Recent Developments in Consumer Credit and Payments

By Elul, Ronel; Ender, Joanna et al. | Business Review (Federal Reserve Bank of Philadelphia), Spring 2006 | Go to article overview

Recent Developments in Consumer Credit and Payments


Elul, Ronel, Ender, Joanna, Hunt, Bob, McGrath, James, Business Review (Federal Reserve Bank of Philadelphia)


Keynote speaker Gary H. Stern, president of the Federal Reserve Bank of Minneapolis and current chairman of the Federal Reserve System's Financial Services Policy Committee, opened the conference.

Stern began his remarks by pointing to the increasing quantity and quality of research on consumer credit and payments. While the Federal Reserve System is a significant producer of research in this area, it is also an important consumer because it acts as a provider and, in some instances, a regulator of payment services. As with monetary economics, good research informs good policy decisions, and this can be especially important when research challenges the conventional wisdom.

Next Stern described some of the differences between the objectives of private providers of payment services (profit maximization) and the Fed, which is to maximize social welfare. In particular, the Fed's mission is to encourage the efficiency, accessibility, and integrity of the payment system. Its ability to make improvements along these dimensions depends on the nature of competition in these markets, the significant network features of most payment systems, and any public-good aspects that arise in facilitating payments. Thus, one rationale for the Fed's involvement in a payment market might be the existence of significant market failure--too little competition or too little investment in security or reliability, for example--that cannot be more easily addressed by other means (such as regulation) (1) When such conditions no longer exist, however, perhaps the Fed should gradually exit the market.

Does economic reasoning inform the Fed's choice of which payment services to provide and on what scale? Stern argued yes, pointing to the Fed's recent decision to reduce its check-processing operations, which accounts for the majority of the System's staffing. The national check-processing market is declining about 10 percent each year. If the Fed does not downsize, it will account for an ever-growing share of the business. But the Fed has determined that there is no market failure in this market that would justify its becoming an increasingly important provider. Nor are there significant economies of scope between its check-processing operations and its other payment businesses.

In response, the Fed has decided to reduce its check-processing capacity while adjusting its prices to ensure that it recovers the full cost of providing these services. The Fed also supported the recently enacted Check 21 law, which will facilitate the electronic presentment of checks, thereby reducing the need to process and ship paper checks.

The market for automated clearinghouse (ACH) transactions has also experienced significant change, and the Fed is adapting. On the one hand, demand has grown dramatically, a situation that requires significant ongoing investment. On the other hand, private-sector providers have consolidated and are now increasingly competitive. While the Fed remains a dominant provider, its market share has fallen over time. improvements in information-processing technology, combined with significant economies of scale, have reduced the cost of ACH transactions, leading the Fed to reduce prices 66 percent over the past decade.

In each of these cases, economic research has aided the Fed's decision-making. Stern offered some examples of how economic research could influence the Fed's policy decisions in the payments arena in the future. First, what is the efficacy of alternatives to the Fed's provision of retail payment services when there are market failures? For example, should the Fed play a more significant role in standard setting, even where it is not an active service provider? Second, how will the electronification of checks affect the market structure and competitive conditions of the check processing business? Third, are the existing theoretical models of payment networks adequate for making policy decisions about whether and how to regulate interchange and other fees that arise in credit and debit card transactions?

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