Executive Voices for August 2004

Banks Go Digital
Check 21: Why the Check is Not in the Mail

By Kel Landis

During the past two decades, banking as we know it has changed drastically. Electronic processing has ushered in significant opportunities to improve not only how quickly banks can process clients’ deposits and withdrawals, but also the very nature of how such transactions occur. No longer do customers need to queue before the tellers to cash a paycheck or make withdrawals from their savings account. Nor do they need to make a trip to the bank to transfer funds between accounts or apply for a loan. Even the very nature of bill payment and presentment has changed thanks to new electronic funds transfer capabilities and data encryption advancements.

And now the next chapter is being written. Later this year, federal legislation known as the Check Clearing for the 21st Century Act, or “Check 21” as it is more commonly known, will go into effect, ushering in a new era in how banks and other financial institutions move monies represented by paper checks.

The Federal Reserve began working on plans to develop a legal alternative to paper checks in the wake of the September 2001 terrorist attacks. During the days that followed the events of the 11th, cargo planes holding millions of paper checks were grounded, thereby bringing the old system of check transfers to a near standstill and bringing the banking system itself to a near-crisis state.

Starting Oct. 28, no longer will a copy of a check be required for the check depositor’s bank to be paid by the institution upon which the check is drawn. Electronic images of that check will be considered “legal tender,” at least from the perspective of bank-to-bank reimbursement, a big step forward in the digitization of the financial services sector.

In terms of cost, time and convenience, the potential benefits to both banks and the immediate parties involved in the check “swap” — the checkwriter and depositor — are considerable, as a quick look at the existing process illustrates.

Once an individual or company deposits a check drawn on a different institution, they typically must wait two or three days for the check to “clear.” Once it physically leaves the branch, the check must be sorted, processed and bundled before being transported to either a third-party check processing vendor or to the local Federal Reserve Bank. That check will then be sent to the bank upon which it is drawn so that the funds can be debited from the checkwriter’s account and payment remitted to the depositor’s bank. The paper check is then further processed for recordkeeping purposes and, in an ever-dwindling practice, returned to the person who wrote it.

So what does this mean for the business community?

Thanks to the passing of Check 21, banks can cut out these costly and time-consuming steps. As a result of new electronic capabilities, the depositor’s institution will be able to verify in seconds whether there are adequate funds to cash the check. If so, the party cashing the check could theoretically have immediate access to the funds, and the party who wrote it will have the funds withdrawn from their account with equal alacrity. Digital images of the paper check will travel between banks over wires now in place of the physical paper check that used to travel on trucks or planes.

Not surprisingly, industry-watchers estimate that Check 21 will eventually save the industry $2-$3 billion annually, and that these savings will enable banks to compete for customers more aggressively by lowering fees or raising rates paid on interest-bearing accounts. Like never before, customers can shop around for the best products at the best rates, a boost for market competition.

As well, customers are expected to benefit from accelerated fraud detection capabilities. While some security officials have raised the question whether the legalization of digital check scans will hurt fraud detection efforts by rendering physical safeguards such as watermarks and specialized paper obsolete, the fact remains that identity theft is undeniably on the rise and that Check 21 can greatly reduce the time it takes for the bank and the victim to detect such fraud.

One of the most noticeable consequences of Check 21 for some personal and commercial banking customers will be the expected disappearance of returned paper checks. With digital imaging, the physical check itself becomes redundant. Accordingly, most institutions will opt to destroy them, making the scanned image of the check available to the writer instead, either online or as part of the monthly statement. According to the American Bankers Association, less than half of all bank customers currently receive their cancelled checks with their statements, perhaps suggesting this change won’t be so remarkable after all.

The second significant change is the elimination of “the float,” the term used to define the time between when a check is written and when the funds are actually debited from the account upon which they are drawn. Once the system enabling electronic verification comes online, the float will shrink from, in some cases, two or three days to mere seconds.

Other aspects of Check 21 will be largely invisible to customers themselves as they largely concern back-office processing operations and automation issues. Businesses will not need to change their check-writing habits — other than being mindful of the float issue — nor alter their check deposit practices.

It’s worth noting that Oct. 28 is merely the first day on which banks must accept electronic check images if presented with them by other banks; the implementation of other Check 21 elements are at the institution’s discretion. At RBC Centura, we chose to adopt a longer project timetable for executing our Check 21 strategy to ensure that the full analysis and resolution of potential customer privacy and security issues take precedence over having bragging rights as an “early adopter” of all of the new system.

Kel Landis is CEO of RBC Centura Banks Inc.

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