Fed Check Proposal Has Banks Worried

The banking industry is unenthusiastic about the Federal Reserve's proposed Check Truncation Act, which aims to eliminate the need to physically transport checks between banks during the clearing process.

The law would allow banks to transmit electronic images, which could be printed out and used as legally-binding "substitute checks."

Current law requires a bank to physically present and return the original check unless the other bank has agreed to accept a substitute-either electronic or paper. The new law would eliminate this requirement, thereby enabling more banks to enjoy the benefits of check "electronification," according to the Fed.

Check truncation today is confined to those few banks that already have electronic check presentment (ECP) agreements, either bilaterally or through exchanges like SVPCo. The difficulty of obtaining such agreements, plus the need to invest in new technology and change operating procedures, has slowed the growth of ECP, with the result that fewer than one-quarter of the 50 billion checks written each year are presented electronically.

The use of substitute checks, while not completely electronic, will promote efficiency by reducing the time and expense associated with transporting checks, according to the Fed. For example, instead of having to ship original checks to a distant bank that refuses to accept electronic files, a bank could transmit an electronic file to a location near the distant bank. From there, the file would be converted to substitute checks for delivery to the distant bank. The distant bank would be indemnified against losses , such as a customer's account being debited twice because an original check was presented along with a substitute check.

The Fed had considered requiring all banks to accept electronic files. But that would have resulted in technology expenditures and operational changes in check processing practices at thousands of banks. The substitute check was deemed a less drastic way to nudge banks toward electronic processing.

The banking industry has no quarrel with the law's objective of promoting a more efficient payment system. "They are taking a proactive stand in promoting check electronification, which the banking industry would say is a good thing," said Bob Ballen, a Washington, D.C. attorney who advises the industry on payment issues.

However, further study is needed before the law's economic impact can be fully understood, he said. "The Fed has articulated realistic and sound benefits, but no one knows the value of those benefits."

Some in the industry are worried that the new law might be expanded to include bilateral and multilateral ECP agreements. Banks so far have enjoyed wide latitude in negotiating such agreements, which govern pricing, technical and procedural issues associated with ECP. "All of the ECP initiatives until this point have been voluntary," Ballen said. "This is the first instance where the Fed is proposing something for banks that don't agree."

The Fed insists that private ECP arrangements won't be affected by the law. Still, the industry is "less than thrilled," said Phyllis Meyerson, associate director at Dallas-based Electronic Check Clearing House Organization (ECCHO), which creates rules for ECP exchanges.

Another concern is the law's provision for resolving disputes arising from the use of substitute checks, such as a customer questioning a check's authenticity. After receiving a claim, banks would have one business day to either produce the original check or credit the customer's account for the amount of the substitute check, up to a maximum of $2,500. Banks are especially wary of this provision because they fear it could be extended to all checking transactions.

Yet another concern is a requirement that Treasury checks be shipped to a Federal Reserve bank after truncation. "That increases the cost of complying with the Act, and may undermine its whole purpose," Ballen said.

Overlaying all these concerns is the fear that Congress might be pressured by consumer groups and other special interests into passing a law unfavorable to banks.