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FOR release on delivery




Statement by

G e o r g e W . Mitchell

M e m b e r , B o a r d of G o v e r n o r s of the F e d e r a l R e s e r v e S y s t e m

before the

S u b c o m m i t t e e on B a n k Supervision a n d Insurance

of the

C o m m i t t e e on B a n k i n g a n d C u r r e n c y

H o u s e of Representatives

N o v e m b e r 26, 1973

I a m pleased to be here to present the views of the B o a r d of
G o v e r n o r s on a feature of the rapidly evolving p a y m e n t s m e c h a n i s m
in w h i c h y o u have a particular interest -- n a m e l y , the w a y in w h i c h
thrift institutions can receive electronic w a g e said salary p a y m e n t s
in m u c h the s a m e m a n n e r as they n o w handle salary checks.

A t the

s a m e t i m e 1 w o u l d like to s u m m a r i z e recent d e v e l o p m e n t s in p a y ­
m e n t s technology a n d B o a r d actions bearing on these d ev e l o p m e n t s
a n d to suggest in a very general w a y w h e r e w e s e e m to be h e a d e d in
the d e v e l o p m e n t of electronic credit a n d debit transfers.
T h e p r o b l e m of i m m e d i a t e co nce rn involves a b r o a d issue on
w h i c h the C o n g r e s s m a y w i s h to provide guidance a n d a n a r r o w e r
issue of the m e c h a n i c s of m o n e y transfer.

1 w o u l d like to set aside,

for the m o m e n t , the b r o a d issue -- that of the m e a n s of participation
of thrift institutions in m o n e y transfer -- a n d clarify, if I c an a
purely technical m a t t e r of m o v i n g funds electronically.
This issue has arisen bec a u s e savings a n d loan associations
w a n t to be able to receive their c us tomers' payroll deposits as
electronic p a y m e n t s in m u c h the s a m e m a n n e r they n o w receive
payroll checks.

C o m m e r c i a l banks, on the other hand, in light of

their innovative effort in developing the n e c e s s a r y software a n d legal
f r a m e w o r k , a n d be c a u s e they have a s s u m e d liability for transmission




-2errors or failures, h ave sought to be satisfied that participation' uj.
thrift institutions w o u l d not create complications that m i g h t
disadvantage t h e m or their customer s.
T h e r e is a technical a r r a n g e m e n t for crediting payroll
checks to accounts in savings a n d loan associations that could
function equitably and, I a m convinced, satisfactorily for all
concerned.

It can be effected quickly a n d can serve until the

C o n g r e s s c hoo se s to address itself to the b r o a d e r issues involving
the role of thrift institutions in the nation's financial system.
im plementation n o w ap pears imm in en t.

Its

B u t let m e d escribe the

d e v e l o p m e n t a n d nature of the n e w system.

T h e D e v e l o p m e n t of the
A u t o m a t e d Clearinghouse
In California a n d in G eo r g i a pathbreaking technical c h a ng es
a r e being w o r k e d out.

T h e s e p e r m i t the conversion of payrolls f t o m

individual che ck s -- ea c h of w h i c h m u s t be sorted, counted, accounted
for a n d routed by a combination of l o w s pe ed m a c h i n e a n d h a n d labor,
at substantial cost to all parties involved - - t o deposit instructions
electronically imprin te d u p o n m a g n e t i c tape.

T h e electronic

instructions a r e p a s s e d to banks receiving the deposits thr oug h
a u t o m a t e d clearing houses, quickly, at very l o w unit cost, a n d with




-3-

m u c h i m p r o v e d certainty- a n d safety.

Savings institutions are n o w

concerned, a n d understandably so, about the m a n n e r in w h i c h they
can receive electronically directed deposits e m a n a t i n g f r o m an
a u t o m a t e d clearing s y s t e m w h i c h they did not create a n d in w h i c h
they ar e not m e m b e r participants.
A n electronic funds transfer s y s t e m s p o n s o r e d by the
California A u t o m a t e d Clearinghouse Association ( C A C H A ) b e g a n to
function in October 1972.

T h e Ge o r g i a A u t o m a t e d Clearinghouse

Association ( G A C H A ) started operations in M a y of this year.

The

California association includes 111 banks in the L o s t A n g e l e s - S a n
F r a n c i s c o area, a n d the Ge o r g i a association includes 178 banks in
Georgia.

T h e t w o electronic p a y m e n t s associations clear transfers

a m o n g their m e m b e r s through a u t o m a t e d clearing h o u s e s in w h i c h
the e q u i p m e n t is o w n e d a n d operated by the F e d e r a l R e s e r v e Syst em ,
in L o s Angeles, Sa n Francisco, a n d Atlanta.

