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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 business. 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 bank. 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 banks. Federal Reserve Bank of Boston Vol. 12 , No. 1 - March 1986 https://fraser.stlouisfed.org 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 improved. 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. Additional Information 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 bundle. 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 2 https://fraser.stlouisfed.org 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 shipped. 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 Recognition.) 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 Network 0 You deposit the check in your bank account. Your Bank Your Aunt Bea in Atlanta sends you a $20 check for your birthday. 00 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. © 0 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. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 ODD 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 . 0 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 .) page3 https://fraser.stlouisfed.org 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 IMPORTANT NOTE: The check 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 distance. New England Update CONNECTICUT 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 secret. 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) 827-7318. RHODE ISLAND 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 coffee. 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 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 4 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. Multi-Media Both Borrower and Lender, produced by the Federal Reserve Bank of Philadelph ia, 16mm film also available on videocass ette, 14:30 minutes. 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 students. 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 materials. 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 10045. 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 5 https://fraser.stlouisfed.org 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.