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VOR RELEASE ON DELIVERY
Monday , September 8, 1975
12:45 P.M., P.D.T.
(3:45 P.M., E.D.T.)
CURRENT ISSUES IN THE DEVELOPMENT
OF THE PAYMENTS SYSTEM
GEORGE W. MITCHELL
Board of Governors
Federal Reserve System
Payments System Policy Conference
The American Bankers Association
San Francisco, California
September 7-9, 1975
CURRENT ISSUES IN THE DEVELOPMENT
OF THE PAYMENTS SYSTEM______
My interest in payments technology goes back twenty years
or more but my first recorded speech on the subject was at the annual
meeting of the American Economic Association in New York City in 1965.
I recall the subject matter was indeed novel for economists then,
many of whom were deeply interested in the rate of growth of money
but hardly at all in how it was transferred, or, to put it in their
terms, in the rate of growth in the efficiency of money use.
Since that time, I am sure to have made a fortnightly payments
talk on some occasion or other.
You can understand, therefore, that
if I have some difficulty in listening to what I have to say today,
others may have a similar problem.
One of my banking friends says
listening to me talk about the banking system and the payments mecha
nism is like being kicked in the shins.
"But," he adds, "it is a
useful though painful reminder."
While the subject is, perhaps, "old hat" to some, the
developments taking place are fresh enough to make trade and general
news and to occupy a considerable amount of Congressional and industry
Payments matters, which at one time were the exclusive
concern of the commercial banking system, the Treasury and the Federal
Reserve, have aroused the entrepreneurial interest of others.
thrift industry, the data processing and communications industries,
the credit card companies and national and area vendors are all
Profit opportunities are apparent to technology sophisticates
who see numerous practicable applications of their expertise.
thrift industry visualizes a change-over in payments technology as an
opportunity to enter the payments business without the operating handi
cap of having to use paper checks processed through commercial bank
Competition and Innovation in the Payments System
Both commercial banks and thrifts are continuously and some
times aggressively seeking assistance from State legislatures and
Congress to enhance their market positions.
Each seeks, at the expense
of the other, to reduce or remove differential statutory constraints
that are disadvantaging or, if circumstances are in their favor, to
maintain or increase those that are not.
In their zeal to limit each
other'8 competitive effectiveness by statutory or regulatory action,
banks and thrifts are overlooking the fact that the real competitive
challenge is coming from another direction— from unregulated enter
The sheer volume of money transfer today (over 100 million
daily, by check alone) has
overtaxed the conventional labor-intensive
technology still widely used by commercial banks and has thus created
an opportunity for more innovative-conditioned enterprises to move in.
I would not want to leave the impression that I believe inno
vation in our regulated depository institutions is entirely absent or
is utterly stifled by regulators acting either on their own initiative
or through the proddings of the regulated.
There are numerous instances
where the relaxation of regulatory constraints has been followed by
-3the introduction of new financial services which the public has eagerly
The New England NOW account experiment, which is aimed at
ameliorating a long-standing discrimination against small savers, is
a good illustration.
Initially confined geographically and by name,
and approved by Congress as an experiment, a service offering to link
or combine an interest-earning savings account to a money transfer
account— as the NOW account does— has given rise to a whole series of
possibilities of great value to individuals, small business and many
The average depositor can use his savings account for money
transfer or as a back-up for his checking account.
By doing so he
earns a return on what he doesn't spend and he avoids the costly penal
ties incurred on account of insufficient funds items.
The number of
these is not inconsequential and as a consequence the banks and the
Federal Reserve get an incidental bonus in their processing cost by
virtue of a reduced level in the costly backwater of return item ad
It is proposed to make savings accounts available to corpo
rate enterprises and to simplify further the transfer of funds between
savings and checking accounts.
Few of t h e ‘
changes made or contemplated
bear the name of NOW accounts and they are not confined to New England
but their origin can be traced to that original innovative step.
The entry of non-depository institutions into the handling
of money payments is possible by fractionating the operating steps of
moving money from payor to payee.
The breaking up of the payments
-4 function evolved from the introduction of the credit card and the re
moval of check processing from a back room operation to centralized
Today, funds transfer, data handling, data
transmission and the extension of short-term credit can be segregated
operationally and all can be performed outside of the banking system
except for funds transfer.
Even that process can be attenuated by
massive combinations of individual transactions.
