In October, digital images will be the legal equivalents of paper checks. Companies must get ready for the new ways banks will process payments.
The Check 21 legislation signed by the president late last October has created a slow-moving tidal wave. It will bring profound change to corporate finance operations but will give companies plenty of time to adjust. The bill legalizes the use of digital images of checks as official image replacement documents (IRDs), so it enables banks and corporations to convert a paper check to digital format and consider the electronic image file to be the legal version of the check.
By October of this year, when the law takes effect, any bank will be able to scan any check -- personal or business -- then transmit the electronic file to the paying bank and burn the paper version. It will even be possible to convert from paper check to digital check prior to deposit. Retailers, for example, will be able to truncate checks at the point of sale and transmit only the digital images to their depository bank. (See Dawn of the E-Deposit below.)
Banks will be able to present the digital version of a check for payment anywhere nationwide within seconds. Clearing float will disappear. Settlement will, of course, accelerate. And the cost and risk of physically transporting checks will evaporate, as may some of the security devices embedded in the check stock.
"This is one of the biggest opportunities we've had in a long time to change the way we make and process payments," notes Lee Madden, senior vice president, business line manager, DDA, investments and images, at Wachovia Bank in Charlotte, N.C. "The legislation itself is fairly simple, but it opens the door to a lot of innovation. Everyone is talking about what it will mean. It's definitely the hot topic."
"The act will have a simple but profound effect on the payments business," notes Dan McCarty, senior vice president and director of treasury management services at Comerica Bank in Livonia, Mich. "This creates a bonanza of new product opportunities. And you can't choose not to play." Adds Carl Shishmanian, senior vice president for global treasury services at Bank One in Louisville, Ky., "It's not a matter of what the players want; electronic truncation of checks is where the industry is going."
Dawn of the E-Deposit
Truncating a check as soon as it is deposited in a bank is fine, but for companies that receive thousands of checks in dozens of offices or stores across the country, the ultimate goal is to truncate checks before depositing them. If that worked, the organizations would be able to close hundreds of local bank accounts and avoid hundreds of transfers to concentration accounts -- which means they'd see big savings in banking fees.
Pioneers are discovering that point-of-sale truncation does work. Raymond James & Associates Inc., St. Petersburg, Fla., got a head start on Check 21 by joining a pilot truncation project with Citigroup. Checks that come in to the Raymond James head office now are scanned and transmitted to Citi as gray-scale images for deposit.
So far, only the head office is testing the technology, but down the road Raymond James hopes to eliminate local deposits by its offices in all 50 states and simply make electronic deposits by image file into one account, explains Ron Whitaker, assistant treasurer. Closing accounts and eliminating funds transfers should save the investment firm at least half of the approximately $390,000 a year it now pays for depository services, he suggests.
Currently Citi works with EDS Corp. to print image replacement documents (IRDs) from each check's electronic file. Then Citi presents the IRDs locally in each Federal Reserve district for presentment to the paying bank. Even though the checks still clear as paper documents -- something that should become unnecessary under Check 21 -- Raymond James is picking up between half of a day and a whole day in improved availability, Whitaker estimates.
Companies with nationally distributed capture locations need to consider how IRDs can help them access funds faster and clear checks more efficiently, observes Craig Vaream, vice president and senior product manager for deposit services at JPMorgan Treasury Services in New York City.
License To Truncate
The early truncation of paper checks -- a goal pursued for decades by banks and other payment processors -- will probably be accomplished in one wave. The law does not mandate the truncation of checks. Depository banks that want to continue clearing paper checks will be able to. However, it does mandate that paying banks accept the digital images of checks, so all banks of first deposit will have a license to truncate if they so choose. Nobody, including corporate check writers, will be able to opt out. Industry experts predict that clearing images instead of paper will save enough time and money that banks eventually will truncate virtually every deposited check.
But most companies will not need to scramble to get ready. "The full effects will take years to show up," predicts Cathy Gregg, a founding partner of Treasury Strategies Inc. in Chicago. "When banks went from hand-sorting checks to machine-sorting them, the change didn't happen overnight," she points out.
