_33_ The U.S. central bank started out providing free check processing services to banks that were members of the Federal Reserve when it was established in 1913. Member banks held idle reserve balances with the central bank for the dual purpose of settling payment transactions and for monetary control (through the deposit multiplier). The main purpose for having the central bank also provide a check processing service was to eliminate the private bank and clearing house practice of non-par checking. Non-par checking was where checks deposited by customers were paid, not at face value or at par, but at a discount from par. This discount from par was how collecting banks covered their costs of collecting a check. However, the discount varied across banks according to their favorable geographical placement in the collection chain (higher discount) as well as their desire to attract correspondent deposits associated with clearing checks (low or zero discount). In order to minimize collection charges, collecting banks would attemp **t** o route checks through those correspondent banks with the lowest collection fees, even though this often was not the shortest distance to the paying bank on which the check was drawn. This led to circuitous routing of checks, increased payment float, and thereby inhibited commerce (Spahr, 1926).

The central bank was given the legal authority to collect checks for its member banks at par and, since this minimized collection and float costs, more and more checks came to be processed and collected through the Federal Reserve. To remain competitive in the check collection business, correspondent banks also insisted on being paid at par, threatening to otherwise collect items through the central bank. Finally, non-par banking was eliminated regardless of who-the central bank or a private bank-was the collection agent.

Prior to the pricing of Federal Reserve payment services in the early 1980s, the central bank's share of the check processing market was around 33%. After pricing, the4 Federal Reserve' **s** hare fell to around 25%. The remaining shares alf comprised of on-us items (<sup>3 0</sup> %) plus correspondent banks and local check clearing houses (45%). With the advent of interstate bank branching in 1997, U.S. banks will become larger and their offices more geographically dispersed. This will increase the proportiop of on-us checks and further reduce the check processing market share of the Federal Reserve.

In the long-run, the Federal Reserve will increasingly become the check processor of "last resort"; it will be used by only small banks for the purpose of offsetting the market power of large correspondent banks. As its market share dwindles, due to the growth of on-us checks, reciprocal _One widely quoted example of circuitous routing at the time concerned a check deposited at a bank in Hoboken, New Jersey, and drawn on a bank only 100 miles away in Sag Harbor, New York. This check '...passed through eleven banks, traveled about 1,500 miles, and was in transit about eleven days...' (Spahr,_ 1926, _p. 105). Almost every businessman, the primary user of checks at the time, had a similar horror story to tell about their ability to collect checks in a timely fashion._

**_44_** _On-us checks are those that are deposited at the same bank they are drawn on and so are processed internally._

_The last survey of U.S. checks was for 1979, before Federal Reserve payment services were priced. Thus these market share figures are estimates._ 46 _With the full implementation of nationwide banking and branching, the central bank's check processing market share may fall to 13 % to 18 % (Berger and Humphrey, 1988)._