Academic journal article Economic Review (Kansas City, MO)

The Federal Reserve's Role in Retail Payments: Adapting to a New Environment

Academic journal article Economic Review (Kansas City, MO)

The Federal Reserve's Role in Retail Payments: Adapting to a New Environment

Article excerpt

The U.S. retail payments system is in the midst of a transformation. The shift from paper to electronics, the emergence of new instruments and payments channels, the rise in non-bank participation, the change in risk profiles--all are elements of this new landscape. The Federal Reserve takes as one of its mandates fostering a payments system that is safe, efficient, and accessible. How does the Federal Reserve fulfill this mandate in this new environment?

Since its beginning, the Federal Reserve has played a crucial role in the U.S. retail payments system. From time to time, that role has been reevaluated, for example, in the 1980s with the publication of the White Paper and in the 1990s with the report of the Rivlin Committee. (1) The current environment suggests the time may be right for another examination.

Other central banks are facing similar issues. The Bank for International Settlements (BIS), for example, has published two important studies in recent years analyzing the role of central banks in retail payments and payments oversight. The European Central Bank (ECB) also has examined such issues and has recently proposed a framework for the oversight of card payment schemes and standards. The Reserve Bank of Australia has just completed a review of its policies with respect to retail payments, and the Bank of England would be granted explicit payments oversight authority under a bill recently sent to Parliament. Experience in these and other countries may be helpful in thinking about the Federal Reserve's future involvement in payments.

This article reexamines the Federal Reserve's role in retail payments in light of the evolving payments system. The first section reviews the changing U.S. payments landscape. The second section explores conceptual issues inherent in central bank involvement in retail payments, covering objectives, roles, and economic rationales. The third section examines perspectives from other countries that may prove useful. The fourth section assesses current Federal Reserve involvement in retail payments, while the fifth section looks to the future, offering a framework for thinking about key issues. The article closes with a brief summary. The principal message of the article is the Federal Reserve will likely continue to play an important role in retail payments. However, given the evolution of the payments system, the role the Federal Reserve plays and the rationale for this role may be different than they have been in the past.

I. THE EVOLVING U.S. PAYMENTS LANDSCAPE

It has become commonplace to describe the U.S. retail payments system as currently undergoing a fundamental transformation. But in fact this is true--unprecedented changes are occurring along many dimensions. Payments methods are shifting dramatically from paper to electronics. Payments processing is taking place amidst relentless technological change. Risk profiles are shifting. Market structures are changing, with rising concentration and controversial pricing increasingly reaching the public spotlight. And nonbanks are becoming more prominent throughout the payments chain.

The shift toward electronic payments has been striking. The most recent Federal Reserve study indicates that electronic payments now exceed two-thirds of all noncash payments. As recently as eight years ago, electronic payments' share was only 42 percent, and at the beginning of the 1980s, it was only 14 percent. According to 2006 data, 16 percent of all noncash transactions are now ACH payments, 23 percent are credit card payments, and 27 percent are debit card payments. ACH and debit card transactions are growing at particularly rapid rates--19 percent and 18 percent, respectively, over the past three years. (2)

This shift toward electronic payments is both organic and reflective of new payments methods. Traditional ACH transactions--for example, payroll deposits and government disbursements--and traditional credit and debit card transactions at point-of-sale (POS) continue to grow solidly. …

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