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HIE E-DNETARY COOTROL ACT OF 1980 A s > HIE PAYMENT SYSTEM iT Remarks by Frederick 1 . Schultz 1 Vice Chairman Board of Governors of the Federal Reserve System at the Banking and Payment Systems International Conference Atlanta, Georgia April 4, 1980 HIE FCi.UARY COT-ITROL ACT OF 1930 AKD IT IE FAYfEfiT SYSTEM I A M DELIGHTED TO HAVE THIS OPPORTUNITY TO DISCUSS THE PAYMENTS SYSTEM WITH SUCH A DISTINGUISHED GROUP OF BANKERS AND BUSINESSMEN. THOSE OF YOU WHO ARE FROM THE UNITED STATES KNOW THAT M E FEDERAL RESERVE HAS URGED THE CONGRESS FOR MANY YEARS TO ENACT LEGISLATION WHICH WOULD GIVE IT BETTER CONTROL OVER MONETARY AGGREGATES AND THE RESERVE BASE, LEGISLATION WAS SIGNED'INTO U W THIS WEEK, SUCH IN ADDITION TO IMPROVEMENT IN MONETARY CONTROL, THE ACT HAS, AS A CONSEQUENCE OF RELATED PROVISIONS, SIGNIFICANT IMPLICATIONS FOR THE PAYMENTS SYSTEM, fbNEY TRANSFER POWERS ARE GRANTED TO SAVINGS AND LOAN INSTITUTIONS AND CREDIT UNIONS, THUS HELPING THESE INSTITUTIONS TO STABILIZE THE IR DEPOSIT BASE. BY REQUIRING THAT THE FEDERAL RESERVE PRICE ITS SERVICES THE ACT ENCOURAGES COMPETITION WHICH SHOULD LEAD TO HIE A W P T I O N OF THE TOST EFFICIENT PAYMENTS PRACTICES. LET ME GIVE YOU SOME SPECIFIC AREAS IN WHICH THIS LEGISLATION, THE MONETARY CONTROL ACT OF 1930, WILL HAVE A DIRECT BEARING ON THE PAYMENTS MECHANISM. FLRST, THE ACT REQUIRES THAT EACH FINANCIAL INSTITUTION HOLD RESERVES OF 3 PER CENT FOR THAT PORTION OF ITS TOTAL TRANSACTIONS ACCOUNTS WHICH AMOUNT TO $25 MILLION OR LESS. THE RESERVE REQUIREMENT FOR TRANSACTIONS BALANCES IN EXCESS OF $25 MILLION WOULD BE 12 PER CENT. THUS, CONGRESS MS RECOGNIZED THE NEED TO ACCORD EQUAL TREATMENT TO TRANSACTIONS ACCOUNTS REGARDLESS OF THE TYPE OF DEPOSITORY INSTITUTIONS IN WHICH THEY ARE HELD. WHILE ESTABLISHING UNIFORM RESERVE REQUIREMENTS FOR TRANSACTIONS BALANCES, CONGRESS AUTHORIZED ALL SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS TO OFFER MONEY TRANSFER SERVICES, IN ADDITION, BANKS ARE PERMITTED -2- TO PROVIDE AUTOMATIC TRANSFER SERVICES FROM SAVINGS TO DIECKING ACCOUNTS, AT THE END OF IS79 DEMAND DEPOSITS AT ca-Y€RciAL BANKS TOTALED $265 B I L L I O N , WHILE SAVINGS DEPOSITS WERE $250 BILLION. NOW ACCOUNTS, THAT HERETOFORE HAD BEEN CONFINED TO t:EW ENGLAND, HEW YORK AND NEW JERSEY,ARE AUTHORIZED NATION/IDE, ACCOUNTS, ALL FEDERALLY INSURED CREDIT UNIONS CAN OFFER SHARE DRAFT THESE ENLARGED