HR 5414, where are you? Testimony outlines proposed check clearing for the 21st Century Act

Today, Dec 2002 by Ferguson, Roger W Jr

check processing

DURING TESTIMONY BEFORE THE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT OF THE COMMITTEE ON FINANCIAL SERVICES, U.S. HOUSE OF REPRESENTATIVES, ON SEPTEMBER 25, 2002, FEDERAL RESERVE VICE CHAIRMAN ROGER W. FERGUSON, JR. PRESENTED A CONCISE SUMMATION OF THE PROPOSED "CHECK CLEARING FOR THE 21ST CENTURY ACT" OR H.R. 5414. THE BILL REMOVES LEGAL BARRIERS TO THE USE OF NEW TECHNOLOGY IN CHECK PROCESSING AND HOLDS THE PROMISE OF A MORE EFFICIENT CHECK COLLECTION SYSTEM. DR. FERGUSON'S TESTIMONY FOLLOWS.

TECHNOLOGICAL ADVANCES IN CHECK PROCESSING

Check processing is far more efficient than it once was. Less than fifty years ago, clerks hand-sorted millions of checks each day. In the 1960s, the banking industry began to use mechanical high-speed check processing equipment to read and sort checks, which had been redesigned for automated processing. Today, banks, thrifts, and credit unions (which I will collectively refer to as banks) process the more than 40 billion checks that consumers. businesses, and the government write each year.

Legal impediments, however, have prevented the banking industn, from fully using these new electronic technologies, such as digital imaging, to improve check processing efficiency and provide improved services to customers. This is because existing law requires that the original paper checks be presented for payment unless the banks involved agree otherwise. We can see how this requirement constrains technological adoption by following a check through the collection process. After a bank's customer deposits a check with his or her bank, the bank typically transports the check from the branch or ATM where it was deposited to a central operations center. The check is then usually sent to one or more intermediaries, such as a Federal Reserve Bank, or a correspondent bank, or a clearinghouse for collection before it is ultimately delivered to the bank on which it is drawn for payment. During each step of this process, the check must be physically shipped to its destination by air or ground transportation. Of course, banks can agree to accept checks electronically, but the large number of banks in the United States makes it infeasible for any one bank to obtain such agreements from all other banks or even a large proportion of them. Therefore, legal changes are needed to facilitate the use of technologies that could improve check processing efficiency, which should lead to substantial reductions in transportation and other check processing costs. H.R. 5414 makes such changes.

PROPOSED CHECK CLEARING FOR THE 21 ST CENTURY ACT

The proposed Check Clearing for the 21st Century Act solves a longstanding dilemma-how to foster check truncation early in the check collection or return process without mandating that banks accept checks in electronic form. The term check truncation refers to any of a number of arrangements in which the original paper checks are removed from the collection or return process. Currently, under typical check truncation arrangements, electronic information about a truncated check is presented to the bank on which it is drawn rather than the original paper check. The act facilitates check truncation by creating a new negotiable instrument called a substitute check, which would permit banks to truncate the original checks, to process the check information electronically, and to deliver substitute checks to banks that want to continue receiving paper checks.

A substitute check, which would be the legal equivalent of the original check, would include all the information contained on the original check-that is. an image of the front and back of the original check as well as the machine-- readable numbers that appear on the bottom of the check. Under this act, while a bank could no longer demand to receive the original check, it could still demand to receive a paper check. Banks would likely receive a mix of original checks and substitute checks. Because substitute checks could be processed just like original checks, a bank would not need to invest in any new technology or otherwise change its current check processing operations.

Banks could use the new authority provided in this legislation in a number of different ways. For example, a bank would no longer need to send couriers every afternoon to each of its branches and ATMs to pick up checks that customers have deposited. Instead, digital images of checks could be transmitted electronically from those locations to the bank's operations center for processing. Not only would this be quicker and more efficient, but it could permit banks to establish branches or ATMs in more remote locations and to provide later deposit cut-off hours to their customers.

Moreover, the act would give a bank the flexibility to transmit checks electronically over long distances, and create substitute checks at locations near their ultimate destination, for example to the bank on which the checks are drawn, substantially reducing the time and cost associated with physical transportation. By enabling the banking industry to reduce its reliance on physical transportation, the proposed act would also reduce the risk that checks may be lost or delayed in transit. Today, bad weather routinely delays check shipments and there have been occasions when checks have been destroyed in plane crashes. The banking industry's extensive reliance on air transportation was underscored in the aftermath of the September 11 tragedy, when air transportation came to a standstill and the flow of checks slowed dramatically. During the week of the attacks, the Federal Reserve Banks' daily check float, which is normally a few hundred million dollars, ballooned to more than $47 billion. Had the proposed legislation been in effect at that time and had banks been using a robust electronic infrastructure for check collection, banks would have been able to collect many more checks by transmitting electronic check information across the country and presenting substitute checks to paying banks.