Fed trims check processors as payments system evolves

Northwestern Financial Review, Sep 1-Sep 14, 2004 by Bengtson, Tom

The Federal Reserve announced August 2 it will discontinue check processing in nine locations by early 2006, reducing its total number of check processing sites to 23. In 2003, the Fed had 45 check processing centers when it announced it would close 13 sites by the end of 2004.

While the Fed maintains it is committed to offering check processing services nationwide, at least one consultant says the Fed should get out of the check processing business all together. "It would be more efficient to shut down the Fed network," said Bert Ely. The Alexandria, Va.based industry observer said that as check volume declines, the Fed is not raising its processing prices sufficiently to cover its costs. The shortfall, he said, amounts to a taxpayer subsidy, which he said should come to an end.

The Monetary Control Act of 1980 requires the Fed to price its check processing services so that it covers its costs and earns a profit equal to what it would earn if it was a profit-sector firm. Ely notes the Fed missed its profit target by $155 million last year. As check volume declines, Ely said the profit shortfall this year will be larger than the $69 million the Fed estimated last fall.

Ely said if the Fed strictly followed the Monetary Control Act, it would raise its prices, which would make the service less attractive and further reduce its volume. Eventually, the Fed would have no choice but to exit the check processing service. Today, the Fed would have to raise its prices by 29 percent, Ely said, to be at a breakeven point in costs.

Referring to the Fed's August 2 announcement, Minneapolis Federal Reserve Bank President Gary Stern said: "These changes are intended to improve the efficiency of our check operations while maintaining highquality check services to depository institutions nationwide." Stern is head of the Fed's financial services policy committee. "Streamlining our check infrastructure is only part of the Reserve Bank's strategy to improve efficiency; for example, we are also launching new products and services to support the implementation of the Check 21 Act in October," he said.

None of the nine centers to close are located in the Midwest, with the exception of the Detroit facility which will be merged into the Cleveland site. Rumors had circulated that the Helena branch of the Minneapolis bank would lose it check processing service, but that has proven to be inaccurate.

"Not only are fewer checks being written, but paper checks are increasingly giving way to electronic alternatives," said Stern. "While this makes for an increasingly efficient payments system, it also means that we must shift work among offices, and unfortunately, some dedicated staff will lose their jobs."

The Reserve Banks will reduce their check processing staff by about 270, representing about 6 percent of their current check processing employees. In the offices where check processing will be eliminated, about 640 positions will be affected. The Reserve Banks estimate they will add about 370 positions at the offices that will continue processing checks.

In 2003, Reserve Banks' check volume declined at about a 7 percent rate. During 2004, check volumes have declined at an accelerated pace, and such declines are expected to continue in coming years. A 2001 Federal Reserve Study revealed that about 42 billion checks were written in the United States in 2000, down from about 50 billion in 1995. The Reserve Banks will release an updated version of that study later this year.

Further accelerating the decline in check volume is the rising number of checks that are being converted to an electronic format through accounts receivable conversion, or ARC. One expert cited by the American Banker newspaper expects the number of checks converted through ARC to double in 2005 to 2 billion compared to current levels.

By Tom Bengtson