The federal government’s plan to stop mailing out paper checks and instead transfer funds electronically initially raised the hopes of local community activists.

Such a move, they reasoned, would prompt commercial banks to finally open more branches in South Central L.A. and other underserved urban areas, and would put high-cost check-cashing operations out of business.

But the exact opposite seems to be happening.

The government’s switch to electronic transfers is “going to help the check cashers proliferate. The government is going to endorse the check-cashing shops as the poor man’s bank,” said John Bryant, chairman and founder of Operation Hope Inc., a non-profit banking organization that is attempting to offer L.A.’s inner-city residents a lower-cost alternative to check cashers.

Forming an alliance with check cashers is clearly a lower-cost alternative to opening new inner-city bank branches.

The alliances would work as follows: Inner-city customers would pay a fee to their local check-cashing shop that would, in turn, open up an account for them at a bank handling the federal electronic transfers.

The government would transfer the funds to the bank account, and then the check casher would serve as the conduit through which the customer could withdraw those funds from the bank account, again for a fee.

Treasury Department spokesman Paul Elliott said the federal government is not to blame for check-cashing shops being used to distribute benefit payments.

“The Treasury can only make payments to federally insured financial institutions,” he said. “These other forms of payment providers (check cashers) are not regulated or responsible to the federal government in any fashion.”

He confirmed that some banks have been forming distribution agreements with non-regulated institutions, such as check cashers. The Treasury is, however, requiring that any bank with such an alliance must disclose the relationship to its customers. He also said that any recipient who finds that the new system poses a burden could continue receiving paper checks through the mail.

One bank that has played a prominent role in government payments and is a leader in direct-deposit technology, Citicorp, has decided to use check cashers as a means of distributing federal benefits, confirmed Mary Regan, a Citicorp spokeswoman. However, Regan declined to comment further about the arrangement.

Daniel Roberts, president of Digital Currency Services Inc., which operates 15 check-cashing shops in the Los Angeles area, said the shift to electronic transfers will probably increase his company’s revenues. “These people are going to have to have access to their money and they may not live close to a bank. So they will want to use check cashers,” Roberts said.

Activists and inner-city community bankers criticized the government for, in effect, saving money by passing on its costs to the consumer.

“Whereas they used to send the check directly you, now you have two middlemen (a bank and a check casher) and they are charging for the service,” said Paul Hudson, president of Broadway Federal Savings and Loan, which operates five branches, mostly in poorer neighborhoods.

Tesa Carmen DeRoy, an analyst at Strategic Action for a Just Economy (SAGE), an L.A.-based community activism group, said: “In our minds it is an effective reduction in benefits.”

Some 800,000 California residents do not have bank accounts and many of them receive Social Security, welfare, Veterans, or other federal payments. They often turn to check-cashing shops to cash the checks they receive through the mail.

There are an estimated 300 to 500 check-cashing facilities in L.A. County, and in South Central the ratio of check cashers to bank branches stands at 17 to one.

Such operations typically charge 2 percent to 3 percent of the value of each check cashed. And unlike commercial banks, check cashers offer no incentive for their customers to save their money.

It’s a problem that speaks to the social-ethnic divisions that exist in L.A., said Robert Gnaizda, policy director at Greenlining Institute, a San Francisco-based banking industry watchdog. “What you are seeing is a segregated banking system, where Latinos get less service for higher costs,” he said.

This would not be the first time check cashers would benefit from a government phase-out of paper checks. Since June 1997, L.A. County has been using check-cashing shops as the sole distribution point for welfare checks.

Even if they have a bank account, all welfare recipients must go to one of 115 participating check-cashing facilities to pick up their checks. Under pressure from consumer activism groups like SAGE, the county will begin giving welfare recipients a direct bank deposit option starting in September.