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MAR 2 8

Checks and Balances
When asked to recite the three most commonly
told lies, people generally begin with, "The check
is in the mail." ("I was just about to call you,"
runs a distant second.) Nevertheless, a lot of checks
must truly be "in the mail" because Americans
write nearly 40 mllion checks a year.
Many people, however, don 't really understand what happens to a check once it enters the
payments system. A person who writes hundreds
of checks a year may not be sure how a check
"clears" or why a check "bounces. "
The following article was written with just
such people in mind. It takes a brief look at how the
handling of checks has changed since the 19th
century, and then it explains how a check m=
through the Federal Reserue's check processing and
clearing nehoork.

Today checks are a safe, convenient, and popular form of payment
- thanks in large part to the efficiency of the U.S. payments system.
But during the 1800s and into the
early 1900s, few people would have
used the word "efficient" to
describe the way most American
banks processed checks.
During the first half of the 19th
century, check collection involved a
lot of walking, running, lugging,
pushing, and shoving - especially
in New York. Each New York bank
sent a messenger, known as a porter, to make the daily rounds of all
the other banks. On any given day,
dozens of porters - each laden with
checks, entry books, and bags of
coins - scurried from one bank to
another in the daily race to present
checks for payment and settle
accounts before the close of
By 1850, New York's bankers
had agreed to continue exchanging
checks daily but to settle accounts
only on Friday. At about the same
time, foot-weary porters informally
agreed to meet in one place to
exchange checks and save steps .

A 19th century clearinghouse.

This practice ultimately led to the
establishment of the New York
Clearing House (1853), a central
place where representatives from all
of New York's banks could meet
"under the supervision of a competent officer . . . settle their accounts
with each other, and make or
receive payment of balances and so
'clear' the transactions of the day."
(For a description of how coffee or
ale may have been responsible for
the establishment of the first clearinghouse in 18th century London,
please see "The First Clearinghouse," sidebar.)
The New York Clearing House
proved so successful that bankers in
other cities organized similar institutions: Boston (1856), Philadelphia
(1858), Chicago (1865), and San
Francisco (1876) . By 1912, there
were 242 clearinghouses throughout the United States.

Despite the success of clearinghouses, certain problems persisted
- most notably the problem of processing out-of-town checks. Banks
sometimes charged "exchange
fees" on out-of-town checks. A Chicago bank, for example, might pay
only $90 when presented with a
$100 check drawn on an Omaha
bank. And the fee might be even
steeper if an out-of-town check were
drawn on an unknown, small-town
From the paying bank's pointof-view, exchange fees made good
business sense. After all, cashing
out-of-town checks involved a certain amount of risk. Communications and transportation were such
that banks often had to wait weeks
for out-of-town checks to clear. (In
all too many cases, out-of-town
banks froved to be out-of-business

Federal Reserve Bank of Boston Vol. 12 , No. 1 - March 1986
Federal Reserve Bank of St. Louis

To avoid exchange fees, banks
sometimes made correspondent
arrangements with one another.
The arrangements, however, did not
always contribute to the efficiency
of the payments system . In one
extreme case, a Birmingham, Alabama bank collecting a check drawn
on a bank four miles away, launched
the check on a 7-day journey by way
of correspondent banks in Jacksonville, Florida and Philadelphia,
Pennsylvania. Clearly, the payments system still needed to be

correspondent banks handle a large
number of checks, and banks clear
many of their own checks as "onus" items . (If you go into your bank
and write out a check to "cash,"
your bank doesn' t need to send that
check to a clearing agent for collection. It simply clears the check as an
" on-us" item.) In short, there is no

set formula for a check to follow in
the collection process.
Nevertheless, the remainder of
this article will focus on how a check
moves through the Federal
Reserve's check collection network.
An illustration shows the step-bystep process, and a brief explanation accompanies each step.

