Sunday, November 29, 2009

Instant Transfers, Instant Profits (for Banks) - UPDATED

In the Banking sub-sector of Financial Services, there is a process in effect which will make the Banking business substantially more profitable, although at the risk of customer dissatisfaction. "Check21" is a 1year old law that allows banks and any other business to accept checks as EFT (Electronic Funds Transfer) debits to the customer (like a debit card- immediate withdrawal) , and EFT credits to the bank. This eliminates "float" for all practical purposes (the time people writing checks had from paying a bill or buying something and the time when it actually posts to the customers' account.) You won't have the 1 day's grace when you write a check until it clears.

When ATMs and POS (point-of-sale) terminals were first introduced in the early 1980s, there was an insufficient infra-structure to support the wide-spread use of them and to generate their true value. Many transactions were simply captured electronically and still processed in "batch". Checks were still checks with float. Now, with the Internet providing the connectivity needed, banks can move to eliminate checks as we know them. Even mail order/bill pay by check services are processing checks as EFT (instant debit to your account, instant credit to theirs) occurrences. With the first significant upward movement of interest rates, the issue will become moot. All transactions will be electronic; there will be no more checks

Checks in the clearing process take 1-2 days ("float") to be processed, or possibly longer if it is a "foreign" item. For every $100 million in float, and for each 1% increase in the rates being paid or earned by a bank, for each day of float the difference amounts to $1 million dollars annually. Assuming rates move back to 5% from the current 0.5% in 2-3 years, and a large bank has $1 billion in float for 1 day, there is $45 million per year in earnings, either gained/retained or lost. Further, the cost in manpower and technology to process the incoming & outgoing checks and other items is staggering.

In the mid 1980s I wrote a paper on this issue for a Mutual Savings Bank trade publication. Remember that those were the days of 10%-15% interest. Even a $2 million per day float cost $200,000-$300,000 a year. Seems small now but it was not then. The issue preventing the change to all electronics was the lack of the Internet. Every device had to be a direct connection; even the ATMs were on dedicated lines. That obstacle is gone. Add to the equation the fact that checks cannot be processed faster without them ending up shredded in the machines, and the machines need time to read the manually typed numbers that reside on the bottom of items showing the amount of the transaction.

Currently there is a debate in Congress about Banks' fee income - overdraft charges, ATM fees, etc. Fee income is the line item all Banks are trying to get; there is no risk like there is in loans. A move to all EFT debits and credits, such as checks, deposits and charges, will result in instant profits for Banks. But then again, so have 30% interest rate credit cards.

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