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The Next Generation of the Check
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Thursday, April 15, 2010 (RemoteDepositCapture.com / Ed McLaughlin)
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The best way forward may not be a new payment type, but instead creatively leveraging the payments infrastructure we already have.
In 2004, Check 21 enabled the use of Image Exchange between banks to clear and settle based on the image of the check or image settlement, and the truncation of the check at the point of capture. This eliminated the need for a bank to receive, store or send the physical paper check to the drawn-on bank, thus reducing the settlement time and costs while improving productivity. The obvious next question after this first step of electronifying the check then became “When will the next evolution that allows for totally electronic checks - a check that were never paper in the first place- take place? Check 21 is the innovator and the process that enables this evolution to take place. Is it possible to have checks that never existed as a piece of paper? Is it possible to initiate a check in the same way we initiate other forms of electronic payments? To answer this question we turn to the regulations that define the term “check” . According to Reg CC, the definition of a check is; “Original check means the first paper check issued with respect to a particular payment transaction” As a result of this definition, even payment transactions that initiate via phone and internet require the creation of a paper document. For instance, to initiate a payment transaction over the phone or via the web using a check, the merchant must obtain the checking account owner’s permission and the owner’s checking account information. The merchant then uses the information from the check, including a representation of the approval by the checking account owner in the signature block area, to create and print a hard copy of the information and that hardcopy can then be considered to be a check and is called a “Remotely Created Check” or RCC. Again, the only proper way to process an RCC is from the original paper item that is scanned (truncated) and the MICR line information along with the front and back images of the RCC are captured for transmission and subsequent processing. Then and only then, is the item eligible for clearing as a check. The system is not perfect and it is redundant,, but it is required to meet the requirements of the regulations, unless the regulations and the current definition of a check are changed.
In addition to the potential for unauthorized RCCs, the current RCC process poses a major challenge: how does the bank know whether the item was ever a piece of paper in the first place or if it was initiated and processed for deposit without ever being a piece of paper? Today there is no indicator or way to tell in the electronic transmission and processing of the item – if the item was ever in paper form. The file format (X9.37) does not include any of the information about the scanning of the item and if it could there is no way, that I am aware of, that it could be verified. The inability to know if the RCC was ever a piece of paper and therefore a check places the depository bank in an awkward position of having potentially processed an illegal item if the item is ever challenged. Without some sort of proof that the item was in paper form, the warranties and indemnification that follow a check would not apply – not even those rules that currently apply to RCC’s. The principal reason the Federal Reserve has put the responsibility for the validity of the RCC on the depository bank is to insure the RCC has been authorized by the drawer. The legality of the item should also be validated. The only recourse the depositing bank has is its’ deposit agreement with the merchant where the merchant has agreed that a paper RCC was used to initiate the payment. Not a lot of comfort to the depositing bank if it is discovered in an an investigation of the item for any reason including items being returned as unauthorized that it is not covered by check regulations. What law covers the transaction as it was processed? It would not be Reg. CC. or Reg. J. It would most likely be The Electronic Funds Transfer Act, Reg. E. for consumer transactions if indeed the transaction was authorized by the consumer?
At BAI Payments Connect 2010 ECCHO (The Electronic Check Clearing House Organization) presented a session where they previewed the potential for a set of rules that would or could address the electronic RCC legality. ECCHO, the authority for specifying the rules that enable banks to exchange checks between each other, is one organization that could help to establish rules to allow for the exchange of checks as “electronic” checks, or as ECCHO refers to them as Electronic Payment Orders (EPOs). ECCHO proposed to develop the rules, in conjunction with its’ members, for the exchange of EPOs. These rules then could be reviewed by the Federal Reserve Bank as being the basis for revising the definition of a check in Reg. J and Reg. CC. At a minimum, the proposed rules would be a way for banks to agree on exchanging these electronic payments. It seems logical that the evolution of the check would follow this course. However, does the EPO address the whole issue or the root cause of the problem? That being said, how does a depositing bank know if what is being sent to them is an RCC or an EPO? Again, it would have to depend on its’ deposit agreement with the merchant for the RCC and the EPO and with the EPO it would depend on both institutions having agreed to exchange EPOs, and, therein is the problem and the legality issue has not been solved. The whole issue of the legality of the electronic check needs to be addressed and resolved.