During the early 1900s, the payments system's shortcomings were
becoming more and more apparent.
Transportation and communications advances were bringing distant parts of the country closer
together. Factor y owners and
farmers were turning their attention
to national markets. Bankers and
businessmen alike were feeling the
need for a more efficient way to
move money around the country.
Congress took a major step
toward addressing that need when
it passed the Federal Reserve Act
(1913), a piece of legislation that
established America's central banking system and ultimately led to the
creation of a nationwide check collection network. The twelve Federal
Reserve Banks began collecting
checks for member banks (mostly
national banks) in 1917, and within
three years the Federal Reserve System was handling half a billion
checks annually.
Over the next 65 years, the use
of checks increased dramatically. By
1983, 48 Federal Reserve facilities
(Reserve Banks, branches, and
regional check processing centers)
were collecting approximately 14.3
billion checks .

High-speed machines read and sort up to 100,000 checks an hour.

Step 1) Aunt Bea from Atlanta
sends you a $20 check for your birthday. Money, the gift that's always in
good taste!
Step 2) You receive her check in
the mail and rush to deposit it at
Your Bank in Boston.
Step 3) Later that day, Your
Bank begins · to process the check.
First it encodes (prints) the check's
dollar amount ($20) in magnetic ink
characters in the lower rignt comer
of the check. At the same time, Your
Bank endorses the back of the check
with information that shows when
and where the check was first
deposited and processed.

Furthermore, the Fed's check
processing services were opened to
nonmember depository institutions
after Congress passed the Monetary
Control Act of 1980 (MCA). Prior to
MCA, only member banks of the
Federal Reserve System were
allowed access to the Fed's check
collection services, and those services were provided free of charge.
Today, however, the Fed's check collection services are open to all
depository institutions - regardless
of Federal Reserve membership but all users must now pay to use
the services.

Next, Your Bank bundles all the
checks it has received that day.
Attached to each bundle is a tape
(similar to a cash register tape) listing the amount of each check in the

Of course, the Federal Reserve
is not the country's sole clearing
agent. Local clearinghouses and

After the checks are bundled,
Your Bank forwards the bundle(s)
by courier to the Federal Reserve

Federal Reserve Bank of St. Louis

Bank. (There are 48 Federal Reserve
check processing facilities around
the country: 12 Federal Reserve
Banks, 25 Branches of these Banks,
and 11 Regional Check Processing
Centers.) The shipment, known as a
"cash letter," also includes a statement bearing the total dollar
amount of all the checks being
Step 4) If you've ever looked
closely at the bottom of a check,
you've probably noticed a row of
unusual-looking numbers . Some
people call them "computer numbers"; bankers often refer to them as
MICR numbers. (MICR is an acronym for Magnetic Ink Character
The MICR numbers are preprinted in magnetic ink across the
bottom of most blank checks. They
provide sorting information: a
check routing number, a bank identification number, and a customer
account number.
The magnetic ink allows reader/
sorter machines to "read" the numbers and sort a bundle of checks
according to banks on which the

Tracing a Check Through
the Federal Reserve's
Check Collection

You deposit the
check in your
bank account.

Your Bank

Your Aunt Bea
in Atlanta
sends you a
$20 check
for your

Your Bank encodes and
endorses the check.
Then it sends the check
to the Federal Re erve Bank
of Boston.

ict Transportation
ITS) flys the check
to Atlanta.



The Federal Reserve
Bank of Atlanta
forwards the check to
Her Bank and deducts the
appropriate amount from
Her Bank's reserve account
or clearing balance.
Federal Reserve Bank of St. Louis



The Federal Reserve Bank of
Bo!>ton gives Your Bank
credit for the check by
adding the appropriate
amount ($20) to Your Bank's
reserve account or
clearing balance .

Her Bank deducts $20 from
Aunt Bea's checking account.
At the end of the month, Her Bank
will send Aunt Bea a monthly
statement and her cancelled checks .

If for some reason Aunt Bea did not have
enough money in her account to cover the
$20 check, then the check would " bounce."
It would be sent back to Your Bank marked
"NSF" - not sufficient funds. (Of course, Aunt Bea
would never do that to you .)

