The Green Sheet Online Edition
December 10, 2007 • Issue 07:12:01
Transformation: Checks in the 21st century
Checks are a mainstay of the American economy, but three years after implementation of the Check Clearing for the 21st Century Act - federal legislation commonly referred to as the Check 21 Act and intended to eliminate much of the paper shuffle that takes place once a check is used for payment - it now seems conceivable that a majority of checks will clear and settle electronically, some day.
"The nature of check processing is changing rapidly, and though a number of electronic instruments will dramatically reduce the number of paper checks processed for clearing and settlement, billions of paper checks will still be written each year," said Nancy Atkinson, Senior Analyst with Aite Group in Boston. "Vendors in the check processing industry will have to adapt as quickly as the industry itself, or risk becoming unnecessary in this rapidly transforming market," Atkinson said.
In a recent impact report, Atkinson predicted the annual number of checks written in the United States will fall to 25 billion by 2012 from an estimated 30.5 billion in 2006. She also predicted roughly one-quarter of paper checks will clear as paper items in 2012. (To be precise, Atkinson expects 6.3 billion checks will clear as paper items in 2012; the remainder will clear electronically.)
Here's some other recently released data that may help put this into perspective:
- The SVPCO Image Payments Network, which handles the lion's share of electronic (imaged) check clearing, saw 328.7 million items in October. The network, owned by The Clearing House Payments Co. LLC, said the results represented a 232% increase over October 2006 volume. Checks cleared through the SVPCO network that month exceeded $535 billion.
- The number of checks converted to electronic debits and processed through the automated clearing house (ACH) system has taken off dramatically in the past year. Almost 250,000 checks were converted to ACH debits using back office conversion (BOC), a brand new category for check conversion, during the second quarter of this year, according to NACHA - The Electronic Payments Association. ACH transactions coded point of purchase check conversion (POP) exceeded 250,000 million, a 65% increase over the first quarter and 112.7% increase over the second quarter of 2006.
- The Independent Community Bankers of America (ICBA), representing thousands of the nation's hometown banks, reports that nearly two-thirds of member banks either offer merchants remote check capture now or plan to offer it within two years - 21% today and an additional 45% within two years. (For more information, see "Fewer checks, faster process," The Green Sheet, Sept. 24, 2007, 07:09:02)
- The Association of Financial Professionals (AFP), a group representing treasury management professionals, reports the typical corporation today makes 74% of business-to-business payments by check, down from 81% in 2004.
- Over the past five years, consumers have increased their use of signature debit cards at the POS by 38%, from 13 to 18 transactions a month, according to a First Data Corp. report on consumer payment preferences. PIN-authorized POS debit card payments increased from nine to 11 per month during the same period.
Dawn of the checkless society?
It's been 40 years since bank technology maven Dale Reistad coined the phrase "checkless society." In the years immediately following, some bankers viewed him as a heretic. In the late 1960s, checking accounts had been in wide use for only about 20 years, and the accounts were providing huge amounts of interest-free deposits.
Entire back-office infrastructures had been created to support check writing. So, why would banks want to discourage what they spent so much time building?
Reistad was Director of Automation at the American Bankers Association at the time. The ABA was instrumental in establishing the ACH system, which was seen as a mechanism for automating routine payments, like paychecks.
After leaving ABA, Reistad went on to run a respected research company, which he sold to American Express Co. He also consulted numerous electronic banking companies and served a stint as President of the Washington-based EFT Association.
It's taking longer for Reistad's predictions to reach fruition than he expected. "No one can say exactly when it's going to happen," Reistad said in a 1967 interview. "The best guess right now seems to be that it is going to start around 1970. It could be a national system by 1985."
That didn't happen. According to the Federal Reserve System, check writing continued to expand until at least 1995. Today, check writing is believed to be declining at somewhere between 4% and 6%.
Contacted by telephone, Reistad refuses to discuss his views on the state of payments. "I haven't been active in the business for some 15 years," he said.
Jerry Milano, Senior Vice President at The Clearing House Payments Co. who joined ABA in 1977 to help spearhead the group's early check truncation efforts, said the nation has come closer to becoming checkless than most bankers thought possible even 30 years ago.
"The idea that we would be transmitting check images across vast distances was so remote that it seemed unlikely to happen in my lifetime," Milano said.
Sizing up check usage
No one knows for certain how many checks are written each year by Americans, but the industry should be a bit better informed later this month when the Federal Reserve System releases its latest payments system research.
Last year, the Fed engaged two respected research firms to help quantify the number and value of checks written and electronic payments made in the United States. A spokesman for the Fed said reports detailing the findings are slated for release this month, but at press time no specific date had been determined.
The Fed has been endeavoring to chart the migration from paper to electronic payments, reporting data periodically on checks clearing, as well as cash and card usage. The last report, issued in 2004, indicated the tide had turned in favor of electronic payments - 44.5 billion electronic payments compared to 36.7 billion checks.
The Fed said at that time electronic payments were increasing at an annualized rate of 13.2%, while checks were declining at a 4.2% annual rate. A recent survey by Aite Group estimated Americans wrote 30.5 billion checks last year and are on track to reduce that total to 25 billion in 2012.
The Independent Community Bankers of America reported this fall that 54% of its member banks paper checks exceeded electronic payments. Only 17% of banks queried for ICBA's 2007 payment research reported more electronic payments than checks.
The future is here
Most experts say electronic check clearing is the way of the future, in large measure because it requires few changes. Checks clear as they have for decades, only instead of moving paper between banks, check exchange networks, such as SVPCO, swap digital check files.
