How does the bank transfer money from your checking account to someone else’s account?

When people wrote checks in England as early as 1762, the banks hired delivery clerks to run back and forth between banks to collect the money.

To expedite matters, banks developed clearinghouses, organizations in the bank’s locality through which checks were exchanged and net balances settled. Woodrow Wilson organized this system on a nationwide basis in the United States when he signed the Federal Reserve Act in 1913, which provides a national clearing mechanism for checks.

A Federal Reserve bank acts as a check clearing and collection center for the banks in its district. There are twelve main Federal Reserve banks (and twenty six branches) in major cities across the country.

Individual banks have deposits at their Federal Reserve (or correspondent) bank, where transactions are settled by crediting the sending and debiting the receiving banks’ accounts. The Federal Reserve banks then must pay each other daily by settling the net balances of each day’s transactions on the books of an interdistrict settlement fund in Washington.

If you send a check from Chicago, for example, to a friend in California, the transfer of money isn’t quite so direct as it might appear.

First, the friend goes to his local bank in Berkeley and deposits your check. The local bank deposits the check for credit in the Federal Reserve Bank of San Francisco, which then sends it on for collection from the Federal Reserve Bank of Chicago. The Federal Reserve Bank of Chicago forwards the check to your own local bank, which deducts the amount from your account (assuming you aren’t bouncing checks) and then tells the Reserve Bank of Chicago to deduct the same amount from its deposit account with the Reserve Bank.

Next, the Federal Reserve Bank of Chicago must pay the Federal Reserve Bank of San Francisco by payment in its share of the interdistrict settlement fund. The Federal Reserve Bank of San Francisco may then credit the local bank in Berkeley, which in turn credits your friend’s account.

In 1979 Americans wrote approximately 34.14 million checks, and each year the volume of checks is estimated to increase by 7 percent. Fifteen billion of these checks passed through Federal Reserve banks; the others, particularly those representing large transactions between banks, were processed by correspondent banks, city clearinghouses, and so on.

Most Federal Reserve banks are equipped with IBM 3890 processing machines, which, at a rate of 100,000 per minute, sort checks into compartments representing single banks or groups of banks, at the same time weeding out forgeries, checks improperly endorsed or dated, and checks drawn on accounts with insufficient funds.

In 1979 more than 4,000 full and part time employees of the Federal Reserve were involved in the national operation of check clearance.

About Karen Hill

Karen Hill is a freelance writer, editor, and columnist. Born in New York, her work has appeared in the Examiner, Yahoo News, Buzzfeed, among others.

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