POWERS FOR THRIFT INSTITUTIONS CREATE THE POTENTIAL FOR MORE COMPETITION IN THE PROVISION OF TRANSACTIONS ACCOUNT SERVICES AND ARE LIKELY TO RESULT IN A REDUCTION IN THE NUMBER OF FAMILIES WITHOUT TRANSACTIONS ACCOUNT SERVICES, IT IS NOT YET CLEAR WHAT PROPORTION OF DEMAND AND SAVINGS ACCOUNTS WILL BE MADE AVAILABLE FOR TRANSACTIONS SERVICES NOR WHAT PROPORTION MAY SHIFT TO TIME ACCOUNTS, THE ACT PROVIDES THAT ALL INSTITUTIONS OFFERING TRANSACTIONS ACCOUNTS HAVE ACCESS TO THE PAYMENT SYSTEM INFRASTRUCTURE, THE FEDERAL RESERVE IS TO PRICE ITS SERVICES, INCLUDING CHECK CLEARING AND COLLECTION, AUTOMATED CLEARINGHOUSE, NET SETTLEMENT, WIRE TRANSFER, SECURITIES SAFEKEEPING, FEDERAL RESERVE FLOAT AND ANY NEW SERVICE WHICH THE FEDERAL RESERVE OFFERS, WITHIN IS MONTI IC AFTER THE DATE OF ENACTMENT THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM IS REQUIRED TO PUT INTO EFFECT A SCHEDULE OF FEES FOR ALL SUCH SERVICES, THE PRICING OF PAYMENT ALTERNATIVES WILL GUIDE AND BE GUIDED BY USER REACTION TO PRICE DIFFERENTIALS AND SHOULD RESULT IN GREATER ADAPTATION TO USERS' NEEDS AS WELL AS A MORE EFFICIENT UTILIZATION OF REAL RESOURCES, PROVISION IS ALSO M\DE IN THE ACT FOR THE FEDERAL HOME LOAN BANK BOARD AND THE CENTRAL LIQUIDITY FUND FOR THE NATIONAL CREDIT UNION ADMINISTRATION BOARD TO PROVIDE DEMAND DEPOSIT ACCOUNTING AND SERVICE BUREAU FUNCTIONS FOR THEIR MEMBERS, EACH AGENCY IS AUTHORIZED TO BE DRAWEES O F , AND TO ENGAGE IN OR TO BE AGENTS FOR, THE COLLECTION AND SETTLEMENT OF CHECK OR CHECK-LIKE ITEMS DRAWN ON OR ISSUED BY MEMBERS. EACH AGENCY IS ALSO PERMITTED TO MAKE REASONABLE CHARGES CONSISTENT WITH THE PRINCIPLES SET FORTH IN THE FEDERAL RESERVE ACT FOR PRICING OF SERVICES, THESE ELEMENTS OF THE MONETARY CONTROL ACT WILL CHANGE THE STRUCTURE OF THE PAYMENT SYSTEM. THF. A C T , BY MAKING IT POSSIBLE FOR ALL DEPOSITORY INSTITUTIONS TO OFFER DEPOSIT TRANSFER SERVICES IS LIKELY TO BRING ABOUT SOME DISPLACEMENT OF CASH AND CURRENCY BY CHECKS AND ELECTRONIC CREDITS AND DEBITS, MORE FAMILIES ARE LIKELY TO HAVE DEPOSIT TRANSFER A C C O U N T S — A B O U T 20 PER CENT ARE WITHOUT SUCH SERVICE NOW AND CONGRESS HAS SOUGHT ADVICE FROM THE FEDERAL RESERVE ON HOW THE ADVANTAGES OF DEPOSIT ACCOUNTS MIGHT BE MADE AVAILABLE TO LOWER INCOME GROUPS, BEFORE I SAY ANYTHING ABOUT HOW THE FED'S ROLE MIGHT BE CHANGED, LET ME OUTLINE OUR CURRENT INVOLVEMENT IN THE PAYMENTS MECHANISM, THE FEDERAL RESERVE PRESENTLY