Developments in the field of electronic money and banking

The following remarks are excerpted from a presentation by Gov. Kelley at the CyberPayments '96 Conference in Dallas, Texas, June 18, 1996.

Edward W. Kelly, Jr.

Published July 1, 1996  | July 1996 issue

The full text of the speech is also available on the Board of Governors' Web site.

... Let me now turn to the Federal Reserve's views of the potential impact of retail electronic banking and payments on the three primary central banking functions: monetary policy, banking supervision and the payment system.

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As for the conduct of monetary policy, in hindsight, it may seem surprising that there were concerns at that time about the impact of the ACH. Then as now, the potential impact on monetary policy of new electronic payment products has been greatly exaggerated. As with the use of the ACH [automated clearinghouse]. we would not expect that the expansion of electronic delivery of existing banking services will have appreciable effects on the money supply or the money markets. In contrast, "electronic cash" or other new electronic payment products, if successful, could gradually lead to shifts among different forms of money held by consumers and thus potentially affect the behavior of the monetary aggregates. Yet concerns about loss of "control" of the money supply are misdirected. In the last 20 years, major shifts caused by other financial innovations have led to some changes over time in the ways in which monetary policy is formulated, with the monetary aggregates now playing a lesser role. Moreover, financial innovation has not seriously undermined central banks' ability to implement policy, although adaptations have sometimes been called for.

Although growth rates of the money supply are no longer the central focus of monetary policy-making, the Federal Reserve still needs to monitor the monetary aggregates carefully in the policy process, and it will remain important that the aggregates accurately measure the various instruments that are being used as money. Accordingly, we do expect to include any significant amounts of new general-purpose payment instruments, such as balances on stored-value cards, in the monetary aggregates, and the Federal Reserve has the statutory authority to require any necessary reports from depository institutions. If new payment instruments were issued by nonbanks, we would expect to obtain voluntary reports from issuers, as we traditionally have done with travelers checks.

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Second, banking supervision. While any substantial implications for monetary and fiscal policy are well into the future, new electronic banking services could require changes in the way that banking supervision is conducted in the relatively near term. The Federal Reserve is responsible for examining and assessing the safety and soundness of bank holding companies, state-chartered Federal Reserve member banks, and U.S. branches and agencies of foreign banks. These examinations include a review of institutions' information systems, including security controls and contingency arrangements. Internet-based home banking services, as well as new payment products such as stored-value cards, have the potential to expose institutions to significant liability if security measures were breached for fraudulent or malicious purposes. Of course, institutions have strong incentives to protect themselves against these risks, and early indications are that the more sophisticated are investing considerable resources in doing so.

The Federal Reserve is actively monitoring developments in this area so as to be in a strong position to address any supervisory concerns that may arise. We are reviewing the way that we examine banks' information systems to address developments in electronic banking, among other things. However, banking regulators cannot possibly assess the adequacy of every Internet firewall or smart card. Rather, the role of regulators is to require policies and procedures to be in place within banking organizations to ensure that risks are identified and managed.

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The third main area of central bank responsibility is the payment system. It may be helpful to begin by considering the nature of payment systems and how they might be affected by new electronic payment products. First, all payment systems consist of money and the means of transferring money from one individual or organization to another. New electronic payment methods that can be envisioned do not change this fact, although they may result in different forms of money and new technology for executing transfers. Second, the payment system comprises several main sectors, ranging from large financial institutions that play a major role both as users and providers of many different payment services, to consumers and small businesses that primarily use smaller value payment systems. Of course, the Federal Reserve also plays a unifying role in the payment system as the provider of currency, interbank clearing and settlement services, and, in some cases, regulator.

New electronic payment products, such as stored-value cards and Internet payment services, are designed primarily to automate the billions of relatively small-value transactions involving consumers and nonfinancial businesses. The transactions involved are as diverse as the commercial economy of the United States, and the future needs for payment systems, both in traditional face-to-face business and in commerce over open networks such as the Internet, are evolving daily.

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As I have mentioned on previous occasions, however, I do not anticipate that the Federal Reserve will seek to provide a new retail electronic payment product in this emerging industry. In the 1970s, the Federal Reserve took a central role in developing the ACH system on behalf of the banking industry, and then explicitly subsidized operation of the ACH for some time. Now, 20 years later, circumstances are sufficiently different that we do not believe that a similar approach would be necessary or desirable to advance the efficiency and effectiveness of the payment system. There is no lack of private sector investment in providing new products and new means of delivering services to consumers. Experimentation is needed to determine which products best fit consumers' needs, but history has shown that the private sector, rather than government, is best able to perform this role.

The Federal Reserve is, however, examining ways in which we can support industry initiatives where appropriate. For example, we are currently reviewing our existing interbank net settlement services for check clearinghouses and private ACH operators and considering whether similar services could be provided for other monetary instruments that the banking industry may offer to their customers.

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History has shown that technological innovations can provide widespread benefits across society. The Federal Reserve welcomes private-sector investment and innovation to improve efficiency and effectiveness in all areas of banking and payments activities, while at the same time preserving the safety and soundness of the financial system. We are always open to discussions and suggestions from the industry in this respect and on any other issues involving emerging money and banking products. This is the strategy I expect we will pursue as experience with new electronic money and banking products unfolds over the next few years.