Perhaps I should make clear what I mean by fractionating or
breaking down various steps in the payments process and how vendors,
for example, can participate in the payments mechanism as a result of
The growing practice of using data processing contractors
for demand deposit accounting work and the handling of transit items
makes it clear that these operations need not be done by or on the
premises of a commercial bank.
But the way in which the linkage between
banking and settlement or money transfer operations is attenuated and
the way in which consumer or merchant credit impinges on bank deposits
may not be so obvious.
A credit card system operated by a bank, a non-bank or a
retailer generates daily payments to merchant vendors, affiliates or
to its operator entity.
The card-issuing institution may finance these
payments internally or through the commercial banking system.
same time, the system generates credits from its card holders for their
These money flows to merchants and from card holders do
not match and that mismatch in debit and credit flows creates the
opportunity for the card issuer to become, in effect, a consumer banker
if he chooses.
If he elects to finance his card holders' purchases,
he makes it possible for them to manage their bank demand deposit
accounts in a different manner and more closely in relationship to
their income flows.
Thus the retailer is competitive, in fact, for two banking
he directly supplies consumer convenience or extended
credit and he indirectly impacts the deposit relationship in the bank
ing system by making it more practicable for consumers to reduce their
holdings of demand deposits.
Whether or not the card operator extends credit, he cumulates
a large volume of payments to accounts in a number of banks.
operation displaces cash and check processing at a bank by performing
the accounting that would go with each such transaction internally.
For example, a card issuer might internally process a million individ
ual transactions in some given period which would have been settled
otherwise by cash or check.
His settlement procedure— the actual move
ment of funds— would be on a consolidated basis, and the number of such
settlements would be small in comparison to the number of original
And if he were able to settle with the banks serving
merchants and card holders on a net basis and enjoyed a significant
level of market concentration, the net amount of funds transfered
could also be small.
Obviously, such systems are far too complicated for non
electronic technology but that gate has long since been opened.
Fair Billing Practices and Payments Technology
Another focus on the breaking up of payments processing was
evident at a recent hearing at the Federal Reserve Board on fair billing
As a consumer protection measure, Congress has directed
the Board to adopt regulations applicable to vendors, card companies
and their agents to establish standards for the identification of pur
chases made with credit cards and the conditions of timely notice of
amounts owing and of remittances.
This hearing explored in detail the
billing and payment techniques of vendors and card companies.
A decade ago, I thought the banking system had an opportunity
to use its primacy in effecting money transfers to become the "commun
ity's accounts keeper."
It might have been a good idea but it did not
strike much response among banking managements.
Such a service would
have been aimed at the small business and consumer market.
years banks were enamoured with liability management and market sources
of funds; few of them were interested in attracting individuals as
customers because the underlying stability of a consumer deposit base
did not seem important at the time.
Thus banks made little attempt to
innovate their customer accounting in order to retain or attract con
The need to displace the return of checks to customers
(the equivalent of "country club" billing) with descriptive monthly
statements was not recognized as a necessary cost reduction measure
if banks were to compete in the consumer market.
Meantime, national retailers and the card companies, bank and
non-bank, saw the diseconomies of country club billing in their operations
and in light of their customers' need for information.
the development of descriptive billing and timely input of such informa
tion into their data processing systems.
Today, many of them have and
are exercising the capability of avoiding costly, inefficient, laborintensive operations of returning basic documents to the customer.
Although planning for the retrieval of essential information on checks
has gone forward, implementation of descriptive bank statements seems
far in the future.
Bank managements with doubts about descriptive statements
should examine the progress vendors have made in automated descriptive
systems which can meet their own and their customers' needs.
systems are proprietary in a sense but are also extensible and adaptable
to others directly or through processing contractors.
The three-party card issuers appear to be hard pressed to
offer comparable billing disclosure to that available from retailers
but one must be impressed with their efforts to narrow that gap and
come up with roughly equivalent results.
In contrast, banks who have
faced a similar problem and for a much longer time have made little
use of contemporary technology for achieving descriptive check state
Participation of Thrift Industry in Payments System
Turning to another issue of the payments problem, I believe
the banking industry has made vital and sustainable progress in dealing
with a realistic participation of the thrift industry in the payments
But progress has been slow.
