We Happily Accept Checks Here!

Reducing Check Processing Costs with Check 21
and electronic check conversion

CHECKS AS ELECTRONIC PAYMENTS

“Checks no longer accepted.” The signs are appearing more often on the doors of many small businesses. Faced with the choice between customer satisfaction, the risk (and cost) of accepting bad checks, and the long clearance time for traditional paper checks, many small retailers have simply chosen to forego accepting checks. But this puts them at a competitive disadvantage to larger retail businesses.

However, the information in this document may dramatically change how retailers think of checks. You may be ready to post a sign stating “We happily accept checks here!”

With Check 21 and electronic check processing it is now possible to process all checks electronically using electronic check payment, check 21, and check image replacement. We’ll explain what some of these terms mean and help reveal the major benefits you can gain from this technology. This includes reduced check fraud, improved return check collection, simplified handling and processing (less room for error or fraud), and improved customer service. (See the “Benefits of Check Conversion” section for a complete list.)

Traditional Payment Method

In the traditional cash scenario, tender accepted at the Point of Sale (POS) is picked up once or twice a shift, then balanced in the store, then deposited. Once the cash reaches the bank it is counted, validated, deposited, and made available for the retailer to transfer back to its main account. Checks, on the other hand, go to a central processing area within the bank. There they are bundled, processed through a machine, and micro-encoded with the amount of the check in the bottom right-hand corner, at the end of the check’s existing MICR (magnetic ink character recognition) line. Then they are processed through a machine that reads the MICR line and makes a microfiche of the check itself. The checks are then re-bundled and sent to the Federal Reserve Bank, typically by airplane. The Federal Reserve processes the checks by breaking apart the bundles, re-bundling them by bank, and sending them back to their originating banks. The originating banks then process them and charge their consumer’s accounts. Depending on geography, this can take five to seven days.

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In the meantime, the merchant has no access to that money; the check is handled by many different entities, pictured, bundled, encoded, and shipped many times over. This method is understandably expensive. The objective of the Check 21 legislation was to reduce systematic risk associated with physical check movement and to provide a mechanism to reduce the costs associated with check payment processing.

Electronic Check Payment Method

In the check conversion scenario, checks accepted at the POS are scanned with the electronic images of the checks sent to the bank. The check images are then validated and sent electronically to print sites near your customer’s banks. The check images are printed on secure watermarked paper. On day two the substitute checks are presented to your customers’ banks and the deposit is available in your account. This method reduces the five to seven day float period mentioned above to 24 to 48 hours.

What is Check 21?

The Federal Reserve Board worked with Congress on the Check Clearing for the 21^st Century Act, commonly known as Check 21, which became effective October 28, 2004. Check 21 uses a new negotiable instrument called a substitute check, which is the legal equivalent of an original check. A substitute check is a paper reproduction of an original check that contains an image of the front and back of the original check and is suitable for automated processing, just as the original check is. Check 21 allows depository institutions to convert original checks, process check information electronically, and deliver substitute checks to depository institutions if they require paper checks.

In this scenario the paper check is captured and converted into a digital image (a representation of all or part of an original check or substitute check.) A Financial Institute, the reconverting bank, uses the digital image to create a substitute check, which is a paper reproduction of the original check. Below is an example of a personal size check that has been converted to a substitute check for forward collection process.

Automated Clearing House (ACH) Network

In addition to a digitized version, a check can also be converted to an electronic transaction and then processed through the Automated Clearing House (ACH) Network.

The ACH Network is a highly reliable and efficient nationwide batch-oriented electronic funds transfer system governed by the NACHA OPERATING RULES, which provide for the interbank clearing of electronic payments for participating depository financial institutions. The Federal Reserve and Electronic Payments Network act as ACH Operators, central clearing facilities through which financial institutions transmit or receive ACH entries.

Checks are most often converted for use as ACH transactions by two methods: Accounts receivable check conversion (ARC) and Point of Sale, also referred to as Point of Presentment (POP). In both of these scenarios the paper check is converted to an ACH electronic payment.

Here is how it works:

Paper check is tendered for payment.
Using a MICR scanner, payee scans MICR data from check.
Payee adds payment amount and name of payee.
Payee transmits data through the ACH Network to debit the customer’s account.

In ARC, the check is destroyed after conversion. In POP, the check is returned to the check writer at the time of payment.

There’s an important distinction between check conversion and check imaging. When a check is turned into an image, the transaction remains subject to check law. When a check is converted to an ACH debit, the rules of the National Automated Clearing House Association apply. Check conversion was developed to provide benefits such as efficiency and additional consumer protection to the nation’s payment system by handling cost-effective electronic transactions (faster collection and return of payments), while allowing customers the option of continuing to write checks.

