Alan Greenspan: The payments system in transition
Remarks by Mr Alan Greenspan, Chairman of the Board of Governors of the US Federal Reserve
System, at the Federal Reserve Payments System Development Committee 2003 Conference,
Washington, DC, 29 October 2003.
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Introduction
It is a pleasure to be with you this morning and to add my welcome to this very important conference
on the payments system being hosted by the Federal Reserve's Payments System Development
Committee. The name of the conference--The Payments System in Transition--captures not only the
state of the financial services that we all use to make payments, but also the expectations of many
payments system participants as they look to the future.
Decades of incremental change have had significant cumulative effects on both our check and
electronic payments systems. Recent data show that the number of checks written in the United
States began to decline in the mid-1990s. In contrast, electronic payments, particularly debit cards and
automated clearinghouse (ACH ) transactions, have grown substantially and now total about 40 billion
per year. Overall, the number of electronic payments has increased almost fivefold in two decades
and, this year or next, may well exceed the number of checks written.
During the past few weeks, after substantial work by Congress and the financial industry, the Check
Clearing for the 21st Century Act, popularly known as the Check 21 Act, was passed. The new law
was signed yesterday by the President and will become effective next October. Passage of this greatly
anticipated statute is an important event for the financial industry. In preparing for the new law, the
industry has begun to discuss the types of check products and services it will provide to the public as
the infrastructure and rules for clearing and settling checks evolve.
Against this background of a system in transition, the participants in this conference will be debating
the future of the products, services, and infrastructure that support our broad and heterogeneous
national payments system. I hope we will all be enriched by this discussion and take home ideas that
will help shape the thinking of users of the payments system, suppliers of payments and financial
services, and public authorities, as they all work to improve and modernize the payments system over
the next few years.
Historical Perspective
For most of the post-World War II period, cash and checks have been the predominant instruments for
making retail and commercial payments in the United States. Public confidence in these instruments
and their usefulness for conducting transactions was built up over a long period of time, which
spanned national debates about the proper instruments and institutions to support a sound national
monetary system. A very large infrastructure for handling these paper instruments has been
developed and maintained by the private and public sectors. In the case of checks, for example, this
infrastructure includes offices, equipment, and staff for rapidly processing, shipping, and presenting
checks throughout the country, literally overnight.
The foundation of much of the current payments system infrastructure was laid in the 1960s. At that
time, a paperwork crisis was overwhelming the financial markets, as the rapid growth in financial
activity outpaced the system's ability to clear and settle financial transactions and payments using
traditional, manual processes. The response of both the financial industry and government was
twofold. Automation was applied to paper-based clearing activities. In addition, new electronic systems
for creating transactions and making payments were established where this seemed practical. In the
payments arena, the ACH and bank credit card systems and the beginnings of debit card systems
date from this era. Reacting to these developments and new systems, commentators of the time
predicted the advent of the "cashless" and "checkless" society. We know the history of these
predictions.
In reality, the 1970s saw a burst of creativity in the establishment of electronic payments systems but a
relatively slow rate of adoption by consumers and businesses. More recently, the 1990s saw a new
burst of creativity, including ideas for creating products called "electronic cash" and "electronic
checks," adapting existing forms of payment to the Internet, and experimenting with entirely new
payments systems. Work also began on projects to convert checks to ACH or other electronic
payments, at the point of sale or at lockboxes, to reduce the costs of processing and to speed the
collection of funds. Some of the results of these experiments are now gaining increasing acceptance in
the marketplace. Many more have not succeeded. Many lessons have been learned from these
experiences, and I am sure you will be discussing them during the next two days.
It would be easy to dismiss the experiments and predictions from the 1990s about change in the
payments system as hyperbole reminiscent of the 1970s. I believe, however, that the situations today
and in the 1970s are very different. First, although data on the use of cash in transactions is
notoriously poor, the nominal value of per capita holdings of small-denomination bank notes--those
used heavily in domestic commerce--is now growing very slowly, and the inflation-adjusted per capita
value has recently declined somewhat. More important for this audience, data from surveys conducted
for the Federal Reserve show that the use of checks in our society has now begun to decline. Second,
data on credit card, debit card, and ACH usage show very strong and sustained growth, to the extent
that electronic payments now account for about half of the number of all noncash payments. Third,
through the use of electronic payments, retailers and billers are continuing to seek productivity gains
and cost reductions in their transactions with consumers. Fourth, data from the Federal Reserve's
surveys of consumer finances show that over time households across most age and income
categories have been adopting basic electronic payment instruments, although, as might be expected,
younger households are in the forefront. Finally, the U.S. government is actively working on new
technologies and services to increase the use of electronics in both its payments and collections.
