Last October, consumers, bankers and law enforcement were wondering what type of impact the new Check 21 legislation would have on the payments industry. Now that a year has almost passed, we see what the banking industry predicted: Check 21 was not a flip of a switch event; but rather, it is a gradual transition.
Today, many financial institutions (FIs) are participating in image exchange networks. Larger banks exchange and settle through Viewpointe or SVPCo, while over 3,800 smaller banks and credit unions are exchanging through the Federal Reserve or Endpoint Exchange. There are also thousands of other FIs that are establishing connections to the networks and will begin to exchange items in the coming months. This year, Viewpoint modified its business model. Now, instead of FIs sending images to a single shared archive, they can use their own internal archive and settle through Viewpoint.
Another model available in the market place is a direct connection between FIs. In August, Frost Bank and Southwest Corporate Federal Credit Union announced direct connectivity to each other. They are large trading partners and found the business case to exchange directly with each other and participate in an exchange network for other items to be quite advantageous.
It is estimated that over 1.25 million items are processed per day through the networks via image exchange. Many FIs are now exchanging high dollar, non-local items in order to significantly reduce transportation costs and improve float time. Right now, it is difficult for many financial institutions to justify the cost associated with exchanging smaller dollar amount and local items due to current inefficiencies in the systems. An example of this inefficiency can be seen in 250,000 imaged items SVPCo processes daily, of which 85% are image replacement documents (IRD).
Industry technicians have discussed the possibility of exchanging real-time at the teller window and settling within a short time frame. However, the adoption rate at the teller window has been lower than expected. Leaders of financial institutions are challenged with the obstacle of large investment dollars in hardware and software at the teller window coupled with declining check volume.
Since Check 21 became law, certain consumer advocacy groups and press organizations have created misperceptions in the media that float time has gone away or significantly decreased. They implied that even though the funds were available more quickly, financial institutions held onto the funds for a longer period of time in order to increase earnings on balances and charge more non-sufficient fund (NSF) fees. Unfortunately, this perception is far from reality. As the check processing system becomes more efficient, the law requires that the funds availability schedules be reduced to allow consumers quicker access to their deposits.
In April 2005, Elizabeth Duke, executive vice president from Wachovia, testified on behalf of the American Bankers Association to the Subcommittee on Financial Institutions and Consumer Credit of the Committee on Financial Services of the United States House of Representatives. She stated in her testimony that contrary to press reports, “It’s important to point out that most banks today already provide funds sooner than the law requires.”
In fact, according to the ABA’s 2004 Deposit Account Fraud Survey Report, most banks provide funds on the day of or the day after deposit. For local checks, depending on the region, between 72% and 87% of the banks provide funds before the law requires. For non-local checks, between 72% and 82% do so. Elizabeth added, “Even when holds are placed, customers receive interest on interest-bearing accounts from the time the bank receives the funds. Check 21 has no impact on the long standing requirement under Section 606 of the Expedited Funds Availability Act that depository institutions pay interest to consumers no later than the time the institution receives credit for the funds.”
Primary Payment Systems, Inc. (PPS) is able to track the time it takes to return a check, tracking over 50% of the returns in the United States. In September 2004, 64.1% of items cleared within two (2) business days compared to 58.79% in May 2005, and 70.73% cleared within three (3) business days in September 2004 compared to 66.54% in May 2005. This data reveals that float time is not decreasing as perceived by the market.
The risk associated with deposits continues to exist in an image exchange environment. While many FIs participate in image exchange, there continues to be a need for financial institutions to monitor deposit activity. FIs have their reputation at stake, and they must protect the payment systems and ensure that the customer feels confident banking with them. Trained risk professionals and highly sophisticated deposit risk monitoring systems must continue to monitor deposit activity, spot fraud schemes and protect the FI and its customers.
As check processing volumes have decreased, an alarming trend has emerged: loss exposure per check is increasing. Comparing the 2004 ABA Deposit Account Fraud Survey with the 2004 Federal Reserve Check Volume Study, it appears that loss attempts per check increased by 14% between 2000 and 2003, demonstrating that fraudsters will continue to look for areas of least resistance to generate income.
Losses occur whether a check clears through traditional methods, image exchange or ACH conversion. Fraudsters simply look for gaps in the system. In a Check 21 environment, different regulations oversee the check, depending upon how it is processed. Paper checks processed in the traditional environment are subject to UCC and Reg CC, while ACH conversion is subject to Reg. E. Under Reg. E, a fraudster may leverage the fact that there is a 60-day window to contest a transaction, which is longer than traditional paper processing. Image exchanged items give the consumer up to 40 days after they receive a statement to question a check. Fraudsters can look at ways to leverage the different regulations and use them to their advantage.
Looking ahead, more financial institutions will sign up for image exchange and many will deploy solutions at the teller window. In order to detect fraud before losses are incurred, financial institutions must continue to rely on risk management departments and sophisticated tools to effectively mange deposit activity.