Financial Update (April-June 1999)

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Advice to the Fed

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Improving the Nation's Payments
System: Advice to the Fed

I f the Fed wants to remain a leader in the nation's payments system, it must become involved in promoting image technology, improving automated clearinghouse (ACH) and electronic check presentment (ECP), and responding to check fraud, said Allen Lipis, chief executive officer of Global Concepts, a payments system consulting company in Atlanta. In a recent presentation to Atlanta Fed staff, Lipis detailed ways that he believed the Fed could concentrate its efforts to help improve the nation's payments system.

Checks and Image Technology

Lipis urged the Fed to undertake a major study of checks similar to the check survey the Atlanta Fed helped lead in the late 1970s. Although use of ACH transactions, credit cards and debit cards has grown, the use of checks has not decreased — in fact, national check usage is now at an alltime high of about 67 billion checks per year. Lipis predicted that these more automated alternatives will not replace checks any time in the near future.

There are some options for making checks more efficient, however. Image technology for checks should be more fully utilized, said Lipis, because imaged checks have lower substitution rates and higher encoding rates per hour and are easier to archive than paper checks. To help banks accept image technology for checks, Federal Reserve Banks should serve as regional image archives, he continued. Images would be stored and available for retrieval on demand. But there are some obstacles to this approach, including legal and technology issues and customer acceptance. Currently the Fed archives images of the checks it processes, and every district offers image storage. The Fed does not, however, store images of checks processed by other check processors.

Federal Reserve Conducts Retail Payments System Study

T he Federal Reserve is conducting a study of the nation's payments system to better understand why various methods of payment are used by consumers, businesses and government. The objective is to understand the recent changes in the retail payments system — smart cards, debit cards and other forms of electronic payment — and the extent to which consumers and businesses are satisfied with the various options available to them.

According to Rich Oliver, retail payments product manager for the Federal Reserve's financial services policy committee and senior vice president of the Atlanta Fed, the Fed is "particularly interested in identifying the barriers to greater use of electronic forms of payment. We also hope to use the results of the study to help work together with the industry to make the payments system more efficient and effective."

Phases of the Study

The first phase of the study has begun and is focusing on compiling a synopsis of existing literature and data; this phase should be complete by late spring 1999. The second phase will involve quantitative research using direct surveys of consumers, businesses and financial institutions to establish a definitive baseline of information on payments initiatives. This phase should be complete by the end of 1999. The Fed plans to share the results of the study early in 2000. For more information, see the Fed's Financial Services Web site at www.frbservices.org.

Electronic Check Presentment

To further improve the nation's payments system, Lipis believes that ECP should be reengineered. ECP is a process in which delivery of a check's magnetic ink character recognition file, as opposed to delivery of the physical check, constitutes presentment of the check. Currently, banks have to agree to receive and send ECP files to one another, and not every bank has the capacity to send files.

Lipis favors an ECP system requiring receivers to be senders, in which a multilateral agreement of accepting ECP files instead of physical checks exists across the industry. These changes, according to Lipis, would redesign check clearing and reduce Fed check volume, which has continued to grow nationally since the 1950s.

ACH Improvements

As another step to improve payments efficiency and reliability, Lipis suggested ACH improvements such as faster clearing, more products and direct sends, which are ACH items exchanged between two financial institutions or a financial institution and a receiving ACH operator. In addition, Lipis recommended eliminating prenotes, which are ACH entries with a zero dollar amount that are sent ahead of a transaction to notify that the entry will soon begin. He also recommended that customers be allowed to change accounts without reverting to a paper transaction process. According to Lipis, the Fed should also increase promotions for ACH, an initiative that the Federal Reserve System has undertaken after the recommendation of the Committee on the Federal Reserve Payments Mechanism, led by Federal Reserve Vice Chair Alice Rivlin.

Combating Check Fraud

Banks lose between $700 million and $1 billion each year because of check fraud. Current techniques used to combat check fraud — signature verification and random check review — are not working, Lipis said. One way banks are seeking to reduce fraud is through transactional analysis. In this process, a bank contacts a customer to verify a transaction if there are irregularities in the check's serial number, paper stock or amount.

Some banks and large corporations are also using positive pay to eliminate fraud, he said. With this method, the bank sends a customer an electronic copy of the check. The customer then verifies that the check is legitimate, and the bank pays the check.

In closing, Lipis urged the Fed to provide strong leadership for image technology, electronic check presentment and automated clearinghouse, to reduce check fraud and to develop other payment initiatives in order to help the nation's payments system move forward.

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