Taken together, these factors point to increasing use of electronic payments, when and where
economic factors press this outcome.
Public-policy perspective
From the perspective of public policy, the key objectives for the payments system have always been
economic efficiency and safety as well as confidence. Indeed, these broad objectives, which include
the goals of integrity, security, reliability, and accessibility, have been endorsed by the G-10 central
banks as international objectives for major payment systems in key reports published by the Bank for
International Settlements and used widely by the International Monetary Fund and World Bank. The
challenge is to bring these abstract ideas to bear on particular payments systems issues during this
time of transition.
Efficiency.
Turning first to efficiency, in the area of check collection, both the financial industry and the
Federal Reserve Banks face classic issues involving the adjustment of infrastructure to declining
demand. Moreover, various programs to convert checks to electronic payments at the point of sale or
the lockbox, or to truncate checks early in the collection stream, imply that the pace of decline in the
volume of paper-check clearings could well accelerate. However, checks also remain a highly
convenient payment instrument with a long and tested history; they are unlikely to be completely
eliminated as a major payment instrument any time soon. As a result, the financial industry and the
Federal Reserve Banks face the prospect of declining demand for paper-check processing, but also
significant uncertainty about the extent and timing of the decline. Nevertheless, we know that over time
the efficient use of resources will require reductions in excess production and processing capacity as
the market demand for checks and check processing declines.
In addition to managing resources to meet declining demand, the financial industry is also producing
innovations in check clearing and storage centered on the development of digital imaging and the
development of archives for these images.
The passage of the Check 21 Act is likely to invigorate these efforts and also to encourage a range of
new check-clearing techniques that are only now being envisioned. Overall, these changes suggest
not only a reduction in the scale of overall check clearing, but also a shift to new technologies and
services to meet remaining demand.
In passing, I would like to encourage banking organizations to participate in a new survey on check
usage that the Federal Reserve will be conducting in 2004--a follow-up to a similar survey conducted
in 2001. Improved data on check usage are very important in helping the financial industry and the
public adjust smoothly to the changes that are now in process.
In the area of electronic payments, the industry faces the opposite challenge from that in check
services. Continuing to meet the growth of electronic payment processing with highly reliable service is
an obvious priority from a public-policy perspective. However, simply accommodating growth may not
be sufficient, and consideration should also be given to meeting the changing needs of the users of
these systems.
One of the common misconceptions in the analysis of payments systems is that only production or
processing costs--that is, conditions of supply--matter from a market or public-policy standpoint. A
problem in early predictions of the growth of electronic payments was the lack of attention to the needs
of users, including the fact that electronic payments could be quite inconvenient and costly for many
purposes. In retrospect, it has taken years of investments in electronic infrastructure at homes and
businesses to support the use of electronic payments as a convenient and relatively low-cost
alternative to checks.
The emphasis in this conference on bringing users of the payments system together with the providers
of financial services demonstrates the importance of a balanced approach as we examine challenges
for the payments system. A number of these topics illustrate the need to identify the attributes that
users value and demand in payments systems--both in current systems and in the next generation of
these systems--and to determine how that demand will be met.
A particularly important topic is how electronic payments systems can better meet the needs of
business users. Business people frequently report that, from their perspective, a payment is only one
part of an overall transaction or relationship with a counterparty. Other parts include orders,
confirmations, shipping documents, invoices, and a variety of accounting and other information that
supports a transaction or relationship. The complexity of this situation has created challenges for
businesses as they integrate corporate information systems with electronic payment capabilities, and
this complexity has likely slowed the adoption of electronic payments for a wide range of business
purposes. I hope this conference will help underscore the need for businesses, financial institutions,
technology vendors, and payments system operators to find common approaches and standards for
addressing this issue.
