The Role of the Federal Reserve

Another important activity of the Federal Reserve is processing and clearing checks between financial institutions. When a check is cashed at a financial institution other than the one holding the account on which the check is drawn, the Federal Reserve's system lets that financial institution - even if distant from the institution holding the account on which the check is drawn - quickly convert the check into cash. Checks drawn on banks within the same Federal Reserve district are handled through the local Federal Reserve Bank using a series of bookkeeping entries to transfer funds between the financial institutions. The process is more complex for checks processed between different Federal Reserve districts.

The time between when the check is written and when the funds are deducted from the check writer's account provides float. Float benefits the check writer by allowing it to retain the funds until the check clears - that is, when the funds are actually withdrawn from its accounts. Businesses open accounts at banks around the country that are known to have long check-clearing times. By "playing the float," firms can keep their funds invested for several extra days, thus earning more money. To reduce this practice, in 1988 the Fed established maximum check-clearing times. However, as credit cards and other types of electronic payments have become more popular, the use of checks continues to decline. Responding to this decline, the Federal Reserve scaled back its check-processing facilities over the past decade. Current estimates suggest that the number of check payments has declined by two billion annually over the last couple of years and will continue to do so as more people use online banking and other electronic payment systems.