Federal Reserve Bank of St. Louis

checks are drawn. Reader/sorters
are capable of handling up to
100,000 checks an hour.
When the shipment of checks
from Your Bank reaches the Federal
Reserve check processing facility,
the Fed sorts the checks and
endorses them. The Fed then adds
the dollar amount of the deposit to
Your Bank's reserve account or clearing balance. (Banks that use the
Fed's check collection facilities must
maintain an account with the Federal Reserve - either a reserve
account or a clearing balance .)
Step 5) The Fed's Interdistrict
Transportation System (ITS) moves
checks between Federal Reserve
Districts. Nearly every night a chartered fleet of small jets carries
checks over a hub-and-spoke route
system. Aunt Bea's check, for example, would go by plane from Boston
to New York (a hub city) . Another
plane would then carry the check
from New York to Atlanta (also a
hub city).
Step 6) When the Federal
Reserve Bank of Atlanta receives the
shipment from Boston, it forwards
the checks to Aunt Bea's bank and
deducts the appropriate amount
from that bank's reserve account or
clearing balance.
Step 7) Aunt Bea's bank deducts
$20 from her checking account. At

the end of the month, the bank will
send her a monthly statement and
her cancelled checks. One reason
why checks are so popular is that
people can use a cancelled check to
prove that they have paid a bill . In
most cases a cancelled check is as
good as a receipt because it bears
the endorsements that are added
when the check is processed.

The First Clearinghouse
Historians are unsure
whether the impetus for the
first clearinghouse came from
an Arabian coffee bean or from
a mug of beer. Prior to 1770, in
London, clearing checks
required each bank to send a
clerk every day to all the other
banks to exchange checks and
settle balances - to "clear" the
transactions of the previous
day. The runners had to cover
considerable ground; they were
often exhausted and footsore. It

collection process allows banks several options.
a) A very large bank might handle the entire process itself by processing checks on its own
reader/sorters and using private
courier services to send checks
directly to banks for collection.

b) A bank might use one or several agents: a local service bureau to
encode, a correspondent bank to
sort, and a Federal Reserve facility to
clear the check.
c) For clearing local checks, a
bank might use a local clearinghouse that holds daily exchanges of
checks among its members.
d) Banks use a correspondent
bank or the Fed mainly to clear
checks with banks at some

New England

On Tuesday, April 22 at 7:00
p.m., the Capitol Region Center will
host a seminar on "Connecticut
Banking at the Crossroads." The
featured speakers will be Peter Shapiro, senior vice president, public
affairs, Connecticut Bank and 'frust;
and Tracey Stangle, senior vice
president, Coburn & Meredith . The
seminar is free and open to the public. It will be held in the Nutmeg
Room, Memorial Hall, Central Connecticut State University.

was natural, then, that they
would drop into a coffeehouse
or a pub for some refreshment.
Tradition has it that one
day runners from two different
banks happened to be drinking
at the same place and started to
discuss the day's work. They
discovered they had drawn
checks for the same amount on
each other's bank, so they proceede d to exchange them.
Shortly thereafter, other runners were initiated into the

The Capitol Region Center is
also working with the West Hartford
Public Schools on a three-session
course entitled "Exploring Economic Lifestyles in Other Cultures."
The course is scheduled for April 9,
23, and 30, 2:15-4:15 p.m ., at the
Sedgwick School, Room 209.
For more information on the
above-mentioned events, please
contact: Ronald R. Daigle, Capitol
Center for Economic Education,
Marcus White Hall, Room 103, Central Connecticut State University,
New Britain, CT 06050; phone (203)


The Rhode Island Council on
Economic Education held its annual
meeting on January 23 at the Providence Marriott. Among the afternoon's highlights was a
presentation on Pennies for Peace,
first-place winner in the Middle
School Division of the most recent
Old Stone Awards Program.
Pennies for Peace was developed
by students and teachers from the
Coventry, Rhode Island school system. The plight of starving Ethiopian children prompted the
Coventry students to write and
record a song to raise money for
famine relief.
During the Rhode Island Council's annual meeting, students from
three Coventry schools performed
the song, We Are One. In addition,
Coventry teachers Ann Stratton and
Bonnie Ursillo discussed how Pennies for Peace was created and what it
was designed to accomplish .

Bank managers, upon
learning what their runners
were doing, were of two minds.
Some managers denounced
their runners as lazy and shiftless. Other managers realized
the value of the idea, taking
exception only to the beer or
In 1775, the London banks
agreed upon a common room
on Lombard Street for the location of the first London clearinghouse. Beer and coffee were
not served.