Turning to questions of infrastructure, I particularly encourage you to discuss ideas for the future
design of the core U.S. electronic payments systems, including those of the Federal Reserve. Some of
the current designs date back several decades, and significant changes have taken place in both
technologies and business needs since that time. The markets will undoubtedly shape the use of
payments systems. However, there are only a handful of core systems and it is very important that
these systems be well designed so that they do not block market innovation.
I am particularly pleased that the Payments System Development Committee has over time focused
on barriers to such innovation. The overall payments system is built on complex rules, business
practices, and technologies. Change can often be difficult. In this situation, structures built up in the
past can become barriers to the implementation of new ideas. Where barriers do exist, it is important
to address them and, when appropriate, remove them, so that the market can provide us with new and
useful payment and financial products and services.
From a broad perspective, the Check 21 Act continues the work of our society to ensure that the
marketplace can respond flexibly to fundamental shifts in our technologies. The
act--appropriately-does not mandate that checks be truncated and turned into electronic payments, nor does it mandate
that all payments be made electronically. Instead, it strengthens a market-based approach to
innovation in the check-collection system. The act allows depository institutions to take digital images
of checks and truncate the original check, provided that they, or a subsequent institution, are also
willing to create a substitute paper check if one is demanded, and to bear the liability for doing so. The
act essentially removes an important barrier to innovation and frees depository institutions to apply
new technologies and market-based ideas to traditional check-clearing activities.
Safety and confidence. Safety and confidence are the other basic public-policy objectives for
payments systems. Sound designs, rules, and risk-management practices promote the safety of
payments for users and their financial institutions. Central banks have an ongoing interest in the safety
and integrity of payments systems, because they provide the infrastructure for transferring money in
the economy.
Public confidence in the payments system is a closely related concern. As I noted earlier, confidence
in the integrity of our basic paper payment instruments and payments systems was built up over a very
long period of time. It is not surprising that society has, at times, been cautious in adopting new
payment ideas. Attitudes toward payments systems are often closely linked to attitudes about money,
since such systems are the means of transferring money to meet a wide range of obligations.
If payments systems do not work well, that can have serious consequences for the wealth, plans, and
reputations of many individuals and businesses. In this context, it seems highly likely that prudent
users will require new systems to earn confidence with strong evidence that these systems will meet
their needs in both normal and exceptional circumstances. As we have seen, the process of building
confidence can take years, and most suppliers realize that confidence is an asset to be guarded
vigorously.
Recently payments systems have faced a number of challenges in the area of risk and risk
management. For example, as payments systems such as the ACH have been more widely used to
make payments over the telephone and the Internet, fraudulent transactions have reportedly
increased. Recent initiatives have apparently improved the situation, but the financial industry has
continued to express concerns about fraud and the need to address it.
I trust that all conference participants will focus on appropriate future risk designs and
riskmanagement practices. While the risk designs of some large-value payments systems have changed
significantly over the past few years, the risk designs for core retail payments systems have changed
less. Indeed, some of these designs continue to be based on concepts dating back to the 1970s.
Limited change may be the appropriate response. However, past designs and strategies should not
themselves become barriers to the development of future payments systems that are more aligned
with new forms of commerce and technology.
Another important issue in the post-September 11 environment is the degree of resilience of not only
our large-value payments systems but also our retail systems. Today, the mix of paper and electronic
payment options helps mitigate the risk of disruptions to retail payments in the event of terrorist
attacks, power blackouts, telecommunications disruptions, or similar infrastructure problems. As the
United States increasingly relies on electronic payments for retail transactions, however, the financial
system will increasingly need to ensure confidence in the resilience of these systems in a variety of
adverse circumstances. As always, heightened resilience has costs. If, however, high resilience is built
into new system designs and technologies as they are developed, it may be possible to mitigate these
costs while strengthening our infrastructure.
Conclusion
Over the next two days, you doubtless will be having many very useful discussions. This conference
provides an opportunity to address a range of significant topical issues, including the implementation
of the Check 21 Act, the direction of the financial industry as it adjusts to lower volumes of checks, and
the adoption of new technologies and business practices for electronic check collection.
In the area of electronic payments, there will be a variety of views on the development of services,
designs, and infrastructure for the next generation of systems. The challenge is both to have vision for
the future and to be grounded in the realities of the marketplace. Your insights on these topics will help
inform the ideas and actions of both the industry and public authorities during this historic period of the
payments system in transition.