Financial Update (April-June 2000)


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Float in Check Clearing Creates Challenges for Banks and the Fed

The payments system is something that most people take for granted, and that’s really the way it should be. But within the payments system, there are some intricate processes that take place so that money reaches one bank account from another. The check clearing process is one that appears simple to the average check writer but is actually more complex behind the scenes. Some checks are routed through several banks before reaching their final destination. Anything that delays a check as it travels from one bank to another creates float.

Float in the check clearing process

In simple terms, float occurs when there is any delay between the time a check is received in payment and when the check finally clears. As a result of float, money in the banking system is counted twice because of delays in processing checks. More specifically, Federal Reserve float refers to money that appears simultaneously in the accounts of two depository institutions, which could be commercial banks, credit unions or thrifts. (In this article, the term bank will be used for simplicity’s sake.) Non–Federal Reserve float occurs when processing delays increase the time between the writing of a check, its deposit, and receipt of credit; this type of float could be caused by a depository institution having processing problems or choosing to close when the Federal Reserve is open.

Federal Reserve Banks do not collect funds from the banks on which checks are drawn until the checks are presented; therefore, anything that slows the check-clearing process can cause float.

Payment by check is by far the most popular form of noncash payment in the United States. Some estimates list check usage as high as 65 billion per year, which translates into roughly one check per business day for every person in the United States. When an institution receives a check for deposit, it provisionally credits the account of the depositor and later collects the funds from the bank upon which the check is drawn. Instead of sorting all the checks and sending each one back to the bank it was drawn upon for settlement, many institutions transfer their checks to Federal Reserve Banks for collection. In turn, Reserve Banks pay the depositing institution for the total amount of the checks and then collect the funds from the institution on which the checks are drawn.

When a Reserve Bank receives checks from a bank, it credits that bank’s reserve account for the checks’ amounts. Based on a prearranged availability schedule, a Reserve Bank gives credit for most checks the same or next business day and within two days for most others. The institution on which the check is drawn does not pay the Reserve Bank until the check is presented to it, however.

When a Reserve Bank credits a bank for depositing a check but has not yet collected funds from the bank upon which the check is drawn, float is created. Thus, both institutions list the funds on their books until the check is presented and the Reserve Bank collects the funds. As a result, both institutions have use of the same funds for a short time, and the amount of money in the banking system is briefly exaggerated.

What causes float?

Federal Reserve Banks do not collect funds from the banks on which checks are drawn until the checks are presented; therefore, anything that slows the check clearing process can cause float. Some types of float are so common that they have been named. For instance, holdover float occurs when there are delays at the processing institution. Malfunctioning check-processing equipment or delays caused by a large volume of checks can result in holdover float. This type of float tends to increase during the winter holidays, when check writing escalates.

Transportation float, as its name implies, results from delays in transportation caused by inclement weather, mechanical failures or air traffic delays. Though this type of float can occur year-round, it tends to increase in the winter months. When checks are returned from payor banks to the Federal Reserve because of insufficient funds, return-item float is created. Interterritory float or intraterritory float occurs when there are delays caused by transporting checks outside or inside a bank’s Federal Reserve district.

But float is not limited simply to checks. In fact, float can also be created or reduced by interruptions to the Fed’s wire transfer system. When errors are entered into the Fedwire system through incomplete or misdirected transfers, the errors are corrected with adjustments. When the adjustment is not made during the same maintenance period in which the problem was entered, then the adjustment is made in the next maintenance period, thus affecting reserve availability in both maintenance periods.

Reducing float in the 1970s and 1980s

During the 1970s the amount of float increased dramatically as the average dollar amount of checks increased because of inflation. This inflation, and the resulting rise in interest rates to combat it, gave large companies an incentive to use remote disbursement, a practice of drawing funds from faraway depository institutions in an effort to benefit from transportation float.

These factors, combined with general growth in the payments system, spurred the Federal Reserve to act. In 1973, the Fed established new regional check-processing facilities throughout the nation. The regional check processing center (RCPC) program was designed to reduce transportation float by expanding the areas in which checks are cleared on a daily basis. There are nine RCPCs in the country, not including Federal Reserve branches.

Payment by check is by far the most popular form of noncash payment in the United States. Some estimates list check usage as high as 65 billion per year, roughly one check per business day for every person in the United States.

During the late 1970s, the Fed’s Board of Governors modified check processing guidelines to limit holdovers to an average of 3 percent of check volume and increased staffing and equipment for check processing. The Fed also expanded its program of monitoring direct sends, which occur when banks send checks drawn on a bank in another district directly to that district bank instead of to their local processing center. The Board of Governors also issued a policy statement in 1979 criticizing and discouraging the practice of remote disbursement.

The largest factor in reducing float, however, was the Monetary Control Act of 1980, which directed the Fed to charge depository institutions for float. Some procedural changes in the 1980s further reduced float. One of these changes was the establishment of a nationwide noon-presentment policy allowing later delivery of checks to depository institutions in cities with Federal Reserve check-processing offices.

Developments in the 1990s

In the past decade, float has continued to decline even though the number of checks processed in the United States continues to grow. In 1990, the Federal Reserve processed approximately 16 billion checks; by 1999, that number had grown to approximately 18 billion checks.

In addition, technology has encouraged some consumers to prefer electronic payments in certain types of transactions. In this regard, the Federal Reserve has assumed a more active role in promoting alternative forms of payments, including automated clearinghouse transactions such as automated direct deposit of paychecks and direct payment of bills. These types of transactions and check, or debit, cards are gaining in popularity.

The controversy over float

Many researchers have argued that float is a detriment to the payments system because it causes resources to be wasted. In 1990, a study by David B. Humphrey, a professor of finance from Florida State University, and Allen N. Berger, a researcher at the Board of Governors, suggested that float is an incentive for consumers to continue writing checks. While this view is somewhat controversial, most researchers believe that float wastes resources because it encourages a delay of disbursement of funds on one end and an acceleration of presentment of checks on the other end.

In the long run, whether businesses and consumers decide to move away from check writing remains to be seen. But until more individuals and businesses adopt more automated types of payments, the Federal Reserve will continue to strive to provide an efficient check processing system that will work to keep float costs to a minimum.