T h e a u t o m a t e d clearing­

ho us e ( A C H ) is the electronic counterpart of c h e c k clearing facilities
o w n e d a n d operated by the Fe d e r a l R e s e r v e at 43 locations in the
United States.
T h e electronic facilities at c o m m e r c i a l ba n k s linked to the
Fe d e r a l R e s e r v e a u t o m a t e d clearing houses w e r e privately developed
a n d equipped o ver the past several years, with the advice a n d technical




-4-

help of the F e d e r a l Reserve, a n d they operate at private expense.
Participating ban ks deliver to the F ede ra l R e s e r v e electronically
r e c o r d e d instructions for the transfer of funds f r o m one institution
to another.

A c o m p u t e r sorts the instructions a n d m a k e s deductions

f r o m the r es e r v e accounts of banks f r o m w h i c h funds are being
transferred, a nd credits the r es er ve accounts of banks to w h i c h
funds are being transferred.

Electronic m e s s a g e s , tapes, or cards

with instructions for debiting or crediting the accounts of individual
c u s t o m e r s a re m a d e a n d delivered to participating banks.
T h e s e a r r a n g e m e n t s , again, parallel electronically the
debiting a n d crediting pro ce s s e s that occ ur in ch ec k clearing.

But

due to the fact that little or n o p a p e r n e e d be handled, the clearing
is d one at a cost in t e r m s of mills p e r item, rather than the cents
p er ite m cost of p a p e r check handling. This results in large savings
for all participants, including the F ed er al Reser ve.
A principal use currently being m a d e of these s y s t e m s is
payroll deposit.

A n e m p l o y e r p r e p a r e s a m a g n e t i c tape with

instructions to the empl oy er 's bank to m a k e payroll deposits at
banks a n d account n u m b e r s supplied by e m pl oy ees .

T h e employer's

banjc extracts a ny deposits being m a d e in that bank, a n d sends the
r e m a i n d e r of the instructions on to the a u t o m a t e d clearinghouse




-5There, as described above, the pay of other e m p l o y e e s is distributed
by electronic processing to their banks a n d to their accounts.

Since

this m e a n s of handling payrolls is a repetitive process, a n d involves
large n u m b e r s of pa yme n t s , substantial savings -- both public an d
private —

can be m a d e , a n d it is thus a natural a n d beneficial

application of electronic transfer.

M a i n Lines of
D e v e l o p m e n t in Electronic P a y m e n t
T h e electronic p a y m e n t s s y s t e m n o w s e e m s to be developing
in the United States along t w o m a i n lines.

O n e is directed at m e e t i n g

the n e e d s of business organizations a nd g o v e r n m e n t s that m a k e i n c o m e
p a y m e n t s in large volume.

T h e s e p a y m e n t s a re usually repetitive

as to recipients a n d are preponderantly for w a g e s a n d salaries,
dividends, interest, annuities, a n d retirement a n d welfare p r o g r a m s .
Since the p a y m e n t function is usually centralized in organizations
m a k i n g s u c h p ay me n t s , conversion to an electronic s y s t e m involves
a m i n i m u m of disturbance to existing a r r a n g e m e n t s .
is operational today but in very small volu mes .

I n c o m e crediting

T h e r e are, ho wever,

active plans to dramatically increase the us e of this technique in
1974.




-6T h e other chief line of d e v e l o p m e n t serves the n e e d s of the
individual c o n s u m e r w h o s e p a y m e n t v o l u m e is small, irregular in
timing a n d does not originate at a single location, but, m o r e often
than not, o c cur s at the place of p u r c h a s e of s o m e g o o d or service -thence, the designation, "point-of-sale.1 Point-of-sale transfer is
1
not operational, except experimentally, in the United States, but
there has b e e n e n o u g h study a n d pilot experience to justify confidence
in its operational feasibility.
T h e s e t w o e m e r g i n g d e v e l o p m e n t s a c c o m m o d a t e another
p a y m e n t s a r r a n g e m e n t in w h i c h c o n s u m e r s a g r e e to p e r m i t their
accounts to be electronically debited for contractual obligations,
su c h as insurance p r e m i u m s , rents, m o r t g a g e and installment
credit p a y m e n t s , a n d for utility bills, credit c a r d p u r c h a s e s a n d
similar type p a y m e n t s .

T h e i n c o m e crediting m a c h i n e r y is best

adapted to these "pre-authorized" p a y m e n t s but "point-of-sale"
m e c h a n i c s could also be used.