In some sectors of the thrift
industry, enthusiasm for participation has been and still is bound
less— it reminds me of an earlier enthusiasm shown by the banking in
dustry for Caribbean branches and for managing and advising REITs.
thrifts should penetrate the payments operation to the extent some con
template, they are most likely to find the deposits generated to be a
more costly source of funds than do banks.
The non-earning assets
levels (cash and balances) to which they are accustomed in the opera
tion of a savings business, which is about 1 per cent of total assets,
will far from suffice for a money transfer function.
At the end of 1974, non-earning assets, i.e., cash, reserves
at Federal Reserve Banks, correspondent balances and items in the pro
cess of collection, were over 13 per cent of total assets at insured
The comparable ratio for non-member banks who are
not required to keep reserves with the Federal Reserve System was 9 per
A demand for full participation in the payments mechanism on
the part of the thrifts will, in my opinion, necessarily involve a full
participation in its costs as well as benefits.
I see at present only
limited evidence that any of the thrift groups are prepared to assume
costs of the order the banking industry now bears.
It is possible,
however, that their anticipated penetration of this market is on a
much more limited basis than their demands for access to it imply.
In that event, it seems to me they have already achieved a satisfactory
-9 There is, of course, the possibility that the thrift indus
try or some sector of it could adopt an industry-wide electronic trans
fer program which would be cost-effective in a broad sense— i.e., in
reducing processing and transmission cost and in holding clearing bal
ances to very low levels.
But the same forces that have impeded banks
in the United States— in contrast to banks in some other countries—
from taking such action also operate within the thrift industry.
principal one is the existence of a large number of independent, un
coordinated institutions which have varying judgments as to the desir
ability of any change in their present operations, to say nothing of
a uniform system which would reduce their own management flexibility.
Equality of opportunity in providing a money service, it
appears today, will be decided in some degree by Congressional action
in determining who can participate in providing money services, what
their role should be, what investment and deposit powers they should
have and the interest rate ceilings and reserve requirements to which
they should be subject.
But Congress cannot legislate the resourceful
ness of entrepreneurial response to any type of competitive climate it
can create or modify, including one which involves handicaps for some
participants and not for others.
Cost of Money Service
It is clear that for some time to come money transfer will
involve currency, checks, electronic tapes and direct electronic com
During this period, transfers will be in mixed media
starting out with one type of input and ending up with another.
example, the planned Social Security System payments will start as
tape or direct electronic input but many will be delivered to the
recipients' bank or thrift as hard copy.
The transformation from one to another payments media affects
so many transactions that it greatly complicates the orderly transition
to the more efficient exclusively electronic mode.
At some point
customers must be given the opportunity of realizing financial or con
venience advantages from the present method of payment or being paid.
If payment in cash is demanded and that cost is X and the cost of pay
ment by check is one-half of X and by electronic means one-tenth of X,
a reflection of these costs is urgently needed to shift the payments
system as quickly as is feasible into the optimum media.
While the Federal Reserve's share of the cost of operating
the payments system is comparatively small, it is not an inconsiderable
sum to us and we have a direct and continuing interest in reducing
such costs by making full use of the most effective technology.
cost studies have demonstrated to us that we and others can save a
major share of present costs per transfer by shifting to a fully
We cannot shift our technology in any truly cost-effective
way unless banks do so too as we do not deal directly with any initi
ators of payments other than the Treasury.
Our facilities must have
the capability of handling payments flowing from one bank to another in
-11any form, and, as 1 have indicated, the vehicle for transmitting pay
ments information may change en route to its destination.
Despite our secondary role, we have tried continuously to
encourage progress toward a more efficient payments system and quite
naturally have encountered opposition on all sides, some saying we have
gone too far and otheis contending we have not gone far enough.
by the results achieved to date, we cannot expect high marks for what
has been accomplished.
I would not give banking managements high marks
either even though I believe I understand their thinking and "hang-ups."
The essence of my comments today is that the opportunity of
the commercial banking system to- serve its individual and small business
customers is being eroded and slipping into the orbit of competitors
who are more innovative and more perceptive in detecting the profit
potential in this market.
These competitors may be in error and your
customers may be entirely content with a "Model T" payments system.
However, the consumer-small business market in our economy is too large
not to be served imaginatively and I can't believe it won't be served
If this is so, the cost of performing that service must
come down because available technology makes it possible to do so and
I would think that fact should be evident to everyone.
- 0O 0