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Into the '90s: Continuing Challenges for Payments System

Top of the Ninth

August 1, 1989


Thomas E. Gainor First Vice President

Into the '90s: Continuing Challenges for Payments System

As the melange of changes associated with deregulation and advances in technology work their way through local, national and international financial communities, the providers of financial services, including the Federal Reserve, will have to adapt their services even more rapidly and more profoundly than before.

The internationalization of money markets, for example, poses questions of legal and financial risk that must be dealt with by those providing payment services. On the national level, the expansion of interstate ownership of financial institutions has created a variety of new interbank relationships whose impact on payments systems and the associated accounting systems has yet to be determined. The technical community has contributed advanced computer and associated communications capabilities that have changed forever the speed and flexibility available to decisionmakers in financial markets. Ninth District institutions, small and large, have strong competitive motivation to accommodate and, if possible, capitalize on these new, challenging realities of the marketplace.

Within that fast-moving environment the Federal Reserve marks its 75th anniversary as an active and innovative provider of payments services in the Ninth District, a district that differs from other parts of the country in the large numbers and wide dispersion of small, independent financial institutions that share the financial services markets with the district's larger institutions.

The longstanding mission of the Federal Reserve, reinforced by the Monetary Control Act of 1980, is to promote efficiency in the payments system by assuring that economical, responsive services are available to financial institutions and the public throughout the district and the nation. Toward that end, our Ninth District staff have pioneered in the field of electronic transmission of check and accounting data and have made a serious commitment to the development of check truncation as a way to reduce the delays associated with collection of paper checks, especially in areas distant from the larger cities. Because of the long distances separating many Ninth District institutions from financial centers, these electronic services offer many Ninth District institutions particularly significant advantages in time and cost over ground transportation. At the national level, the Federal Reserve is experimenting with electronic check image transmission as a further step in the evolution from the movement of paper toward electronic transmission of payments information.

A number of other initiatives are afoot within the Federal Reserve System to improve its capacity to deal with the changes in financial marketplaces. Major improvements have been made over the last year in the reliability of the computer mainframes that handle Federal Reserve electronic transmissions. Considerable effort is likewise being devoted to the development of common software to be used nationwide for the electronic connections between Federal Reserve Banks and terminals at financial institutions. That will ultimately speed the handling of electronic payments through Federal Reserve hardware and software between financial institutions coast to coast. As these systems are developed, our challenge will be to make available the latest technology to handle the speed and volume requirements of the larger institutions, while at the same time providing equally responsive alternatives for smaller institutions whose lower volume requirements do not require such costly equipment.

A serious challenge facing the Federal Reserve in the delivery of its payments services is to find practical ways to reduce risks associated with the huge payments, more than $1 trillion pay day, handled by Fedwire, the Federal Reserve's high-value electronic payments system. One avenue is to reduce the risk of hardware failure by investing in backup hardware and logging systems that permit instantaneous recovery from equipment outages. Another avenue is to reduce the risk associated with intraday credit, the approximately $100 billion in daylight overdrafts that occur when the Federal Reserve delivers final credit to the accounts of receiving banks before the paying accounts contain sufficient balances to cover those payments. The Federal Reserve is considering a number of steps to reduce the volume and value of daylight overdrafts and to reduce the risks associated with those that remain. Crucial to any of these steps is the reliability and accuracy of the Fed's electronic transfer and accounting systems.

The costs associated with fault-free reliability and effective emergency backup are high and must be recovered in the prices charged for the services. In the face of these unwelcome economic realities, the Reserve Banks are seeking new ways to control or reduce those costs and the associated prices we must charge. One potential cost control measure is to reduce the number of mainframe computer installations used to process Federal Reserve transactions. Feasibility studies currently under way indicate the possibility that existing computer and communications technology might be capable of generating sizable savings by handling electronic payments requirements through fewer Federal Reserve computer processing sites.

The decade of the '80s, whose initial years included reexamination of the Federal Reserve's role in the financial services business, unleashed a lively mix of competitive energies both in the private financial services industry and in the Federal Reserve. An equivalent or greater measure of innovation and achievement will clearly be needed to guide the evolution of the U.S. payments system, and its international counterparts, through the challenges and changes of the 1990s. Federal Reserve staff, nationally and in the Ninth District, are looking forward to contributing their best efforts to that evolution.