A c c e s s by a
P ay ab le -t hr oug h T r a n s f e r
A feasible said i m m e d ia te ly available m e t h o d of a c c e s s to the
benefits of electronic transfer for savings institutions, a n d one that
appeals to us as being equitable a n d fair to all, w o u l d be an adaptation
of the "payable-through" draft.




Savings ba nks have be e n using this

-7 terchnique for s o m e time.

A d a p t e d to electronic transfer, it can

be u s e d for credits as well as debits.

T o explain:

A c c e s s by a thrift institution to electronic transfer of funds
involving an a u t o m a t e d clearinghouse

would, in the payable-through

process, involve a n u m b e r identifying the institution in an operation­
ally feasible way.

T h e clearinghouse

c o m p u t e r s w o u l d be able to

associate deposits b o u n d for a particular savings a n d loan with a
c o m m e r c i a l ban k through w h i c h the savings a n d loan w a s participating
in the clearing a n d settlements process.
Specifically, an e m p l o y e e wishing to h a v e his pay deposited
automatically in a savings a n d loan w o u l d provide his e m p l o y e r with
the n u m b e r assigned to his savings a n d loan, together with his
personal account n u m b e r .

U s i n g this n u m b e r , the e m p l o y e r w o u l d

provide his c o m m e r c i a l ba n k with instructions o n m a g n e t i c tape to
deposit the e m p loy ee 's p ay in the savings a n d loan.

T h e employer's

b a n k w o u l d send taped instructions to the a u t o m a t e d clearinghouse
There, the clearing c o m p u t e r w o u l d recognize the identifying n u m b e r
as that of a savings a n d loan clearing t hrough a certain c o m m e r c i a l
bank.

It w o u l d credit the payroll deposit to that b a n k which, in turn,

w o u l d credit it to the indicated savings a n d loax:..

This w o u l d be

a c c o m p l i s h e d in the s a m e tim e span as applicable to c u s t o m e r
deposits in a c o m m e r c i a l bank.




-8T h e payable-through m e t h o d w o u l d operate without inconvenience
to the savings a n d loan depositor: he w o u l d be dealing directly with
his savings a n d loan just as if he carried his c he ck there for deposit.
T h e c o m m e r c i a l b a n k through w h i c h p a y m e n t w a s m a d e w o u l d be
involved only as an agent of the savings a n d loan.

T h e savings and

loan c u s t o m e r w o u l d n e e d n o contact with the c o m m e r c i a l b a n k to
effect pre-authorized deposits in (or withdrawals f r o m ) his account
at the savings a n d loan.
P a y a bl e- th ro ug h clearing w o u l d h av e a further advantage,
f r o m the point of v i e w of the savings a n d loam and f r o m the point of
v i e w of a competitive financial system.

It w o u l d p e r m i t a savings

a n d loan to select the c o m m e r c i a l bank offering it the m o s t advantageous
a r r a n g e m e n t s -- a n d to chang e its agent b a n k if it w i s h e d -- without
disturbing p a y m e n t s a r r a n g e m e n t s with its cu st om er .

T h e savings

a n d loan w o u l d m e r e l y tell the clearinghouse to r e p r o g r a m its
comp ut er s, so that the n u m b e r identifying the savings a n d loan w o u l d
be associated with B a n k B instead of with B a n k A.

Everything w o u l d

then go on as before.
O th er solutions to this p r o b l e m ha v e b een advanced.

Some

h av e advocated the a s s i g n m e n t of a regular ban k n u m b e r , thus
implying that savings an d loan associations, for clearing purposes,




-9should be treated exactly as c o m m e r c i a l banks.

Others ha ve

suggested that the H o m e L o a n B a n k s be participants in the clearing
p r o c e s s an d all debits a nd credits to accounts in savings an d loan'
associations should be routed through the H o m e L o a n Banks.
T h e first of these suggestions w o u l d a d d to F ede r a l R e s e r v e
costs by increasing the n u m b e r of "end points" to w h i c h it w o u l d n e e d
to m a k e daily sorts a n d delivery.

Looking a h e a d to the p re cedent for

future policy, if all thrift institutions, or eve n the large ones w e r e
included in this system, thousands of n e w e n d points w o u l d be added.
(There are 4, 300 savings a n d loans and 390 m u t u a l savings banks,
a n d 23, 000 credit unions, in the nation.)
Since present channels can be u s e d to achieve essentially the
s a m e result it does not s e e m desirable to treat the thrift institution
exactly as c o m m e r c i a l banks ar e treated in this respect unless they
b e c o m e m o r e like banks in other respects, or until the C o n g r e s s
considers the basic questions involved in su c h a transition.

