B2B Payments: Is the Cheque Still in the Mail?
The 1897 Mark Twain quote, “The reports of my death are greatly exaggerated,” is applicable to paper cheques usage in the US. For many decades, industry pundits prophesied the decline and ultimate elimination of paper cheques as a payment vehicle, but cheques still hung on.
It has been nearly five years since the Check Clearing for the 21st Century Act, better known as Check 21, came into effect, which facilitates electronic clearing and settlement of cheques. Consumers are definitely writing fewer cheques. Further, many consumer cheques have been converted to automated clearing house (ACH) items at the point-of-purchase (POP) since 2000, banks’ lockbox sites (ARC) since 2002 and as of March 2007, merchant back-office processing (BOC), removing large numbers of consumer cheques from the paper clearing and settlement processes.
Although the number of cheques being written by consumers is declining, cheques are still used more than any other form of payment for business-to-business (B2B) transactions. Approximately 75% of B2B payments are initiated with paper cheques.
The ACH solutions that are designed to convert paper cheques to ACH files apply only to consumers’ cheques. A National Automated Clearing House Association (NACHA) rule that took effect in September 2006 established business cheque parameters that exempt them from cheque conversion. Businesses resist having their cheques converted for a number of reasons: to continue the advantages of float, to retain cheque-based fraud prevention services, and to keep from complicating internal bank statement reconcilements, since ACH transactions appear in different portions of the statement from cheques.
With a ‘if you can’t beat them, join them’ philosophy, the payments industry’s focus has moved from replacing payments initiated by cheque to electronifying cheque payments for clearing and settlement. While cheques are written to make B2B payments, frequently they are cleared and settled as electronic transactions.
Paper cheques are cleared in a variety of ways: as paper cheques, image replacement documents (IRDs), MICR exchange (being eliminated year-end 2009) and cheque image exchange. Figure 1 shows the decline in cheque usage and adoption of IRDs and cheque images from 2005 to 2012. By 2011, the decline in cheque use reaches a floor, while paper cheques comprise a miniscule amount of cheque clearing.
Remote deposit capture (RDC) is an important offering for all sizes of banks. The capability to scan cheques at remote sites, to capture magnetic ink character recognition (MICR) information, and to create images of the front and back of the cheques is creating both cost control and revenue generation opportunities for banks and their business clients. As a revenue generation and deposit gathering product, RDC is being embraced more rapidly than any recently introduced product; thousands of business clients of banks offering RDC have adopted it. For many banks, RDC is targeted to be incorporated into account opening for any business client.
Early adopters of remote deposit technology were forced to choose from only a handful of financially viable vendors that offered strong solutions at the time. The solutions were primarily Windows-based and often offered only basic deposit functionalities.
As the number of remote deposit deployments increases and the technology becomes mainstream, financial institutions and their business customers are forcing the technology to evolve. Solutions are being enhanced with more sophisticated features and functionalities, and the market is shifting away from Windows-based solutions to browser-based ones.
Institutions are replacing first-generation solutions with more enhanced ones or with thin-client web-based solutions, which promise an easier deployment and greatly reduce workstation requirements for the end-user. Vendors have been able to overcome market perceptions that browser-based solutions are not able to deliver the same level of scalability and depth of functionality as Windows-based ones. While many vendors offer both architectures, browser-based solutions are emerging as the favoured architecture.
A competitive market has led to greater need for vendors to differentiate themselves. Vendors are achieving this by offering enhanced remittance capabilities and tighter integration with accounts receivable solutions, more sophisticated reporting capabilities, and by providing customers with greater online marketing and training tools. Three major areas of differentiation for vendors include:
Remote deposit is increasingly being offered as part of a suite of solutions that also include branch capture, teller capture and ATM. These solutions often reside on a single platform, thereby enabling a single administrative tool for banks to learn and manage, as well as the potential for greater duplicate detection throughout multiple channels. The similar look and feel among the various solutions also cuts down on training time.
Vendors offer various levels of remittance capabilities. At the most basic level, users are able to create custom fields to manually enter additional information that can be linked to a cheque image. This data can later be exported in a common separated values (CSV) format into the business users’ accounts receivable solution. More advanced solutions also enable coupons to be scanned. Scan lines can be read using optical character recognition (OCR), and data can be parsed into individual custom fields. Data entry fields are then available for export, research and validation. Some solutions also support payee lookup capabilities to automate the determination of the payer account number information within the business customer’s accounts receivable system for recurring payments.
