks come in cas h letters from ot her commercial banks. In southern Florida an d in the Washington-Baltimore area, cor respo ndent banks previous ly ran clearinghouses for other banks, but operations ceased ab ruptly upon the formation of check processing centers. Generally, however, the effects on co rrespondent banks have been mixed an d have depended to an important degree on the co nditions under which the center will acce pt checks from participating hanks and on the altitud e or correspondent hanks. Ir only members of the Federal Reserve System arc permitted to deposit checks with th e RCPC, the tran sit items of nonmembers must be cleared through correspondents. If Monthly Review • December 19/2 a n ear ly deadline is imposed by th e RC PC for th e receipt of checks from bank s outside th e geographical a rea served by th e RCPC , those banks wishing to speed th e co llection of checks a re required to use co rrespo nd ent banks. Si milarl y, if th e ce nt er's requir eme nts for encoding an d so rtin g are res tri cti ve, th e now of checks will be affected. A 1972 stud y of check clearing practices in Kan as a nd the Tenth District portion or Mi sso uri fou nd that over 73 per cent of th e ba nk s wit h deposit over $ 10 million normally send co rrespo nden ts amount encoded items, but only 39 per cent of those with deposits betwee n $5 and $ 10 million and X per cent or those with deposits under $5 million a111ount encode items . 111 The lim it or 300 u11encodcd items whi ch ha s been in effec t at most Federal Reserve Ba nk s in recent years (and a t some R PC's) wo uld acco mm odate most rural banks with less than $2.5 mill ion in deposits and virtually no city banks. S imil a rl y, on ly about IO per cen t of th e banks wit h less than $25 million in deposits indicated they were prepared to perform any comprehensive rough sort o n items. Whil e th e Board of Governors' gu id elin es for RC PC's wo uld permit most sma ll er ba nk s to se nd checks directly to the clearing ce nte r, the deg ree to which banks bypass co rr esponde nts has o ften depended on the attitude o f th e co rres pond ents. orre pondents which have actively so licited th e wo rk o f smaller banks have u uall y met with so me uccess. Some banks choose to avo id the sor ting and encoding requirem ents by sending to correspondents. Others do not wish to have their reserve acco unts debited or credited or to dea l with defe rred ava il ab ility of item s a nd se nd to correspondents. Some who wou ld have g reat diffi culty meetin g normal dea dlines for the receipt of items at the RCPC send to corresponde nts because co rre po ndents ca n perform a fine so rt which normal10/ A larger proportion. however, indicated th ey wen: using data processing centers. sugges tin g that the cen ters are forced to do a large amount o f encoding. 23 The Impact of Changing Check Clearing Arrangements on the Correspondent Banking System ly has a later de adlin e. Some clear t hrough correspondents to keep the relatio nship acti ve. It is too early to judge the total impac t of RCPC' s on the correspondent banking system. Only a few have opened on a large sca le and any a nalysis for these centers is complicated by special situati ons existing prior to opening and th e fact that the operating rule frequentl y do not parallel th e Board's guidelin es. During th e next yea r over a doze n additional centers wilt open and oth ers will expand. These newer centers will be more indicative of the impact of RC PC's. However, where RCPC's are prese ntly operative, lhe co nseq uences for co rrespondent ba nk s have been mixed a nd have frequenlly depended on whether sma ller ba nk s co ntinu e lo clea r through co rr espo nd ents. Some co rre pond en ls have expe ri enced virtually no adverse effects whil e deposit losses at ot hers have eq ualed the potenti al losses described ea rlier. Wh ere losses have occurred, by far the largest share has typica lly represented a drop in uncollected funds which has largely been offset with a reduction in cash items in process of collection. Losses of collected funds due other banks pa rtici pati ng in region al clearing arra ngements have occas ionall y been offset by obta ining quicker co llecti on of items drawn on these banks or by so liciting the cor res pondent busin ess of region a l bank th at wish to obtain quick er collection of items drawn on all participating banks. Nevertheless, mo st correspondent bank s dir ectly affected by RCPC 's have lost both collected and uncollected balances. As regional clearing centers expand and check s are accepted from all participating banks on relat ively liberal terms , deposit losses are likely to become more generalized. H owever, these lo sses a re ·not lik ely to be as great as th e maximum s suggested ea rlier or what has occurred at a few correspondent banks up on the opening of RCPC's. The bank s experiencing the most severe redu ctions in " du e to" ba lances were somewhat unusu al in th at 24 th ey were loca ted in high float a reas and had an a bove average amount of uncollected balances. Not all sma ller ba nk s will wish to sort or encode items th emselv es, and correspondent banks may be as ked to provide the services. Eco nomies of sca le, which appear to be of some importance in transit operations a nd data processing, may mea n that correspo ndent banks can perform these service more cheaply than cou ld small individu a l banks themselves . Many nonmember banks will undoubtedly con tinue to hold large correspondent balances for reserve requirement purposes and ot hers wi ll hold "excess" balances to ensure th e avai labi lit y of correspondent servi ces . As more and more correspon dents , on the other h;.incl, an.: raced with a redu cti on in transit vo lum e, they arc lik ely to offer addit iona l serv ices to respondents and to place greater em phasi on deve loping compensating balances fo r services not presently considered when the profitability of accounts is determined. CONCLUDING REMARKS The corresponden t banki ng system is facing a chall enge. Traditional check clearing se rvices which have formed the foundation of the cor respondent ba nkin g system are not lik ely to di appear quickly but will be of less import ance in generati ng bal a nces. Whether or not most banks ultimately are served by RCPC' , the deve lopment of such centers will place high priority on the speed of check collections. If the electronic payments system evolves, as some envision, with remote terminals (money machines) scattered at numerous strategic locati ons aro und th e co untry- airports, hotel s, supermark ets- correspondent banks can pro vide a natura l mean s to tie many sma ller bank s into th e system. Co rresponden t bank which have played an acti ve role in the cha nging pay ments system and in the provis ion of data process in g services will be in an idea l position to capita li ze on th eir ex peri ence and relationships. Federal Reserve Bank of Kansas City
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