Eugene M. Katz and Robert H. Rosenblum*
Once upon a time, there was no concept of money. People ate what
they grew or hunted, lived in a structure they built or found, and
generally did not engage in commercial transactions. As civilization
and economies developed, the practice of barter, or trade, developed,
so that a farmer could trade fruits and vegetables for the clothing
made by someone else. Eventually, this system grew too cumbersome,
and people began trading on symbols of value -- sea shells, coins
and pieces of paper that we call money, and evidences of indebtedness
coupled with a promise to pay, such as what we now call checks and
credit card payments. These symbols have little or no inherent value
(the piece of paper on which a $100 dollar bill, along with the
ink on that piece of paper, is not worth pennies, much less $100).
We value them, however, because we are confident that other people
will value them. We believe that our local grocery store will accept
cash in payment for the food we buy there so we are willing to accept
cash in payment for the products we produce or the services we provide.
We also believe that we will receive cash (perhaps in the form of
a credit to our bank accounts) when we accept a check or a credit
card payment in return for our products or services, provided the
person purchasing those products or services by check has adequate
money in her checking account.
The basis for our confidence in our monetary symbols is well founded.
A complicated
but well functioning set of statutes, regulations and practices
assures that a merchant can deposit a check in a local bank that
was drawn on a bank account from across the country or on the other
side of the world, and that her bank account will receive the money
promised to be paid on the face of the check. Similarly, the merchant
can accept as payment an IOU in the form of a credit card and, except
for the payment by the merchant of certain fees to the appropriate
credit card company, that IOU will be converted into cash and deposited
in her bank account. As a result of current and developing technology,
many new forms of payment instruments are becoming available, including
prepaid or stored-value cards, electronic purses and Internet-based
and other electronic payment mechanisms. Integral to these and a
number of other commercial and financial transactions that occur
each day is the "payments system."
The "payments system" is a term that does not have a
precise definition, although most industry observers and participants
have a fairly consistent idea of what it covers. Generally, it refers
to the clearing and settlement services that are provided by the
Federal Reserve System ("FRS") through the regional Federal
Reserve Banks, and by other clearing an settling organizations that
interact with the FRS and carry on their activities under the guidance
of the operating rules and policies established by the Board of
Governors of the FRS (the "Board"). Among the many significant
functions performed by the payments system are the traditional clearing
and settlement of paper checks through the FRS and regional clearinghouses,
and the electronic clearance and settlement of the transfer of funds
(principally large dollar transfers) through automated clearinghouses
and electronic funds transfer services such as the FRS's FedWire
and private networks such as CHIPS and SWIFT.**
Traditionally, direct access to the payments system has been limited
to depository institutions (referred to herein for ease of reference
as "banks"), whether or not they are members of the Federal
Reserve System. Institutions other than banks generally are not
permitted to have direct access to the payments system.
The reason for this limitation of access to the payments system
probably arose partly from commercial practice, and partly from
legitimate regulatory concerns. Among the legitimate regulatory
concerns were (and are) limiting access to the payments system to
financial institutions that would conduct their activities in such
a manner as to assure the proper functioning and safety and soundness
of that system. As discussed earlier, confidence in receiving cash
in a timely manner is a critical component in our willingness to
accept checks, credit cards and other instruments in lieu of cash.
This confidence could be severely shaken by an interruption in the
smooth functioning of the payments system, such as might occur if
one or more of the significant participants in that system defaulted
on their obligations, or if there was a significant breach of the
security of the payments system (such as by a computer hacker).
Such a loss of confidence, in turn, could cause severe disruptions
in the normal flow of commerce and finance if , for example, merchants
began refusing to accept checks or credit cards and instead insisted
on receiving only cash.
These reasons, however, do not explain why only banks are permitted
access to the payments system. No doubt, as a general rule banks
are credit worthy participants in the payment system, due in large
measure to the regulatory oversight of state and federal banking
regulators. It might be tempting to also assume that the federal
government's insurance of the deposits of banking customers also
provides significant comfort to the financial integrity of the payments
system, although on reflection this is not necessarily the case.
First, deposit insurance is available only to deposits, and only
to deposits of up to $100,000. Many of the electronic transfers,
large checks and other items processed by the payments system simply
are not eligible for deposit insurance, either because the underlying
funds are not drawn from bank deposits, or because the transactions
greatly exceed $100,000. Second, even if the federal government
were to pay depositors of a failed bank (or, as is more often the
case, arranges for that failed bank and its deposits to be acquired
by another bank), this process takes significant time, and the payments
system would be significantly disrupted if the settlement of transactions
in which such a failed bank was involved had to await final payment
by the FDIC on deposits (or the final acquisition of the failed
bank by another bank).
Nonetheless, while banks generally are credit-worthy participants
in the payments system, there are other financial and other institutions
that potentially also are credit-worthy participants. As an example,
many major brokerage houses, insurance companies, diversified financial
holding companies and others are as a group at least as credit worthy
as banks, and certainly in general are more credit worthy than,
say, financially troubled banks with large portfolios of bad loans
(which, despite their financial difficulties still may have access
to the payments system). The reason that these types of institutions
do not have access to the payments system probably rests less on
any overarching regulatory policy considerations than it does on
a simple fact of history: Until recently, these financial institutions
did not particularly want access to the payments system.
