A comparison of social costs and benefits of paper check presentment and ECP with truncation - Electronic check presentment

New England Economic Review, July-August, 1997 by Joanna Stavins

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Items Truncated by an Intermediary

Three-quarters of on-others items (50 percent of all checks) are assumed to be truncated by an intermediary such as a Reserve Bank or a clearing house. Table 3 presents a summary of the costs and benefits of truncation by an intermediary as compared to collecting the paper check. Note that the social cost of truncation is almost identical whether a check is truncated by the bank of first deposit or by an intermediary, but the social benefit is greater when a check is truncated earlier in the process. The paying bank and the intermediary are better off if truncation takes place at the bank of first deposit. Neither depositing nor paying customers are directly affected by where the checks are truncated. See Appendix C for detailed cost and benefit calculations.

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All Checks - A Summary of Costs and Benefits

Table 4 summarizes the overall social costs and benefits per check, including on-us as well as on- others checks, truncated by the bank of first deposit or by an intermediary. The costs and benefits are weighted according to the share of checks in each category: 33.3 percent on-us (safekept), 16.7 percent truncated by the bank of first deposit, and 50 percent truncated by an intermediary.

Several conservative assumptions were made: Benefits to the bank of first deposit are likely to be undervalued, as the benefits of decreased risk and fraud are assumed to be zero; and the costs to the paying bank are probably overestimated, because the paying bank costs of processing ACH items are assumed here to be as high as the costs of paper check [TABULAR DATA FOR TABLE 4 OMITTED] handling. On the other hand, the cost to the paying customer of not receiving canceled checks may be over- or undervalued, as it is estimated based on limited experience with individual consumers, with no data available on business customer preferences. Because of the lack of data, the one-time costs of transition to ECP are not included in this study.(23)

The overall net benefits are positive. If the on-us checks were safekept and the on-others checks were truncated either by the bank of first deposit or by an intermediary, society would save 2.39 cents per check. Approximately 60 billion checks are collected each year.(24) If all the checks were truncated, the total annual savings would amount to 60 billion x 2.39[cents] = $1.434 billion. Note, however, that the paying customer loses as a result of truncation. Without redistribution, the depositing customer (and possibly his or her bank) captures the bulk of the social gains realized in moving from paper check processing to ECP with truncation.(25) While the paying bank would also benefit, the paying bank could accrue most of its gains just with safekeeping, that is, without having its checks stopped earlier in the collection process.

III. Why Are We Not There Yet?

According to the Coase theorem (Coase 1960), market forces will always lead to an optimal allocation of resources if the following conditions hold: perfect information, no transaction costs, and no externalities affecting third parties. Since none of these conditions is met in the market for check truncation, it is not surprising that market forces have not yet taken us there. Neither paying banks nor their customers are certain that they can see a copy of a check whenever they want and that they will never be required to give a canceled check to a creditor on demand. Likewise, transaction costs associated with setting up another infrastructure for processing checks are likely to be significant. And network externalities (see below) are also present. The above may or may not constitute a reason for some form of government intervention.(26) While this study does not attempt to design an optimal form of government involvement, it is worthwhile to spend some time analyzing the obstacles that prevent the market from reaching universal check truncation.