Fed torpedoes move to fully electronic checks

The Federal Reserve Board has torpedoed industry efforts to make checks a fully electronic payment option. Regulatory changes disclosed earlier this month make it clear that financial institutions cannot clear electronically created items (ECIs) through the Reserve Bank System. While most checks start out as paper items, the majority today clear between banks and credit unions (often through the Reserve Banks) as electronic images – over 99 percent by the Fed's reckoning. The conversion from paper to electronic images is often executed by payees using their banks' remote deposit capture services, or at the bank of first deposit.

ECIs are like paper checks in every respect except that they originate as electronic messages, which eliminates the need to truncate paper checks and significantly compresses the clearing cycle placing it on par with electronic payments. In fact, experts note, it is not uncommon for ECIs to clear and post on a same-day basis.

No one knows for certain how many ECIs clear through the banking system on a daily basis, since they are generally indiscernible from electronic image files of checks that start out as paper. A 2017 analysis by the firm All My Papers suggested about 80 million ECIs clear through the banking system each year. Most ECIs are business payments, stated David Walker, president of Tiller Endeavors LLC, and former president of the Electronic Check Clearing House Organization.

Fed's rationale questioned

Broader adoption of ECIs has been held back by a lack of clarity over ECIs since check laws pivot on the existence of paper documents. Walker and others had urged the Fed to address this through its check collection rule set, Regulation J. But Reg J amendments proposed by the Fed earlier this year included a ban on clearing ECIs through the Reserve Bank System. Last month, the Fed decided to adopt the proposal, despite receiving 14 comment letters in opposition and just three in favor of the ban on clearing ECIs through Reserve Banks. And it added that it "will not conduct further studies on ECIs at this time."

Walker said he was disappointed by the Fed's ruling, and he called into question the Fed's rationale. "The arguments they gave frankly don't make any sense," he said.

The Fed's decision to ban ECIs from the Reserve Bank clearing system comes as the Fed continues to push the concept of faster payments, with an eye toward near-real-time clearing and settlement. Walker noted, however, that such a system will likely need to be built from scratch, and that it could take a decade, or more, for such a system to achieve the scope of existing interbank clearing and settlement systems, like the check and automated clearing house systems. ECIs take an existing payment method, the paper check, and render it a truly electronic method, he noted.

In discussing its Reg J amendment, the Fed said that nothing about its decision would stop banks from agreeing to clear ECIs between one and other. But because a large share of checks clear through the Reserve Bank System – 45 percent on the forward collection side and 68 percent of returns, according to the Fed's data – most experts expect banks will not encourage business clients to use ECIs rather than issue paper checks. The Reg J amendment on ECIs takes effect Jan. 1, 2019.

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