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For release on delivery
7:00pm E.D.T.
September 19, 1996

Remarks by
Alan Greenspan
Board of Governors of the Federal Reserve System
at the
U.S. Treasury Conference
Electronic Money & Banking:

The Role of Government

Washington, DC
September 19, 1996

You have heard many points of view today on electronic money
and banking.

New products are being designed to challenge the

use of currency and checks in millions of routine consumer

Other new systems may allow payments or banking

instructions to be sent over networks such as the Internet, which
is unprecedented in providing versatile, low-cost communication

Again, as in the 1970's, articles are being

written and conferences are being held to pronounce the end of

They may again prove premature.

The payment systems of the United States present a paradox.
Our systems and banking arrangements for handling high-value
dollar payments are all electronic and have been for many years.
Banking records, including those for loans and deposits, have
been computerized since the 1960s.

Securities markets also now

rely on highly automated records and systems, born out of
necessity following the paperwork crisis of the 1970s.
Yet in transactions initiated by consumers, paper—currency
and checks—remains the payment system of choice.

Debit and ATM

cards, along with Automated Clearing House payments, account for
a very small percentage of transactions.

Even the use of popular

credit cards has only recently begun to challenge paper's
Brand names used for many new electronic payment products
are designed to suggest analogies to paper currency and coins.
It is not surprising, therefore, that they sometimes evoke
comparisons to an earlier period in U.S. history when private

currencies circulated widely.

We should, of course, recognize

the limitations of this particular experience for drawing policy
conclusions relevant to the present.

Many of the new electronic

payment products are more similar to conventional products, such
as debit cards, than to currency.

And certainly, the U.S.

financial system has evolved considerably since the era of
private currency.

Thus the baseline from which innovation and

experimentation is occurring is doubtless different today.
Nonetheless, evaluations of that period can clearly add to our
Throughout much of the 19th century, privately issued bank
notes were an important form of money in our economy.

In the

pre-Civil War period, in particular, the federal government did
not supply a significant portion of the nation's currency.


charter of the Bank of the United States had not been renewed,
and there was no central banking organization to help regulate
the supply of currency.

Notes issued by state-chartered banks

were a major part of the money supply.

This was a result, in

large part, of the "free banking" movement, a period when state
chartering restrictions on banks were significantly loosened.
Free banking dominated the landscape in most of the states in the
Union starting in the 1830s, and lasted until the National
Banking Act was adopted in 1863.
The free banking period was a controversial one in U.S.

The traditional view has been that this period gave

rise to "wildcat banking," in which banks were created simply to

issue worthless notes to an unsuspecting public who would seek in
vain among the "wildcats" for redemption in specie.


clearing of bank notes, along with suspension of specie payments
by banks and outright defaults, did lead to risks and
But more recently, some scholars have suggested that the
problems of the free banking period were exaggerated.
Retrospective analyses have shown, for example, that losses to
bank note holders and bank failures were not out of line with
other comparable periods in U.S. banking history.
The newer research also suggests that, to a degree, the
problems of free banking had little to do with banking.


particular, although free banking laws varied considerably by
state, issuers of bank notes were often required to purchase
state government bonds to back the notes they issued.

In some

cases, these securities were valued at par rather than at market
prices—a structure that evidently did foster wildcat banking.
Moreover, no matter what the regulatory valuation scheme, when
the state government ran into financial problems, as many often
did, both the bonds and the bank notes sank in value.

In some

cases, this contributed to bank failures.
In the pre-Civil War period, when the general ethos of
laissez faire severely discouraged government intervention in the
market economy, private regulations arose in the form of a
variety of institutions, which accomplished much of what we
endeavor to do today with our elaborate system of government rule

making and supervision.

In particular, scholars have noted that

the period saw the development of private measures to help
holders of bank notes protect themselves from risk.

As the notes

were not legal tender, there was no obligation to accept the
currency of a suspect bank, or to accept it at par value;
accordingly, notes often were accepted and cleared at less than

As a result, publications—bank note reporters—were

established to provide current information on market rates for
notes of different banks based on their creditworthiness,
reputation, and location, as well as to identify counterfeit

Bank note brokers created a ready market for notes of

different credit quality.

In some areas, private clearinghouses

were established, which provided incentives for self-regulation.
Banks competed for reputation, and advertised high capital
ratios to attract depositors.
days often exceeded a third.

Capital to asset ratios in those
One must keep in mind that then, as

now, a significant part of safety and soundness regulations came
from market forces and institutions.

Government regulation is an

add-on that tries to identify presumed market failures and,
accordingly, substitute official rules to fill in the gaps.
To be sure, much of what developed in that earlier period
was primitive and often ineffectual.

