Banks Need Higher Interest Rates To Switch

Regional air cargo carriers that ferry cancelled checks around the country each night had at least a year's notice before the Check Clearing for the 21st Century Act (Check 21) took effect last month. While the law will one day make air transport of checks obsolete, nothing will change until banks can make more money on the electronic transactions. However, profits won't go up until interest rates go up.

Congress a year ago enacted Check 21 as a way to speed up the transfer of money between banks using the 21st century's digital technology instead of the 20th century's mechanical invention - the airplane. The legislation blessed a new legal document - the substitute check, a printout of a digitized check. Instead of one bank forced to fly a check cross-country to the check writer's home bank, the check - and the dollars it represents - can be zapped across fiber optic lines so that the money can change hands the same day, not in two or three days. Instead of a cross-country flight, the transaction may need as little as a cross-town courier.

Until it makes economic sense to switch technologies, a bank will not do so, said Steve Ward, an executive vice president with Fiserv [FISV], one of the nation's largest check clearinghouses that counts more than 1,600 banks as its clients. And then, everybody has to make the switch. A bank's processing costs would increase if it were to adopt Check 21, but at the same time it has to maintain the infrastructure needed to move the original paper checks to those banks not adopting digital technology.

However, as more banks switch to the digital age, the volume of checks transported by air will decrease, forcing the air carriers to increase their unit price. "Air transport is measured in pennies per item. If it goes up to dimes per item, then the dynamics will change," Ward said.

As enacted, the new law will not save the banks on paperwork, said Ward. A courier service will still be needed to move the substitute checks from a bank clearinghouse, like Fiserv, that prints out the new document to the local bank.

Americans have been writing fewer checks in recent years as banks have adopted swifter payment methods, including debit and credit cards. With fewer checks to cash, fewer planes have been needed to move the checks around the country from one bank to another.

In 2000 there were 42 billion checks processed - down from about 50 billion in 1995, according to the Federal Reserve Board. The Federal Reserve Bank in Atlanta coordinates nearly 200 nightly flights between various branches of the Federal Reserve. In 2000, the Federal Reserve system's share was about 17 billion checks, while the rest were private-sector transactions.

Since 1998, the Atlanta bank has had six air cargo firms under contract with a collective fleet of 45 planes making the nightly flights. The carriers are using 15 Learjets and 30 twin-engine turboprops, said Pierce Nelson, a spokesman for the Atlanta bank.

The Federal Reserve is acting as a third-party clearinghouse for checks as it competes with private sector firms, including Fiserv. Outside of the Federal Reserve's contract fleet, the largest transportation vendor is Columbus, Ohio-based AirNet [ANS], which has a fleet of 120 planes.

"We don't expect to see any impact of Check 21 in the next one or two years as banks sort out their new authority and how to best use it," Nelson said.

Anthony Mulei, president of Denver-based American Check Transport, echoed the Federal Reserve's observation. "We are still carrying as many checks. We don't think we will be impacted that much for at least three or four years. Much of our business is between branches of the same bank or for the Federal Reserve. Those who do the big-bank-to- big-bank business will be the most impacted."

American Check flies 22 Metros each night in the Midwest.

AirNow, based in Bennington, Vt., now devotes only two Cessna Caravans of its fleet of 30 planes to cancelled check runs, said David Corey, the carrier's president. "Our check business is about 10 percent of our overall operations. We don't expect any significant changes for several years. Over time - and you can't predict the timing - this business will disappear."

Over the last 10 years, AirNow has diversified away from the check flights and it is no longer actively seeking new check ferrying contracts. "In the past, our business was heavily weighted in the check business," Corey said. "The volume of the business has been decreasing. And, we were faced with fairly effective competitors."

AirNow, with 13 Caravans and 17 Embraer [ERJ] Bandeirantes, has contracts with a variety of integrated carriers moving their small packages.

AirNet, whose fleet includes 40 Learjets, has tried to diversify itself from the check-hauling routine. As early as 1984, when it purchased a documents courier, AirNet has been seeking other income streams. However, its bank services unit generated $26.2 million of its $42.1 million in second quarter sales this year. It now has a small package delivery unit and luxury passenger charter division.

It has also established a new unit, Fast Forward Solutions, that is nearing a final contract with Fiserv. Under the plan, an AirNet client needing a substitute check will contract with Fiserv to print the check at one of its 50 check-processing centers around the country. Fast Forward will then coordinate the movement of that substitute check from the printing plant to the check-writer's bank. A plane may be needed if the printing plant is still some distance from the bank or only a ground courier may be needed to handle the last leg.

In the end, the banks will change to electronic transactions when they can earn a greater profit, as opposed to the current system that depends on the regional cargo carriers. Banks need to make major capital investments in new technology before adopting Check 21 or other electronic alternatives, Ward said. These investments compete against new bank branches and ATMs for scarce capital dollars.

The banks earn a few pennies of interest income on each check that it holds before releasing the funds to the check recipient. Ward said a bank typically places a two-day hold on the funds backing a check, but normally it only needs one day to complete the transaction. Thus for one day the bank invests the funds. With current interest rates hovering at 1.5 percent, even a large check generates only pennies in interest income per day. Should interest rates rise, the income could rise to more than a $1 on a large check.

"Every large bank as a staff that does nothing but manage the whole float and the transportation business. It is all based on how much money they can make," Ward explained.

"There is no way to accelerate the collection of checks by flying them faster. There is a way to accelerate the process by converting to electronics," he said. For example, each day thousands of pounds of checks sit an extra day on the West Coast because of early deadlines to get them flown to an East Coast bank by 8 a.m. Interest income is lost on each of those checks - whether it is a $5 check or a $10,000 check - for the day they sit. "These checks are excellent candidates to be electronified. It would take away from the volume that would be air transported," Ward said.

>>Contacts: Steve Ward, Fiserv, (262) 879-5966; Pierce Nelson, Federal Reserve, (404) 498-8748; Anthony Mulei, American Check Transport, (303) 371-3611; David Corey, AirNow, (802) 753-5225.<<