Did Nonpar Banks Earn Economic Rents ?

The payment functions of central banks vary among nations. Some central banks provide only limited payment services, such as issuing and redeeming currency and facilitating settlement among members of payments systems by transferring reserve balances.1 In the United States, the Federal Reserve has been a provider of payment services since the early 1900s. By 1918, the Fed had acquired a large share of the nation’s check-collection activities, especially in clearing interregional checks, and the Fed had begun processing wire transfers of reserves among banks. The Federal Reserve recently has been re-examining the appropriateness of its role in processing checks and automated clearinghouse payments (Rivlin 1997). To provide a more complete background for these deliberations, this article examines the validity of arguments for the Fed’s initial entry into its payment activities. Before the Fed was established, critics of the operation of the payments system argued that interregional check collection (collecting and paying banks located in different communities) was inefficient; they maintained that indirectly routing checks to avoid exchange charges by paying banks lengthened the collection process and resulted in higher operating expenses for banks than more direct routing from collecting banks to paying banks. An evaluation of whether Reserve Bank services made the payments system more efficient rests on the nature of the payments system prior to the Fed’s formation. Therefore, the first section of this article describes the payments system before Congress established the Fed, and the second section develops a theoretical framework for examining the effects of innovations on payments system efficiency. Subsequent sections describe the legal foundation of the Fed’s collection services, trace the development of Reserve Bank services, and examine the evidence for and against the argument for improved payments system efficiency.