Published Monday May 25, 2009

Fed should play bigger role in electronic payments, K.C. chief says

BY STEVE JORDON
WORLD-HERALD STAFF WRITER

The Federal Reserve should play an active role in the electronic card payment system even as private businesses compete for transactions and payment methods, the president of the Federal Reserve Bank of Kansas City, Mo., said Monday.

Thomas Hoenig"The Federal Reserve should play a larger and more active role in electronic retail payments if it wants to promote the efficiency and integrity of the payments system," said Thomas Hoenig in the text of a speech given at the ECB/De Nederlandsche Bank Conference in Frankfurt, Germany.

The Federal Reserve's role in electronic payments has international implications because a growing share of retail purchases are being done electronically and the number of systems handling those billions of yearly transactions is shrinking.

Hoenig said other nations' central banks, like the Federal Reserve, have a similar role to consider in their own nations' payment systems.

Two-thirds of all non-cash payments in the United States are electronic, Hoenig said, and the Federal Reserve has a mandate to keep the nation's financial system sound and promote its efficiency.

The Federal Reserve still processes paper checks, helping banks exchange payments, although the use of checks is decreasing and private businesses also process checks. The central bank was a strong advocate of the move to more electronic payments, he said, and operates one of the nation's two large electronic clearing houses.

Today the debit card system is dominated by three networks which handle more than 80 percent of all such transactions, and the number of networks has fallen to 14 from 43 in 1995, he said. Similar trends are under way in other types of electronic transactions, such as credit card purchases.

"To me, these developments raise important concerns about the competitiveness of card payments systems," said Hoenig, who said his views are not necessarily those of the Federal Reserve System. A concentrated payment system could be subject to disruption, failure or fraud, he said, and involvement of non-banks in the system also introduces "new risks."

The Federal Reserve also can help bring innovations to the system by subsidizing new services which otherwise would be slow to develop due to the costs involved, he said. It would help coordinate services so they would be compatible, such as creating uniform transaction standards or common technologies.

He said an example of "underinvestment" by private transaction companies is the continued use of cards with magnetic strips and the slow transition to "smart" cards with computer chips which have a greater range of functions.

"By competing with the private sector on a level playing field, the Federal Reserve can encourage efficiency and integrity from an 'on the ground' position," Hoenig said.

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