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For Release on Delivery March 17, 1987 12:00 noon, E.S.T. 9:00 a.m., P.S.T. Remarks by Wayne D. Angell Board of Governors of the Federal Reserve System before the National Automated Clearing House Association San Diego, California Remarks of Wayne D. Angell before the Annual Conference of the National Automated Clearing House Association March 17, 1987 It is a pleasure annual conference. a group whose to be here this morning at NACHA's 1987 I find it particularly rewarding to meet with focus is on applying technology to improve the nation's payments system. interested society's in programs resources. As that The an economist, promote ACH I more system am especially efficient has proven uses of to be an efficient and reliable payments mechanism, and holds even greater promise for the future. My remarks today will relate not only to the ACH, but also to issues that will affect electronic payments systems generally. First, I would like to discuss why the Federal Reserve's role the payments system is important, and why we at the Federal Reserve are committed to enhancing the integrity of the payments system. and some of the efficiency Second, I will briefly review why the ACH is a very important part of this commitment. address in Finally, I will issues confronting the payments mechanism today, both policy and operational, and look at some approaches for addressing those issues. Congress established the Federal Reserve System in the early days of Woodrow Wilson's presidency universal belief in response that the banking system ~ the early years of this century — was the near- as it functioned in inadequate needs of an increasingly complex economy. to to meet In part, these the - concerns related system. banks to the 2 - inadequacies of the check collection Checks often traveled through a series of in correspondent a highly circuitous route before they were paid. When the checks finally were cleared, they were typically settled ©b a non-par basis. The establishment of the Federal Reserve in 1913 altered the nation's payments system in three important respects. reduced the to the extent that transfer funds using a single along with it need for banks to maintain their complex network of correspondent balances to clear checks least First, the and Federal other payments, at Reserve member banks could reserve account balance. This, Fed's role in processing and collecting checks, brought long-needed efficiency to the check collection system. Second, the need to provide account access to reserve balances for both funds management and payments purposes quickly led to the establishment network. convenient Fedwire of a national wire transfer operations began in 1914, using the telegraph system and Morse code to transmit messages between Reserve Banks. This laid the foundation for the Federal Reserve's long-standing commitment to electronic payments. window safety net that is discount important tool in ensuring the integrity of the payments system. Thus, the Federal was a Fed's an Reserve provided Finally, the in part created to promote operating efficiency and to ensure the safety and soundness of the payments system. The Fed has sought, throughout improvements in private sector. such the its history, to payments mechanism in cooperation with the It is this cooperative approach that has yielded impressive results over the years. The establishment and continued enhancement, of the automated clearing house just stimulate one example — but an important one — of the Federal Reserve and private sector system is of the joint efforts to achieve a common goal. Some observers are critical of the progress of the ACH, because the volume is relatively insignificant when the number of check payments. of the ACH. public's increasing Over the last decade, private sector use of the ACH has grown at an percent. to Although our early estimates were overly optimistic, we are encouraged by the acceptance compared average annual growth rate of 26 And, in 1986, commercial ACH volume exceeded government volume for the first time, with slightly over 700 million commercial and government ACH transactions processed by Reserve Banks. During its relatively short become increasingly A relied on the decade the ACH system has more efficient and attractive; contributing to this progress is its evolution system. history, ago, physical to virtually delivery of a more fully electronic all depository institutions magnetic tapes listings to originate or receive ACH transactions. or paper Today about a third of total ACH dollar volume is delivered electronically; and - 4 - in some parts percent. the of the country, this figure is as high as 70 The automation of return items has also contributed system's to improved efficiency, by cutting the return process by more than two days. In addition Federal to Reserve increased operating automation, consolidation of sites and improved operating systems have decreased significantly the unit cost of Federal Reserve ACH services. During the past four years, for example,, unit cost has declined at an average annual rate of 10 percent. One of the greatest beneficiaries of the ACH system has been the federal government. In the mid-1970s, the Social Security Administration and the Treasury Department were facing a dilemma. Treasury's operations were not equipped to handle the ever- increasing volume of paper checks that were issued on Social Security. behalf of It either had to make a massive investment in new equipment to handle the growing check innovative alternative. ACH proved to solution. Today, of Social Security 44 The percent volume, or be find the an perfect recipients receive their benefits via the ACH. While the Treasury used the ACH to curb its mounting check volume, some banks hope to use it as a efficiency of the check system. bank, often called certain check vehicle to enhance the Although truncation at the payor safekeeping, is very successful in segments of the industry, it still requires checks to be transported physically to the payor bank or its agent. If the banking industry and the benefits,'checks must be stream. Federal Reserve are to reap the full truncated earlier in the collection The ACH is being used to transmit payment information in the only interbank check truncation However, program now in operation. this program is progressing slowly, with only about 200 thousand checks truncated each year. Substantial increases in possible in the near interbank future. truncation volume are We recently began exploring the possibility of using truncation to solve one of the problems with "nuisance checks." the rebate check. A perfect example of the nuisance check is Rebate programs generate millions of low value checks that require significant resources on the part of both the Federal Reserve and the industry to handle. checks would Truncation of these provide a much more cost effective answer, and may provide a significant growth opportunity for the ACH. This potential use of the ACH as well as you will be many others that discussing today and tomorrow should contribute to significant future volume growth and increasing improvements in the efficiency of the nation's payments system. Now, I would like payments more broadly. must be addressed. to focus on the future of electronic I believe several very First, how will country's financial industry evolve and have access risks and to the payments system? operational risks the what important structure issues of this institutions will Second, how can the credit associated with rapidly growing volumes of payments be controlled? Finally, how do we ensure that the cooperation between the Federal Reserve and the private sector continues? One of the more controversial banking issues is that of access to the payments system by nonbank nonbank banks are typically portrayed regulation and