MAINTAINS 43 CHECK CLEARING CENTERS WHICH PROCESS OVER 60 MILLION ITEMS EACH BUSINESS D A Y , IT CLEARS ANY CHECK AND CHECK-LIKE INSTRUMENT THAT HAS BEEN DEPOSITED BY A MEMBER BANK FOR COLLECTION. AMONG THE CHECK~LIKE DOCUMENTS ARE THE NOW ACCOUNT DRAFTS FOR THRIFT AND COMMERCIAL BANK INSTITUTIONS AND THE SHARE DRAFTS FOR CREDIT UNIONS, FLONMEMBER BANKS MAY DEPOSIT ITEMS DRAWN ON LOCAL BANKS, PAYABLE -n- THROUGH MEMBER BANKS W I T H THE FEDERAL R E S E R V E . IN 1979 THE FEDERAL RESERVE PROCESSED A B O U T 15 BILLION CHECKS AND INCURRED COSTS OF $253 MILLION PROCESSING IHLSE ITEMS, THE FEDERAL RESERVE OPERATES 35 OF THE 36 AUTOMATED CLEARING H O U S E S . IN 1978, 176 MILLION A C H TRANSACTIONS WERE HANDLED AT A DIRECT A N D SUPPORT C O S T OF $9.7 MILLION — 5 . 5 CENTS PER ITEM. ACH VOLUME IS PRESENTLY DOMINATED BY GOVERNMENT PAYMENTS W H I C H ACCOUIYT FOR ABOUT 84 PER CENT OF TOTAL V O L U M E . THIS VOLUME IS BEING FED INTO A SYSTEM W I T H THE CAPABILITY OF HANDLING 500 MILLION A C H TRANSACTIONS ANNUALLY WITHOUT ANY MORE THAN A NOMINAL INCREASE IN COST A N D BRINGING THE UNIT COST DOWN TO 1.9 C E N T S . THE FEDERAL RESERVE WIRE NETWORK HANDLES CREDIT TRANSFERS OF RESERVE ACCOUNT BALANCES ON BEHALF OF THE T R E A S U R Y , MEMBER B A N K S , AND CUSTOMERS OF MEMBER B A N K S . $68 T R I L L I O N , IN 1979, 35 MILLION WIRE TRANSFERS WERE M A D E , VALUED A T THE FEDERAL RESERVE INCURRED DIRECT AND SUPPORT COSTS OF $14.6 MILLION FOR WIRE TRANSFERS IN 1979. THE NATION'S REQUIREMENTS FOR CURRENCY A N D COIN ARE SUPPLIED BY THE FEDERAL RESERVE SYSTEM BY TWO BUREAUS OF THE DEPARTMENT OF THE T R E A S U R Y . CURRENCY IS PRINTED BY THE BUREAU OF PRINTING AND ENGRAVING AND IS SUPPLIED TO THE FEDERAL RESERVE AT C O S T . COIN IS PRODUCED BY THE TREASURY'S B U R E A U OF THE HINT AND IS ACQUIRED BY THE FEDERAL RESERVE FROM THE MINT AT FACE VALUE, IN 1979, THE FEDERAL RESERVE SPENT $149 MILLION FOR ISSUE, PROCESSING .AND TRANSPORTATION OF CURRENCY AND $25.9 MILLION FOR PROCESSING AND TRANSPORTATION OF C O I N , WHAT IS THE LIKELY IMPACT OF THE MONETARY CONTROL ACT ON THE FEDERAL RESERVE'S ROLE IN THE PAYMENTS SYSTEM? UNIFORM RESERVE REQUIREMENTS ON TRANSACTIONS BALANCES IN ALL DEPOSITORY INSTITUTIONS WILL ELIMINATE THE DISTINCTION BETWEEN MEMBERS AND NONMEMBER COMMERCIAL BANKS, AND BETWEEN COMMERCIAL BANKS AND THRIFTS, WITH RESPECT TO DIRECT SETTLEMENT WITH THE FEDERAL RESERVE. PRICING WILL ELIMINATE