A Paperless Environment - Has the Time Come?

For years it’s been said that the check is on its deathbed. Yet an estimated 50 billion checks are issued every year in the United States. A number of regulatory initiatives are quickening the pace towards a more electronic environment. National Receipts Consulting Team Leader Jill Toth recently shared her expertise on Check 21 at the U.S. 2003 Perspectives seminars held for Bank of America clients.

Q. Check conversion and check truncation – How do they compare?

A. There are similarities, but the differences are significant:

• Check conversion transforms a check to electronic settlement. A paper check is changed, mid-life-cycle; one example is the conversion of returned checks to ACH transactions. A key difference is that conversion changes the check’s legal standing. Once a check is converted, the transaction is no longer governed by the Uniform Commercial Code (UCC), but by Reg. E. This is significant as it relates to finality and settlement. Since a converted check is governed by Reg E, legal finality comes 60 days after the transaction was posted to the account. Not funds settlement, not funds availability, but legal finality.
• Check truncation transforms a check to image-enabled electronic or paper settlement. Truncation involves the use of an electronic image or an image replacement document (IRD) to improve the existing check payment system. The Check 21 Act will allow the replacement of the original check with a substitute check. Truncation does not change the check’s legal standing. When the check is truncated and turned into an image, it is still considered a check, and it continues to be governed by the UCC.

Under the “Check Clearing for the 21st Century Act,” passed in June 2003 by the U.S. House and Senate, banks will be allowed truncate original checks and replace them with either paper or digital substitutes. On October 28, 2003, President Bush signed this legislation into law. The effective date is October 2004. During this time, the banking industry will develop rules and standards surrounding the check truncation process.

Q. What are some of the other differences?

A. There are some other areas of difference, as follows:

• Dollar limits: With conversion, some transaction types have dollar limits, as with RCK, for example. With truncation, however, there are no dollar limits.
• Customer notification: Conversion requires customer notification and/or authorization, whereas with truncation no additional customer authorization is required.
• Transaction types: NACHA currently restricts check conversion to consumer transactions, whereas truncation applies to all checks.

Q. Are these changes in place today?

A. Check conversion is available today. Check truncation legislation was signed by President George W. Bush on October 28, 2003. The effective date of the legislation is October 2004. During this time, the banking industry will develop rules and standards surrounding the check truncation process.

Q. Are there costs associated?

A. Yes, it’s important to consider the hidden costs of payment alternatives, both tangible and intangible. Tangible costs include administrative returns, customer service staffing costs, the cost of an additional payment stream, and provider costs. Intangible costs include customers’ experience with the new system, possible impacts on the reputation of corporate customer service, and implementation of the service offering.

Q. Could you elaborate on administrative returns?

A. Often the Routing Transit and account numbers on a check are not equivalent to the same data in the ACH transaction. If the data is not recognized by the Automated Clearing House or the paying bank, the item is returned to the depositing bank. Consequently, the depositing institution or the client – depending on who has done the conversion – must correct the item.

The topic of administrative returns is a major point for those considering POP (point of sale check conversion) or ARC (Accounts Receivable Entry), because they average 0.35% of the total check conversion volume. That may not be significant in some businesses, but it could present a serious problem in some industries. For utilities, as an example, a 0.35% return rate due to problems with the settlement at the paying financial institution could prove significant.

An experienced Bank of America associate can repair about 70 administrative returns an hour. It is not unreasonable to expect 3,500 administrative returns on 1 million converted items. The cost associated resolving those returns (50 hours) is significant and is supported by the client.

Most clients that are converting consumer checks have noticed a bubble in customer service inquiries. When the consumer’s check is not returned in the bank statement, the consumer generally contacts her financial institution. If the bank’s explanation does not satisfy the consumer, the bank will refer the customer to the company that converted the item. Eventually consumers will adapt to the change, but the companies on the forefront of this technology will be the ones providing the education on this new clearing process.

Q. What is the purpose of Check 21?

A. Check 21 will improve the nation’s payment system by granting an image replacement document (IRD) the same legal status as the original check. This will encourage financial institutions to exchange images in lieu of transporting the original check to the paying bank. IRDs must meet the criteria established. The IRD must contain images of the front and back of the check and contain a valid MICR line.

Q. Does the Check 21 Act address conversion of checks to ACH?

A. Issues involving conversion of checks to ACH are not part of the legislation.

Q. Within the provisions of Check 21, will the use of image exchange be mandated, or will it merely be optional?

A. While not mandating the receipt of checks in electronic form, Check 21 will foster innovation in the check collection system. Banks must be able to process any substitute checks they receive, notify customers that they may no longer receive their original check, and abide by a new set of rules for re-crediting consumers’ accounts if mistakes are made involving a substitute check.

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