It has been three years since the banking industry had a clear picture of its payments systems; meanwhile, paper checks have ceded their position as the leading payment method to electronic ones.
The decline of checks and the powerful growth of just about every type of e-payment are well documented, but the Federal Reserve System's first industrywide look at noncash payments since 2001, issued Monday, provides the hardest numbers yet to document this trend.
The numbers paint a compelling picture of consumers and businesses shifting to e-payments. And though the transition will eventually lead to a more efficient and less expensive system, it could bring some short-term pain.
The report, which covers 2003, found that banks processed 36.7 billion checks that year, or 12.4% fewer than they did in 2000. (The earlier study was published in 2001.)
At the same time, e-payments (automated clearing house transactions, credit cards, and debit cards) surged in popularity. The number of such transactions jumped 45.4% last year, to 44.5 billion.
The Fed predicts that by 2007 the number of credit and debit card payments should each exceed that of checks.
Richard Oliver, a senior vice president with the Federal Reserve Bank of Atlanta and the Fed's manager for retail payments, said all the factors that encourage electronic payments and deter the use of paper checks will accelerate.
"What we are seeing now is the door to a checkless society beginning to crack open," Mr. Oliver said. "For the first time in history we are seeing a payments system in demise."
The "2004 Federal Reserve Payments Study" said that checks had fallen at an average annual rate of 4.3% since the last report. But Mr. Oliver said the actual rates were more lopsided, with the drop intensifying between 2000 and 2003. He estimated that check use could end up falling by as much as 5% this year.
Debit cards posted the highest gains. Their use rose 88% between 2000 and 2003, to 15.6 billion transactions.
Mr. Oliver said that one of the reasons for the shift was that consumers are now comfortable using a debit card for small purchases, for which they used to pay cash. Fast-food restaurants now accept cards, for example, and anecdotal reports indicate that consumers are pleased, he said. "Debit cards are eroding the use of cash and, in some cases, replacing credit."
Credit cards, in fact, posted the smallest gains of all e-payment options. They rose by 21.8%, to 19 billion transactions. ACH payments, in contrast, increased 46.8%, to 9.1 billion.
One surprising result was that the number of returned checks is declining at an annual rate of 7.7%. "That caught us off guard," Mr. Oliver said. Banks have been more aggressive about offering overdraft protection, which lets them charge a fee to prevent a check from bouncing, he said.
Banks remain saddled with an extensive, fixed-cost processing infrastructure, he said, and a decrease in check use will drive up costs per item.
"In the short term the industry will have a significant amount of excess capacity on the paper side," which will probably cut into the profit generated by checks, Mr. Oliver said. "If a good piece of banks' payments profits are generated" from the check system, that part is being challenged.
Elliott McEntee, the president and chief executive of Nacha, the electronic payments system, said banks should be prepared for a shift that could take several years. He cited three things that could converge to drive down check use: businesses' converting paper checks into ACH payments, banks' starting to process checks as digital images, and the emergence of business-to-business e-payment systems.
If banks and their corporate customers aggressively promote all three things, within three to five years most payments could be processed electronically, Mr. McEntee said. If they do not, the transition could last as long as a decade.
In the meantime, banks will be faced with receding revenue from checks and the fixed costs for processing them. "That certainly could put a big squeeze on banks," Mr. McEntee said.
It is important to note that accounts receivable conversion - a process that lets lockbox operators convert paper checks into ACH payments - is having a significant and growing effect. Nacha reported that 160 million checks were converted using ARC in 2003; that figure should exceed a billion items this year.
Mr. Oliver said that because these checks are ultimately processed electronically, they are included in the e-payments total rather than the paper one.
Carol Malicki, a senior vice president and the strategic migration leader at Wachovia Corp., said banks need to manage this change carefully. Though they could lose some revenue, they could recoup it by offering new services based on e-payments, she said.
For example, Ms. Malicki said, Wachovia has introduced a consumer rewards program that encourages customers to use debit cards, as well as a faster positive pay service for corporate customers.
"I think there is some short-term care that needs to be taken," she said. "But if we're good at this, we will be better off."
One of the most significant conclusions of Fed's landmark 2001 check volume study was that the growth in check use was slowing. The study concluded that the number of checks written by people and companies in 2000 rose 28% from 1979 (the last time the Fed tracked a national total), to 42.5 billion - far below industry expectations.
The latest report included a slightly lower 2000 total: 41.9 billion.
In 2000 many bankers had believed check volume was 65 billion to 68 billion, Mr. Oliver said. "I used that figure myself in speeches," he said, so the Fed's report showing the estimate to be off by more than a third was a bombshell.
"There is a lot of value in knowing the actual numbers," he said.
