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HIGHER PRODUCTIVITY DEMAND DEPOSITS

Remarks of

John E. Sheehan

Member
Board of Governors
Federal Reserve System

at the

Workshop on Federal Reserve Payments System Activities

ABA Automation Conference
Miami, Florida
May 3, 1972

I am genuinely happy to be here today to participate
in the work of your panel on the Federal Reserve System's
activities in the payment mechanism area, because the efforts
of the past few years are bearing fruit.

And we appear to be

in the vanguard of the program Mr. Nixon and his lieutenants
are suggesting to the nation—sharply improve the nation's
productivity.
Before the end of this year most of the 66 million
checks now being written by Americans each business day will move
into Federal Reserve Regional Check Processing Centers--which we
call RCPCs--initials that will very soon be part of most bankers'
lexicon.

With the RCPCs clearing, presenting and collecting most

checks overnight, demand deposit money will have been given a
faster turnaround period.

That is, the RCPCs will substantially

Increase the payment productivity of demand deposits, since what
was deposited yesterday can be respent tomorrow, instead of two
or three days from now.
Also during 1972 we will see the beginnings of the second
stage of the task of building.a higher productivity payments
mechanism begin to come into operation.

This will be the first

one or perhaps two city or area exchanges in which the payments
instructions now usually given and effected by check will be made
instead--where authorized by bank customers--by instructions
stored electronically on tapes, and cleared in a computerized
Federal Reserve electronic clearing house.

Commercial banks in

-2the San Francisco-Los Angeles area, and in Atlanta, have put
several years of faith and hard work--with Federal Reserve
encouragement and assistance--into pioneer designing of "paperless"
payment systems for customers who want to make use of this low cost,
high convenience means of paying and collecting.
Every type of repetitive payment—payrolls, utility
bills, dividends, social security payments, periodic interest
payments are a few examples—can be made at substantially lower
cost in this way.

Recipients will get their money sooner--and

with less risk--than they do by mail.

When the systems develop to

point-of-sale use, terminals at the supermarket counter, for example,
can be used to reduce costs and risks much further, by built-in
processes for the verification and truncation of checks, and
validation of customer balances or credit.
It looks like the initial stages of both the San
Francisco-Los Angeles and the Atlanta systems would become
operational before the end of 1972.

Looking on with interest are

at least 22 other commercial banker groups that we know to be in
various stages of study or design of city--or area — electronic
payments systems.
As for the Federal Reserve, we have already agreed to
supply space, equipment and management for electronic clearing
houses to serve both the San Francisco-Los Angeles and the Atlanta
systems.

I am certain everyone who comes up with a practical design

--one that will receive and can handle a high volume of payments at

-3reduced costs—and with firm pledges of money and management to
market the new services can be assured that we will give them at
least as much help.

That is not our only interest.

We see the

proliferation of these local electronic payment systems as
creating nod es that can be linked together, via Federal Reserve
communications, into a national system.

This would be the primary

implementation of the general substitution of electronic payments
for checks that the Federal Reserve Board looked forward to in its
June 1971 policy statement on improving the payments mechanism.
Rather than go back into the important history of the
foundation laying of the better payments system that is now
coming into being, I want instead to focus now on what is
happening in the watershed year of 1972.
In effect, as Governor George Mitchell has put it,
the Board's June 1971 policy statement called for all possible
efficiency to be squeezed out of the check while a paperless
payments system is brought on line.
This challenge was taken up by the Federal Reserve
System Steering Committee on Improving the Payments Mechanism
headed by Governor Mitchell and on which I now serve.

On the

basis of intensive study by the Steering Committee, the Board
in February issued Guidelines for the establishment and operation,
under the supervision of the Federal Reserve Banks, of Regional Check
Processing Centers--RCPS.

-4The Federal Reserve Board's Guidelines made a number
of crucial decisions, which include:
--Host of the new clearing centers are to be located at
the 37 places where Federal Reserve offices now exist: the 12
District Banks, the 24 Branch Banks and our Miami office.
--The clearing regions surrounding our offices are to be
as large as optimum use of transportation facilities permits for
afternoon and evening gathering and processing of checks deposited
that day, and delivery of those checks for payment the next morning.
--The new system will make maximum use, consistent with
improved service to the public, of check processing centers
operated by commercial banks.
--A clearing center will accept from participating banks
in its clearing region all checks written on other participating
banks in the region.

