Fed Requests 3-Day Clearance for Local Checks

NEW YORK —  Buried in a torrent of requests before the new Congress is one from the Federal Reserve that would give banks an extra day to clear local checks.

Critics charge the measure, if approved, could cost consumers millions of dollars in bounced-check fees.

The issue hits a hot button with consumer groups, which believe checks deposited in consumers’ bank accounts should quickly be made available to them.

The Fed, the central bank, has asked Congress to amend 1987 legislation that requires banks to make funds from deposited local checks available within two business days.

Banks often guard against check fraud by not releasing the money until a check has cleared, which, thanks to modern technology, can happen quickly, sometimes the same day.

“A check can be cleared and credited with almost the snap of a finger,” said Mark Green, the public advocate for the City of New York.

“If anything, the Federal Reserve should be looking at ways to give people faster access to their own money--not devising ways to force customers to subsidize banks.”

But because the Fed’s clearing system is based largely on moving pieces of paper from bank to bank, the Fed says banks need three days to make sure a check is good.

A 1995 Fed survey found that even though banks must make the money available within two days, fewer than half of locally generated, fraudulent checks are returned to the check writer’s bank within that time. That means banks end up paying out money they can’t recover.

In a report to congressional banking committees last October, the Fed said extending the holding period “would improve banks’ ability to manage their risk.”

Congress’ five-day clearing deadline for out-of-town checks is not as big a concern, the Fed said, since more than 80% of non-local checks are returned within the deadline.

Some consumer advocates and banking experts contend that revising the local-check rule would do little to intercept bad checks. Most check fraud is due to forgeries of signatures, which are not caught by the check-clearing system.

Instead, the consumer advocates said, it would inconvenience consumers, who, unaware of the change, might bounce more checks.

For low-income consumers, an extra day’s hold on checks can mean paying the rent late or not having enough money for groceries or medical prescriptions, the critics said. And, they argued, it would raise banking costs to low-income people, who would be forced to turn to expensive check-cashing services to get quick access to their paychecks.

The rule change would put the onus of fraud protection on consumers, who can least afford to wait an extra day for their money, said Green and two other New York City-area Democrats, U.S. Rep. Carolyn Maloney and state Sen. Franz Leichter, in a letter to House Banking Committee Chairman Jim Leach, R-Iowa.

Maloney and Henry B. Gonzalez of Texas, the House Banking Committee’s ranking Democrat, are soliciting all House members to sign a second letter to Leach opposing the proposal.

Another issue is how much extra money financial institutions can earn by holding on to deposited funds for another day and investing them at the overnight bank rate, currently just over 5%.

Martin Mayer, a fellow at the Brookings Institution, estimates that U.S. financial institutions would make $250 million to $300 million a day by keeping the funds another day. Fed officials could not confirm or dispute the figure.

Maloney, a member of the House Banking Committee, contended the Fed is trying to stay in the check-processing business even though it is not competitive.

Banks pay the Fed a fee for processing their checks. The Fed is required by law to recoup all its costs, plus a little extra, from banks using its service. Any extra money the Fed makes on check clearing is returned to Congress, officials said.

The Fed’s clearing system, created in 1913, has in recent years lost business to private check processors, particularly in large urban areas like New York and Chicago.

The Fed now processes only about a quarter of all checks written in the United States, the Fed officials said.

And the Fed’s record for returning checks compares unfavorably with private companies. The Fed’s survey found it had returned only 15% of fraudulent local checks that went through its processing within two business days, compared with 48% for private handlers.

“It’s outrageous that the public at large should be asked to give up a day’s use of its own money to help the Fed compete against private-sector clearing operations,” Mayer said.