The industry is moving slowly on Check 21, partly because several major banks have just completed mergers, while small banks which lack research capabilities are waiting to see what the big players do.

Analysts at Financial Insights predict that the Check Clearing for the 21st Century Act will lead to a state of confusion for a while, particularly since it doesn’t require that banks accept check images. The new law allows banks to truncate original checks and process more check information electronically, but “allow” is the key word, as the change introduces a new option rather than a mandate.

“Banks are concerned, but they are still thinking in terms of old strategies,” said Aaron McPherson, an analyst at the research firm. And although banks report that check volumes are declining three to six percent a year, each of those surveyed said they expect to increase the volume they process at their institution as a result of the new law.

The Bank of New York sees “Check 21,” as the law is called, as a way to take deposits directly from companies that do business outside its region, so it is actively promoting check scanners that firms can install in their offices to scan checks and deposit them through imaging directly to the bank.

Called Remote Check Deposit, the service is already attracting interest, especially from financial firms such as brokers and financial advisors, said John Gannon, vice president in global payment services management at the bank.

HP OpenBank.NET provides a bridge from customer facing applications to legacy host systems.

Running Microsoft Windows 2000 and Windows XP, the desktop scanners can handle up to 1500 checks a day in batches of 30. They offer remote offices a way to make same-day deposits to their primary bank, instead of depositing into the branch of a nearby regional bank and then sending the money to a corporate account through an ACH transaction the next day.

“It reduces holdover of checks that come in later and typically are deposited the next day,” said Gannon. “It also reduces courier costs – whether you have someone walk over to the bank to make the deposit or use an armored car service. And it provides the benefits of account consolidation and the ability to get volume pricing.”

The bank will also offer remote deposit outside the U.S. Now its clients use DHL to ship checks to the bank for clearing, and that can take one to four days.

Currently, running in an internal pilot, the check scanning hasn’t run into any problems, Gannon said. External pilots are planned for the first quarter of 2005.

At Harland Financial, John Meyer, director of operations for EZ Teller, expects that merchants of all sizes, and professional offices such as dentists, will begin installing scanners to get deposits into their accounts on the same day they are received. Banks with extended networks will be able to get late day deposits into the Federal Reserve and earn interest on the money.

Regional banks need to look at their fee structures, he added. If banks like BNY come in and take deposits directly, the local banks will have to increase the fees they charge businesses for coins and bills since those could turn into standalone services with no compensating overnight balances.

David Kvederis, the president and CEO of BankServ who has been pushing check imaging since 1996, is amazed at how slowly banks are responding to the opportunities of Check 21.

“They need to understand there is a real revenue opportunity here,” he said. “They don’t appreciate that. They are thinking of it as a replacement of the way they take deposits today. But we’d be willing to pay a premium if we could scan checks and save our bookkeeper the need to walk several blocks a day to deposit the checks we receive from our clients.”

Banks could face competition in the market from players such as Intuit, he added. “They already have three million businesses that effectively do their accounting with them, why not clear their deposits? The banks could lose more of their payments franchise.”

At Financial Insights, analyst Joanne Capachin predicted banks would turn to outsourcing for their check processing, although they are restrained by concerns over internal fiefdoms and a belief that check processing is a core function of banking.

Gary Cawthorne, vice president and general manager at Unisys, expects that the top-tier banks will continue to process their own checks because they have such a huge investment in systems, while mid-tier and smaller banks will outsource to companies like Unisys, EDS, and Fiserv.

To Cawthorne, the slowness in adoption of the new law is no surprise. Although the U.S. writes more than 80 percent of the checks produced in the world, the inefficient means of payment has led to highly efficient processing; it now costs about a penny to process a check. With Check 21, if the paying bank can’t receive images, the bank which received the check has to send a paper image replacement document (IRD) that costs from five cents to 13 cents to produce and process.

“At the low end, that amounts to a 500 percent increase in costs,” said Cawthorne. “Unless you outsource or upgrade your systems to clear checks with images, and you convince your customers that they don’t need to get paper checks back, you won’t get the benefit of Check 21.”

Who is responsible if the image isn’t good enough? Under the law, the paying bank determines whether an image or check replacement document has acceptable quality, said Tim Sloane, an analyst at Mercator Advisory Group. He expects legal negotiations between banks to clarify issues of image quality before check truncation takes place. As banks prepared to implement the law, which went into effect at the end of October, they learned that the changes from Check 21 are greater than they had predicted, he said. One bank thought Check 21 changes would touch about two dozen processes, but it was more than 100.

That’s part of the reason banks are moving slowly. Much of the progress is still hidden, said Andy Kurtz, senior product manager for point of presentment solutions at Wausau Financial.

“The smaller banks don’t necessarily have the time or resources to do the research, so they tend to wait until organizations like the Federal Reserve start to do something, and then they react,” he said.

