Check 21 Moves Checks from Pony Express Era to Computer Age

Posted on June 06, 2008 by Ginger Watford

by Stephen Parezo
 

October 14, 2004-After Oct. 28, the old adage that "the check is in the mail" literally will not compute, thanks to the Check Clearing for the 21st Century Act or "Check 21." This act, which simplifies the check clearing process, is seen as an absolute boon for banks across the nation. Experts say these financial institutions will reap up to $50 to $70 million in fees alone during the first year.

According to the Federal Reserve Board, Check 21 is designed to enable banks to handle more checks electronically, making check processing faster and more efficient. More than $40 billion checks are processed each year, valued at $39 trillion. Original paper checks must be physically moved from the bank where the checks are deposited to the bank that pays them, an inefficient and costly route.

It's expected that the new law should benefit businesses in a variety of ways. These include faster check clearing, deposits posting faster, reduced risk of check fraud, more security and fewer delays.

Hits could be significant
Under Check 21, checks will now be allowed to clear electronically with digital images of checks serving as substitutes for more traditional checks.
Electronic payments surpassed the use of checks for the first time last year, according to a study by the American Bankers Association, a Washington, D.C., trade group, and Boston-based Dove Consulting. Cash and checks accounted for 47% of consumer purchases in 2003, down from 51% in 2001. The ABA estimates that annual savings generated by processing checks electronically will be $2.1 billion.

Many short-funded check-writers relying on a several-day lag or "float" to get a check back to their own bank for payment could wind up with a number of nonsufficient funds (NSF) notices and fees. With Check 21, checks are going to clear the next day.

"That's going to be the biggest single impact-that's where the banks are going to make a fortune in fees. It's going to be dramatic and traumatic," said John Innes, president and founder of ACH Processing Company of Savannah, GA, a processor of electronic funds transfers on behalf of originators and financial institutions through the direct Federal Reserve Fedline system.

Regardless of whether the payor has sufficient funds in the bank to cover the just written check, Innes says the transaction "is going to hit the next day, not a week from now. That means that person is going to get hit with bank fees and the depositor might also get hit with fees. That could be significant."

This means entrepreneurs will have to keep better records and make sure that what's registered in their checkbook is written clearly because they won't have the paper check stub in their hands.

Electronic check processing is not new to the financial industry and the Fed maintains that it's a safe and reliable way of processing payments. Here's how it works: Banks capture a picture of the front and back of the check along with the associated payment information and transmit this information electronically. If the receiving bank or its customer requires a paper check, the bank can use the electronic picture and payment information to create a paper "substitute check."

The Fed took steps to change traditional check handling after the 9/11 terrorist attacks when checks sat on grounded planes for days, bringing the nation's flow of commerce to a grinding halt.

"It was the straw that broke the camel's back," Innes said. "The Fed said there has to be a better way."

Smart Brief

• Check 21 is designed to enable banks to handle more checks electronically.
• Benefits of new law include faster check clearing, deposits posting faster, reduced risk of check fraud, more security and fewer delays.
• Checks will now be allowed to clear electronically with digital images of checks serving as substitutes for more traditional checks.
• Checks are going to clear the next day.
• Entrepreneurs need to keep better records; tighten up their cash flow.
• Most large banks don't plan to implement new law until mid-2005.

It's All About Cash Flow Management

Fiducial's Randy Penn believes that Check 21 is a great deal for the economy and for business as a whole because good business people plan to have their cash flow in place and don't plan on writing checks they can't cover.

"This is modernization of the banking system so we catch up to the electronic world," he said.
Check 21 should help those cashing checks of substantial amounts not to wait so long for access to their money. For example, if a business owner walks into a bank with a $10,000 check and the bank puts a hold on those funds, ACH's John Innes indicated that the new law "should cut some of this hold out. You should have a return almost immediately."

In an increasingly cashless society, there's an invisible tug-of-war between credit card companies and major retailers. At stake is whether a customer uses their bank-issued card using a Personal Identification Number (PIN) or a signature which affects the size of the accompanying fee the merchant and sometimes the customers must pay. Fees for using the PIN usually range from 18 cents to 65 cents per transaction while a signature-based debit transaction can cost the merchant more than $1 per transaction.

There's also the matter of dispute resolution, which will need to be addressed by the banks. Innes questions whether banks will charge customers for substitute checks and if they don't get a substitute check back do they have the right to be re-credited if there's a dispute.

"The bad news is there doesn't seem to be any limits on what banks can charge," he said.
As far as these charges go, Penn says it's up the banks as part of their pricing scheme and that most banks are every reasonable about doing that.

To avoid getting hit by any NSF fees, business owners can prevent being the recipient of a "hot" check by better knowing their customers.