A

similar line of thinking applies to incorporating a ch ec k clearing
function into the activities of the H o m e L o a n B a nks .

It m a y be that

C o n g r e s s will find this to be desirable at s o m e point, but s uc h an
a r r a n g e m e n t is not necessary, in our opinion, to provide a thoroughly
equitable a n d equivalent treatment for savings a n d loans in the receipt




-10of payroll deposits.

Thus, the payable-through m e t h o d involves

m i n i m a l cost to the F ed e r a l R e s e r v e a n d i m p o s e s n o unfair b u r d e n s
of cost or inconvenience elsewhere.
Considerations of equity, as well as of costs to the F e d e r a l
R e s e r v e (and, indirectly, to the Treasury), are involved in the
question of access.

T h e B o a r d has stated its general views, as y o u

k no w, M r . C h a i r m a n , in a letter I a d d r e s s e d to y o u on M a r c h 21 in
res po ns e to questions y o u h a d raised about the operation of the
California A u t o m a t e d Clearing House.

I should like to as k to include

that letter in the r e c o r d of this hearing.
T h e letter noted the B oa rd' s belief that the public s y s t e m
using c h e c k or electronic transfer of funds f r o m one institution to
smother should be s u c h as to insure that the conditions of entry into
a general clearing a r r a n g e m e n t ar e fair, a n d that equitable treatment
is a s s u r e d for institutions with similar

p o w e r s a n d responsibilities.

Let m e just emph as iz e, in ending these r e m a r k s concerning
the technique of a c c e s s to electronic funds transfer, s o m e of the
b r o a d e r questions invoked by that pr o b l e m .

All institutions should

h ave acce ss on t e r m s that place n o unfair bu rdens on any.

T h e very

great benefits that will result f r o m electronic funds transfer should
be equitably related to the pattern in w h i c h the costs of electronic




-11transfer -- both private a n d public costs -- a re borne.

T h e eventual

s y s t e m involving all financial institutions wishing to participate in
it should offer the m a x i m u m convenience to its users, small a n d
large.

A n d that s y s t e m should be suc h as to p r e s e r v e competition

in the types of service offered, the convenience of the service, a n d
the cost of it, so that the incentive to innovation is encouraged, a n d
the benefits of innovation are widely distributed.

T h e Responsibility for
a n Efficient P a y m e n t s S y s t e m
Senator Carter Glass c o m m e n t e d , at the t i m e of the p a s s a g e
of the F e d e r a l R e s e r v e Act:
" . . . If the B o a r d will hav e the w i s d o m a n d c o u ra ge
to establish . . . a c o m p r e h e n s i v e a n d e c o n o m i c a l plan
of ban k clearings, it will be difficult to c o m p u t e the
advantages that this section of the c u r r e n c y bill will
sec u r e . . . " (51 Cong. R e c . , P ar t 17, p. 563).
T h e Bo ar d' s efforts with r e g a r d to the d e v e l o p m e n t of an
electronic transfer s y s t e m ha v e b e e n focused on general a n d equitable
e n j o y m e n t of these benefits.
M o r e than a decad e

ago, the Federal Reserve, in

collaboration with the nation's banks, took an im po rtant step t o w a r d
stretching the viable life of the c h e c k p a y m e n t s s y s t e m by developing
the m e t h o d of m a g n e t i c ink encoding on chec ks with b a n k account a n d




-12routing n u m b e r s , to wh i c h magnetic ink encoding of the a m o u n t of
the check is added in the clearance process.

M a k i n g this standard

usage for checks m a d e the m a c h i n e processing of checks possible.
That, 1 might add, required a public education task similar to that
n eeded n o w to bring to the public the benefits of electronic funds
transfer.
M o r e recently, guidelines for regional overnight check
clearing a r r a n g e m e n t s w e r e announced by the B o a r d F e b r u a r y 3,
1972, as an effort to squeeze as m u c h efficiency as possible out of
the check.

This has n o w resulted in a national netwo r k of regional

clearance centers, mostly located at Federal R e s e r v e B a n k s or
B r a n c h Banks, currently clearing m o r e than half the checks handled
by the Federal R e s e r v e on an overnight basis.
T h e regional overnight clearance s y s t e m w a s established in
furtherance of a policy statement issued by the B o a r d June 18, 1971.
This called for "basic changes in the nation's s y s t e m for handling
m o n e y p a y m e n t s (that) are, essentially, transitional steps t o w a r d '
replacing the use of checks with electronic transfer of funds. "
This a n n o u n c e m e n t in turn rested upon the fact that since
1968 the Federal R e s e r v e had been engaged in building up a
computerized communications network, linking the B o a r d and all




-

13

-

Federal R e s e r v e B a n k s and B r a n c h Banks.

