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Paying and Being Paid-The Convenience and Economics of Electronic Transfer of Funds Remarks of George W . Mitchell Member, Board of Governors of the Federal Reserve System at the Annual Stockholders' Meeting of the Federal Reserve Bank of Boston Boston October 14, 1971 Paying and Being Paid-The Convenience and Economics of Electronic Transfer of Funds Five years ago I addressed this group on the subject of "Tomorrow's Money." At that time my task was to block out roughly the elements of an electronic settlement system and to suggest some of its implications for banks and their customers. Since then the diseconomies of check handling have become more obvious and so much progress has been made in the means of dealing with them that my task today is that of discussing the immediate problems of living with and taking advantage of the elements of an electronic system which have already come into existence, and of other elements which are coming on line shortly. We are currently in the transition phase of a change-over to electronic settlement and the new capability is affecting more transactions and more people each day. Preliminary to a discussion of the problems of exploiting the advantages of an electronic system, I believe it would be helpful to make a few summary comments on the dimensions of the money transactions, the mechanics of money transfer, and the essential characteristics of an electronic system. The aggregate dimensions of the nation's money transactions are huge. We start with the fact that there are about 23 billion checks written annually. These checks transfer 13 trillion dollars--an amount thirteen times the current gross national product of the economy. If you were to make a quick, -2- and accurate, mental calculation of the average amount per check you probably would think you had misplaced the decimal point to have come up with an average check of over $560. You might be even more perplexed if you knew that over 50 per cent of the checks written were for amounts of less than $25. But by that time, as bankers, you probably would realize that the huge size of a relatively small number of financial transactions in our economy could account for the seeming inconsistency. While the large checks present a problem in the payments system, it is not a glut of paper work. If we define as large, checks of $10,000 or m o r e , there are only about 100 million of such checks written in the course of a year. But these 100 million items account for close to half of the 13 trillion dollar annual check volume. The identity of check writers is vital information for appraising the payments problem. As nearly as can be estimated from fragmentary information, individuals write about 52 per cent, business 43 per cent, State and local governments 2 per cent, and the Federal Government 3 per cent. All together there are now about 90 million demand deposit accounts and 81 per cent of these have balances of under $1,000. If it is assumed that virtually all of the accounts under $1,000 are for individuals, the average monthly check volume per account would be 14 debits per month. -3- Average activity per account for businesses and governments is not a very meaningful statistic because of the very wide range of activity in such accounts. Some special purpose accounts may have less than 100 debits per year--less than the average activity of the average individual account. In others, activity may range all the way up into the hundreds of thousands of items. The top is undoubtedly the more than 600 million checks the Treasury writes each year. In addition to identifying check writers (payors) we also need, so far as the mechanics of automated transfer are concerned, to identify the recipients (payees) and the character of their transactions. It is especially important to identify the volume of checks written to payees who show up at regular intervals in the check book of the payor. In the case of individual payors these would be retail stores, oil companies, utilities, the family doctor, insurance companies, credit card issuers, etc. Further, we need to identify among the repetitive payees those who receive the same amount regularly as, e.g., rent, mortgage and car payments, insurance premiums, etc. The repetitiveness of payees and amounts in the settlement process provides the opportunity for an optimal use of electronic gear. The adaptive feature of the repetitive transaction is that it obviates the need to convert each individual transaction into machine language. This is the most costly phase of the opera- tion and, since electronic equipment can store and reactivate identical transactions weekly, monthly, or periodically at an -4- extremely low cost, the economic advantages are evident. Even if amounts change in a given transaction, having the payee's identification readily available in machine language is a significant cost saving. For businesses, repetitive payments (not necessarily in identical amounts) would be for salaries and wages of employees, dividends to stockholders, interest to bond holders, insurance annuities and intra-company transfers. For govern- ments, repetitive payees would include employees, allotees, retirees and social security beneficiaries. It is worth noting that electronic deposit of sums directly into the bank accounts of millions of individuals receiving wages, salaries, allotments, pensions and benefits from businesses and governments would significantly ameliorate many serious security problems involved in the depositing, handling and cashing of checks. Since the transactions where both the payee and amount are repetitive at regular periods is the ultimate in adaptability for an efficient electronic transfer system, result in a uniform average arrangements which monthly payment over a period of a year with reconciliation at the end of the period are needed. The number of repetitive amounts is relatively small under present billing practices but it can be significantly increased by broadening the scope of average monthly billing by utilities. The evident course of electronic technology in the payments mechanism is the conversion of a very large number of -5- transactions, probably something on the order of 50 per cent in terms of number of transactions, from checks to electronic credit transfers or to authorized charges. Thus, employees do not get payroll checks which they must redeposit, but credits to their bank accounts on pay dates. The same arrange- ments would apply to Social Security, pension, unemployment compensation and other regular welfare or allotment payments. Individuals do not write checks to pay households bills but, instead, authorize their bank to charge their account on some specific date for a repetitive monthly charge, or a specifically approved variable amount. The credit card can do--and is d o i n g — m u c h to reduce check usage. For transactions which do not involve repetitive payees or that do not require immediate payment in "good" or immediately spendable funds, the credit card as it is now used aggregates a number of transactions into one bill settled by one check. As it can be used, and is starting to be used, the credit card can activate and complete the transfer of funds at the point of sale. Since I spoke to this group five years ago, the banking industry and the Federal Reserve have been working steadily and effectively toward an electronic payments system. Several commercial banks have been experimenting with point-of-sale electronic terminals for the transfer of deposits or the accumulation of charges for later transfer from shoppers to