Not so long ago, banks offered a relatively well-defined and relatively
unique set of products and services. Among these, for example, were
check writing privileges, and as a necessary corollary, a mechanism
for clearing and settling checks (that is, assuring that when person
A wrote a check to person B, person A's checking account was debited
by the appropriate amount and person B's checking account was credited
by the appropriate amount). This clearance and settlement function,
and related services, were and are handled by the bank through its
direct access to the payments system.
As long as financial institutions other than banks did not offer
check writing and other services that required access to the payments
system, there really was no need for those institutions to have
access to that system. But recently, competition and technology
have permitted non-bank financial institutions to offer products
and services that do require access to the payments system. For
example, brokerage firms offer the functional equivalent of check
writing privileges from money market and wrap fee accounts, and
permit electronic transfers of money from investment accounts. Many
non-bank institutions offer various other types of sophisticated
and not so sophisticated products and services that permit or facilitate
the transfer of money from one person to another. One increasingly
important example of this are computer companies that are developing
and refining computer systems and programs that permit individuals
and companies to transfer money electronically, directly from their
home or business computers. As a result, many non-bank financial
and other companies now have a legitimate interest in having direct
access to the payments system, rather than having to access that
system indirectly through a bank.
Fundamentally, there does not appear to be anything unique to the
deposit-taking or any other core functions of a bank that should
cause banks, and banks alone, to have direct access to the system
that clears and settles checks, electronic transfers and the like.
The reason that banks need direct access to the payment system --
to assist them in transferring money from one person to another
-- is now equally compelling in the case of other financial institutions
and companies that offer products and services that involve the
transfer of money. Moreover, securities and commodities firms have
long been participants in the securities and commodities clearance
and settlement systems (such as National Securities Clearance Corporation,
or NSCC), which conceptually function in manner quite similar to
the payments system. It is difficult to conceive of a legitimate
danger to the payments system if securities firms were to be permitted
direct access to that system, when securities firms already have
direct access to the systems that clear and settle stocks, bonds,
futures contracts and the like.
Currently, Congress, the Administration, banking regulators and
the financial services industry in general are considering how to
regulate financial services providers in the United States. It is
widely accepted that banks, securities firms, insurance companies
and other financial services providers are offering products and
services that directly or closely compete with products and services
offered by the others. In this environment, laws that were written
with the assumption that banks offer distinct products and services
from those products and services offered by securities firms, insurance
companies and other financial services providers are being reevaluated.
As part of this reevaluation, the concept of who should have access
to the payments system also should be considered. Indeed, Senator
D'Amato (R-NY), Chairman of the Senate Banking Committee, has on
several occasions suggested that access to the payments system should
be considered as part of broader legislation to modernize the financial
services industry.
While providing non-banks access to the payments system would raise
a number of issues, it is likely that a regulatory structure providing
such access could be developed around the following three key principles.
1) Does the proposed participant in the payments system have a
genuine need to have direct access to that system? For example,
a bank that offered solely trust services to its customers might
not actually need access to the payments system, while a securities
firm that offered check writing privileges to wrap fee account customers
might well have a legitimate need to have direct access to that
system (such as in the form of being able to offer lower costs or
better services to its customers due to the direct access).
2) Does the proposed participant have sufficient financial resources
to justify permitting it to have direct access to that system? As
discussed above, confidence in the safety and soundness of the payments
system is critical to our commercial and financial world. Presumably,
entities with direct access to the payments system should have adequate
capital, and should be subject to legitimate rules that govern access
to that system. In this regard, it is not at all clear that any
particular class of financial institutions should have automatic
access to the payments system. For example, it might be appropriate
if banks that do not meet certain minimum capital requirements lose
their ability to directly access the payments system, and instead
must access the payments system through a correspondent relationship
(i.e., through a financial institution that does have access to
the financial system, much the way non-bank financial services providers
access the payments system today).
3) Does the proposed participant have sufficient safeguards in
place to prevent unauthorized access to the payments system? Such
safeguards presumably would include appropriate policies and procedures
governing employees and supervisors, and appropriate computer and
technological safeguards.
Any efforts to permit additional access to the payments system
also should attempt to strengthen that system. While that system
works well, the increasing number, value and complexity of transactions
that the payments system must handle will at some point test that
system. Permitting access to the payments system to well capitalized
institutions with a legitimate need to access that system, while
simultaneously denying access to that system to other institutions,
should decrease costs to (and arguably increase competition among)
financial services providers, while at the same time strengthening
that system.
*Mr. Katz, a member of Womble Carlyle Sandridge & Rice PLLC,
was formerly Director of the Litigation Division of the Office of
the Comptroller of the Currency and Senior Deputy Chief Counsel,
of the Office of Trift Supervision. Mr. Rosenblum, a lawyer with
Fulbright & Jaworski LLP, previously was counsel to a commissioner
of the Securities and Exchange Commission, and is the author of
a forthcoming book on the Investment Company Act. Womble Carlyle
and Fulbright & Jaworski represent a number of clients which
may have an interest in the subject matter of this article, although
this article expresses only the views of the authors, and not necessarily
the views of Womble Caryle, Fulbright & Jaworski, or their clients.
**Section 11(a) of the Federal Reserve Act contains a list of the
clearing and settlement services provided by the FRS for which full
cost pricing is mandated. This list provides a relatively good picture
of what the payment system consists of : (1) currency and coin services;
(2) check clearing and collection services; (3) wire transfer services;
(4) automated clearinghouse services; (5) settlement services; (6)
securities safekeeping services; (7) Federal Reserve float; and
(8) any new services which the Federal Reserve System offers, including
but not limited to payment services to effectuate the electronic
transfer of funds.
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