A lot depends on how quickly the big banks that dominate the check-clearing business decide to switch over to image presentment, says Leonard Heckwolf, senior vice president and head of consumer payments for global treasury services at Bank One in Chicago. "Over the next six months, you'll see announcements of individual and joint strategies. It could happen fairly quickly or evolve slowly," he says.
What's coming is an evolution in the infrastructure that processes check payments. Different banks will make the transition at different times. Companies that receive high volumes of low-dollar checks will have the most to gain from processing efficiencies and may want to get ahead of the curve. Managers at other companies will be able to take their time reading articles, attending trade show presentations and asking their banks about the changes at their convenience.
What Will Change
While Check 21's potential effects may be big, they are not unprecedented. The accounts receivable conversion (ARC) program already allows consumer checks under $500 to be scanned and converted into ACH payments at either the point of sale or the retail lockbox. However, Check 21 improves on the ARC method in two ways.
First, payments converted to ACH under the accounts receivable conversion program cease to be checks. They clear through the ACH infrastructure and are reported as ACH items. Checks truncated under Check 21 will continue to be checks; they will be processed through the check-clearing infrastructure and reported as checks. Services such as positive pay and account reconcilement will continue to work with truncated checks, but they usually stop working when items are converted into ACH payments.
Plus, says Anita Stevenson, associate director of liquidity management at BellSouth Corp. in Atlanta, until banks link their ACH and check systems, the check systems won't track checks converted to ACH transactions. Holes in reports of check payments could cause problems even for consumers using Quicken.
The second area in which Check 21 surpasses ARC is that the latter method isn't available for business checks or for any consumer checks worth more than $500. Because Check 21 allows companies to truncate every check they receive, image truncation will become the preferred collection strategy for many companies, Stevenson says.
Some banks have already taken steps toward check truncation. They use electronic check presentment (ECP) systems, so they post items within hours by capturing and transmitting MICR line information, McCarty notes. But settlement still isn't final until the paper check is presented. "Check 21 lets ECP be real ECP," he observes.
Clearly, widespread electronic check presentment will have a dramatic effect on payment timing. Cash managers have made a science of predicting delays in check clearing, but soon that science will be obsolete and a new one will have to be developed to support cash forecasts. New availability schedules will reflect quicker settlement of incoming items.
For outgoing payments, disbursement float will take a big hit. "The payment that takes two days to clear today might take one day or less when Check 21 is implemented," McCarty says.
"Banks could do same-day exchanges, but most haven't decided yet whether they will," says Lex Litton, vice president of operations at Phoenix-Hecht, the Research Triangle Park, N.C., firm that specializes in payment timing studies. "But eventually one-day clearings should become commonplace for most check payments."
Disbursement float strategies that focus on geographic destination will have to be revised once image processing has been introduced, Heckwolf points out. Checks mailed at the same time to two companies in the same industrial park in the same city might clear on different days if they are deposited in separate banks that handle image presentments differently. However, mail float will presumably remain unchanged, since truncation can occur only after the paper check is received.
Finance executives have mixed feelings about the changes. "There are pros and cons" to Check 21, notes John A. Forster, treasurer of WPP Group USA in New York City. "It will cut paperwork and the costs associated with processing checks, but it also will hurt our disbursement float," he says. WPP pays mostly by check, and float is a big reason. "As the float gap between paper and electronic payments narrows, we'll start to ask, 'Why bother with checks?' " Forster says. "This may be the biggest blow yet to the value of check disbursements."
Because truncation cuts float on both check collections and disbursements, and because corporations take in from A/R more than they pay out through A/P, Check 21 should result in a positive, permanent reduction in net working capital over time, says Craig A. Jeffery, senior vice president and practice leader at Wachovia Treasury & Financial Consulting in Atlanta.
Some companies fear that these potential gains will prove impossible to achieve. "We hope to get good funds quicker on the collection side, but payers have a way of paying later to offset quicker clearing times," Stevenson notes.
Raymond James & Associates Inc. in St. Petersburg, Fla., has moved quickly to expedite collections with check truncation, but assistant treasurer Ron Whitaker admits, "At some point, we'll stop swimming and tread water because we will lose float on disbursements just as we gained it on collections." However, Whitaker expects being ahead of the curve to provide net float gains for Raymond James for a while.
