The Federal Reserve is poised to make policy changes that will force many banks and other financial institutions to change the way they think about money.

In an effort to reduce cash-handling costs, the Fed has announced its intent to introduce a custodial inventory program which will encourage banks to hold currency in their vaults rather than shipping it to the Fed.

In 2006, it plans to begin imposing fees on depository institutions that deposit and order currency from Reserve Banks within the same week, a practice called cross-shipping.

"This is a fundamental shift in the mindset for a majority of FIs in the U.S.," said Tyson Nargassans, vice president of sales and marketing for eClassic Systems, a provider of cash-management software. "Institutions must take greater responsibility and ownership of their cash inventories."

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In 2002, U.S. Reserve Banks processed 34.2 billion notes at a cost of $342 million. According to the Fed, 19.4 billion of the notes were $5 through $20 bills - nearly 6.7 billion of which were followed or preceded by orders of the same denomination by the same institution in the same week.

Based on the 2002 data, the Fed estimates it could reduce annual processing costs by up to $35 million by cutting down on cross-shipping of $5 to $20 notes, the only denominations that would be initially included in the new policy.

Banks will be allowed to transfer $5, $10 and $20 bills into custodial inventories rather than shipping them. The currency will be owned by a Reserve Bank - even though it will remain in a bank's vault. To become eligible to hold inventories, a bank must commit to re-circulating a significant amount of currency and be capable of segregating the Fed currency from its own cash.

The Fed also has proposed a penalty of $5 to $6 for each bundle of cross-shipped currency in the $5 to $20 denominations. Banks would not pay a penalty for the first 1,000 cross-shipped bundles in a particular zone or sub-zone each quarter.

Nargassons said the proposed changes will require banks to adopt more proactive cash management strategies. "The plan will force each institution to monitor vault levels and predict cash usage for each endpoint to better utilize existing resources."

Exempting ATMs

Some banks want ATMs to be exempted from the policy.

"Most cross-shipping of currency in our industry results from the need for currency fit enough for automation, such as for ATMs," Amy Dronzek, KeyBank's national manager of Cash Vault Services, wrote in a comment letter. She said that some banks will have to invest in more currency sorting equipment - or pay higher fees for cash replenishment.

"If the armored courier companies obtain currency from depository institutions, then they will increase ATM service fees for the additional handling of the currency that will be required," she wrote.

In its comment letter, Huntington Bank raised the possibility that "using recirculated money that does not meet strict fitness levels could cause ATM downtime or additional costs for emergency cash transportation."