For release: Aug. 31, 2004

Contact:	Charles Henderson
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Federal Reserve Check Operations: What Are The Trends?

St. Louis — While both the number of checks written and the number processed by Federal Reserve Banks have been declining and may continue to do so, an analysis by the Federal Reserve Bank of St. Louis suggests that the Fed's check clearing offices became more efficient during the 1990s.

The analysis was done by David C. Wheelock, an assistant vice president and economist at the St. Louis Fed, and Paul W. Wilson, a professor of economics at the University of Texas at Austin. Their comments appear in the September/October issue of Review, the St. Louis Fed's bimonthly journal of economic and business topics. The publication is also available on the Reserve Bank's web site.

Data reveal that the number of checks written in the United States declined from 49.5 billion in 1995 to 42.5 billion in 2000. At the same time, the number of electronic payments increased by more than 14 billion items.

Prior to 1980, the Fed provided financial services to its member banks for free. The Monetary Control Act of 1980, however, required the Fed to charge fees for those services to both member banks and other depository institutions to cover (1) the Fed's expenses and (2) imputed taxes and profits that would be earned by a private firm providing similar services.

To study efficiency in the Fed's check clearing business, Wheelock and Wilson employed a new technique that enables researchers to look at "peer" offices—offices that are not only processing comparable volumes, but also are serving a similar number of geographic endpoints.

Wheelock and Wilson found that, on average, Reserve Bank check offices became less efficient between 1980 and 1982, when the pricing requirements of the Monetary Control Act were fully implemented. Efficiency continued to worsen to a peak in the third quarter of 1986. "Some of this is understandable," said Wheelock and Wilson, "as Fed offices were on a learning curve to adapt to the new requirements."

New settlement rules adopted in 1994 caused a sharp drop in the number of checks processed by the Federal Reserve. Moreover, the Fed's check processing volume has been declining since 1999, a trend that is expected to continue as electronic forms of payment become more popular. More recently, "Check 21" legislation, which will allow depository institutions to substitute printed reproductions of the original paper checks from digital images, has the potential to further reduce volume.

Wheelock and Wilson's analysis suggests that the technical efficiency of the input of the Fed's check processing offices, on average, declined after 1999. In the last several years,
however, the Reserve Banks have moved to improve long-run efficiency in their check clearing operations by migrating toward a common operating platform. The Federal Reserve has also begun to reduce its processing capacity in response to both current and projected declines in check volume.

"Because it's difficult—and costly—to reduce input amounts quickly, you would expect to observe a decrease in the efficiency of an office that's experiencing a sharp drop in check processing volume," said Wheelock and Wilson. "As a result, one should be cautious about drawing strong conclusions about performance from short-run fluctuations in estimated efficiency."

Wheelock and Wilson noted that some factors—check volumes in particular—are beyond the control of most check managers. At the same time, however, they concluded that the methodology developed for their analysis "could provide a framework for identifying differences that could help guide managers in their search for ways to control costs."

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve Banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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