Fed's Research Reveals Opportunities for E-Payments, But Obstacles Lurk

N ew data from the Federal Reserve suggests Americans may be writing fewer checks than most experts had reckoned. But don't interpret that to mean checks are on the wane. No matter how you view the Fed's latest payments research, Americans wrote nearly 50 billion checks in 2000 - a 55% increase over check numbers published for 1979. Taken together, check payments in 2000 had a total value of $47.4 trillion.

Electronic payments are gaining on checks - quite a bit, according to the Fed's data. The Fed's data collectors estimate almost 30 billion payments were initiated electronically in 2000. Included in the estimate are transactions initiated using general purpose credit cards, private label cards, offline debit (check) cards, online (PIN-based) debit cards, electronic benefit transfer (EBT) cards and the automated clearing house (ACH). Total value of all those transactions: $7.2 trillion.

The data, presented as "A Snapshot of the Retail Payments System," suggest huge opportunities for growing e-payments further, especially when viewed in the context of check usage.

Consider, for example, that most checks (51%) are written by consumers. A little more than 14% of checks written in 2000 were tendered at the point-of-sale, according to the Fed's data. An additional 6.4% of checks were characterized as "Remittance/POS." (These checks most likely were handled outside of automated POS or lockbox operations, the Fed conjectured.)

The Fed contends that all of these - about 10 billion of the estimated 50 billion checks written in 2000 - are ripe for conversion to electronic payments.

The Fed's research - the first comprehensive survey of the payments system in more than 20 years - is timely and of critical importance. Many of us who are old enough to remember attending the New York World's Fair in 1964 or devouring Alvin Toffler's 1970 tome, "Future Shock," would have expected that by now checks would be passé - messy reminders of the Industrial and post-Industrial ages.

Intuitively, we've understood for years that it was not going to be the case. But getting an accurate fix on the number of checks exchanged between consumers, businesses and government agencies has been a challenge. There's no central repository of information on check payments, and the multitude of clearing options - banks, clearing houses, the Fed and service bureaus - makes it tough to gather and compare numbers.

The only thing approaching a definitive study of payments was conducted in 1979 by the Federal Reserve Bank of Atlanta, and many of the estimates offered by analysts since then (myself included) have been extrapolations based upon results of that study.

In 1979, though, the ACH was a nascent payment mechanism, and no one had heard of ATMs, EBT or POS debit cards. In addition, credit cards were a relatively novel concept, embraced by a new generation of adult consumers - the baby boomers - to counter the effects of spiraling inflation.

About 10 years ago, the Bank Administration Institute, with advice and assistance from staffers at the Federal Reserve Board (in Washington) attempted a survey of interbank check clearings. Responses were spotty, though, and eventually that survey was scrapped.

The 2001 data collection effort was planned and performed by several reputable research and consulting firms, under the direction of a panel led by Roger W. Ferguson Jr., Vice Chairman of the Fed board of governors.

Actually, three different surveys were conducted, including analyses of a randomly selected pool of about 30,000 checks. Organizations providing data for the three surveys included 89 electronic payments providers (including Visa, MasterCard and the leading debit card networks) plus more than 1,300 financial institutions.

The Fed has a mandate from Congress to promote electronic alternatives to checks. Alice Rivlin, Ferguson's predecessor as the Fed's Vice Chair, took the mandate to heart and began an industry dialogue that opened the way for the "snapshot" that was published by the Fed in November. The Fed, in a press release at the time, said plans are to continue taking these snapshots every two to three years.

Cathy E. Minehan, President of the Federal Reserve Bank of Boston and a member of the Fed panel that commissioned the surveys, said the data shows the Fed has been successful in carrying out its electronic payments mandate.

"Not only do we have a much better idea about the size of the total retail payments system, we clearly see that electronic payments are taking a strong hold of the market and are poised for significant growth in the next few years," Minehan said in a statement released by the Fed.

But wait: In 1979, Americans wrote an estimated 32 billion checks; by 2000 that number had grown to 50 billion. That's an increase of 18 billion checks! Put another way: For every three new electronic payments counted in 2000, Americans wrote five checks.

Even more disturbing - and potentially in conflict with Fed assertions that e-payments are poised for growth - is a legislative proposal, sent by the Fed to Congress in December, for promoting check truncation.

In truncation, the physical movement of paper checks is stopped (at the bank of first deposit or the point-of-sale) and replaced with electronic exchanges, bank-to-bank, via the Fed or the ACH.

The Check Truncation Act (CTA), as drafted by the Fed, however, would introduce yet another paper document - a check substitute - to the payments system. Banks that can't or won't justify electronic check exchanges can print and/or request substitute checks - also known as image replacement documents, or IRD - to run through their check sorters. Each IRD would contain images of the front and back of a check plus a stripped-in MICR line to facilitate machine readability.

The Fed says the draft legislation aims to promote electronic check exchanges "while acknowledging that some payments system participants may prefer to continue receiving paper checks." Opponents - and there are plenty - say the plan as currently drafted is costly and a potential boon to check fraudsters.

In sending the legislation to Congress, the Fed raised the specter of 9/11. You may recall that in the days following the 9/11 attacks, airplanes were grounded nationwide. With hundreds of millions of checks stalled on America's runways, the Fed had to pump huge amounts of money into the banking system to sustain liquidity. Representatives of the banking industry say they're troubled by Fed references to 9/11 in its letter to Congress accompanying the draft legislation. Some fear the CTA could be tacked onto anti-terrorism legislation, which would place the measure on the legislative fast track.

Most, I suspect, simply hope the idea will die of neglect.

However well intentioned, the CTA as now drafted is a bad idea. We cannot simultaneously get rid of checks and print "substitute" checks for those banks that remain tied to paper. It simply defies logic.

The Fed, to be sure, is in an awkward position. By law it must provide payments services to all federally insured financial institutions, especially those too small to fend for themselves. The Fed also has a legal mandate to operate its payments business as a profit center. And, the Fed has been tasked to facilitate the transition from checks to electronic payments in the U.S.

The payments survey data released by the Fed in November shows that the transition from checks to electronic payments is occurring. In a little more than 20 years, retail electronic payments have grown from a nascent concept to a pool of nearly 30 billion transactions.

There are opportunities for growing this pool further, the most obvious being to convert to e-payments some of the 50 billion checks Americans write each year. Those opportunities could be undermined, however, with the introduction of a paper-based check substitute.

Perhaps it's time to require that all financial institutions clearing and/or settling transactions through the Fed be able to send and receive electronic check files. After all, it is the 21st century.