Trends in the Efficiency of Federal Reserve Check Processing Operations

rules adopted in 1994 caused the number of checks processed by the Fed to fall sharply, to a low of 15.5 billion in 1995.2 Although the Fed’s processing volume rose annually between 1995 and 1999, in 1999 the Fed handled 17.1 billion checks and volume has since been declining steadily. The Monetary Control Act of 1980 requires the Federal Reserve to charge fees for providing payments services, including check processing, to cover (i) the Fed’s expenses and (ii) imputed taxes and profits that would be earned by private firms providing similar services. Because of declining volume, the Federal Reserve recently determined that it must reduce the number of its offices that process checks to remain in compliance with the cost-recovery requirements of the Monetary Control Act. Legislation taking effect in October 2004 has the potential to reduce further the volume of paper checks processed by the Federal Reserve. The Check Clearing for the 21st Century Act, or Check 21, creates a new negotiable instrument, called a substitute check. Substitute checks are printed reproductions made from digital images of the original paper checks and are the legal equivalent of the original checks. The legal status of substitute checks will facilitate the truncation of checks and greater use of electronic check processing. It will thus replace some of the physical movement of paper checks from the banks where checks are cashed or deposited to the banks on which they are drawn or returned.