more competition opponents are painted as banks. for as Proponents advocates financial of less services, while advocates of greater regulation. like some other members of the Board, am opposed to removing barriers between banking and commerce. lead I, the I hold this view in part because I believe that the combination of may of commerce and banking to greater regulation of the marketplace, not less. will elaborate on this point later, but first I want to I discuss the access issue. The Federal institutions critical to as Reserve believes intermediaries the safety of independent credit judgment defense a against undue risk. corporation transfers to facing amounts in the that it This bank-provided protection may owned the payments system. provides They the process is exercise an first line of For example, a bank may insist that financial that that the role of depository difficulty limit its funds can cover with collected funds. disappear by an unregulated holding company. when bank is Hill a bank be able to impose such restrictions on a financially ailing that corporation controls the bank? the corporation if 7 Nonb^nk bank proponents argue that a "Chinese wall" would be erected between the bank and its corporate affiliates. to However, ensure that that wall is standing and structurally sound, the same apparatus that is used to examine and regulate industry might have to minimizing important the objective. corporations under banking be applied to the nonbank bank and its parent and other affiliates. issues, the In dealing with financial structure need In for my the regulations view, banking should bringing regulatory compelling argument against the removal of be nonfinancial apparatus the an is a banking-commerce wall. Another issue that commands much of our attention is the risks inherent in the payments system. We at the Fed, and you in your banks and corporations, have seen a constant acceleration in both the number of payments. payments and the dollar volume of those Demand-pull and technology-push give us a transaction velocity that would have been unthinkable, a decade ago. For example, on January 20 of this year, an unsurpassed dollar volume of payments — nation's of over large-dollar payments volume $1.5 trillion — was processed funds transfer networks. leads to increased risk on the This escalation and increased potential for disruption of the entire financial marketplace. A year ago, the Fed implemented policies to reduce risks on large-dollar payment networks. encouraging. The results to date have been The level of daylight overdrafts in relation to the dollar volume of funds transfers has declined last March. frequently An is overdrafts." appropriate overdraft important "what is Rather level, an than one problem question that acceptable the 23 is level percent since raised quite of daylight Federal Reserve determining the ultimate solution may be pricing. to the daylight Today, since charges are not imposed on the use of daylight overdrafts, there are inadequate incentives for institutions to minimize their overdraft position. Pricing could provide the needed incentive. concept raises a number attention of both the Recently, in conjunction of Unfortunately, complex issues, which require the Federal Reserve with and issuing the several public comment that are designed to reduce credit the Board asked pricing daylight the this public for overdrafts. I its hope industry. proposals for risk further, views on the concept of your organization will provide its comments to assist us in our analysis. Another proposal deals with controlling risk in the ACH. While the ACH is an effective substitute for the paper check, is an inadequate transfers. increases Use of temporal substitute the ACR for for many such large payments dollar to the risk for the originating institution. large-dollar networks, the potential for high about future risk. funds volume and securities growth funds significantly we recognize that risk on the ACH system today is fairly compared it raises While minimal transfer concern One objective of the ACH proposals is to improve the credit and operating, controls significant. in the system before the risk It is imperative that both the industry and the Fed do their part to ensure that as the ACH continues risk becomes does not grow commensurately. to grow, the I won't address the specific proposals at this time, since they are the subject of a panel discussion later this morning. Another issue related to payment system risk is reliability. The Federal Reserve, communities, now have improved reliability in devoting significant as well a our as the heightened payments attention to banking and corporate awareness of the need for systems. We have been contingency processing. many of you know, the System has a contingency processing As center in Culpeper, Virginia, that is designed to provide back-up in the event of an processing. The outage, including back-up ACH for However, we realize that this alone is not adequate. Federal contingency extended Reserve processing Bank of center New York to enable operations in the event of an outage. has it established to a continue its We are looking at longer term approaches to solving this problem, including the concept of having the Reserve Banks serve as back-up for each other. The Federal Reserve has not only been looking at improving reliability but also at other potential changes to our electronic payment systems. phase of The Fed staff has recently completed the first a major study on the future of our electronic payments - systems. 10 The study delves into requirements do the - a number of questions: banking and corporate communities have for the design of electronic services in the next decade? the demands for timeliness different types of service What payment be available? of processing messages? What What and delivery hours should are of the Does it make sense to have one format for all electronic payments, as we have one MICR line standard for checks? Cooperation between the Federal Reserve and the private sector will be a critical factor in developing answers questions. the constructive criticism and suggestions that are provided by the industry public aspect comment of cooperation these is the One to process. A good example of this is the proposal to allocate the cost of ACH float through the use float factor. of a The comments we received on this proposal raised significant concerns with the learned in approach we had suggested. We a lot from these comments, and are now in the process of developing a different approach to recovering ACH float. In contrast to our initial timetable, we no longer plan to implement a change in the way we recover the cost of ACH float in 1987. As an economist, I tend to view most business terms of an economic model. decisions in The determination of the optimal electronic payments system for the 1990s is no exception. We intend making to follow an economically rational decision approach that will evaluate the costs and benefits of maintaining - 11 the current approaches. system Of contrasted with adopting alternative course, in considering the costs of alternative approaches, the transition costs will also be factored model. into the From this exercise, we hope to design a system that will provide greater benefits than the current payments system at a lower cost. But simple. as you know, in economics things are never quite that Defining the societal alternatives is benefits no small task. aware that these decisions will and costs of various And, of course, we are all well not be made in a political vacuum. In conclusion, I would like to reiterate that cooperation in the development and operation of the payments system has key to success in the past. a Cooperation will be one of the keys to the future success of the ACH. Thank you. been
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