Universal Access, Cost Recovery, and Payment Services

Abstract

We suggest a subtle, yet far-reaching, tension in the objectives specified by the Monetary Control Act of 1980 (MCA) for the Federal Reserve’s role in providing retail payment services, such as check processing. Specifically, we argue that the requirement of an overall cost-revenue match, coupled with the goal of ensuring equitable access on a universal basis, partially shifted the burden of cost recovery from high-cost to low-cost service points during the MCA’s early years, thereby allowing private-sector competitors to enter the low-cost segment of the market and undercut the relatively uniform prices charged by the Fed. To illustrate this conflict, we 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. Uniform pricing is dropped in this model once cream skimming has subsumed half the market. These results help illumine the Federal Reserve’s experience in retail payments under the MCA, particularly the movement over time to a less uniform fee structure for check processing.

The authors wish to thank Vadim Anshelevich, Hesna Genay, Gautam Gowrisankaran, Preston McAfee, Marci Rossell, Bruce Smith, Joanna Stavins, Ed Stevens, James Thomson, David Van Hoose, John Weinberg, and participants at the 1998 Southern Economic Association meetings in Baltimore and the Federal Reserve Financial Services Research Group Workshop for comments and suggestions. The views expressed may or may not coincide with the positions of the Federal Reserve Banks of Chicago or Dallas, or the Federal Reserve System.