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Can the Fed Compete???
by
E. Gerald Corrigan, President
Federal Reserve Bank of Minneapolis

presented at the
American Bankers Association 1980 Convention
Chicago, Illinois
October 13, 1980

Can the Fed Compete???

I welcom e the opportunity to appear today before the bankers of the nation
assembled in convention, but I do so with some trepidation, knowing that the Federal
Reserve has been accused, by some, of being unresponsive in its service policies to the
banks that it serves.
observation.

In fact, I will admit that there is an element of validity to that

The Fed has, in many cases, been satisfied to provide its own version of a

"no frills" service. One of your coileagues—paraphrasing Henry Ford—described the Fed's
attitude as follows:

"You can have any color you want, as long as it's black." In defense

of the Fed, though, I'd like to note that our basic black was a pretty reliable product and
that basic black was able to blend into a number of different color schemes.
But, the Fed is changing—indeed, it has to change.
major reassessment of its service policies and attitudes.

It is in the midst of a

That reassessment is a natural

outgrowth of the legislatively imposed mandate that we price our services.

But, from my

personal vantage point, that fundamental reassessment must go beyond—considerably
beyond—the narrow questions of how we determine our prices, how we respond to shifts in
patterns of demand for our services, and how we adapt our operations to this new
environment. In that light, I would like to use the time provided for my prepared remarks
to share with you some of my tentative impressions about some of these broader
implications o f Fed pricing.
As you are well aware, the new program of Fed pricing is quite different from
past practices.

Under the present program, the Fed's services are, for the most part,

available only to members, and at no explicit charge—but the services, of course, are not
free.

The implicit price of these services is the amount of income member banks have

foregone by virtue of the maintenance of nonearning Fed reserves.

And, as you know

better than I, many bankers had concluded that the implicit price of the services was




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greater than the value o f the services—hence, one critical element of the so-called Fed
membership problem.
Under the new program of pricing, the Fed's services will be available to ail
depository institutions on the same basis and will be explicitly priced. The Fed will set a
fe e for each of the services it offers, so that it recovers its costs—including the so-called
private sector markup~as if it were a private firm .
institutions will be subject to reserve requirements.

At the same time, essentially all
Thus, there still will be a cost

associated with reserves, but that cost will no longer give one depository institution a
comparative advantage over another.

Members and nonmembers alike will have to play

the game by the same rules!
However, the underlying rationale for Fed pricing and, indeed, the congres­
sional intent regarding Fed pricing goes beyond the creation of the so-called "level playing
field ."

A t its root, the move toward Fed pricing reflects a desire—one shared by the

Fed—to ensure that payments services are provided in the most efficien t manner.
As I see it, the market for payments services that is unfolding is fully
compatible with that objective, in that it will produce a more efficien t payments
mechanism, if by effic ie n t we mean that it produces the desired amounts of goods or
services at the least cost.

Compare the Fed's present approach to the new approach.

Currently, the Fed really doesn't have a good way to make decisions about the quantity
and quality of the services it provides.

How fast should checks be cleared?

How often

should coin and currency be delivered?

It can't answer such questions clearly, because it

cannot readily determine if the benefits of improved service are worth the additional
costs.

So the Fed generally makes its production decisions—educated guesses—and then

proceeds to minimize its costs.
Under the new com petitive approach, in contrast, the Fed will have an
unambiguous way of knowing if its production decisions are yielding benefits commensu­
rate with their costs: the bottom line.




The change is that it will know for sure which

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services are really wanted at what price. If the Fed's price is too high, the demand for its
services will shift to those with lower prices—those that are presumably more e ffic ie n t—
and the objective of overall efficien cy will be served. In those circumstances the Fed will
be faced with the need to match those efficiencies or get out of the particular line of
service in question.

The reverse is also true if the business shifts to the Fed.

But in

either case, the market—not the ambiguities associated with a particular regulatory
structure—will make the decision.
What I have just described is a rather straightforward textbook description of
how things should work in a com petitive environment.

In fact, you and I both recognize

that markets and institutions seldom conform to the simplicities of the textbook model.
The case in point is no exception.

There are characteristics associated with the market

for payment services and characteristics associated with the players in that market that
are not readily captured in my synopsis as to how things should work.

Those characteris­

tics will, however, have an important bearing on how things will work.
For example, one of the textbook prerequisites for a market is that there be
perfect knowledge about prices on the part of all market participants. This will hardly be
the case in the market for payments services. Fed prices and our costs must be laid out in
detail for scrutiny—if not nit-picking—by competitors and customers and the Congress
itself.

Our com petitors—the large correspondent banks—do not have that constraint.

Similarly, they do not have to publish their prices and possibly even some price changes
for public comment!

The resulting advantage, I suspect, is not inconsequental, since I, at

least, am not so naive to believe that practices such as "loss leader" pricing do not or will
not exist in the market for payments services.
When

I look

at

the

competitors under this regime.