"With the contact that we have we know our customers better than they know themselves," he said.
For businesses that have had a bad hot check experience it may drive them to other forms of payment like credit cards or cash.

It's not coming out of left field
Experts agree that what Check 21 really boils down to is cash flow management.

"If you're using it, it's going to improve your cash flow," Penn said. "If not, it will have the opposite effect."

Industry insiders concur such as John Moorhead, a Check 21 program coordinator with Beavercreek Inc., a Grand Island, NE-based marketing firm that serves the banking industry.

"For small business owners the biggest thing is to watch their cash management," said Moorhead. "They need to prepare for that. For example, they will have quicker access to their money and funds deposited because of the [quicker] float time."

Moorhead does not anticipate that any additional fees will be charged by banks as a result of Check 21 or substitute checks.

"There's no fees expected other than nominal ones that have always been there such as for research," he said. "Our expectation is that banks will absorb the costs to create those checks."
Most people are aware of Check 21, Moorhead says, so it's not as if it's coming out of left field.

"I think the majority are for the changes," he said. "The most upsetting part of the whole act is that it doesn't give much time since the government is forcing it on banks within a short period of 91 days from the first ruling, July 26, to the final ruling on Oct. 28."

Tightening up on cash flows
Mike Spink, a Certified Financial Planner in Fiducial's Mt. Vernon, WA, office says that due to Check 21, small business owners need to tighten up their cash flow.

"There are a lot of security issues that need to be addressed," he said. "Any time you have monies flowing you always worry about unauthorized attacks on your funds. You always worry about people getting access to your account."

Some law enforcement agencies contend it will be harder to convict the majority of check-writing felons without the original check to examine for paper stock, color, printing techniques, fingerprints, handwriting characteristics and pen pressure points. Others argue that the faster electronic processing will actually help fight fraud since accountholders can see their checks posted on Internet-enabled financial sites and will be alerted to fraud more quickly.

Check law provides protections against fraudulent checks and the Fed says that generally you are not responsible if you notify the bank in a timely fashion. This is the case whether you receive an original check, a substitute check, an image statement, or a line item on your account statement. When in doubt, check with your bank.

Those playing the float game may just lose three to five days out of their cash flows.

"A lot of business owners are going to be hurting cash-flow wise," Spink said. To stem that tide, he advises owners to see their local banker to extend their line of credit and to make sure they have overdraft protection. Bounced checks can cost a fortune because they come in batches with fees typically ranging from $15 to $30 per check.

The jury's still out
Most experts believe the jury's still out on the issue of how Check 21 will play.

"To a degree, it could be on the fly," ACH's Innes said. "There is no date certain when this thing is going to be universal. All banks are not going to be involved. A bank doesn't have to do it."

Randy Penn, Branch Manager of Fiducial's Arvada, CO, office cautioned that it's too early to speculate on how things are going to turn out for Check 21 implementation.

"The good news is banks won't be able to use the collective balances issue against you anymore-either in calculating fees or what checks to pay," he said. "They have an old habit of only paying on collected balances. Now it's going to be transmitted electronically."

Penn points out that most people don't realize that a picture is taken of every check every time it changes hands all down the line until it finally clears. With Check 21, only one picture is taken at the first bank which then ships the check electronically on throughout the system.

"This not only saves on the transportation costs but it saves the cost of filming all those checks and people to do that," he said. "It will save banks a ton of time and labor and thereby make it cheaper for them to provide services."

The key, says Penn, is that Check 21 "will help our clients clear their checks more quickly."

It's going to be an evolution, not a revolution
Most bankers expect a truly paperless system to be phased in only gradually over three to five years and not just for the smaller institutions, according to an industry spokesman.

"This will be a real gradual change," said John Hall, ABA's associate director of public relations. "It's going to be an evolution rather than revolution. There's a lot of hype surrounding Check 21 just as there was for ATMs and Internet-only banking."
Hall says it's not as if on Oct. 28 that a switch will be flipped and all checks will be processed electronically.

"Most large institutions don't plan to implement this until the middle of next year," he said. "Beta tests are already in place. Some of these banks process one million checks a day so they want to get it right."

Banks are expected to spend around $20 billion industry-wide on upgrading their image-based processing systems. Customers' checks have been imaged for decades by banks with these images accepted as proof of payment by the courts and the Internal Revenue Service.

"This is a tried and true system," Hall said. "The main change is where the bank images the check earlier in the process. If you write a check they'll image it and send the image through an image exchange network or clearinghouse."

The time it takes a check to clear will be reduced to about 24 hours or about as long as a local check takes to clear.

"We're moving the checking process from the pony express era to the computer age," he said. "Checks used to be sent in airplanes, trucks and trains through an antiquated and clunky system and we're just bringing it up to speed for other payment forms like credit cards."

Stephen Parezo is the Media Manager for Fiducial