A national private alternative to the Federal Reserve's system for processing electronic payments such as bill payments and payroll deposits will begin operations in early January.

Citibank, Chemical Banking Corp., and Chase Manhattan Bank will be the first New York banks to join in the pilot. They will send electronic transfers via the New York Clearing House Association.

The pilot will also involve the 50 banks that use Visa U.S.A. to process automated clearing house items, and the 14 banks that are served by the Arizona Clearing House Association.

Streamlining the System

The arrangement is designed to reduce or eliminate most of the fees the Federal Reserve charges, and to build transaction volume on the private sector systems in order to reduce costs to members.

"The initial savings won't be significant," said Seymour Rosen, a vice president at Citibank. "But this is the forerunner of setting up in the ACH arena the same kind of alternative that already is available in the check arena."

The private sector exchange will streamline the current system. Currently, Visa sends New York-bound items to the San Francisco Fed, which in turn sends the items to the New York Fed. The New York Fed delivers the items to the New York Clearing House.

The Private Sector ACH Exchange, or PAXS, represents an example of private-sector rivals cooperating to compete more effectively with the Fed.

"We realized with the Fed consolidating [data centers] that they would have real economies," said George Thomas, senior vice president 6f data processing at the New York Clearing House Association. "Visa and we realized we had to work together."

Chase's participation in PAXS is slightly different than that of Chemical and Citibank.

Chase, the nation's largest originator of automated clearing house items, already exchanges electronic payments directly with Visa, and will use the New York Clearing House as a gateway only to the Arizona banks.

"This is a great step forward," said James Hopes, vice president of Chase Manhattan Corp. "Basically it puts the private sector on an equal footing with Fed delivery."

The plan eventually could pose a strong threat to the Fed's clearing house.

The Fed has had a virtual monopoly since the system was launched in the 1970s, until Visa entered in 1987, and went national last year.

Of the 1. 4 billion bank-initiated clearing house payments last year - largely direct salary deposits and automatic insurance premium payments - the Fed processed about 80%. Visa processed about 8.5%; the New York Clearing House about 9.2%; and the Arizona Clearing House about 2.4%, according to the New York Clearing House.

Few Participants

For now, PAXS will settle transactions using Visa's net settlement capability, which the Fed granted the processor three years ago.

But only a few New York banks are participating because of concerns that Visa's net settlement capability cannot handle settlement for the more than 600 New York Clearing House participants.

Banks in a debit position that are exchanging clearing house items on Visa settle by sending a wire transfer in the middle of the settlement day to a Fed account. When the debits have all been received, the banks in a credit position are paid from the account.

While the system work$ for the approximately 50 banks that today settle with Visa, bankers say the system would be unmanageable for the the New York Clearing House participants.

Mr. Hopes said the process creates a management problem when many hundreds of banks all need to get their wire transfers in by midday, and because clearing house and wire transfer areas are handled separately.

The New York and Arizona Clearing Houses settle by sending an electronic settlement entry to the Fed which gets posted on the evening of settlement day.

"Visa settles 12 hours earlier than we do, so it's less risky," said Mr. Thomas. "But Visa becomes cumbersome when more parties are involved."

So the New York Clearing House has asked the Fed for permission to expand its settlement capability to banks outside the second Fed district. A decision is pending.

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