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Research Report: Proposed Check Truncation Act
Authors: Federal Reserve Bank - Alan Greenspan Date: Dec. 17, 2001 Size: 12 Pages Relevance Rating: High Web Address: www.federalreserve.gov/paymentsystems/truncation//gs_archive.php?emagazineIssueNumber=020601
Executive Summary On Dec. 17, 2001 - a little more than three months after the 9/11 terrorist attack - Alan Greenspan submitted to Congress a piece of legislation that could turn out to be the single most important change in payment systems in more than a decade. That legislation has come to be known as the Check Truncation Act.
While CTA had been in development for almost two years, 9/11 and the days immediately following that tragedy provided the Federal Reserve with enough justification to quickly finish the document and move it to the top of the Federal Reserve's Congressional initiatives. The link above takes you to an FRB page containing Greenspan's cover letter to Congress, the proposed legislation and a section-by-section analysis of the CTA.
As all of us remember, airports were closed across the country for the next three days after 9/11. While this policy decision caused a great deal of inconvenience and cost, no one paid a higher price than the Federal Reserve Bank. It was forced to pump into the banking system TRILLIONS of dollars of liquidity - funds needed to support banks that were unable to clear checks sitting in trucks near airports around the country.
While this financial crisis was going on, the Fed also noticed that ATMs, ACH, credit card settlement and other forms of EFT continued to move money as if nothing unusual had happened. The conclusion drawn at the Federal Reserve was that the paper check and its physical transportation represented a structural monetary weakness that our country could no longer afford to maintain.
In simplest terms, what CTA represents is a set of compromises that enables the truncation of checks at the point of first deposit into the banking system. The CTA authorizes an image taken of the original check to act as a replacement, thus enabling the digital transport for settlement at the payee bank.
Given that it will take years for most banks to upgrade their check operations centers to create and accept images for settlement, the CTA allows for the creation of an "Image Replacement Draft" (IRD), which can be presented and processed as if they were receiving the original check.
What this legislation makes possible is for large banks with image-processing capabilities to leverage those investments to truncate the flow of checks, process them electronically and create machine-readable substitute checks for less sophisticated financial institutions. These substitutes would be the legal equivalent of the original checks.
Before CTA, the banking industry has been operating under a set of Uniform Commercial Code (UCC) regulations that stipulate original checks must be exchanged between banks unless they have obtained agreements to do so electronically.
Banks have found it difficult to obtain and enforce such agreements on a large scale - which has made the justification for image technology difficult for all but the largest banks. CTA is designed to facilitate check truncation without mandating the receipt of checks in electronic form.
At this stage in the description of CTA, it is necessary to step back for a moment and segregate the 50 billion or so checks cleared in the U.S. each year into two categories: two-party checks and three-party checks.
Two-party checks are those type of payments in which the maker (consumer) is presenting the check directly to the payee (retailer). Three-party checks are those in which the payee (employee) is cashing a check (payroll) made out to him or her at a location (consumer's bank) other than the bank the check was drawn upon.
Two-party checks are now being truncated under regulations that the National Automated Clearinghouse Association (NACHA) has mandated. These are referred to as Electronic Check Conversion (ECC) transactions, in which the original check is scanned and authorized at POS by a retailer and, if approved, a receipt is generated that discloses the conversion process and asks the consumer for signed authorization.
When that signed receipt is obtained, the check is canceled and immediately returned to the consumer, and the funds are moved from the consumer's bank account to the merchant's bank account via ACH or ATM debit card network.
Both parties in the two-party check exchange must be present for ECC to work. It is estimated that ECC could create check truncation for approximately 10 billion of the 50 billion checks in circulation today.
CTA was designed to allow truncation on the remaining 40 billion three-party checks. The three-party check (paycheck) cannot be returned to the consumer (employee), because he or she is not the maker (employer).
These items have to be presented to the bank upon which the check was written. Under CTA, these three-party checks will be able to be truncated at the employee's bank and the image substituted for presentment at the employer's bank to allow for funds transfer.
For smaller banks or credit unions that can't accept check images because they lack the processing sophistication to do so, the CTA allows for the image to be sent to a local large bank or check processor that will print and physically deliver the Image Replacement Draft for funds transfer.
The overnight check-image exchange can be performed nationally without consideration for traffic jams, flight delays or weather disturbances - not to mention terrorist attacks.
In addition to transportation-cost savings, faster cash settlement should occur along with substantial reduction in fraud and NSF losses - the result of earlier notification. Rather than take up your reading time discussing the merits of CTA, you can read the Fed's section-by-section summary to see why it thinks this is in the best interest of all parties. Instead, I will be summarizing some of the "loose ends" that will need to be tied off before this legislation can make its way through Congress and become the law of the land. Problem #1 CTA makes it likely that consumers and businesses will no longer be able to get back their original checks, yet the CTA legislation is silent on the issue of minimum image-legibility standards. Problem #2 CTA effectively forces consumers and businesses to experience "involuntary truncation" but grants the check writer the right to have the bank replace disputed funds within one business day.
For consumers or businesses that agree to have their checks truncated as a part of opening a checking account with this language, CTA does not provide replacement of disputed funds. Problem #3 CTA does not require the replacement or substitute draft to be full size. Therefore, the bank may elect to provide compressed images on a single piece of paper showing front and back of the original check. Problem #4 CTA is silent on fees banks can charge for supplying images or substitute checks to consumers or businesses. Problem #5 CTA does not impose any minimum time period on banks to keep original checks. Under current UCC law, banks can destroy original checks so long as they have the capacity to provide a legible copy of the check for seven years. Problem #6 While it is clear that funds availability will be accelerated under CTA, there is no provision to assure that that cash-flow advantage will accrue directly to the depositor. Problem #7 Whenever there is choice on the settlement of checks in their original format or as an image, the opportunity presents itself for multiple presentments of the same item. CRT doesn't stimulate a re-credit right, which would allow consumers or businesses to have use of their money while the bank is resolving disputes of this type.
For more discussion on these problems and others relating to CTA, I refer you to the link below where the Consumers Union objections are detailed.
In summary, the Federal Reserve's total commitment to CTA combined with the full support of the largest banks in the country virtually assures passage of this legislation in the near term. Most experts are predicting fall Congressional approval and signing by President Bush. Web Sites for More Information on the Check Truncation Act
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