Writing paper checks is still common in the U.S., a fact that surprises many foreigners. Instantaneous (or very fast) electronic payments have become the norm in many Western countries, and many young people have never owned a checkbook. A recent U.K. survey found that just 3% of Britons aged 18 to 24 placed importance on having access to checks.
Check use in the U.S. is falling, although at a slower rate than in other places: as recently as 2006, checks were still the most-used form of noncash payment in America. Checks are now less popular than either credit or debit cards. The sharpest reduction has been in business-to-consumer checks, as ACH payments become more widespread.
Despite that, 18.3 billion checks were written in the U.S. in 2012, with a value of $26 trillion. Even in 2014, American businesses were still using checks to pay half their bills, and consumer-to-consumer check usage was flattening out through 2012. (It will be interesting to see how peer-to-peer payment apps have changed that picture.)
Checks persist in the U.S. due to a complex set of circumstances. At different points, technology has both undermined and assisted the check. Patchwork regulation and a relatively fragmented banking industry have contributed to the check’s survival—as has sheer old-fashioned habit. We’ll examine what keeps checks in circulation in the electronic age.
1. Size and Diversity of U.S. Banking
One reason why the U.S. has been slower than other countries to adopt electronic payments is that smaller markets tend to be dominated by a few major banks. Those banks not only find it easier to create new payment systems because of their national presence and large market share; they also derive more benefit from those systems.
You don’t need to look too far north for an example. Debit cards in Canada are dominated by Interac, a nonprofit corporation. Interac was founded by Canada’s five biggest banks, which held enormous market share between them. The Big Five gave Interac wide national reach through their own customers, which then put enormous pressure on smaller institutions to make Interac a de facto debit card standard.
In Australia, where four big banks hold over 75% of deposits, an electronic bill payment solution called BPay covers 95% of the consumer market and serves over 22,000 billers. BPay happens to be co-owned by the same four big banks.
The U.S. has a very different banking system, with some 6,420 commercial banks and savings institutions in existence. Many of these confine their operations to their home regions or states. The biggest U.S. financial institutions may be too big to fail, but in relative terms they’re small: in December 2014, the five biggest banks in the U.S. held 44% of all bank assets. While that was a greater share than ever before, that’s far more competitive than many countries, as we’ve seen.
The result is that even the very largest American institutions, however powerful, don’t have the reach necessary to impose electronic payment solutions on the entire industry.
Banks also lack incentives. The San Francisco Fed has argued that electronic payment networks create ‘network externalities’. In short, a network becomes exponentially more valuable as more customers are plugged in, because the wider its reach, the more useful it becomes. As with social media, larger networks offer more potential connections than smaller networks. But if the last person to join the network benefits the most, no one has a strong incentive to be first.
By contrast, banks in the U.K., Australia, and Canada have more market share, so by joining together they can share the benefits among themselves. In economic terms, they can internalize more of the network externality.
There do need to be strong incentives for banks to act, because there are huge costs to systemic upgrades of payment systems. Banks have to meet those costs upfront, for an uncertain return. One way to overcome that hesitation is an aggressive regulator—leading to our next big factor.
2. Regulatory Fragmentation
Countries with powerful central banks, or strong banking regulators at the national level, can more easily push the payments industry towards improving systems for consumers.
In Australia, the Reserve Bank has pursued a strategy of persuasion, joining a self-regulatory body that works with the private sector to improve the payments industry. The U.K. is using regulation to work towards the same result: a powerful new regulator, the Payment Systems Regulator, came into being on April 1 this year. The European Union has introduced the Single Euro Payments Area, aimed at breaking down barriers to transferring euros within Europe.
Again, the U.S. banking system isn’t so simple. States regulate State-chartered banks, which also have a Federal regulator. At the Federal level, any of the Federal Reserve, the FDIC, or the OCC may be a bank’s regulator, with different parts of the biggest banks scrutinized by different bodies. The Federal Reserve wants to improve electronic payments, but it doesn’t have the same regulatory heft as its peers elsewhere in the world. And even if it did, a new system would have to be comply with the laws of fifty separate states.
3. Changes to Check Technology
Checks might still have become too impractical if they hadn’t evolved over time, especially with the end of large-scale physical presentation and paper processing.
The U.S. Commercial Code once required a check to be presented physically to the bank where it would be drawn on for payment. Banks therefore trucked and flew checks worth billions of dollars around the country every day. This system came to a standstill after the terrorist attacks of September 11, 2001, exposing a vulnerability in the financial system. In 2004, Congress therefore allowed banks to accept electronic images of checks in lieu of the physical paper.
Nowadays, practically every check is cleared electronically, either by image processing or as an Automated Clearing House (ACH) payment. In 2012, one-sixth of checks were also deposited with banks as electronic images.
This is all much more efficient, but the logic of it is a little strange. Mark Dragiff at Finextra stated the irony: “the payment data begins life in an electronic format, is converted to paper for transport and then is reconstituted in an electronic format upon receipt.”
4. Business Comfort
Finally, there’s the simple fact that many consumers and businesses simply prefer the systems they’re comfortable with, and don’t want to change. Since there’s often a delay in depositing checks, small businesses also like them because they get breathing space for cash management.
The result of all these trends? Barriers to faster, more secure payments will gradually be broken down, and check use will continue to decline, but they’ll be with us for a while yet. When the Federal Reserve reports again on noncash payments, we’ll know more about the future of one of the world’s longest-serving financial instruments.