Federal

Reserve

Banks relative

to

their

potential

I am also inclined to believe that certain "nonprice"

considerations will weigh very heavily in the manner in which the demand for payments
services is ultimately met.




For example, the full array of services offered by large

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correspondent banks to their prospective customers—computer services, loan sharing
agreements, investment advice, not to mention splendid receptions at bankers conventions--is

far

wider

than

the services

provided

by

the

Fed.

In short, the large

correspondent banks are, in fa ct, supermarkets for banking services, while the Fed is
something more akin to the corner delicatessen.

Given our society's preference for

convenience shopping, here too, I suspect that the Fed banks are at a real disadvantage,
even if its charges fo r —say—processing a check are close to or even below charges
available in the private sector.
I don't want to leave you with the impression that the Fed is without some
comparative advantages of its own in these areas.
have

considerable

capital,

We have considerable expertise; we

both human and physical; and we have a solid, if

not

spectacular, reputation for the delivery of services. There may also be areas in which the
Fed has an inherent advantage in providing services, if for no other reason than the fact
that customer relationships are not divulged to prospective competitors for loans and
deposits. And, as with the Fed wire or net settlem ent services, there may be some areas
in which the Fed has its own nonprice com petitive advantage.

But, even if I make some

generous allowances as to the significance of those factors in a com petitive environment,
I am inclined to the view that we in the Fed will not be able to fully match the scope and
types of competition we will face in the new environment.
All of this raises the question as to how the Fed should go about the business
of being a market com petitor—stated differen tly, just how vigorously should the Fed
compete?

Should the Fed advertise?

And if so, how and how much?

Should it draw the

line at inform ative mailings, at a billboard campaign, or at hiring Bob Hope to be its
national spokesman? Should it hire a public relations firm to change its image? Should it
sponsor a television show like "Dialing For Dollars"?
Or consider the gifts or premiums that private firms give away to customers.
Should the Fed im itate these firm s? Should it give football tickets to institutions that buy




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a lot of services? Should it give toasters or teddy bears to institutions that open clearing
accounts at the Fed?
Although these examples may be a little farfetched, offering demand deposit
accounting services to depository institutions— if priced to cover our costs— may not be
so farfetched.

And, in such less exotic areas, it doesn't seem to me that offering a fuller

range of services, if priced appropriately, would be incompatible with the intent of the
Congress that the Fed compete.

I am not predicting any such result, but I do think we in

the Fed must consider the question of how we will compete within a framework in which
we realistically appraise the nature o f the competition we face.
In fact, we in the Fed cannot answer the question of our com petitive posture
in the same ways that a private sector firm would. We have, it is clear to me, underlying
public and statutory responsibilities relating to the payments and banking systems that
transcend our role as a com petitor in the market for payments services.

These public

responsibilities may, at some point, come into conflict with the mandate to compete or,
at least, the mandate to compete in the more traditional ways that private institutions
might compete. In a word, we could encounter situations that from the perception of the
public interest might pose serious dilemmas. Let me give an example or two:




Is it possible—looking down the road a few years—that economies of scale are,
or will be, such that the clearing and correspondent business for the nation as
a whole will end up concentrated in a handful of electronically interdependent
large banks, and if so, is that result in the public interest?
Is it possible that the current Fed share of the market for check clearing will
be "cherry picked" to the point where the Fed is serving only the most remote
of locations with the result that prices of such services in those locations will
be many times in excess of prices available in other locations—that is, the
post o ffic e problem—and, if so, will that result be acceptable?

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Finally,

is there

any

real

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risk—
-however

rem ote— that,

in the name of

competition, operational practices or credit risk insensitivities which are
contrary to the public interest could crop into the payments mechanism? We
in this country are fortunate indeed to have a highly e fficien t, reliable, and
flexible payments mechanism—a payments mechanism that ultim ately rests on
the confidence we all have in the payments we make and receive.
confidence

is central

That

to the functioning of our banking system and our

economy at large. Whatever we in the Fed and you in the banking system do in
response to this new environment, we must preserve that confidence!
I don't know the answers to these questions, and I don't know if events will
unfold in a manner that will require that we answer these questions. But, I do know that
from my personal vantage point as a central banker it would be as inappropriate to ignore
them as it is devilishly intricate to answer them.
If I've raised more questions than I've answered today, it's because I have more
questions than answers.

That's an indication of where I, at least, stand today.

To get at

the answers--indeed, to be sure we know all the questions--will take time and some
careful thinking. But, in spite of all the unanswered questions, I do believe that the move
to Fed pricing is the right move.

Pricing is more e ffic ie n t—it should provide services in

the desired amounts at the lowest cost.

Pricing is more equitable— it makes the

institutions that use the Fed's services pay for them and pay for them in proportion to use.
And pricing is perhaps what the Fed needs to further improve its services.

In a few

years—who knows?—the Fed may o ffe r not just the standard black, but a whole rainbow
of choices.