Today, SVPCO claims it can reach 10,000 electronic endpoints with its image check network. "As more endpoints become image-enabled, you'll see a lot more image check exchange," Atkinson said.
Bob Meara, Senior Analyst at Celent LLC, agreed electronic check clearing is the way of the future. He predicts much of the up tick in adoption will be driven by merchant acquirers and their partners.
Meara pointed to an October ann-ouncement from Heartland Payment Systems of a bank-neutral remote check deposit service for merchants.
Customers using Heartland Express Funds scan checks and transmit the electronic check files via an Internet connection to Heartland, which then presents those files for deposit to customer banks.
The service also provides customers with online access to check images and deposit details. Acquirers and ISOs are also offering electronic check products, but Heartland's process is different; it deposits checks to banks electronically on behalf of customers.
Other acquirers offer electronic check clearing as a transaction-based service, not unlike credit and debit cards. Imaged checks might clear through an electronic check clearing system, the ACH or through a card network, Meara said.
"You aren't going to get people to stop writing checks," Atkinson said. But, she added, you can change the way checks get handled once tendered for payment, and image check clearing and ACH check conversion do just that.
"This is the way of the future," Atkinson said.
The transition begins
The migration to electronic check clearing has been plugging along for decades. But it took an act of Congress to jump start the process.
The Check 21 Act, which became effective in October 2004, created a legal basis upon which consumers, banks and other businesses could dispense exchanging and retaining paper checks.
It did this by legalizing a new, check-like document called a substitute check or image replacement document that can be created and used in place of an original for proof of payment and other legal purposes.
The legislation, with broad support among bankers and the Federal Reserve System, made possible wide scale implementation of check truncation, and opened the way for new product offerings such as remote check deposit services, also known as remote deposit capture (RDC).
"By busting down the legal barriers [to exchanging check images] they killed any resistance at paying banks," said Jerry Milano, Senior Vice President of The Clearing House. Paying banks had resisted electronic presentment in large part because of liability concerns over the lack of physical checks, Milano said.
RDC offers a host of benefits to businesses, including improved funds availability and the ability to make deposits any time of the day or night without ever having to leave your place of business.
The only investment the client needs to make is in a desktop image scanner, or a POS check scanner. And, "The cost of scanners has come way down," Meara said.
Basic models have been advertised for as little as $150 in bulk quantities.
"Remote deposit capture is changing the face of banking," said Scott Hutton, President and Chief Executive Officer of Drake Bank, a 5-year-old community bank in St. Paul, Minn.
Hutton and his sales team bring check scanners along on all sales calls to small to mid-sized business customers and prospects to show them how quick and easy the process is. "Once they understand it, they go 'wow,'" he said.
Under the radar
While there are plenty of banks pursuing RDC customers, Meara said his research indicated most are focused on small to mid-sized companies, but not necessarily on merchants.
"It looks like banks are going to pass by the opportunities" available in the merchant community, Meara said. "They will abdicate to third parties." Not unlike the way banks turned over card acquiring to third parties, he added.
Milano isn't surprised. He said most banks can't put enough feet on the street to pursue merchant customers in earnest. He also suggested many banks would be hard-pressed to match the compensation structures ISOs and MLSs are accustomed to. Banks, for instance, don't generally pay lifetime residuals.
Meara expected merchants to provide a major growth spurt for electronic check products. "Everybody knows that check usage at the [POS] is nose-diving," he said.
In 2005, only 11% of consumer POS transactions were by check, down from 15% two years prior, according to Dove Consulting's Survey of Consumer Payment Preferences. The Smart Card Alliance predicts cash and checks will account for only 30% of consumer spending by 2011, down from 50% in 2006.
A comprehensive report on checks and electronic payments, with verifiable data from 2006, is expected to be released this month. (For more information, see accompanied story, "Sizing up check usage").
Meara is optimistic about "meaningful growth" in the adoption of electronic check products among middle-market and large retailers, especially with retail giant Wal-Mart Stores Inc. moving to POP check conversion. Wal-Mart, working with First Data's TeleCheck unit, has been rolling out check conversion at all of its stores, including Sam's Clubs, since late 2005.
According to NACHA's data, 168 million transactions coded POP cleared through the ACH in 2005.
In 2006, the total grew to 269.3 million, and based on data from the first nine months, the ACH will handle almost 1 billion POP transactions this year.
In addition to getting Wal-Mart on board, several recent ACH rule changes have made check conversion a more attractive option for merchants, industry experts noted.
One of those changes effectively eliminated previous requirements that merchants return checks to customers once the information needed to create ACH items was captured and the paper checks voided. The change, which took effect in March, created the BOC format.
With BOC, checks are accepted at the checkout just like any other form of tender, and decisions about how to clear the items - using the ACH or another electronic network - are made later in the back office.
As ACH rules become more favorable and electronic check networks grow, so will opportunities to enter new vertical markets with electronic check services. Meara offered a few suggestions, including professional services and brokerage firms. "Check risk solutions products are a growth market," he said.
Bob Carr, Heartland's Chairman and CEO, agreed. "By expanding our offering to current customers and entering new markets with this product, we believe we can become the largest nonbank provider of remote deposit services by the end of 2007," he said in an October statement announcing the company's Express Funds product.
Atkinson sees plenty of opportunities for ISOs and MLSs who understand and offer innovative check services. "Helping merchants figure out the best way to collect various forms of payments presented by consumers is going to become very important," she said.
Patti Murphy is Senior Editor of The Green Sheet and President of The Takoma Group. E-mail her at firstname.lastname@example.org.
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