The Bank of New York is using products from Wausau for its direct check deposits, and the International Bank of Commerce in Texas plans to install scanners at 90 teller windows. The Bank of America Military Bank will use check scanners in five countries to take deposits.

Researchers said that some image exchange will begin in 2005 and electronic clearing will probably appear in 2007. That will lead to some behavioral changes among check users.

Studies indicate that a third of the people who write checks at grocery stores don’t have the money in their account to cover the check – they know that bank float gives them at least a day for funds to be deposited. Once stores can capture checks at the checkout and debit the account in real time, consumers probably will pull out their checkbooks less frequently and use debit cards instead, predicted Cawthorne.

Securing the Image

Check 21 offers the potential to make an enormous reduction in check fraud, which cost US banks an estimated $4.3 billion in 2001, according to the American Bankers Association’s Deposit Account Fraud Survey Report. More than $27 million in bad checks are written daily and 37 percent of all bad checks are never collected. But the move to transferring images of checks, rather than the physical checks themselves, opens the door to new kinds of fraud that exploit vulnerabilities in the imaging process. The good news is that some relatively simple steps can make image-based check processing secure. “After rigorous testing by an independent testing laboratory, we found that many of the security features can provide a viable method of reducing risk in an image enabled world,” said Zachary Tumin, executive director of the Financial Services Technology Consortium (FSTC). “We highly recommend that financial institutions and check issuers consider adopting additional security features such as those included in our automated test.” Paradoxically, in an age of electronic imaging one of the most important factors is the paper. “A lot of security features out there are applied on paper and are very inexpensive,” said Frank Jaffe, a consultant who was project manager for the FSTC survivability study and runs his own research and consulting firm, MorSecure. Banks can improve security through watermarks, different printing techniques, chemicals and paper treatments, he said. In addition, newer security features are coming into use, such as printing information similar to bar codes on the check surface. The bar codes can contain information such as the beneficiary’s name, which can be read by a scanner and verified automatically with special software, eliminating the need for new hardware. Solutions proposed fell into three categories: Printing a standard bar code with some check information on the face of the check; Using a proprietary symbol or method of creating a symbol; Looking at the specific characteristics on a check such as font, check size, background, and spacing between letters. Just as it occurs today, verification initially would happen when the check is presented to the bank it is written on. The FSTC has proposed a follow-on study to look at ways of moving fraud detections closer to presentment. “The process has to be fast,” said Jaffe. “We have to develop a protocol that allows a person at the cash register to cash out quickly.” The project tested solutions from Fiserv, Cheque Guard, Clarke-American, ASD Corp., SQN Banking Systems, POPPS, MediaSec Technologies and VeriSecure Systems. www.fstc.org

Don’t Count Paper Out Yet

Processing check images is going to combine a mixture of smart technology and mundane physical concerns, like paper quality. Image quality is very important, said Sydney Smith Hicks, president and CEO of VECTORsgi, one of the companies that has developed solutions for Check 21. It was recently acquired by Metavante. “Every camera from every vendor is different. But to get a good image, you need good paper,” she said. Some check designs will have to be dropped because they are too hard for scanners to read efficiently, she added. “You don’t have much time, since you have to push everything out by midnight. I am a little surprised that banks are just beginning to understand some of these issues,” she said. VECTORsgi runs an image capture platform on Windows 2000. The application has proved very effective in recording images. Three of five bank clients had no missing images in one month, while another had one image missed out of 50 million items. “This is in contrast to old systems which often had one missing image in 10,000,” she said. If an image is missed, the Windows system allows quick recovery, she added. “With the transport flying through 2,400 items per minute, it is tough to get the information if you don’t have a Windows system; you could have 40,000 items pass before a missing item report came back from a mainframe,” she said. www.vectorsgi.com

Test Market:Qatar

The future of exchanging check images is already working in Qatar where the Qatar Central Bank implemented a national check image clearing system in February 2003 based on an application from ProgressSoft. One hundred forty bank branches have Windows 2000 or Windows XP scanners that capture the check images and send them to the central bank for clearing. The central bank runs a cluster of Windows 2003 servers for its processing. Image capture screens include prompts for staff to review information from optical character recognition for accuracy. “This is the world’s first implementation of electronic check clearing,” said Michael Wakileh, ProgressSoft’s business development manager, who is based in Jordan. The banks are storing the paper checks for six months in case the actual document is needed for resolution of a dispute. Hewlett Packard will offer the solution to banks in the US and Canada. Interestingly enough, one result of the electronic clearing has been a doubling of the number of checks written in Qatar, said Ahmad J. Alsooj, assistant director for electronic systems at the central bank. Now instead of carrying large sums of cash to close a real estate transaction or to buy jewelry, customers can use checks, he said. “With real-time clearing, you no longer have to go to your own bank to cash a check,” he added. The bank is now processing 20,000 checks a day, up from 10,000 before the electronic clearing. www.progressoft.com