Federal Reserve Update

1. Federal Reserve Update ICBA National ConferenceLas Vegas, NevadaMarch 7, 2006 Richard Oliver - Retail Payments OfficeFred Herr - Retail Payments OfficeJack Walton - Board of Governors

2. Agenda • Federal Reserve Initiatives • Check 21 Update • Regulatory Changes • Questions

3. Federal Reserve Initiatives Rich Oliver Retail Payments Office

4. Federal Reserve High Level Strategic Initiatives • Scale the check infrastructure downward • Promote the electronification of checks • Offer new ACH products and services • Encourage industry collaboration • Adopt appropriate regulatory changes

5. Check Restructuring • The Reserve Banks have been consolidating check processing offices in response to the decline in check use nationwide • Prior to 2003 the Reserve Banks processed checks at 45 offices • The Reserve Banks will have reduced the number of check processing offices to 21 by early 2007 • Further consolidations are expected as check volumes continue to decline • Implications • Ever increasing proportion of checks will become local • Ever increasing proportion of checks will be processed electronically

6. Federal ReserveCheck Processing Territories in 2002

7. Federal ReserveCheck Processing Territories in 2007

8. FedACH Initiatives • Deploy new IP-based network solutions • Implement enhanced risk management services • Expand/improve FedACH International • Strategically evolve the technology platform

9. Check 21 Update Fred Herr Retail Payments Office

10. Check 21:2005 in Review • Measured implementation pace to start the year… • …strong finish at year end • Check 21 volume has grown from 115,000 items per day in January 2005 to over 2.5 million per day in December 2005 • Customer testing & implementation process now aligned with their ‘readiness’ • Well-positioned for the future

11. 2005 Check 21 Status

12. Check 21 Factoids • Volume and dollars processed continue to grow each month • Average daily volume in January was over2.6 million items with a value of $13 billion • FedForward peak day volume was just under 4.5 million items; dollars peaked at just over $20.0 billion • Most Tuesdays we set a volume record • FedReturn volumes are growing slowly • Average 36,000 items per day • Represents over 7 percent of Federal Reserve return volumes • FedReceipt/Plus implementations are picking up speed • Average daily volume in December was ~240,000 items per day with a value of $100 million

13. What is driving FedForward Volume Growth? • In the first half of 2005, volume originated almost exclusively from customers interested in float improvement and transportation reengineering • Since the second half of 2005, we have seen growth primarily from community bank ‘clear all’ solutions – Image POD or branch capture • December – Volume • Float Improvement 43 % • Clear All 57 % • December – Customers • 438 “Clear All’ ICL Depositors • 73 “Float Driven” ICL Depositors • 195 Paper to Image Depositors • 1,085 Check 21 Cull Customers

14. What is driving FedForward Volume Growth? • 50+ vendors support Check 21 customers currently in production • Top 10 vendors support ~ 60% of customers • Vendor readiness doesn’t necessarily translate into customer readiness • Integration of vendor software may be difficult and time-consuming • Some vendors require hardware upgrades to support ICL functionality • Customers often have different infrastructures which requires additional testing and support • Most vendors can only support a limited number of parallel implementations

15. Industry Implementation Challenges • Industry is finding that building a robust, scaleable, full function infrastructure is extremely difficult • Vendor readiness doesn’t necessarily translate into customer readiness • Integration of vendor software may be difficult and time-consuming • Some vendors require hardware upgrades to support ICL functionality • Customers often have different infrastructures which requires additional testing and support • Most vendors can only support a limited number of parallel implementations

16. Industry Implementation Challenges • Litigation is having a cooling influence • Uncertainty in the marketplace has created doubt • Emerging state laws regarding payments have added further confusion • Interest in remote capture is picking up • New small retail customers • Availability of scanning equipment is limited • Duplicate Substitute checks • Can occur at many stages of the collection process • File level checking and strong print procedures can greatly decrease, but not eliminate, duplicates • Item level checking problematic at any point other than the paying institution • Probability of false positives is greater if matching is done early in the cycle • Short processing window • Initially impacted largest customers of largest banks

17. Image Exchange • Image exchange is being pursued but….. • Most industry file standards have optional or conditional fields that are sometimes used differently by customers • Different exchanges implemented disparate and sometimes conflicting edits • No usability standards in place for Image Quality Assurance • Interoperability challenges draw attention • Several banks are depositing image cash letters with the Fed through the SVPCo network • Endpoint Exchange and Fiserv are also depositing through a lead bank

18. Strategic Outlook • Need focus on end-to-end electronics • Movement to full electronification will continue to evolve • Rate of change • Efforts need to be directed toward electronifying the check as early in the collection process as possible. • As check volume continues to decline, there will be increasing pressure on all participants to manage costs • Physical infrastructure, transportation, and equipment • Branch capture and remote capture solutions are critical • Transition solutions to support the migration from check processing to electronic payments will be vital • Enable end-to-end electronics while allowing for paper where needed • Business case analysis should look forward and not isolate on send benefits

19. Strategic Outlook • Industry collaboration is a must • Exchanging images requires willing partners • Interoperability between payments aggregators is also crucial • Despite growth in the number of electronic receivers, substitute check printing not likely to peak until 2007

20. Regulatory Update Jack Walton Board of Governors of the Federal Reserve System

21. Regulatory Changes • Regulation E • Electronic Check Conversion • Payroll Cards • Regulation CC – Remotely Created Checks • Check 21 Implementation • Check Restructuring • Large Value Payments Processing

22. Regulation EElectronic Check Conversion • Enables “alternative authorization” for check conversion if a merchant posts signage and provides the consumer with a written notice • For example, the check conversion notice that a merchant provides at the point of sale may now state: “If you submit a check as payment, we [the merchant] may process the payment as an EFT or as a check” • This change facilitates so-called “back-office” conversion of checks submitted for payment at the point of sale • Extends Regulation E coverage to merchants and other payees, for the limited purpose of providing notice to obtain consumer authorization • Merchant coverage intended to help ensure uniform and consistent notices • Sunset date: Three years

23. Regulation EPayroll Cards • Scope limited to payroll card accounts as opposed to stored-value cards • Justification for limited coverage • Greater likelihood that a payroll card account will serve as a consumer’s primary transaction account, whereas stored-value card products may be used only on short-term basis • Coverage of stored-value products could stifle development of those products

24. Regulation EPayroll Cards • Regulation E typically requires paper periodic statement from financial institutions. As an alternative to providing paper periodic statements for payroll card holders, financial institutions may instead: • Make available balance information via telephone; • Make available an electronic history of account transactions; and • Make available promptly, upon request, a written history of account transactions • Board is issuing rule in interim form to solicit comment on modified requirements

25. Regulation CCRemotely Created Checks • Increased fraud associated with the use of demand drafts • Definition of remotely created check: a check that does not bear the signature of the drawer and that is not created by the paying bank • Previously, a paying bank was unable to recover from an upstream bank for an unauthorized remotely created check once its midnight return deadline passed • Regulation CC was amended to include a new warranty for such checks, thereby facilitating recovery from the depositary bank • Effective date: July 1, 2006

26. Check 21 Survey • Congress mandated a Check 21 study • Study will assess the effects of Check 21 on the payments system • Report due no later than April 2007 • The Board is conducting a survey of about 3,000 institutions to gather data from a nationally representative sample of depository institutions • To view the survey (look for “FR 3080”): www.federalreserve.gov/boarddocs/reportforms/review.cfm

27. Check 21 and Electronic Check Conversion - A Comparison

28. Working together to make the payments system a better place

29. Questions