Check 21: Pay Attention—Or Pay

Steve Swanston, Credit Union Magazine
December 22, 2004

“Paperless banking,” far from total reality, took another step forward Oct. 28 when the Check Clearing for the 21st Century Act (Check 21) became effective. The act, however, already is raising some critical questions:

Are accountholders fully aware, much less prepared, for life without “the float?” Two or three days of float will become one day or less—almost as instant as an automated teller machine (ATM) transaction. Are credit unions poised for increased bounce check activity and the attendant management problems? Check 21 allows financial institutions to electronically exchange checks through digital imaging, as opposed to previous requirements demanding physical transport and processing of paper checks. The institution can destroy the paper version it receives and create a “substitute check” that legally performs all the functions of a canceled check.

The new rules aren’t mandated, but the early adopters believe more members will be encouraged to use online services, which are capable of displaying check images. Substitute checks, or printouts of the processed images which are identified by special markings, will still be returned to requesting accountholders, but there may be a fee charged. Banks are required to keep the images for seven years.

The Federal Reserve System, which serves as the check clearinghouse, already has hastened the time it takes for checks to clear by streamlining many of its processes. Check 21 will let financial institutions work directly with each other to settle accounts without involving the Fed. That could sharply reduce the handling of a single check—now as many as 12 times, according to Mario Villarreal, chief technology officer for U.S. Dataworks, a Houston-based check processing and conversion software firm.

The Fed took steps to change traditional check handling after the 9/11 terrorist attacks, when checks sat on grounded planes for days, significantly slowing the nation’s flow of commerce. The delays swelled the float to $47 billion, almost 100 times its normal size, because aircrafts transport a significant share of the 40 billion paper checks written annually by consumers (50.9%) and businesses (32.3%). Banks process an estimated $200 billion worth of checks daily.

A study for KeyBank National Association shows the financial services industry spends about $250 million annually to transport paper checks, or an estimated 101 million checks daily. According to industry estimates, financial institutions may invest $10 billion in check imaging equipment over the next three to five years, with a potential savings of $2 billion to $3 billion annually.

Cyndi Koan, senior vice president-operations for Denver-based SunCorp, told the Denver Business Journal that “only 30% of large banks and small banks are image-enabled, while 40% of mid-sized banks are image-enabled. So the process of conversion nationally will take a while to implement. By 2007, all of the large banks, 80% of mid-sized banks, and 40-50% of small banks are expected to be image-enabled.”

Consumer advocates argue that if checks clear sooner, deposits to accounts should speed up, too.

Check 21 May Stimulate Overdraft Programs

Although only 2,000 to 2,500 of the nation’s financial institutions have formal overdraft programs, all have some kind of penalty, fee, or charge for nonsufficient funds (NSF) items when an account lacks adequate funds.

Automated, nondiscriminatory overdraft privilege programs, also known as “courtesy pay” and “bounce protection,” offer distinct advantages to accountholders and the institutions. Such programs help accountholders avoid embarrassment, inconvenience, and additional costs when retailers or others present that same check for payment more than once.

For financial institutions, such programs will ease the decisioning burden on paying or returning the check. It also reduces item processing by 10% to 30% and improves noninterest income. Much of that income isn’t new, but simply redirected fees from accountholders who might otherwise use credit cards, payday lenders, check cashers, and others for short-term assistance.

Accountholders, educated on their overdraft limit and accepted use of the program, could still experience a higher number of overdraft charges if they don’t realize that float is becoming an endangered species. The charge on an NSF item ranges from $17 to $35, averaging $22.50 in 2003. Studies indicate the average accountholder writes about 3.4 NSF items per year.

The top-tier providers of check overdraft programs worked diligently last summer to educate their clients about the impact of Check 21. Many financial institutions, in turn, have communicated the coming change to their accountholders through advertising, local media coverage, and with statement inserts.

The financial services industry is working diligently to ensure consumers don’t experience multiple charges by the merchant and the financial institution with the advent of Check 21. No financial institution executive wants to see a customer/member’s credit record blemished or consumer-merchant relationship tarnished. Dissatisfaction and frustration over bounced checks and fees will make account retention difficult.

Fraud Prosecution

A potential drawback to electronic processing may be in the area of fraud prosecution. 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.

Some industry executives respond that the faster electronic processing will actually help fight fraud by leaving less “getaway room” for check forgers. Accountholders who can see their checks posted more quickly on Internet-enabled financial sites will be alerted to fraud more quickly.

If that argument is valid, electronic banking will make a major stride because studies show that only about 30% of accountholders even bother to open their monthly statements. One may wonder, then, how many people ever balance their accounts, as well as realize why overdraft programs are enjoying growing popularity. Will they check their activity online now that Check 21 in place? “Do the math” has never been a popular admonition in American society, but consumers may quickly and painfully learn that electronic check clearing and traditional float no longer add up to three days.

Steve Swanston is executive vice president of sales for John M. Floyd & Associates Inc., a Houston-based provider of noninterest income products to financial institutions. Contact Swanston at 800-809-2307 or steve.swanston@JMFA.com. This article first appeared in Credit Union Magazine at http://creditunionmagazine.com and is reprinted with permission.