From the Federal Reserve member banks in the

region, it will accept all items wherever they originate.
--Participating banks must agree to payment for their
checks upon the day of presentment, in immediately available funds.
--Participants should exclude checks drawn on them and,
generally, those performing check processing services for other
banks should exclude items drawn on banks they are servicing.
--As an assist to small banks, participating member banks
may send in up to 2,000 unsorted items daily.
One of the important requirements for use of an RCPC--a
requirement that completes the circle of higher productivity of demand

-5deposits--is payment, in immediately available funds, upon the day
checks are presented.

In March, the Federal Reserve Board proposed

an amendment to Regulation J, covering check collection, that would
require all banks using Federal Reserve check collection services to
give payment in immediately available funds for their checks the same
day they are presented.
optimistic that it will —

If this proposal becomes final—and I am
banks contemplating participation in an

RCPC will not need to look over their shoulder to see if a nearby
bank, by staying out of the RCPC, is going to get early credit for
many of its checks, while making deferred payment.

This is a matter

of equity that is essential if we are to have a banking system that
benefits from a healthy level of competition, because it places
ail competitors on the same payments taw line.
Why the RCPCs?

Why the emphasis upon moving toward

electronic transfer?
Modernization of the check payments system is not a
matter of choice but a matter of timely preparedness.

You might

call the difficulty the check payments system is in, a problem
with the least recognition for its size.

The fact that we have

a major problem looming in the operation of the check payments
system, but that practically everybody concerned is reasonably
happy with the check system as it now stands, is perhaps the most
difficult aspect of reaching a solution, because it tends to
unusually suppress acceptance of change.

-filler e, briefly, are the numbers.

As I indicated earlier,

we are writing some 66 million checks per business day right now.
That is approximately 24 billion checks a year.

Almost all of

those 24 billion checks are, in effect, a special piece of currency,
created for one transaction only, that has to pass through complex
and repeated identification, verification, accounting and sorting
operations--to say nothing of the large amount of transportation
involved--before it is retired.
dollars yearly right now.

These checks transfer some 16 trillion

The best available estimates suggest that

by the end of this decade, we will be using some 44 billion checks
a year, unless we are able to switch a substantial part of our
payments instructions into more efficient--that is, electronicchannels .
Checks require so much human attention, despite all
the banking industry has done to develop and install automated
handling devices, that on the growth curve x/e are climbing—
doubling check usage every 10 years--we xd.ll soon overrun the
amount of lox; cost clerical help available for such work (and that
type of help will be decreasing, as more people are educated).
So the unit cost of handling a check is bound to go up.

It will

go up not just because it will require banks to bid for more
people from a shrinking labor pool.

It will rise also because

wages will rise relative to productivity in such x^ork.

And it will

rise also because—if nothing is done--of the indirect costs

-7associated with the amount of nonproductive assets tied up in
uncollected balances.
There will come a time--again, unless very substantial
changes in our payments system intervene--when two things x-zill
happen to the banking industry, one possibly only a disaster,
the other merely a calamity:
--There will be a disastrous piling-up of checks in
the back offices, slowing down financial transactions, multiplying
errors, and impeding the transactions of the entire nonbanking
part of the economy which looks to banking for swift, smooth
money settlements.
--There will be a calamitous loss of public satisfaction
with bank services, as banks seek to preserve their soundness by
passing on mounting check handling costs to the users of checks.
Businesses, which keep a sharper eye on their balances, will
revolt first, and seek alternative, nonbanking means of making
and receiving payments.
Following that, banks will be assailed by an outcry
by housewives who will come to realize that the checking account
they have always thought of as an inexpensive and very useful
service is becoming an expensive convenience.
What this all adds up to is something centrally importanta severe loss of productivity in our principal financial sector:
banking.

Ours is a high-consumption, high-transaction, large-scale

-8economy that can only succeed if productivity increases in
every sector of the economy where it can possibly do so.