THESE DISTINCTIONS WITH RESPECT TO ACCESS TO THE FEDERAL' RESERVE'S CLEARING AND COLLECTION SERVICES. CURRENTLY, ALTHOUGH MORE ARE ELIGIBLE, THE FEDERAL RESERVE PROVIDES FULL CHECK COLLECTION SERVICES TO ABOUT 3,500 COMMERCIAL BANKS AND UNDER THE fbNETARY CONTROL A C T , ALL M , 0 0 0 COMMERCIAL BANKS AS WELL AS THOUSANDS OF THRIFT INSTITUTIONS COULD CONCEIVABLY MAKE USE OF FEDERAL RESERVE SERVICES. THERE MIGKT BE SIGNIFICANT DEMAND FOR CASH AND WIRE TRANSFER SERVICES FROM EVEN SMALLER DEPOSITORY INSTITUTIONS. IT IS UNLIKELY THAT THE FEDERAL RESERVE WHICH CURRENTLY HANDLES ABOUT 40 PER CENT OF ALL CHECKS WRITTEN WOULD EXPERIENCE A DRAMATIC INCREASE IN VOLUME. SMALLER INSTITUTIONS PREFER TO USE THE FACILITIES OF CORRESPONDENT BANKS AND NONBANK PROCESSORS BECAUSE THEY PROVIDE A FULLER PACKAGE OF SERVICES WHICH THE FEDERAL RESERVE DOES NOT INTEND TO DUPLICATE. THUS, THE FEDERAL RESERVE DOES NOT LOOK FOR AN EXPANSION IN CLEARING EVEN THOUGH THE NUMBER OF ACCOUNTS KEPT WITH THE SYSTEM MIGHT TRIPLE OR QUADRUPLE. THE fbNETARY CONTROL ACT MAY SET UP A NEW RELATIONSHIP BETWEEN THE F-EDERAL HOME LOAN BANK B O A R D , THE CENTRAL LIQUIDITY FUND AND THE FEDERAL RESERVE. BOTH AGENCIES ARE GIVEN THE AUTHORITY TO COLLECT AND SETTLE ITEMS -6- DRAWN ON THEIR MEMBERS, IN PROVIDING THESE FUNCTIONS A FEDERAL HOME LOAN BANK OR AN AGENT BANK OF THE CEI^TRAL LIQUIDITY FUND IS PERMITTED TO UTILIZE THE SERVICES O F , OR BE A MEMBER O F , A FEDERAL RESERVE BANK. T H U S , THRIFT INSTI TUT IONS WOULD HAVE DIRECT ACCESS TO FEDERAL RESERVE CLEARING AND SETTLEMENT. LODAY, THRIFT INSTITUTIONS CLEAR AND SETTLE SOLELY THROUGH CORRESPONDENT BANKS. IT IS UNLIKELY THAT MANY THRIFTS WILL CHOOSE TO CLEAR AND SETTLE DIRECTLY WITH THE FEDERAL RESERVE BECAUSE CORRESPONDENT BANKS DEAL WITH S E L L E R NUMBERS OF INSTITUTIONS AND CAN OFFER THEM CUSTOMIZED SERVICE. W E , ON THE OTHER H A N D , PROVIDE A BASIC LEVEL OF CLEARING SERVICE TO OVER 3,000 INSTITUTIONS. THE ACT'S REQUIREMENT THAT THE FEDERAL RESERVE PRICE ITS SERVICES SHOULD HELP IT TO EXPEDITE THE CONVERSION TO ELECTRONIC CAPABILITIES THAT NOT ONLY WILL REDUCE COST AND FLOAT, BUT WILL GREATLY ENHANCE CONVENIENCE AND CERTAINTY. AUTOMATED CLEARING HOUSE TRANSFERS (ELECTRONIC CHECK PRESENT- M E N T , AND CHECK TRUNCATION) SHOULD BE MORE COMPETITIVE WITH CHECK SERVICES UNDER PRICING, ESPECIALLY AS THE FEDERAL RESERVE ELIMINATES FLOAT OR PASSES THE COST OF FLOAT ALONG TO THE USERS