Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

The Check Float Puzzle

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

The Check Float Puzzle

Article excerpt

Although the last few years have seen a dramatic surge in interest in new electronic payment instruments, consumers and businesses in the United States still write checks in vast numbers. Nearly 63 billion checks were written in 1995 according to one estimate, representing 78.6 percent of all noncash payments (Committee on Payment and Settlement Systems of the central banks of the Group of Ten countries 1995). Check use has continued to expand in recent years, despite the increased use of debit cards and the automated clearinghouse; the per capita number of checks written grew at an average annual rate of 1.3 percent from 1991 to 1995. Moreover, forecasts call for check use to remain around current levels for the foreseeable future (Humphrey 1996). Because the social costs associated with the use of paper checks constitutes the majority of the real resource costs of the payment system-65.4 percent according to David Humphrey and Allen Berger ( 1990)it will be important to continue to seek improvements in the efficiency of the check system in the years ahead.

The efficiency of check clearing is affected by the arrangements governing presentment and payment. These arrangements have a feature that is, for economists, puzzling. Helen writes a check to John for, say, $100. When the check is ultimately presented to Helen's bank for payment, the bank pays $100, and deducts $100 from Helen's account. What is surprising, from an economist's point of view, is that the bank pays the same amount, $100, no matter how long it took for the check to be presented. This implies that John's bank earns an additional day's interest by getting the check to Helen's bank one day sooner. This feature is puzzling because it is difficult to identify any significant social benefits to Helen or Helen's bank from getting a check from John's bank one day sooner; certainly nothing approaching the magnitude of one day's interest.

Check float is the time between when a check is tendered in payment and when usable funds are made available to the payee (John in our example) .1 Because John and his bank bear the opportunity cost of foregone interest until the check is presented, they have an incentive to minimize the float. But check float provides interest income for Helen and her bank. Under current arrangements Helen and her bank implicitly reward John and his bank for reducing check float. Helen's bank stands ready to turn over their float earnings. John's bank thus has an incentive to capture those float earnings by accelerating presentment. Another way to state the puzzle is that the benefits to Helen and her bank do not seem to justify the incentive provided to John and his bank to minimize check float. For this reason I call it the "check float puzzle."

The resolution of this puzzle is of more than intellectual interest. Because collecting banks forgo interest earnings on the checks in their possession, they have a strong incentive to present them as quickly as possible in order to minimize the interest foregone. Collecting banks are motivated to incur significant real resource costs to accelerate the presentment of checks. Check processors, including the Federal Reserve Banks, routinely compare the cost of accelerating presentment to the value of the float. Checks are sorted at night and rapidly shipped across the country. But if there is little or no social benefit of accelerating the presentment of checks, then much of the real resource costs associated with check processing and transportation would represent waste from the point of view of the economy as a whole. It may be possible to alter this puzzling arrangement and improve the efficiency of the payment system.

The check float puzzle can be directly attributed to the fact that the laws and regulations governing check clearing mandate par presentment; the payor owes the face value of the check, no matter when the check arrives. Par presentment implies that the real present discounted value of the proceeds of clearing the check are larger the faster the check is presented. …

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