But the financial system

itself was just beginning to evolve.
From today's presumably far more sophisticated view of such
matters, we may look askance at what we have often dismissed as
"wildcat banking."

But it should not escape our notice that, as

the international financial system becomes ever more complex, we,
in our regulatory roles, are being driven increasingly toward
reliance on private market self-regulation similar to what
emerged in more primitive forms in the 1850s in the United
As I have said many times in the past, to continue to be
effective, governments' regulatory role must increasingly assure
that effective risk management systems are in place in the
private sector.

As financial systems become more complex,

detailed rules and standards have become both burdensome and
ineffective, if not counterproductive.

If we wish to foster

financial innovation, we must be careful not to impose rules that
inhibit it.

I am especially concerned that we not attempt to

impede unduly our newest innovation, electronic money, or more
generally, our increasingly broad electronic payments system.
To develop new forms of payment, the private sector will
need the flexibility to experiment, without broad interference by
the government.

The history of the Automated Clearing House

provides a useful caution.

The Federal Reserve, in partnership

with the banking industry, has taken a leading role in developing
the ACH system for more than twenty years.

It was the advent of

the ACH that led many economists to discuss money in a "cashless

Although the ACH has allowed the automation of some

important types of payments, it has never been widely used by

This experience suggests that creating new technology and
providing an interbank electronic clearing system were easy.


developing electronic payment products based on this technology
that were more convenient and cost effective than paper, from the
standpoint of both consumers and merchants, turned out to be

In our enthusiasm over new electronic payment

systems, we significantly underestimated the convenience of paper
for consumers and especially the cost and difficulty of building
a broad-based infrastructure to support new electronic payment

It is also possible that efforts by the government to

choose and support a single technology—the ACH in this case—may
have slowed efforts by the private sector to develop alternative
In the current period of change and market uncertainty,
there may be a natural temptation for us—and a natural desire by
some market participants—to have the government step in and
resolve this uncertainty, either through standards, regulation,
or other government policies.

In the case of electronic money

and banking, the lesson from the ACH is that consumers and
merchants, not governments, will ultimately determine what new
products are successful in the marketplace.

Government action

can retard progress, but almost certainly cannot ensure it.
Before we set in stone a series of rules for this emerging
new medium, let us recall that, across many industries in the
economy, forecasting the particular direction of innovation has
proven to be especially precarious over the generations.


Professor Nathan Rosenberg of Stanford has pointed out, even
relatively mature technologies can develop in wholly
unanticipated ways.
Our optimum financial system is one of free and broad
competition that is presumed to calibrate appropriately the
changing value of products to consumers so that the risk-adjusted
rate of return on equity, measures the success in providing what
people want to buy.
This has turned out to be broadly true in practice and
supplied regulators with some sense of which products were
serving consumers most effectively.

This signal may not be so

readily evident in the case of electronic money.

The problem is

seigniorage, that is, the income one obtains from being able to
induce market participants to employ one's liabilities as a

Such income reflects the return on interest-bearing

assets that are financed by the issuance of currency, which pays
no interest, or at most a below market rate, to the holder.
Historically when private currency was widespread, banks
garnered seigniorage profits.

This seigniorage increasingly

shifted to the federal government following the National Bank
Act, when the federal government imposed federal regulation on
bank note issuance, taxed state bank notes, and ultimately became
the sole issuer of currency.
Today, there continue to be incentives for private
businesses to recapture seigniorage from the federal government.
Seigniorage profits are likely to be part of the business


calculation for issuers of prepaid payment instruments, such as
prepaid cards, as well as for traditional instruments like
travelers checks.

As a result, in the short term, it may be

difficult for us to determine whether profitable and popular new
products are actually efficient alternatives to official paper
currency or simply a diversion of seigniorage from the government
to the private sector.

Yet we must also recognize that a

diversion of seigniorage may be an inevitable byproduct of
creating a more efficient retail payment system in the long run.
The innovations being discussed today can be viewed from a
very different perspective than that afforded by the financial
system of the 1850s.

Unlike the earlier period, we have a well

developed and tested set of monetary and payment arrangements and
a strong national currency.

Yet, as in the earlier period,

industry participants may find that self-policing is in their
best interest.

We could envisage proposals in the near future

for issuers of electronic payment obligations, such as storedvalue cards or "digital cash," to set up specialized issuing
corporations with strong balance sheets and public credit

Such structures have been common in other areas, for

example, in the derivatives and commercial paper markets.
In conclusion, electronic money is likely to spread only
gradually and play a much smaller role in our economy than
private currency did historically.

Nonetheless, the earlier

period affords certain insights on the way markets behaved when
government rules were much less pervasive.

These insights, I

submit, should be considered very carefully as we endeavor to
understand and engage the new private currency markets of the
twenty-first century.