Our payments system has not always enjoyed this high degree of confidence. In the 19th and early 20th centuries, a series of financial shocks battered the nation's economy.

A particularly severe crisis in 1907 was made worse when the system used to clear and settle check payments broke down. In response, Congress chartered the Federal Reserve System in 1913 and gave the Fed the authority to establish a national check-clearing system to improve the stability of the payments system. Today, the Fed supports confidence in the payments system by guaranteeing the large-dollar payments financial institutions make to each other over the Fed's electronic transfer system, Fedwire^®. And, should a financial crisis arise, the Fed can quickly inject cash into the banking system to maintain liquidity.

The payment services the Fed provides have expanded well beyond its founding check-clearing mandate. The Fed offers a variety of services -- primarily Fedwire funds transfers and securities transfers, check processing and the automated clearinghouse (ACH) transactions -- to financial institutions for clearing and settling of paper and electronic payments. In 1996, the Fed processed $464 trillion worth of payments in these services.

Prior to the passage of the Depository Institutions Deregulation and Monetary Control Act (MCA) in 1980, only banks that were members of the Federal Reserve System had access to these services -- services the Fed provided free of charge. The MCA radically redefined the Fed's relationship with its member banks and its participation in the payments system. The MCA required the Fed to open access to its payment services to all U.S. depository institutions and to charge fees for these services, thereby making the Fed compete with private clearing systems. It must recover, in the long run, all costs associated with providing payments services -- including imputed costs like taxes that would be incurred, the cost of capital, and profits that would be earned -- had the services been provided by the private sector.

Thus, the MCA imposed the same market discipline on Reserve Banks that private-sector firms face. To remain viable providers of financial services, Reserve Banks must meet the market's benchmark for quality and price.

Reorganizing Financial Services

In light of the changes brought about by the MCA and in recognition of the forces, like interstate banking and technological changes, that are reshaping the financial industry, the Fed set out to reinvent its management of financial services. This recognition resulted in the creation of the Financial Services Policy Committee (FSPC). The FSPC sets the strategic direction for Fed financial services nationwide. Under the FSPC umbrella, individual Reserve Banks serve as product and function offices for the entire System (see sidebar above). This restructuring transformed a regional approach to payments system innovation and delivery into one that is truly national.

The FSPC's primary objective is maintaining payments system efficiency, integrity and accessibility. This objective is accomplished by focusing on improvements in the Reserve Banks' automated systems and operating environments. Since the FSPC's debut, the Fed's ability to respond to customer needs in a changing environment has improved in a number of ways. One example is the account structure the Fed implemented in 1998 in response to the Riegle-Neal Interstate Banking and Branching Efficiency Act, which allows state-chartered banks to open out-of-state branches. Anticipating this significant change in the banking landscape, the Reserve Banks developed a single account structure for their customers that accommodates institutions operating in multiple states and Fed Districts. This allowed financial institutions with accounts at multiple Reserve Banks to consolidate them into a single account at their "home" Fed bank.

Promoting Electronic Services

The current management structure provides a vehicle for the Fed to aggressively carry out its long-term strategy: improving the payments system through the use of electronic technology. Several of the Fed's high-priority projects along these lines include:

Automated Clearinghouse -- The Fed's development of the automated clearinghouse (ACH) in the 1970s reflects an early effort to bring electronic technology to retail payments. While acceptance has been slow, businesses and governments are now making greater use of the ACH for recurring payments, like direct deposit of employee paychecks and Social Security payments. Since 1990, ACH transaction volume has increased roughly 16 percent a year, reaching 4.5 billion payments worth over $12 trillion in 1997 (see chart). This trend will no doubt continue as the federal government relies more heavily on the ACH to achieve its 1999 electronic payment mandate.

Electronic Check Presentment -- Although some 80 percent of the value of all U.S. payments move over large-dollar interbank electronic systems like Fedwire, these transactions make up less than 1 percent of the total number of payments each year. The reason for this lopsided bias is that Americans find that checks are a convenient form of payment. We write the lion's share of the world's checks -- some 65 billion per year. And, despite the increased use of electronic forms of retail payment -- such as debit cards and the ACH -- over the last five years, U.S. check use has continued to grow approximately 2 percent a year. This preference comes with a huge economic cost: The processing of paper checks is extremely labor intensive, requiring ground and air transportation and the physical handling of millions of checks each day. To bridge the gap between this high cost and Americans' continuing preference for paper checks, the Fed has focused on promoting electronic check presentment (ECP). ECP allows a bank that's collecting a payment to rush the critical payment information electronically to the paying bank. Whether or not the physical checks are returned to the check writer, the handling and processing costs are reduced. Right now, about 11 percent of all the checks the Fed presents are electronic.

Wire Funds Transfer -- Two important efficiency improvements were made to the Fedwire funds transfer system in 1997: The format was expanded, and the operating hours were extended. The changes affect both domestic and international payments markets. The format was expanded in response to industry interest in having more complete information about all parties to a funds transfer. It brings added efficiency to processing and posting transfers. The expanded format, which is similar to those used by international funds transfer and information services, permits increased communication across global systems. The operating hours for on-line Fedwire funds transfers were extended from 10 to 18 hours a day, enabling banks to move money earlier in the day and correspond more closely with settlements in international financial markets. The extended hours reduce risk by giving banks more time to settle their international transactions in the same business day.

Improving Internal Efficiency

An effective restructuring of the Fed's financial services management could not have been accomplished without a parallel effort in the systems that support these services. In this regard, the Reserve Banks are nearing completion of a five-year restructuring effort of their mainframe computer systems, enabling electronic payments like fund transfers and ACH to be handled at central sites, rather than at each of the 12 Reserve Banks.

Consolidation has allowed the Banks to launch new nationwide services and enhance existing ones at a lower cost. It also has dramatically improved the Reserve Banks' disaster recovery and information security capabilities, increased the Fed's ability to respond quickly to change, and expanded the central bank's management of payments system risk. Moreover, the consolidation effort gave the Fed a headstart on preparing its computers for the Year 2000. The consolidation process, begun five years ago, required new centralized applications for services like Fedwire funds and securities transfers, and ACH. All were designed with Year 2000 compliance in mind.

The financial services industry has already realized dividends from the Fed's increased efficiencies in processing Fedwire and ACH payments. These dividends include improved software to run these systems and a series of price reductions begun in 1995, which will generate a savings of $42 million in fees by year-end 1998 for Fed customers.

The Reserve Banks also have improved the efficiency of the other services they provide to banks and the public. The Fed consolidated the number of processing sites for its noncash collection service for maturing coupons and bonds from 27 to one and for savings bond operations from 24 to five. Along with the Treasury, the Fed also has introduced automated processing to the previously paper-based Treasury auction system, thereby improving the accessibility, integrity and timeliness of the Treasury securities auction process. Finally, the Reserve Banks have consolidated the handling of commercial tenders from 13 to three sites using the automated system. Overall, these changes have improved the reliability and security of many Fed services and have enabled the Reserve Banks to respond more quickly to changes in their own business environments and the demands of their business customers.

Fedwire^® is a registered trademark of the Federal Reserve Banks.

Click here for a TEXT-ONLY version of the Federal Reserve Bank of St. Louis 1997 Annual Report