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Fed may phase out paper check processing in 10 years

How quickly will the payments system change over the next few decades? Will a "checkless" society ever come to fruition? These topics were addressed recently by Dr. Donald Kohn, Vice Chairman of the Federal Reserve System Board of Governors at a payments symposium in Las Vegas.

In a prerecorded video, Kohn gave his perspective on the continually evolving payments system and the Federal Reserve's future role in it. His remarks were played on Sept. 11 to over 200 attendees of the Western Payments Alliance Payments Symposium 2006.

This date was appropriate given what occurred in the aftermath of the 9/11 terrorist attacks and how it is changing check processing.

"The attacks highlighted the banking industry's extensive reliance on air transportation as planes came to a standstill, and the collection of checks slowed dramatically," Kohn said.

"This prompted a heightened focus on how electronic processing technologies could be applied to the check collection system to ... improve check processing efficiency."

The result: In October 2004, the Check Clearing for the 21st Century Act, or Check 21, took effect. Check 21 allows for a paper check to be converted to a paper substitute - an electronic image replacement document, or IRD. The "electronification" of checks is rapidly increasing, Kohn said.

He gave the Federal Reserve Banks' latest Check 21 volume as an example. More than 6 million checks a day (about 17% of the total checks deposited at the central bank) valued at $20 billion are now deposited using the Fed's Check 21 products. And this number is growing.

"Check 21 has begun to diminish the importance of geography and physical transportation in check processing," Kohn said. "And banks have started to re-engineer their back-room processes to accommodate end-to-end electronic check clearing."

New Fed study coming in 2007

That's not all that's changing, though. Kohn cited shifts in consumer behavior, rapid industry innovation, and legal and regulatory change as factors dramatically reshaping the payments system.

"Because of the increasing availability and declining cost of convenient electronic payment alternatives, many payments that were, until recently, being made in paper form are today being made electronically," he said.

Given these changes, the Fed plans to repeat its triennial survey of retail payments. Its most recent study, "Analysis of noncash payments trends in the United States: 2000 - 2003," revealed dramatic changes in consumer behavior.

For the first time ever, the number of electronic payments in the United States, including credit, debit and automated clearing house (ACH) payments, surpassed check payments.

Kohn attributed part of the shift in payment behavior to changes in the ACH network's rules and regulations. Now the network can be used for one-time nonrecurring payments. (In the past, it was used mainly for recurring payments such as payroll and mortgage payments.)

Purchases made in stores, over the telephone and online are completed using the ACH. The rules also now allow the use of the ACH to convert consumer checks mailed to businesses or presented at the POS.

Changes coming at the Fed

The rise of electronic payments has caused the Federal Reserve Banks to reduce by half the number of their paper check processing operations.

In 2003, they had 45 offices across the United States versus 22 in 2006. By 2008, they will have 18.

"Perhaps sometime late in the next decade, the Reserve Banks may process checks at only a single office nationwide," Kohn said. He added it's also possible in the next 10 to 20 years the banks will only accept checks that are deposited and can be presented electronically.

"Any remaining paper checks may have to be cleared through other channels," he said.

Since its inception in 1913, the Federal Reserve has been closely involved in overseeing the nation's payments system. It also competes with the private sector as a provider of certain retail payments, such as check and ACH services.

The Fed periodically re-examines its role in the system. The most recent assessment was conducted in the late 1990s by the Committee on the Role of the Federal Reserve in the Payments System, also known as the Rivlin Committee. It determined the Fed should continue to provide those services.

However, Kohn said, "As we move into a more steady state of an electronic check environment, the Fed may find it appropriate once again to review its longer term operational role in the retail payments system.

"Clearly, at that time, the Federal Reserve's national reach will no longer be a compelling reason for its operational role." He added that a "marked" shift will occur in the next three to five years "once the glide path to electronic processing" is clear.

"The Fed will continue to foster a safe and efficient payments system," Kohn said. "This shift away from paper and toward the electronic processing of payments has significant ... implications that all must ponder.

"An ongoing dialogue ... will help us address in a balanced and thoughtful manner these important issues that affect the long-term strategic direction of the U.S. financial system."

Nonprofit WesPay is the nation's oldest ACH association. It represents nearly 1,000 financial institution members and more than 100 corporate members in the Western United States and Canada.

The organization is a founding member of NACHA - The Electronic Payments Association and participates in the rule-making processes that govern transactions flowing through the ACH.

WesPay's Payments Symposium covers key trends and issues facing the industry. Payments Symposium 2007 will take place Sept. 9 - 11 at Harrah's Hotel & Casino in Las Vegas.

To listen to Kohn's speech in its entirety and for more information on WesPay, visit

Article published in issue number 060902

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