The Future of Controlled Disbursement
Corporations have a lot more at stake than float gains and losses. Controlled disbursement is a core finance service that takes advantage of the fact that paper checks presented for payment are delivered in one large shipment each day. Knowing for certain by around 10 a.m. Eastern time which checks will hit a disbursement account in a given day enables treasurers to fund the account with precision so that they don't waste idle funds on a safety cushion or run the risk of incurring overdraft fees. And companies that know how much cash they will need to cover disbursements know how much they have to invest -- or how much they need to borrow.
What will happen when checks can be presented electronically in smaller batches throughout the day? In the short run, controlled disbursement cutoffs will stay. Gregg speculates, "The final presentment might be moved up to 8 o'clock instead of 10 o'clock, based on faster processing."
But fixed cutoffs may not survive for long. Eventually, Check 21 will create the capacity to process large telecommunications feeds of check images in real time. Intraday settlement will become possible, observes Craig Vaream, vice president and senior product manager for deposit services at JPMorgan Treasury Services in New York City.
Banks will be able to delay the posting of items that arrive after an artificial cutoff until the next day -- and many will be tempted to do so initially to keep controlled disbursement customers happy -- but eventually they may adopt multiple cutoffs spread throughout the day, Vaream predicts. "We could see more feeds and batches; there won't have to be a hard cutoff," he says.
Intraday check clearings that had to be funded late in the day would put pressure on businesses to adjust their forecasting techniques, Stevenson points out. "That probably will happen, but it won't come quickly, and by the time it gets here, we'll figure out how to deal with it," she says.
In the long term, controlled disbursement will have to be retooled, weighing the benefits for both parties, Comerica's McCarty says. "I'd hesitate to say that Check 21 will bring the end of controlled disbursement, but I'd also hesitate to say that it will survive in its present form," he says. "Immediate, real-time clearing now becomes possible."
Another area in which check truncation raises questions is security. Some security features embedded in paper check stock will survive truncation, but others will not. Check-printing vendors are working with banks to see what can be done to maintain security features, Bank One's Shishmanian reports. Positive pay, with or without payee matching, should still work when checks are converted to image files, he adds.
In most respects, depositors should see big gains in security. They will find out much sooner about counterfeit, altered or bounced checks, and they will be better able to recover funds when checks bounce, industry experts agree. However, legal action could be affected by truncation. Court battles over alleged check forgeries will have to be argued using the electronic image file because original checks will have been destroyed in most cases, Heckwolf says.
The reduction in physical check transportation should bring security gains. The September 11 terrorist attacks provided incentive for the passage of Check 21; banking systems generally continued working after the attacks, but the physical transportation of checks stopped when planes were grounded, notes Jeff Oleske, director with Citigroup's global transaction services in New York City. Image presentment would enable check payments to stay on schedule when physical transportation broke down due to weather, strikes or terrorist attacks, Oleske says.
One of the arguments for truncation was that it would bypass the high cost of transporting paper checks all over the country. Theoretically, eliminating the need to move paper will cut banks' costs and create savings they can pass on to corporate customers.
Don't hold your breath. Bankers are already working to deflate expectations of price cuts. "The economics are challenging," Heckwolf suggests. "How large the savings will be and how quickly they will be realized are still very much up in the air." Initially, converting to image presentment will cost money, not save money, he says.
Oleske agrees that costs are being added as well as taken away. Converting checks to ACH transactions under the ARC program was supposed to lead to big savings, but they never materialized, he says. "The jury is still out on whether we will realize any cost savings," he cautions.
It's not clear whether Check 21 will usher in a checkless society. The law provides an effective push toward doing away with paper and forcing all payments to start out electronically, Stevenson says. But McCarty argues that Check 21 and imaging technology may actually extend the life of the paper check as a disbursement strategy. Many companies use checks because of internal reporting, control and audit concerns. If truncation makes checks cheaper and more reliable, the incentives to discard them as a payment method will shrink.