Universal Access, Cost Recovery, and Payment Services

The Monetary Control Act of 1980 (MCA) required the Federal Reserve (Fed) to provide all banks with equal access to payment services, not just member banks, and to price those services with explicit fees. The legislative history of MCA suggests this mandate had the twin purpose of promoting competition in the provision of payment services and generating revenue for the Treasury.

Chakravorti, Gunther and Moore analyze the interplay between two of MCA’s most salient features in the area of retail payment services. The first is the requirement that the fees charged for Fed services should in total cover both the costs of providing those services and an adjustment factor designed to reflect the taxes that would have been paid and the return on capital that would have been generated had the services been provided in the private sector. The second is the requirement that, in setting its prices, the Fed should strive to ensure that an adequate level of payment services is provided nationwide. This latter provision specified that the Fed should set prices for payment services below the levels otherwise required by MCA if doing so is necessary to ensure equitable access to payment services for banks in all areas of the country.

They contend that these two requirements are inconsistent and that they essentially entailed a cross-subsidy from low-cost to high-cost service points, thereby allowing private-sector competitors to enter the low-cost segments of the market and undercut the relatively uniform prices charged by the Fed. To clarify the ultimate implications of this legislative environment, they develop a voter model for what begins as a monopoly setting in which a regulatory regime that establishes a uniform price irrespective of cost differences and restricts total profits to zero initially dominates through majority rule both deregulation and regulation that sets price equal to cost on a bank-by-bank basis. Deregulation occurs in this model once cream skimming has subsumed half the market, and the alternative regulatory regime that ensures the equality for individual banks of service fees and costs is never selected by the voting mechanism.

These results suggest that MCA set the stage for a declining role of the Fed as a provider of retail payment services, including check processing, and that the losses in Fed check volumes that started around 1993 may have more to do with the provision of universal access along with some structural changes than with private sector competition in and of itself. Hence, their model points to the increasing complexity of the Fed’s fee structure as a relaxation of, but not departure from, the universal service objective, necessitated by the tension between universal service and cost recovery.

Their results take on increased importance in light of recent controversy surrounding the prices charged by the Fed for retail payment services. Lacker and Weinberg (1998) argue that the movement toward greater differentiation in fees may reflect market power enjoyed by the Fed in servicing relatively remote presentment points. Under this view, the increasing differentials observed in the Fed’s fee structure reflect efforts to shift costs to protected market segments in rural areas, thereby leaving room to maintain relatively low fees in the more closely contested city markets. While they cannot rule out this possibility based on the results presented here, their findings nevertheless are important in this regard, in that they show movement toward greater complexity in prices should be expected as a natural outcome of MCA.