Nyu – Leonard N. Stern School of Business Operations in Financial Service – B60. 2315. 030

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Competitive Environment

The Federal Reserve is in a unique market position garnering many competitive advantages with its large size, political checks, and layers of bureaucratic control being it primary competitive disadvantages. The competitive advantages of Federal Reserve Banks include:

Economies of Scale

The Federal Reserve processes close to 60% of interbank checks and has an account relationship with almost every American financial institution. The volume of check, substitute checks, and ACH entries which go through the Federal Reserve each day give it the ability innovate down the marginal cost of such orders.

Economies of Scope

The Federal Reserve is involved in almost every type of financial transaction, electronic and traditional. The expertise, technology, and resources of any one service may translate over to offering in other areas, decreasing the research, development, maintenance, and marginal cost of each product.

Name Recognition

Certainly, the Fed is the best known and most trusted transaction mechanism in the history of the World. Beyond the obvious advantages of this position, the Federal Reserve also has the backing of the Federal Government insuring its quality and credit-worthiness.

Federal Regulation

The Federal Reserve is instrumental in writing its own policy as well as the policy which it may dictate to its customers, business partners, and even competitors. For example, the Federal Reserve may require security interests against instruments of transactions to cover overdrafts without securing possession of the instruments, a position that no other institution in the country could take.

Innovation & Standardization

The Federal Reserve System leads the industry in key aspects of transaction innovation. Further, the Federal Reserve may adopt and set standards based on its business need

Traditional Check Processing

The payee (check depositor) will receive credit for the check amount only when the physical check is presented to the originating bank (writer of the check) – the check must be transported from the Bank of First Deposit (BoFD) to the paying bank.

Figure 5

Operational Details


Check Deposit – The physical check is first deposited at an institution. This would be achieved directly through a bank’s teller or indirectly through an ATM, telephone or Lock Box. Checks of various denominations and institutions will all converge here.


Check Sorting – The depository bank then sorts and categories each check by type and destination. The face value of each check is typed in MICR ink and reader sorters sort the checks into pockets for their capture.


On-Us Checks - The depository bank will process on-us checks by debiting the depositors account and crediting the payor’s account. The turnaround time for these types of transactions is quickly and the depositor can expect payment immediately – providing that there are sufficient funds.


Local Processing – Local checks would have been pre-sorted to be sent to local clearinghouses. Depending on the number of local destinations and the volume of checks, the depository institution would have setup a courier delivery schedule for different times of the day/week/month or year.

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Payment – The local or private clearinghouse completes the transaction by crediting the accounts of the depositing banks electronically. If at this point the specific checking account does not have sufficient funds to cover the check amount (NSF), the check is labeled to reflect this and returned to the depository bank through the same channels. In this case, the depository institution would not credit the payee’s account but notify them by mailing the returned check or, depending on the amount of the check, use a more direct approach.


At this point, the depository bank makes the decision of whether to send the check to a private clearinghouse, the local or destination Federal Reserve or choose to directly send it to the paying institution.

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Routing - The depository institution then has the option of clearing the check at either a local Federal Reserve office, private clearing house or directly at the corresponding destination Federal Reserve. The main driver of this decision would depend on where the accounts lie for each institution and given the volume of checks going there, which would be the lowest cost alternative.


Clearing Process – In the most cases, inter-bank check settlements would occur through the U.S. Federal Reserve. The Federal Reserve would act similar to private clearing houses where checks would be processed and the appropriate accounts be updated.


Direct Send – By far the most expensive option and is usually reserved for special circumstances (large denominations and/or guaranteed settlements)

Productivity Analysis

Note that in addition to all of the variables listed below, the average variance would also be appropriate to measure for productivity as well as quality metrics. Though these complementary variables have not been listed, they are vital to high volume queued processes which rely on the consistency of each step in the system.
The basic metric of productivity in check processing is speed. Every minute that the average check is in the settlement process is a minute of float lost by the depository bank. Considering the gigantic volume of checks in the settlement process, depository bank have a desperate need for a speedy settlement. On the other side of the equation, the depositor and the payor bank have a great need for accuracy of checks being settled. The depository bank and settlement processor will generally be the ultimate losers if a check is incorrectly processed or is lost, stolen, or damaged. On one hand, millions of checks must be processed at an incredibly rapid rate; on the other, the players open themselves up to almost unlimited liability if any of those checks are mis-processed.

Productivity Inputs
Number and dollar value of checks to be settled categorized by

Variable Costs per check including

Fixed System Costs

  • Overhead labor including management and administration

  • Overhead equipment, facilities, and transportation costs

  • Other overhead such as legal costs

Productivity Outputs

Number and dollar value of checks successfully processed categorized by:

  • Settlement Chain participant

  • Time of day/ settlement batch

  • Settlement chain process

  • Transportation and settlement function used

Average Time of processing checks broken into

  • Time from entrance into the Federal Reserve or Private Clearinghouse settlement function to the successful completion of the transaction

Time to process check categorized by:

  • Time of Day/ Check batch

  • Originator and Destination Banks

  • Settlement method used

  • Clearinghouse Facility used

Quality Inputs

Number of checks entering the settlement system

Quality Outputs

Number and dollar value of checks successfully cleared

Number and dollar value of misrouted checks

Number and dollar value of delayed checks

Number and dollar value of lost checks

Number and dollar value of damaged checks

Float Cost of checks in the settlement system

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