Check conversion was developed to speed collection and return of payments, while allowing customers the option of continuing to write checks.

Trends in Electronic Payments

On April 15, 2005, The Electronics Payments Association announced that more than 12 billion automated clearing house (ACH) payments occurred in 2004. The 20% increase over 2003 is mostly attributed to ARC – the accounts receivable check conversion application supplying 54% of all ACH transactions. In its 3-year lifespan, ARC reached 1.2 billion payments--the fastest growing payments application to surpass the 1-billion threshold in the ACH Network’s 33-year history.

Future of Check Conversion

¹A 2004 Federal Reserve Payment Study confirmed that electronic payment transactions in the United States exceeded check payments for the first time. The number of electronic payment transactions totaled 44.5 billion in 2003, while the number of checks paid totaled 36.7 billion, according to studies done by The Depository Institutions Payments Study and The Electronic Payment Instruments Study.

According to Richard Oliver, senior vice president of the Federal Reserve Bank of Atlanta and the Federal Reserve Bank’s product manager for retail payments, “The balance has shifted from check writing to electronic payments, and we expect this trend to continue. Indeed, at current growth rates, credit cards and debit cards will both surpass checks in terms of total annual transactions in 2007. Such rapid change presents opportunities andchallenges for an industry traditionally geared toward paper-based payments.”

¹ Image taken from http://www.celent.com/PressReleases/20041027 /CheckProcessing.htm

In a report published by Celent, The Future of Check Processing in the US, (www.celent.com) Celent projected that paper check processing will nearly disappear in the US by the end of the decade. Image exchange of transit checks will grow from more than 14 percent in 2005 to 61 percent by 2007. By 2010, more than 93 percent of transit items will be image exchanged.

Among other key findings, Celent expects the total volume of checks presented to amount to 38 billion this year and to gradually slide down to 24 billion by 2010.

Writing checks may be on the decline, but it will still be a long time before people stop writing checks. However, as more and more banks and merchants become aware of the advantages of check conversion, processing checks electronically will likely grow dramatically.

Benefits of Check Conversion

According to a white paper done by IVI Checkmate, 1999 Electronic Check Conversion, there are four main benefits for retailers who incorporate check conversion: reduced check fraud, improved returned check collection, simplified funds management and improved customer service. Key points for each benefit follow:

Reduced Check Fraud

When a retailer uses electronic check conversion (ECC), negative file data is updated within 48 hours of settlement, reducing the retailer’s exposure to check losses. Paper checks take 5 to 7 days to update.
Using ECC, banks can eliminate the consolidation, sorting, and proofing of paper checks, thus saving time and cost. This lower cost is passed to the retailer.
Because negative file information is updated within 48 hours, the number of negative checks passed is greatly reduced.

Improved Returned Check Collection

Electronic check conversion streamlines collection activities by eliminating paper check handling and re-depositing of paper checks.
Eliminating paper checks allows for quicker access to customer accounts for re-presentment (up to 4 days sooner than paper checks).
During the ECC collection process, the retailer gains an extra presentment into the customer’s account that would have not been available if paper checks were written by the consumer. With the additional re-presentment chances of collecting on the check are greatly improved.

Simplified Funds Management

Electronic check conversion reduces the time it takes for retailers to submit checks to the host processor, thus checks are cleared within 24 to 48 hours.
By eliminating the expense of handling and encoding checks as well as the reduced number of non-sufficient funds (NSF) checks, the bank is positioned to reduce its fees to the retailer.
Paper checks need to be counted and the value of the checks needs to be calculated. ECC computes check totals electronically and makes the deposit automatically. Bad checks are automatically re-submitted saving the retailer time and cost.
It takes an average 7 days to notify a retailer of a returned check. ECC reduces that time frame to 48 hours when checks are identified in accordance with Automated Clearing House (ACH) regulations.
Electronic check conversion allows check funds to be consolidated upon initial deposit into the merchant’s bank account of choice.

Improved Customer Service

Although customers are required to sign authorization forms during the first occurrence, retailers find it is 30% faster to serve a customer using ECC than without.
The cashier does not need to count and recount checks with ECC, thus the process of “end of day” closeout is simpler and faster.

How Can Cougar Mountain Software Help?

Cougar Mountain Software has been in the business of providing businesses with powerful accounting, nonprofit accounting and point of sale software solutions for more than 23 years. Cougar Mountain’s quest for innovative technology, enhanced business practices, and commitment to customer service contributes to the development of award-winning, flexible, and powerful products.