West Coast banks are easing California's budget gridlock by accepting IOUs instead of checks, but the processing costs are making them think twice about continuing the practice.

In the wake of a budget impasse that has frozen state funds since July 1, the state of California last week began paying government employee wages, income tax refunds, and other bills with registered warrants rather than with checks.

The registered warrants are essentially interest-bearing promissory notes payable when the budget is passed.

Good Will May Have Limits

As a service to customers, almost all California banks have been honoring the warrants as though they were regular checks. But as budget negotiations continue to stall, banker's patience could run out.

"It's a fair statement that California hits the wall on Aug. 1," said Jay Ziegler, a spokesman for the California State Controller's office. "The good will of the banking industry has kept the budget impasse from creating a lot of hardship so far, but it's clear [bankers] don't intend to continue this way for long."

To date, the state of California has issued about 81,000 registered warrants, valued at around $75 million, and most of these cover income tax refunds.

Volume to Rise

However, bankers anticipate increased volume after state payroll checks are mailed out next week. July 15 is payday for about 12,000 transportation workers, and by month's end almost 200,000 state employees will have received IOUs in place of their monthly pay-checks.

"By land large, bankers aren't thrilled to be cashing the warrants, but they realize that their customers need to pay their utility bills [and] their mortgages, so they are offering it as a special service," said Nancy Badely of the California Bankers Association.

If the budget impasse continues to the end of July, the Controller's office expects that bankers will have in essence lent the state $2 billion.

Paltry Payback Expected

And since the warrants carry an annual interest rate of only 5%, none of the banks interviewed for this story expect to garner much compensation for their trouble.

"We have not fully assessed the cost implications yet, but it's pretty clear we're not going to make anything from this," said Betsy Graves-Mahan, vice president in government relations at First Interstate Bancorp, Los Angeles. "What remains to be seen is whether it will cost us."

In addition to cost considerations, bankers are concerned about fraud. Although banks make funds from the registered warrants available immediately upon deposit, it's difficult to authenticate the item before it is paid by the government.

Special Procedures

Wells Fargo & Co. and other institutions are working with the state to come up with a system to verify warrants more quickly.

To handle the warrants, California banks have had to set up special procedures in their check processing and accounting departments.

First Interstate, for example, adjusted the sorting patterns in their check processing system to pull the warrants out of general circulation. The items are then typically forwarded to the accounting department, which will redeem them when the budget is passed.

However, the smaller institutions are having a harder time adjusting, and many of them have no choice but handle the warrants manually - an expensive and time-consuming process.

"There is no way we could use a computer system to handle them at the moment," said a spokesperson for American Savings Bank, based in Irvine.

To complicate matters even more, the state has indicated that it may not be required to issue warrants in place of pay-checks.

This raises the specter of hosts of unpaid state employees, and several banks have said they would feel compelled to set up special loan programs to help their customers through such an ordeal.

All of this will be moot, of course, if and when the budget passes. But observers said a protracted stalemate is likely at this point, and if the deadlock continues beyond Aug. 1, "the state will be passing along a lot of hardship," said Mr. Ziegler of the Controller's office.

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