With pending federal legislation providing the impetus, a growing number of banks are preparing to process checks electronically--that is, without physically moving the paper through their systems.
The new check clearing and settlement process promoted by the legislation, the Check Clearing for the 21st Century Act, would pull paper checks out of the equation the moment they are handed over to a bank. Once digitized, the information would be used to settle and debit accounts, while an image of the check would serve as the check writer's receipt for the transaction. The original paper check would become dispensable early in the process.
This method, known as check truncation, could help banks save millions in operating costs, according to the financial industry. Consumer groups, on the other hand, argue that legislation would have an adverse impact on consumer privacy rights and habits, as well as hamper their ability to recover losses because of check fraud.
The momentum, however, is clearly behind modernizing check processing regardless of whether the legislation is actually enacted. Banks are searching for ways to reduce the $2.1 billion a year they currently spend on processing and transporting the nearly 50 billion checks that enter the financial system.
Just last month, 20 of the nation's largest banks funded Small Value Payment Co. (SVPCo), a consortium of their payment systems, to begin building a network that will specifically handle the transfer of checks' digital images between member banks. The network is expected to be up and running in the first quarter of 2004, according to the company's president, Hank Farrar. Backers include Citibank, Bank of America and The Bank of New York.
"Our business case and where we are going (are) not contingent on the act passing. That's the good news," said Farrar. "Check truncation is inevitable."
The travels of a check
A check written today has a long roundtrip journey. The financial industry estimates a check is processed, on average, about 2.6 times before making it back to the payer in a monthly statement. A check is first deposited in the payee's bank, which runs it through a reader/sorter to gather relevant information. The information is electronically sent to the check writer's bank and debited from his or her account, but the check itself still has a ways to go.
Cracking the nest egg
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convenience of online banking.
While the banking industry is modernizing its check collection and return process, the system's legal framework still mandates that a physical check must be returned unless a consumer agrees to a substitute an image or some other record.
"Legal impediments...have prevented the banking industry from fully using these new electronic technologies, such as digital imaging, to improve check-processing efficiency and provide improved services to customers," said Roger W. Ferguson, a member of the Board of Governors of the Federal Reserve System, before the Congressional Subcommittee on Financial Institutions and Consumer Credit on Sept. 25. "We can see how this requirement (to present the paper check) constrains technological adoption by following a check through the collection process."
In other words, the problem is that consumers still want to receive their paper checks after they have been processed, forcing banks to also require them throughout the process.
"This legislation is really being pushed by banks," said Avivah Litan, an analyst at research firm Gartner. "Frankly, consumers still like to have a written record in the United States. They're just used to it."
Even without the legislation, Farrar believes that as many as 90 percent of account holders will allow their checks to be truncated as SVPCo's business matures. But in order for banks to truly bring cost savings about, they will need the other 10 percent, and the legislation could present the best option to do that.
"Getting to virtually 100 percent truncation is when the value comes in," Farrar said. "As long as we have to do it both ways, there are costs associated with it."
Farrar said the banks backing SVPCo process 60 percent of the checks written in the U.S. but consortium?s network will be an open system interoperable with all U.S. banks, including the Federal Reserve.
Digital as good as paper?
A coalition of consumer groups have banded together in the hopes of derailing the legislation as it stands. These groups include Consumers Union, Consumer Federation of America, U.S. Public Interest Research Groups and National Consumer Law Center.
There are several drawbacks to the act, these groups say, including the following:
The act does not effectively protect consumers from new errors that could crop up by electronic imaging of checks.
It does not guarantee that consumers can get an original check or a substitute check back without a fee.
It contains no privacy protections stopping the information stored in the digital image from being used for market research or sold to direct marketers.
The act makes it much harder for a consumer to recover losses due to forgery.
"Consumers will be hearing from banks that they get all the same information as on a check," said Gail Hillebrand, a senior attorney for Consumers Union. "But you don't get the pressure that was applied by the pen, which can be valuable in proving that a check is forged."
However, Litan, the Gartner analyst, said she could see an electronic system making a difference with fraud. "There (would be) more opportunity to do online validation as the check moves through the electronic network."
As for the promise to speed up the check-processing system for banks--something the act promises to do--Hillebrand said consumers won't see any benefits from the faster speeds. Banks are under no obligation to make the cleared funds available sooner to the consumer. Currently there is a 48-hour holding period for most deposited checks, even if the bank receives the actual funds earlier.
Some analysts said that consumers actually want the ability to access the digital images of their checks and deposits slips online. "A number of banks, including Bank of America and Wachovia Bank, have rolled out such services," said Chris Musto, director of financial services at Gomez Internet Quality Measurement, a research and consulting firm.
Consumer groups said they are not opposed to progress that improves services offered to consumers. But they do caution consumers to not rush to accept products and services based on new legislation.
"We're not opposed to new technology, but new technology that changes the way checks are processed should recognize the new risks and treat consumers fairly," said Hillebrand.