Federal Reserve Takes a Bath on Paper Checks

Declining check volumes, and the prospect of more to come as a result of Check 21, has led the Federal Reserve to predict a sharp increase in the price of paper-based payment services.

Even as President Bush signs the Check 21 legislation into law, last week's Federal Reserve announcement of fee schedules for 2004 shows the impact that declining check volumes have already taken on back-office economics.

The Federal Reserve, which provides payment-related services to financial institutions, expects the price index for paper-based payment services to rise 5.9 percent in 2004. That's the result of both volume declines and the costs of restructuring initiatives. "Higher-than-anticipated volume declines, as well as a shift by customers to lower-priced check products as a result of low interest rates, have resulted in check service operating revenues in 2003 running $26.9 million below budget," writes the Federal Reserve in an Oct. 22 notice.

The budgeted change in paper check volumes for 2003 was a 1.9 percent decline; the actual year-to-date figure, through August 2003, was a decline of 4.8 percent.

The decline in check volume will only accelerate given the passage of Check 21. Although the legislation will help the industry as a whole, it will certainly made it difficult for the Federal Reserve Banks to hit its budget targets. "Check 21 presents risk to existing volumes, pricing, and product strategies," writes the Fed.

Furthermore, the price increases for processing paper payments should only accelerate the trend towards electronic payments. Indeed, the price index for electronic payment services " including FedACH, Fedwire funds and electronic check products " is slated to decline by 1.2 percent in 2004.

That creates conditions for a downward spiral for paper checks, according to NACHA spokesman Michael Herd. "With a decline in check volume, there are fewer items over which to spread the fixed processing costs, making each item more expensive."

"Prices are then raised, which makes checks less attractive, further lowering volume," Herd writes. "A vicious cycle ensues."

Correspondingly, there's a "virtuous cycle" for increasingly cost-efficient electronic payments, he adds.