This network has n o w

been brought to a high state of operational capacity, and can be
extended to direct links with c o m m e r c i a l banks.

T h e Board's Request for C o m m e n t
on the D e v e l o p m e n t of Electronic Transfer
T h e development of electronic funds transfer systems calls
for an overhaul and extension of the Federal Reserve's Regulation J,
wh i c h presently governs only the collection of checks through the
Federal Reserve.

T h e B o a r d one w e e k ago published for c o m m e n t

such a revision of Regulation J, and I a m submitting a copy of it for
you r records.

T h e proposed revision suggests a legal f r a m e w o r k

for electronic funds transfer, both the passing of credit, and the
collection of payments.
But the Board, in proposing this regulatory modernization,
recognized that the development of electronic funds transfer involves
n e w relationships and roles for various institutions, public and
private.

T h e Board, therefore, went beyond the specifics of the

rule changes it w a s suggesting and asked for c o m m e n t also on the
basic structure of the nation's p a y m e n t s m e c h a n i s m , and the
appropriate roles in it of the Federal R e s e r v e and other institutions.




-

14

-

T h e range of questions on wh i c h the B o a r d requested c o m m e n t
in connection with Regulation J so as to a c c o m m o d a t e electronic
transfer delineates, in broad form, the m a i n public policy questions
arising f r o m this technological development. 'I want, therefore, to
cite the m a i n issues on which w e seek advice.
T h e B o a r d asked for c o m m e n t on basic issues including:
(1) T h e appropriate roles in the ownership and
operation of an electronic p a y m e n t s s y s t e m -- including
adjuncts thereto -- o f (a) the Federal R e s e r v e System,
(b) other public bodies, and (c) individual or groups of
private institutions, including c o m m e r c i a l banks, auto­
m a t e d clearinghouses, credit card companies, thrift
institutions, credit unions, the "bank wire, " and other
institutions or organizations such as those specified in
the attached proposal;
(2) T h e extent and the conditions of access to the
electronic funds transfer s y s t e m by various kinds of
depositor institutions, and of other financial institu­
tions, as well as the t e r m s of access;
(3) H o w the cost of electronic funds transfer should
be allocated, including such questions as whether the
Federal R e s e r v e should charge for the use of its
facilities; if so, against w h o m should the charges be
levied, whether they should cover all costs, and
whether reserves maintained by m e m b e r banks
should be taken into account in any fee schedule w h i c h
might differentiate between Federal Re s e r v e m e m b e r
and n o n m e m b e r institutions.
W e expect to benefit substantially f r o m the response w e receive
with respect to these issues, including -- perhaps I should say
particularly -- the advice w e receive f r o m the Congress.




-15Policies or attitudes which inhibit participation in the e c o n o m i e s
and added capacities that will be provided by future electronic techno­
logical development tie us to obsolete costs and inconvenience.

By

avoiding rigidities, the policies and attitudes of both public and private
parties to electronic transfer will give a m p l e opportunity and incentive
for innovation to continue to occur in electronic transfer facilities,
and to be put to timely use.
Technological change can alter institutional relationships.
H e r e also, avoidance of rigidities in either public or private policy
will permit us to a c c o m m o d a t e not only to technical change, but also
to altered relationships a m o n g financial institutions.

Some
Conclusions
Let m e add only a few w o r d s of emp h as i s and conclusion:
T h e r e are n o technical barriers to the spread of electronic
funds transfer.

It parallels all the w o r k done by the check system,

and does it better, m o r e cheaply, faster and at greater convenience
to all users of the p a y m e n t s system.

The n e w payments system

should a i m at bringing into the p a y m e n t s m e c h a n i s m the m o n e y
transfer needs of that substantial part of the nation's families not
n o w using the check system.




-16T h e allocation of the costs of electronic funds transfer a m o n g
its vendors and its users -- both public and private -- m u s t be such
that the economies realized f r o m electronic transfer are spread
fairly.
T h e r e should be a public presence in electronic transfer, to
the extent necessary to guarantee that the n e w p a y m e n t s s y s t e m develops
in a w a y that m a k e s it capable of doing the job of m o n e y transfer, f r o m
whatever quarter, without unwarranted exclusions of would-be
participants.
imum

A

goal of the public presence should be provision of a max­

range of different services -- including credit cards and other

p a y m e n t "concentrators" -- compatible with the degree of technological
uniformity necessary to ensure efficient operation.
T h e B o a r d looks forward, in the discharge of its s e g m e n t of
responsibility in this area, to the advice and e n c o u r a g e m e n t of the
Congress.




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