Several vendors have also focused greater attention on enhancing their reporting and research capabilities. They have increased the number of standard reports for merchants and some enable the merchant user to create customised reports. In addition to reports, some solutions have advanced research capabilities, allowing users to search for data and images within the solution’s integrated archive. In these solutions, users can typically search on all MICR fields, amount, date and range, as well as user-defined custom fields.
The more advanced solutions also offer a wealth of reporting capabilities at a central site. Through this site, financial institutions can track several metrics by account and user, as well as log activities, which can be presented to auditors or used to prevent fraud.
Early RDC required the user to understand the cheque scanning process. Today’s solutions include workflow tools and capabilities that direct the user through the process. Most solutions limit the number of decisions that users have to make, and make it virtually impossible to perform steps out of order. The correction process is extremely user-friendly. Items requiring correction are clearly identified or are segregated from the processing flow, including the reason why an item failed image-quality control.
Initially, vendors offered limited sales and training tools. Now, vendors provide these aids, which are highly valued by banks. Online sales tools can be placed on the bank’s website to help banks sell the product and online training is embedded within the RDC solution. Short videos explain how to set-up scanners and walk users through the cheque scanning process. Other solutions provide help menus specific to the user’s location in the application. Financial institutions experience greatly reduced costs and save time by no longer having to teach merchants how to use the solution or field commonly asked questions.
Small businesses are an attractive market for financial institutions, so technology vendors are integrating their solutions with QuickBooks or other accounting applications used by small businesses. Such integration provides greater convenience and saves time for small business owners.
Small businesses are prime targets for the smallest institutions. As remote deposit deployments move further down market to the smallest banks, vendors see great demand for application service provider (ASP) deployment environments. Larger banks have a greater propensity to deploy the technology in-house because their expected cheque volumes drive economic benefits and they often desire higher levels of control. Smaller financial institutions, or those adopting a defensive strategy, are more attracted to the ease of entry and lower costs offered through ASP deployments.
The Federal Financial Institutions Examination Council (FFIEC) is an interagency body that provides oversight to the Federal Reserve Board (FRB), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration, Office of the Comptroller of the Currency (OCC), and Office of Thrift Supervision (OTS) to promote uniformity in the supervision of US financial institutions. In January 2009, the FFIEC published ‘Risk Management of Remote Deposit Capture’. Prior to this publication, there was little government guidance regarding the perceived risks of RDC, or factors that examiners will consider regarding financial institutions’ offerings of RDC.
While the FFIEC document lacks specificity about what risk controls examiners will want to see, it provides insight into the government’s concerns regarding remote deposit capture and the high-level actions that institutions are expected to take as a result. Risk categories for RDC are legal, compliance, reputational and operational. The FFIEC wants to ensure that financial institutions perform due diligence on customers to which they offer RDC. Risk-based customer qualifications are required for compliance with the Bank Secrecy Act (BSA) and anti-money laundering (AML) and must be applied for RDC. Given financial institutions’ push to incorporate RDC in account opening, these concerns add a level of risk review beyond standard account opening practices.
The most significant potential risks the FFIEC identifies include:
While there are a number of concerns about the potential for fraud with RDC, especially in regard to duplicate presentment of an item, today’s solutions have robust built-in features to detect duplicate scans. These features compare scanned items to images stored (often on a central server).
In addition to duplicate detection, vendors offer other solutions to lessen a financial institution’s vulnerability to fraud including the following:
In the few years since Check 21’s initiation, the number of image-enabled financial institutions grew dramatically. The most accurate measure available is the number of ‘routing transit numbers’ (R/Ts) that are image-enabled. Today, there are about 22,000 R/Ts in use, representing approximately 16,000 financial institutions. Given that some R/Ts are used for specialty purposes that do not lend themselves to cheque image exchange, nearly all US financial institutions have the capability to exchange cheque images. By 2010, all viable R/Ts will be image-enabled (Figure 2).
Interconnectivity between and among the various image exchange models, such as the Federal Reserve, Endpoint Exchange, SVPCO and Viewpointe, facilitate quick adoption of cheque image exchange. Both SVPCO (gateway distributed traffic agent and correspondent bank programme) and Viewpointe (Pointe2Pointe) offer Internet-based connectivity to encourage smaller institutions to accept cheque images rather than IRDs.
Value-added services like intelligent routing, incorporating least cost routing, and remittance data capture, matching and reporting will become the differentiators for financial institutions. Those vendors who support these capabilities will also have a competitive advantage.
What is clear from the adoption of electronic cheque solutions is that almost all paper is being eliminated from the payment workflow without regard for the number of cheques actually being written. Solutions are available for any financial institution to allow their customers to continue writing cheques, while the institution gains from the advantages of electronic processing for clearance and settlement.