This is the third and final essay in my series on proposals to help reduce the number of unbanked households in America. In my prior essays, I examined the history of the postal savings system between 1910 and 1966, and I evaluated present-day calls to allow the U.S. Postal Service to offer bank accounts—and possibly small-dollar credit—to its customers. But no review of contemporary financial inclusion policy would be complete without considering the case for direct provision of retail deposit accounts by the Federal Reserve, extending to households and nonfinancial businesses what is currently only available to member banks of the Federal Reserve System.[1]

FedAccounts

Perhaps the most prolific and influential advocate of universal Fed accounts is Morgan Ricks of Vanderbilt University, who has co-authored several papers and testified before Congress in support of this initiative. Ricks and his co-authors first made their case in 2018, before the announcement of the Libra private digital currency project and the onset of the COVID-19 pandemic. But those events have made policymakers better-disposed to grant their suggestions a hearing. In particular, the disappointing performance of government systems in the delivery of stimulus (“economic impact”) payments in March and April has animated some policymakers to explore more permanent government infrastructure for directly transferring benefits and tax refunds.

The Ricks et al. proposal would make “FedAccounts” available to all U.S. citizens, residents, and nonfinancial businesses. These accounts would offer the same services as commercial bank accounts, except for overdrafts. (The proposal doesn’t involve any call for the Fed to grant retail credit.) Like ordinary bank accounts, FedAccounts would come with debit cards, ATM access, and direct deposit and online bill pay services. They would also support internet and mobile banking and include a customer service number. These features would put FedAccounts in direct competition with commercial bank checking and savings accounts.

Cui Bono?

Ricks and his co-authors believe that the absence of minimum balance requirements or account maintenance fees on FedAccounts would make them attractive to “millions of people who currently choose not to or are unable to maintain bank accounts.” They also claim that by using these accounts instead of cash the unbanked would enjoy indirect benefits, such as easier access to credit cards.

Ricks et al. also claim that FedAccounts would speed up the U.S. retail payments system, as the accounts would connect to the Fed’s existing real-time gross settlement (RTGS) service for banks, called Fedwire. By clearing payments instantly, FedAccounts could save consumers overdraft fees they presently incur while they wait for checks to clear in their commercial bank accounts. In 2019 alone, such fees totaled $11.68 billion, according to FDIC data. Under Ricks’ proposal, the Fed would not charge interchange fees for FedAccount card payments and would eliminate existing fees for interbank transfers on Fedwire.

Besides these consumer benefits, Ricks and his co-authors believe FedAccounts would help macroeconomic stability, “crowding out” runnable deposit substitutes such as money market funds, which, while used as a cash equivalent, lack deposit insurance. By offering households and businesses “riskless money with a positive yield,” FedAccounts would render these alternatives uncompetitive. In the process, they might even make some prudential regulation redundant, as the demise of runnable cash equivalents would reduce and perhaps eliminate financial institutions’ vulnerability to funding crunches.

The Question of Take-up

Ricks et al.’s assumption that FedAccounts would appeal to unbanked households is based on the fact that cost-related issues are the most important category of reasons for lacking a bank account, according to the FDIC’s biennial survey of the unbanked. In this survey’s recent editions, lacking enough funds to meet the minimum account balance requirement has been the most cited reason the unbanked gave. “Account fees are too high” was the fourth most popular reason. By dispensing with a minimum balance requirement and other fixed fees common to many commercial bank accounts, FedAccounts could prove attractive to households living paycheck to paycheck, including ones that are currently unbanked.

Yet Ricks et al.’s conclusion that FedAccounts would lead to a substantial reduction in the number of unbanked households may be unwarranted. Although 38 percent of them are mainly concerned with account maintenance fees, 62 percent cite other concerns, such as not trusting banks, preferring greater privacy, and “personal identification problems,” that is, lacking the documentation required for opening an account. Even among those who cite account fees, take-up might only be substantial once the Fed proved itself capable of delivering good retail banking services, despite its lack of experience in the field. After all, it took Visa, Mastercard, and their competitors decades to build the networks they run today. The expectation of slow take-up is not itself a reason against FedAccounts, but it could make alternative routes to bank the unbanked—such as expanding the range of private account providers—look more attractive.

A Government Surveillance Tool?

Even though discussions of financial inclusion tend to focus on account fees, privacy is also an important concern for many unbanked. More than a third of them told the FDIC that privacy was one reason why they were unbanked, and 7.1 percent said it was their main reason. Another 20 percent cited ID problems among the barriers they face. Whether because they work in the informal economy, or are undocumented immigrants, or just because they see bank accounts as an intolerable tool for surveillance, some unbanked refuse to hold them. Because FedAccounts would not protect against surveillance any more than regular accounts do, they would be unlikely to reassure these people.

Not all forms of digital cash are equally vulnerable to government surveillance, though. Cryptocurrency advocates such as Coin Center’s Peter Van Valkenburgh have called for any future Fed-supplied digital dollars to take the form of “bearer tokens,” which anyone in their possession could use, instead of accounts intermediated by the Fed or private institutions. By allowing their users to remain anonymous without arousing the interest of law enforcement, these tokens would be closer to physical cash than FedAccounts.

