The Federal Reserve in the U.S. Payments System

The Federal Reserve plays an important role in the U.S. payments system. The twelve Federal Reserve Banks provide banking services to depository institutions and to the federal government. For depository institutions, they maintain accounts and provide various payment services, including collecting checks, electronically transferring funds, and distributing and receiving currency and coin. For the federal government, the Reserve Banks act as fiscal agents, paying Treasury checks; processing electronic payments; and issuing, transferring, and redeeming U.S. government securities.

By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check clearing system. The System was to provide not only an elastic currency that is, a currency that would expand or shrink in amount as economic conditions warranted but also an efficient and equitable check collection system

Congress was also concerned about some banks’ paying less than the full amount of checks deposited by their customers because some paying banks charged fees to presenting banks to pay checks. To avoid paying present­ment fees, many collecting banks routed checks through banks that were not charged presentment fees by paying banks. This practice, called circuitous routing, resulted in extensive delays and inefficiencies in the check-collection system. In 1917, Congress amended the Federal Reserve Act to prohibit banks from charging the Reserve Banks presentment fees and to authorize nonmember banks as well as member banks to collect checks through the Federal Reserve System.

In passing the Monetary Control Act of 1980, Congress reaffirmed its intention that the Federal Reserve should promote an efficient nationwide payments system. The act subjects all depository institutions, not just member commercial banks, to reserve requirements and grants them equal access to Reserve Bank payment services. It also encourages competi­tion between the Reserve Banks and private sector providers of payment services by requiring the Reserve Banks to charge fees for certain pay­ments services listed in the act and to recover the costs of providing these services over the long run.

More recent congressional action has focused increasingly on improving the efficiency of the payments system by encouraging increased use of technology. In 1987, Congress enacted the Expedited Funds Availability Act (EFAA), which gave the Board, for the first time, the authority to regulate the payments system in general, not just those payments made through the Reserve Banks. The Board used its authority under the EFAA to revamp the check-return system, improve the presentment rights of private-sector banks, and establish rules governing the time that banks can hold funds from checks deposited into customer accounts before making the funds available for withdrawal. In 2003, Congress enacted the Check Clearing for the 21^st Century Act, which further enhanced the efficiency of the payments system by reducing legal and practical impediments to check truncation and the electronic collection of checks, services that speed up check collection and reduce associated costs.

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