merchants. Developments in this important area -6- have been retarded by card identification problems and terminal and line costs. Fortunately, our decentralized banking system has made it possible for innovative-minded bankers in various parts of the country to tackle these problems on a scale which permits experiment, adaption — and even failure. There is no doubt that some of the installations now in being, or coming on line, will provide successful patterns for the industry as a whole. One very significant project, the so-called automated clearing house, is the product of the California Scope Committee, a group organized and supported by 10 large California banks and the Federal Reserve Bank of San Francisco. This project is in its test stage now and should be operational in a few months. It will cover both payroll crediting and pre-authorized debits. Other SCOPE-type projects are getting under way in various parts of the country. While the banking industry has been hard at work on a paperless payments system the Federal Reserve has not been idle either. The System's program on the payments mechanism is expanding our wire transfer operations, extending existing Federal Reserve clearing areas and will soon be opening a few new clearing centers in areas away from our present offices. Wire transfers will, of course, be in Federal funds. Clearing -7- centers will make settlements, charges and credits, in immediately available funds on the day of presentment to the payor bank. The communication system for large-scale wire transfer traffic is in place now. We are anxious to see it used for all inter-bank and sizable third-party transfers as soon as practicable. To this end we have reduced the cost, and liberalized the rules, for the use of our network. We hope for a large volume before the end of 1971, and that virtually the entire volume of member interbank and large third-party transfers will come to be made by wire in the course of 1972. We believe the new and enlarged clearing areas we are now in the process of establishing will not only have an immediate effect in reducing unneeded handling and transportation of checks, but will also ease the transition into a floatless electronic system. centers. We have draft guidelines for the operation of clearing They are "draft" only in the sense that we do not want to freeze the pattern of operation before we have thoroughly tested alternatives available to us. In their final form, the guidelines will have flexibility, since we do not, of course, expect that identical rules will appropriately fit all sections of the country, considering difference in banking structure, topography, population, concentration, etc. In the clearing centers we would like to be dealing exclusively in items fully qualified for machine processing. -8- But, at the outset, we will qualify a limited number of checks from small banks for machine handling by encoding amounts on them. This recalls experience with MICR. It was after a reasonable period that we accepted checks without MICR only as noncash items. A similar policy would be appropriate for amount encoding. Sorting requirements will be directed at striking an optimum balance between the work done at commercial banks and at the Federal Reserve clearing center. For example, we do not intend to handle high volume local destinations, except perhaps as package items. These can be most efficiently directly exchanged and thus spare the clearing center sorting and transportation costs. The centers can obviously give better service for packaged sorts, but our intent, and our expectation with respect to economies, is to concentrate on more downsorts of the less frequent destinations on which we can generate a respectable volume and the sending bank cannot. We believe substantial savings can be achieved in scheduling our work and more fully utilizing our equipment if we absorb a larger share of transportation costs and have greater influence on pickup schedules. We do not intend to function now or in the future in any respect as a partial substitute for a demand deposit processing center. On the contrary, in time we probably will be dealing exclusively with processing centers so far as receipt and dispatch of checks is concerned. Correspondent balances associated with such processing services should not in any way be adversely affected. Since clearing centers will be giving credit, and collecting for items, on the day presented, correpondent balances predicated on earlier availability than is presently the case in parts of the clearing areas may be adversely affected. The clearing service we will be offering will be superior in most respects to that we offer now: earlier availability, more sorting, less transportation costs, later closeoff hours. The major problem remaining is one of obtaining public acceptance for an electronic system. There is plenty of evidence that business and government attitudes will be receptive to electronic transfer. Payroll crediting and preauthorization, for example, are becoming established because of obvious cost advantages. Economics insure acceptance where large volumes of transactions are concerned. Where large amounts in a single transaction are involved "playing the float" as a payor is not uncommon. The very existence of this practice indicates that businessmen distinguish between "good money" and checks. If commercial practice permits payment in tomorrow's or the next day's money some corporate treasurers will not pay in today's money. But these same corporate treasurers cannot be unaware of their position as a payee, and of being exposed to the same -10- nonpayraent in "good funds" by the practices of other corporate treasurers. Who gains from such maneuvers may not be very important because of the magnitude of the amounts involved. Perhaps corporate treasurers' contributions to corporate earnings may look more impressive but the net effect on overall corporate profits may be adverse because so sharp a management of corporate bank balances can hardly avoid an offsetting influence on banking accommodation, or even the pricing practices of suppliers. The major problem of public acceptance lies in altering the money mores of individuals. happy with checking accounts as they are. and savings accounts. Many of them are Others prefer currency Few have had experience with preauthorization, payroll crediting, point-of-sale terminals, or any other facet of electronic transfer. In all probability convenience is the feature of electronic banking that will appeal to them. Check writing and trips to the bank for depositing pay checks or making currency withdrawals are chores for most people. A system which significantly cuts back on those activities will gain broad acceptance as soon as it can be experienced. The rapid penetra- tion of the credit card into individuals' money management illustrates the possibility of changing money habits. And, as I have implied, the now familiar credit card can be used for most banking transactions and for commercial transactions -11- involving the transfer of funds. In this expanded role it will do a great deal to obtain public acceptance of electronic payment and settlement. The time is fast approaching when the individuals-not to speak of banks--will find the conventional check becoming a high cost, obsolescing device for most transactions; then the electronic payments system will be not only a convenience, but an economic necessity. We in the business of banking must be prepared for this technological evolution to survive as institutions and to meet our public responsibilities.
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