Check 21, which became effective Thursday, is yet another reason that the volume of paper checks presented to paying banks will continue to decline rapidly.
The Fed has responded to falling volume by closing regional check processing centers to cut costs, but that is not enough. It must sharply raise its check processing prices.
The Monetary Control Act of 1980 obligates it to cover all out-of-pocket costs in processing checks and to earn a profit equivalent to those of its private-sector competitors. But last year the Fed missed its profit target by $155 million, after falling $69 million short in 2002 and $51 million short in 2001. And next year it will probably miss by more than the $69 million it forecast last fall.
These losses come right out of the taxpayer's pocket, because they reduce the amount of money the Fed returns to the Treasury.
The Fed board of governors will soon have the opportunity to begin meeting its profit obligation, when it sets its check processing prices for 2005. That may occur when it meets next Thursday.
Having substantially exhausted its cost-cutting opportunities while preserving its national check processing network, the Fed has no choice but to hike its prices.
As American Banker reported Oct. 14, the Fed recently projected a 10% to 11% drop in its check volume this year; last fall it forecast a 8.9% decline. Though the Fed forecasts a drop of 13% to 15% next year, it does not expect Check 21 to really hit before 2006.
In that year, as check imaging at the point of receipt or deposit takes hold, the Fed's check processing volume could drop to one-half to two-thirds the 2003 level. Further declines will almost certainly hit after 2006.
The strategy of responding to declining volumes through cost cutting has fallen far short of bringing the Fed in compliance with its profit obligation. By the end of next year the agency will have trimmed its check processing centers to 23 from 45. It did raise its check prices for 2004 by an estimated 5.2%, but as this year's financial results will show, that was grossly insufficient.
The Fed has tried to hold on to as much volume as possible by flying checks from cities with closed centers to remaining processing sites, but that is not working. The Fed could close a few more processing centers, but each closure would rip an even bigger hole in the fabric of its national check processing capability without materially reducing costs.
Within a few years the Fed must integrate its check processing network with the parallel network operated by commercial banks and third-party processors - or even get out of the business. Until it does, it must meet its profit target so that it is not competing unfairly against private-sector competitors that face the same volume-reduction challenges.
Some may argue that higher check processing prices will hurt the users of Fed services, but there is no valid public-policy argument for using taxpayer monies to subsidize a dying business.
Higher check processing fees actually will be quite salutary. They will give equipment manufacturers more revenue with which to improve the quality of check images. That will lead to more imaging at the initial stages of the check-handling process and will encourage paying banks to accept electronic images in lieu of the paper substitute checks authorized by Check 21.
Ironically, then, by holding down its check processing prices the Fed impedes the transformation of check processing from paper to electronic presentment.
The Fed's initial pricing for presenting electronic images and substitute checks to banks suggests that it will be charging more than for processing paper checks. The reverse should be the case.
Despite its substantial commitment to processing and moving paper checks around the country, the Fed has provided key leadership in improving the efficiency of the U.S. payments system, notably in developing and promoting the Check 21 legislation. Now it must follow through - and significantly boost its check processing prices.
It can and should start by sharply raising those for 2005.
