2004 Fed Forecast: Enhanced Electronic Payments

Third quarter 2004 is right around the corner, and the Federal Reserve Bank's Financial Services Policy Committee (Minneapolis) still has plenty of issues to address. With the Check 21 deadline rapidly approaching, the committee is tackling topics ranging from check and electronic payment services to research in non-cash retail payments. Claudia S. Swendseid, SVP of the committee, spoke with Bank Systems & Technology's Cynthia Ramsaran on the organization's goals for 2004 and what it is currently doing to move the financial services industry gracefully from paper to electronic checks.

BS&T: What are the key technology-related projects/goals that the Federal Reserve Bank's Financial Services Policy Committee (FSPC) is aiming to accomplish this year?

Swendseid: The Federal Reserve, as mandated by the Monetary Control Act (MCA), seeks to offer check services to all depository institutions (DI) at prices that fully reflect our costs over the long run. Achieving full cost recovery is inevitably more challenging as the volume of check usage declines. Thus, a critical issue that the Federal Reserve faces is how to respond to the decline in paper check volumes and the pressure that puts on our ability to recover our operating costs. The check processing industry, generally, is confronting this same issue. Reduced demand for paper checks, reflecting marketplace forces, has led to overcapacity for the Federal Reserve and the broader industry overall - an industry that is characterized by many participants and competitive pricing. Consequently, the Federal Reserve is reducing its check processing infrastructure.

We have begun to close 13 of our 45 offices (announced in 2003), taken steps to streamline our adjustment and FedImage infrastructure, and have been cutting costs aggressively across the full range of our check business. Also, the Federal Reserve has recently completed a multiyear effort to upgrade and standardize its check technology platforms, so that DI customers will have access to the same check processing, adjustments and image services regardless of location. This effort, called "Check Modernization," positions the Federal Reserve to improve operating efficiencies and reduce costs, as well as speed our ability to adapt to future market-driven change in retail payments.

The Check Clearing for the 21st Century Act, or Check 21, has been vigorously supported by the Federal Reserve. We see it as a means of enabling the marketplace to achieve greater efficiency and reliability in payments, proceeding at its own pace and in its own way. The Federal Reserve also expects that Check 21 will provide a benefit in terms of risk mitigation. Check 21 will help alleviate the danger of checks being lost or delayed during transport. As clearing time shrinks, credit risk is reduced as well. Indeed, the Federal Reserve's experience in the aftermath of 9/11 focused our attention on the value of electronification from the reliability standpoint. The interruption of air travel - and check transportation - in the days after the 9/11 attacks pushed the Fed's check float up to over $47 billion, more than a hundred times the normal level. In its role as a provider of check services, the Federal Reserve is preparing to support the industry's best use of options under Check 21.

Managers of the Federal Reserve's electronic payment services are engaged in an initiative to map out the potential characteristics of our next generation of electronic payment services and supporting infrastructure, including technology. As part of this process, we are analyzing the major attributes of current and expected payments. While this initiative is still preliminary, we hope it will help us assess far-reaching questions, such as the desirability of producing new payment mechanisms that combine features of current retail and wholesale offerings. This effort will require that we use not only the best available assessments of the current payment dynamics but also ongoing Federal Reserve survey-based research on the demands and payment priorities of corporate end-users and the distribution of non-cash retail payments.

Thus, the Fed will continue to develop our products and services and expand our electronic payments capacity in response to marketplace evolution and our customers' needs. At the same time, we will take steps to foster an environment for improved payments-system efficiencies and vibrant private-sector innovations.

BS&T: How is the Federal Reserve responding to changes in the retail payments environment?

Swendseid: Regarding the changing retail payments environment, observers of the U.S. payment system generally agree on two broad trends. The first is the accelerating movement from paper-based to electronic payments. The second is the blurring of alternative payment mechanism boundaries. The Federal Reserve is seeking to respond appropriately to both of these changes.

Fostering understanding of payment system trends through market research has been and continues to be an important responsibility of the Federal Reserve. As a result, much of the data to confirm that the trend toward greater reliance on electronic payments and less on checks comes from Federal Reserve-sponsored research. Indeed, Federal Reserve-sponsored analysis has documented an absolute drop in check volume occurring at some point between 1995 and 2000.

Research conducted by the Federal Reserve Board's staff reinforces the notion that the adoption of technological change is a highly complex process with a very large number of factors determining a household's willingness to adopt new technologies for the consumption of financial services. Recently the Federal Reserve announced that it will be conducting research in 2004, similar to that conducted in the late 1990s to 2000, to allow us to further assess the pace of change in non-cash retail payments.

In addition to this type of survey research, the Federal Reserve believes in the benefit of continuing dialogue and collaboration with other payment system stakeholders, both providers and users. In that vein, the Federal Reserve, through its Payment System Development Committee (PSDC), sponsored a major conference on the payment system in transition, which brought together end-users, financial institutions and other payments providers.

BS&T: Gary Stern, president of the Federal Reserve Bank of Minneapolis, said last October that it is important to encourage the move to electronic payments from paper checks. Is the Federal Reserve doing anything to facilitate the adoption of electronic payments?

Swendseid: Central banks like the Federal Reserve have long-standing interests in the effective operation of payment systems due to the critical role that a well-functioning payment system plays in a country's overall economy. At the Fed, this interest manifests itself in a number of ways, including but not limited to research and analysis, regulation and supervision, and direct provision of financial services. As noted above, the Fed has and will continue to conduct market research on payments trends and share the results with the industry. With respect to migration to electronic payments, this information should help the industry develop effective plans that support marketplace payment preferences - in particular, electronic versus paper payments.

BS&T: How does the committee use technology to foster its initiatives?

Swendseid: The FSPC, like the executive leadership of most other large, complex organizations, seeks to ensure that its investments in IT resources are aligned with financial services priorities and provide value. In addition, IT resources that support Federal Reserve financial services must provide high reliability, resilience and security in a 24/7 environment. These attributes are even more important as we migrate further to Internet/Web-based technology.