Still, I doubt that policymakers would favor bearer tokens over FedAccounts. (I am not the only one: Coinmetrics’ Nic Carter, while calling on governments to respect privacy, is also skeptical.) The push for greater surveillance of bank accounts is one among few bipartisan causes in Congress, even though the Bank Secrecy Act and other anti-money laundering/ know-your-customer (AML/ KYC) legislation account for more than 22 percent of the regulatory burden on community banks. Nor is there much evidence that these regulations aid national security or the fight against violent crime. But if that has not managed to persuade Congress against new invasions of financial privacy, I doubt the debate around digital dollars will.

In the Red

Setting aside concerns about take-up and privacy, Ricks et al.’s proposal still leaves another important question unaddressed: how would the Fed cover the cost of providing FedAccounts absent account charges, interchange and Fedwire fees?

Under the 1980 Monetary Control Act (MCA), the Fed must set the price of services it provides in competition with the private sector to cover those services’ short- and long-run costs. Ricks and co-authors recognize in a footnote that their proposal to eliminate all Fedwire fees might conflict with the MCA. But even ignoring its requirements, many policymakers would probably want to know if FedAccounts could ever break even before lending their support to the proposal. And while Ricks et al. confidently assert—based on the annual profits the Fed remits to the Treasury Department—that FedAccounts would pay for themselves, a little back-of-the-envelope math suggests otherwise.

Consider that, in 2019, the Federal Reserve System had net income of $55.5 billion, of which it remitted the bulk ($54.9 billion) to the Treasury. On a balance sheet of approximately $3.9 trillion on average over the period, that represents a return on assets (ROA), net of interest paid on bank reserves, of around 1.4 percent, slightly above commercial banks’ average ROA of 1.29 percent for 2019. Assuming FedAccounts managed to attract $5 trillion of customer deposits—around a third of total deposits in the U.S. commercial banking system as of 2019—this rate of return would generate $70 billion of additional income for the Treasury.

But is it realistic to assume the Fed could maintain its profitability after the introduction of FedAccounts? Assume the $5 trillion were all invested in Treasury securities of different maturities—in equal portions across 3-month and 1-year bills, 5- and 10-year notes, and 10-year bonds, for example. Given such a distribution and current yields to maturity for these different securities, the Fed would earn approximately $32 billion on $5 trillion worth of deposits. From that we must subtract 10 basis points, the interest rate that the Fed currently pays on commercial bank reserves and which Ricks and co-authors would like it to pay for retail deposits, too. That leaves a net interest margin of $27 billion.

But remember that the Fed would incur setup and running costs for its FedAccounts system. These would include not just the core infrastructure for retail payments, but also an ATM network, devices and software for merchant card acceptance, mobile and online banking applications, a permanent customer service workforce, and other expenses characteristic of commercial banking. Because FedAccounts would not include credit, there would be no expenses related to underwriting, monitoring, and collecting on customer loans, but the Fed would not earn more on its assets than the “risk-free” rate of interest either.

At any rate, these investments would be quite different from the ones the Fed is accustomed to. And they would be sizable: according to the FDIC, noninterest expenses for all commercial banks were equal to $466 billion, or 2.5 percent of total banking system assets, in 2019. Even allowing for scale economies and other efficiencies from the use of, for example, post offices as FedAccounts banking facilities, and assuming on that basis that the Fed’s noninterest expense would be 2 percent of assets, that still comes to $100 billion—nearly four times the central forecast for interest income and $30 billion more than even our most optimistic estimate.

Besides interest margin income, the Fed collects fees from enabling interbank payments on Fedwire. But Ricks and his co-authors would like to axe these fees, which already do not suffice to fully offset costs—perhaps due to generous volume discounts for high-volume member banks. Based on 2019 figures, eliminating Fedwire fees would lead to additional expenses of around $140 million. All told, it is difficult to see how FedAccounts could ever break even, let alone comply with a strict interpretation of the MCA, which calls for full cost recovery (including capital costs).

Conclusion

Central bank provision of retail accounts is gaining traction around the world, often in the guise of central bank digital currency (CBDC) proposals. Whereas in Britain and the euro area, CBDCs are supposed to address the decline of cash use and the growth of nonbank e-money providers, in America FedAccounts are mainly intended as a tool for financial inclusion. Yet even if these accounts involved no fixed fees, the majority of the unbanked might not adopt them, out of concern for their privacy. Nor would FedAccounts be likely to meet the MCA’s cost recovery requirements. Policymakers who wish to increase the rate of banked households might therefore be better off facilitating the entry of alternative providers, by for example giving nonbanks access to master accounts at the Fed and reducing AML/KYC obligations on digital wallets.

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[1] A few other organizations, such as the government-sponsored housing enterprises, foreign governments, and the Department of the Treasury, also hold accounts at the Fed. But most accounts belong to commercial banks.

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