Check 21: The Check is Dead, Long Live its Image

A variety of forces are literally changing the face of the paper check and how it is processed, cleared, and settled. The first wave of change came with the advent of check conversion and the ability to convert a check into an Automated Clearing House (ACH) payment. The second wave is building with check imaging and truncation and the replacement of the paper check by a check image and an electronic data file. The most dramatic change will be point-of-entry capture, that is, the capture of the check image as far upstream in the process as possible. These waves of change are touching all banking customers, causing a revamping of numerous operations, and generating multiple business opportunities.

Check processing is getting a jump start. After several decades without any seismic change, change is underfoot (the last watershed was the introduction of MICR, magnetic-character ink recognition, which occurred decades ago). Check imaging is just beginning to hit its stride thanks to The Check Clearing Act for the 21st Century (Check 21) and notable improvements in imaging technology’s price/performance equation. Although Check 21 directly addresses only the creation of a substitute check, it indirectly revolutionizes check processing by opening the door to check truncation and image exchange. However, it does not provide any road maps, nor does it address legal issues surrounding truncation and exchange. The map making will be up to financial institutions, and already several hundred early movers are forging ahead.

The Substitute Check

The focal point of Check 21 is the substitute check. Many other areas of check processing, however, have been associated with Check 21. From all the hype in the press, one would think that Check 21 governs check truncation and image exchange. It does not. Hence, a useful starting point to understanding Check 21’s implications is to outline what Check 21 is not.

First and foremost, Check 21 does not make a check image or an electronic check presentment (ECP) file the legal equivalent of a paper check. Second, it does not require a bank to send or receive ECP files or to create a substitute check. Third, it does not require a bank to keep the original check for any specified time period (nor does any current law).

What Check 21 is, is nonetheless profound. The figure below outlines the check processing world before and after Check 21. The key difference is that, post-Check 21, a presenting bank that wishes to truncate a check can do so regardless of whether or not the paying bank is image-enabled. At the end of the line, the check image can be ‘reconverted’ into a substitute check.

Unlike some technologies, check imaging is not merely paving the cow paths. Rather, it is enabling the paths to be redrawn. Under the current process, billions of checks are physically transported at least one time and are often transported multiple times, including by relatively expensive air transport. During the process, checks are typically handled 21 to 26 times over the course of a single day to over a week. Fast-forward to the most extensive implementation of check imaging – involving point-of-entry capture, image-based statements, and image exchange – and the process is dramatically restructured, pushing the number of steps towards zero.

Similar to any operational leap, check imaging and truncation does not have an on/off switch, but rather involves a transition period during which paper and electronic processes co-exist. Given the sheer volume of checks and the number of financial institutions involved in the process, the transition period is expected to last at least a decade.

Integral to a smooth transition is banks winning customers’ acceptance of check images and, in some cases, of substitute checks as well. While the task is significant, banks should not be daunted by it. Early movers have found that well-informed customers are open to receiving check images in lieu of the originals. Most early-mover community banks have achieved acceptance rates of over 99 per cent for both retail and commercial customers. While large banks have not yet achieved such high overall rates primarily due to their diverse commercial customer base, they have fared well with retail customers.

The Incentive

The early-mover banks have found that customer acceptance is a function of education and comfort level. Education requires multiple messages over several statement cycles and notices in physical locations (branches and ATMs). A smooth migration from paper checks to images or substitute checks is gradual one. Customers must not feel coerced into accepting images. The carrot should be used before the stick. So for Check 21 the ease of filing image statements compared to stacks of cancelled checks and the ability to get check images on-demand online should be focused on, instead of the charges for return of original checks. In addition, quality of images and front/back images help make customers more comfortable. Several early movers are piloting new types of image statements (e.g., ones with bigger images, front/back images) and gauging customer satisfaction.

The more challenging educational exercise is explaining the reduction in float. For customers who play the float game, a reduction in posting times will come as a shock, especially when accompanied by NSF fees. In order to mitigate consumer ire, banks will have to be diligent in setting consumer expectations regarding float reduction. On the flip-side, banks will be able to offer customers improved funds availability with next-day availability likely becoming the norm.

October 28, 2004, the day Check 21 took effect, marked the first day of a gradual migration from paper check presentment to image/data file presentment. Paper checks, substitute checks, and check images with ECP files are expected to co-exist through to the next decade. Paper will exist to some degree for three of the four combinations while imaging will dominate one combination: non-local, image-eligible items. Ultimately, paper checks may never go away for a small sliver of transit items, e.g., local, high value checks. Substitute checks will eventually go away when all banks are image-enabled.