If

productivity declines at the financial heart pump of the economy,
all other sectors will be affected, perhaps in greater degree.
This cannot be allowed to happen.

That is why we in

the Federal Reserve are doing all we can, as quickly as we can,
to strengthen the banking industry by increasing—through revisions
such as now proposed in Regulations D and J--equity among banks,
by increasing the productivity of the check payments system through
the RCPCs to make the check system operate at acceptable cost
levels for as long as possible, and, meanwhile, encourage and
prepare for large-scale payments transfer by electronic means.
IJhere do we stand right now?
Let me touch on St. Louis--just to suggest that in the
RCPCs, and in demanding immediate payment, we are not doing anything
that commercial bankers themselves have not long accepted as a
normal way of doing business.

There has been an RCPC operating

in Greater St, Louis for half a century.
It got started back in the 1920's for reasons that no
one now recalls.
growth.

And it has had a record of slow, continuous

This, and particularly the fact that as new banks in the

Greater St. Louis area have come into being, they have joined up-suggests a high degree of acceptance.

I am told that within its

area--roughly 15 miles out from the St. Louis city limits--this

-9grandfather RCPC serves 69 banks at a processing center in the
St. Louis Federal Reserve District Bank, doing a nightly check
volume averaging 366,000 items, all on an immediate "good money"
payment basis.
Every bank in the area covered is a member, with the
exception of one small bank on the outer fringe.

Management of

the Center reports no complaints from participating banks.
There is another RCPC with a long enough lifetime-a history of growth and evident satisfaction among participants-to be encouraging.

This is the until recently "experimental"

Baltimore-Washington RCPC.

It began operations in January 1970.

And just today it expanded from 109 to 128 banks.

Before expanding,

volume averaged over 1,000,000 items each business day.

In the

area it covers there are only two banks that are not participating.
But they have informed the Richmond District Bank, which started
this experiment, that they will come in when the proposed new check
collection procedures under Regulation J are in effect.
This is in line with a considerable number of enquiries
x*e have had, indicating that many banks regard the earlier credit
they will get in the RCPCs as an offset to the earlier payment
they must make for their checks under the proposed change in
Regulation J.

-10Other history in the Baltimore-Washington Center would
appear to be of interest.

It was set up with five specific

objectives for improving the productivity of demand deposits in
participating banks.

These were:

1.

Earlier collection of items.

2.

Earlier credit on checks.

3.

Earlier return of unpaid items.

4.

Reduction of check kiting.

5.

Reduction of commercial bank float.

A survey of the then 96 participants in this RCPC found
that all five objectives had been accomplished.

Furthermore, the

survey indicated that both large and small banks found benefits in
the arrangement.

The distribution of dollar gains and losses to

individual banks appeared to be as much a factor of individual
bank management finesse as of dollar trade-offs resulting from the
changed way of doing business.
An RCPC in and around Chicago went into operation at
the beginning of April.

It has 282 participating banks, with a

daily check volume of about 900,000.

The Center reports that

since it got going, only one bank had asserted a \ i s to pull
r.h
out, for what was found to be a trivial and easily remedied
reason.
The Kansas City Federal Reserve District Bank has two
RCPCs currently in operation.

These are expanded zones of

immediate payment around Kansas City and Denver.

The Kansas City

-11region includes 97 banks, with a daily check volume of about
410,000.

The Denver Branch Bank is operating an RCPC with

142 participants sending in approximately half a million checks
each business day.

Our Kansas City management reports that it

would rate acceptance in the two RCPCs as better than 90 per cent.
Kansas City adds two items of information that I want to
pass on to you.

First--the larger banks have been active in selling

the RCPC to their correspondents.

Second--these larger banks have

encouraged small banks' participation by making adjustments in their
correspondent balances.

This last item is of very considerable

interest to us, since we are aware of some apprehension among
independent bankers that they will not get such adjustments.
The Kansas City experience demonstrates two things:

no such

assumption can be taken for granted, and, where reasonable
adjustments to the new situation are not forthcoming, a little
competitive pressure might do wonders.

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