Courtesy , Federal R eserve Bank of Philadelphia
Federal Reserve Bank of St. Louis


The Old Stone Awards Program
is funded by a special grant from the
Old Stone Bank Educational Foundation. The program's major purposes are: 1) to identify and reward
teachers who design and implemen t
outstandin g classroom instruction
in economic educatio n; 2) to
increase student economic literacy;
and 3) to encourage Rhode Island
teachers in all subject areas to teach
more economics.
If you would like more information on the Old Stone Awards Program, please contact the Center for
Economic Education, Rhode Island
College, Providen ce, RI 02908;
phone (401) 456-8037.

Both Borrower and Lender, produced by the Federal Reserve Bank
of Philadelph ia, 16mm film also
available on videocass ette, 14:30
This entertainin g film provides
information that today's consumer s
can use to better satisfy their financial needs. The plot follows George
and Helen Barron as career changes
take them from a big-city apartment
to a tumbledo wn country house
with lots of atmospher e. As they set
out to find financial services in their
new town, George wants loans to
repair the house and buy a car,
while Helen seeks informatio n on
savings and checking accounts .
They discover a variety of institutions with a bewilderin g selection
of loan and deposit options. They
also find that people, like banks and
thrifts, often are borrower and
lender, and they gain an understanding of how such institution s

operate. The film uses computer
graphics to explain the best choices
among the many new options in
loans and deposits .

Once Upon a Dime, comic-style
booklet, published by the Federal
Reserve Bank of New York, 23
pages .
The mysteries of money are
unraveled for youngster s in Once
Upon a Dime, a new comic-style
booklet published by the Federal
Reserve Bank of New York.
In telling the story of how the
mythical island of Mazuma moves
from a simple barter-bas ed economy to a modern economy using
money, the booklet enables fourth
and fifth grade students to learn the
basic concepts of barter, coins, currency, checks, banking, and central
banking. These are brought humorously to life through the economic
trials and tribulations of the island's
inhabitant s.

Both Borrawer and Lender is available on a free-loan basis to senior
high schools, colleges, and adult
organizat ions (also available on
videocassette in the VHS format).
Please direct all requests to: RHR
FILMEDIA, INC., 49 West 37th
Street, New York, NY 10018.
Elementary Economics, a bibliography, published by the Federal
Reserve Bank of Chicago, 40 pages.

Elementary Economics fills an
important need. It serves as an
excellent resource for educators
who would like a guide to the many
economic education materials available for use with elementar y school
Elementary Economics does not
attempt to include all economic education materials for kindergar ten
through grade six. Materials available from professional publishers , for
example, were not included because
of the broad advertisin g and distribution mechanism already in place.
Rather, the bibliograp hy includes
only those suppleme ntal print
materials, teaching kits, microcomputer disks, and audiovisua l materials that are available nationwid e
from companies and organizati ons
whose primary business is not the
production and sale of education al
For a free copy of Elementary Economics, please contact: Public Infor-

Free copies of the 23-page comic
book are available from the Public
Informatio n Departme nt, Federal
Reserve Bank of New York, 33 Liberty Street, New York, NY 10045. A
four-page teacher's guide is also
available upon request.

Once Upon a Dime is a supplement to the New York Fed's 28min u te multime dia learning
program of the same name. The
multimed ia package includes a
three-part filmstrip, three audiocassettes, materials for classroom activities, and a teacher's guide. The
package is available for $29 .50 from
the Public Informatio n Departme nt,
Federal Reserve Bank of New York,
33 Liberty Street, New York, NY

mation Center, Federal Reserve
Bank of Chicago, P.O. Box 834, Chicago, IL 60690; telephone (312) 3225112.

the LE DG ER
Editor: Robert Jabaily
Graphics Arts Designer: Ernie Norville

This newsletter is published periodically as
a public service by the Federal Reserve Bank
of Boston. The reporting of news about
economic education programs and
materials sl1ould not be construed as a
specific endorsement by the Bank. Further,
the material contained herein does 1101
necessarily reflect the views of the Federal

Federal Reserve Bank of St. Louis

Photography : Wilson Snow
Johannah Miller

Reserve Bank of Boston or the Board of
Gouernors. Copies of this newsletter and a
catalogue of other educational materials
and research publications may be obtained
free of charge by writing: Bank and Public
Information Center, Federal Resen.,e Bank
of Boston, Boston, MA 02106, or by
calling: (617) 973-3459.