OF THE CHECK SYSTEM. PRICING MAY RESULT IN A SHIFT OF VOLUME BETWEEN THE FEDERAL RESERVE AND THE PRIVATE SECTOR. WE EXPECT THAT PRICING WILL ENCOURAGE THE USE OF LOCAL CLEARING AND EXCHANGE ARRANGEMENTS BECAUSE THERE ARE ECONOMIES INVOLVED IN LOCAL CLEARING WHICH THE FEDERAL RESERVE WOULD NOT BE ABLE TO MATCH. ON THE OTHER HAND, THERE ARE ECONOMIES OF SCALE ASSOCIATED WITH THE FEDERAL RESERVE NATIONWIDE CLEARING OF 15 BILLION ITEMS THAT IT WILL BE DIFFICULT FOR ALTERNATIVE ARRANGEMENTS TO MATCH. FOR EXAMPLE, THROUGH PRICING TOE FEDERAL RESERVE CAN ENCOURAGE INSTITUTIONS TO DO SORTING OPERATIONS IN THEIR OWN SHOPS WHEN THEIR COSTS ARE LESS THAN O U R S . -7- 1HERE HAS BEEN A MIXED REACTION BY THOSE WHO HAVE ATTEMPTED TO PROJECT THE IMPLICATIONS OF THE F'ONETARY CONTROL A C T ON FEDERAL RESERVE PAYMENTS O P E R A T I O N S , SOME NAMELY THOSE IN THE S Y S T E M - A R E FEARFUL TH<\T THE A C T AND ITS REQUI RET IEITTS WILL RESULT IN LOST PAYMENTS V O L U M E , AND T H U S , CONSTANTLY PRICES MAKING OUR SERVICE OFFERING NONCOMPETITIVE AFTER AWHILE, INCREASING OTHERS— MAINLY THOSE IN THE PRIVATE S E C T O R - H A V E BEEN MOTIVATED TO LOBBY FOR THE INCLUSION OF REQUIREMENTS THAT W O U L D , INDEED, MAKE FED PRICES NONCOMPETITIVE AND FED FLEXIBILITY TO REACT TO C H A N G E , UNWIELDY. LET ME GIVE YOU MY OWN THOUGHTS ON WHAT THIS LEGISLATION WILL D O , I LOOK UPON IT AS PROVIDING A CHALLENGE AND AN OPPORTUNITY FOR THE FEDERAL RESERVE TO MODERNIZE ITS PAYMENTS SERVICES, AND T H U S , TO PROVIDE A SUPERIOR SERVICE TO THE PUBLIC, THIS HAS ALREADY STARTED, LAST Y E A R , FOR EXAMPLE, THE BOARD ANNOUNCED A PROGRAM TO EXPAND THE USE OF ELECTRONIC DELIVERY OF PAYMENT ITEMS TO MEMBER B A N K S , I EXPECT THIS AREA TO RECEIVE INCREASED ATTENTION NOV/ THAT WE CAN RECOUP OUR C O S T S — T H R O U G H AND PERHAPS EVEN ACCELERATE THIS PROGRAM, PRICING— JUST THIS PAST QUARTER, THE BOARD ANNOUNCED T>/0 PROGRAMS, ONE ON OUTSORTING LARGE DOLLAR ITEMS AND THE OTHER ON ELECTRONIC CHECK PRESENTMENT, THE LETTER, YOU WILL N O T I C E , REQUIRES ELECTRONIC DELIVERY TO BE SUCCESSFUL, OTHER ALTERNATIVES ARE UNDER R E V I E W , INCLUDING THE POSSIBILITY OF MAKING CHANGES TO OUR CHECK AVAILABILITY SCHEDULE WHICH WOULD MAKE AUTOMATED HANDLING OF P A Y M E N T S ™ AND ELECTRONIC DELI V E R Y — M U C H MORE COMPETITIVE WITH OUR CHECK SERVICE OFFERING AND PROVIDE INCENTIVES TO THE PUBLIC TO SEEK OUT SUCH AN ALTERNATIVE ARRANGEMENT.