The discussion continues on whether check law should be extended to cover the EPO electronic items or whether EPOS should be covered under Reg. E, which is already in place and covers electronic fund transfers. The issue with Reg. E is that it only covers consumer originated payments and was not intended for business transactions. Whereas checks and check law have evolved over the years to also meet the needs of businesses through the regulations and a suite of treasury products offered by financial institutions. The discussion on the business use of electronic checks has to be included in the general discussion about EPO. It is interesting to note that today’s discussion about the RCC is not a new one but one that goes at least as far back as 2006 and the Federal Reserve discussion in; Docket No. R-1226, 12 CFR Parts 210 and 229 Regulations J and CC; to define Remotely Created Checks (RCC) and to create transfer and presentment warranties . In the discussion and explanation of how the final rule was developed The Federal Reserve begins with a definition of an RCC that supersedes the various state UCC definitions where they may be in conflict with the Fed’s definition. The Fed in reviewing the commentary that was received prior to the release of the rule stated that many of the open questions about the justification of the RCCs existence were raised and some are “answered in the Rule but some are left open”. Now in 2010 the same questions are being raised and the same open questions are still looking for answers. On page 5 of the Fed document they include the following discussion about the RCC;
“Some commenters, including Attorneys General representing 35 states, recommended that the Board prohibit the use of remotely created checks altogether, arguing principally that legitimate use of remotely created checks has significantly declined, largely as a result of new automated clearing house (ACH) payment applications that can be used in place of remotely created checks. Several commenters, however, reported an increase in the use of the remotely created checks (albeit some noting that this increase in use has been accompanied by a commensurate increase in unauthorized remotely created checks).”
It goes on to say;
“The Board believes that substantial additional research would be required about the uses of remotely created checks and the commercial impact of an outright ban before a prohibition by statute or regulation could be justified. The Board believes its rule provides effective protections against unauthorized remotely created checks while still allowing for the legitimate use of those checks.
Some commenters argued that remotely created checks also should be covered by the Board’s Regulation E (12 CFR Part 205), because payments by remotely created check are in fact electronic fund transfers subject to the Electronic Funds Transfer Act (EFTA), which, among other things, requires certain disclosures related to transfers covered by the Act.”
Sound familiar? It is time to address the issue of the RCC and the electronic check, to answer the open questions and to not leave the banks exposed to risk, as they currently are.
Imagine how much more convenient and efficient the system would be if the drawer or the merchant on behalf of the drawer (consumer or business) could create an electronic check to complete payment. It sounds a lot like the process that is now in place using NACHA rules for WEB, TEL, ARC and BOC. POP is, it could be argued, really an electronic check if you consider that the original item is never scanned except for the MICR line, is given back to the consumer and is processed totally as an electronic item. However, check system and image exchange have more checks and balances in place for a business to minimize fraud. Either or both would be effective solutions to the legality issues of an RCC.
It seems that after years developing the most secure reliable and finest financial system for payments in the world that we should take full advantage of this infrastructure and kill the paper before it is written where possible. The financial services network of image exchange partners using ECCHO rules and ACH connected banks using NACHA rules, are the gold standard for security and reliability. Why are we not taking advantage of both of these networks to move the check to the next generation, the electronic check? The Federal Reserve is chartered with safety and soundness of the financial system. The RCC legality issue needs to be addressed to remove doubt and uncertainty from the system and one approach would be to modify the definition of a check to include the electronic check.
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1) Title 12: Banks and Banking, PART 229—AVAILABILITY OF FUNDS AND COLLECTION OF CHECKS (REGULATION CC)
Subpart A—General , § 229.2 Definitions (ww).
2)FEDERAL RESERVE SYSTEM, 12 CFR Parts 210 and 229, Regulations J and CC; Docket No. R-1226;
Collection of Checks and Other Items By Federal Reserve Banks and Funds Transfers Through Fedwire and Availability of Funds and Collection of Checks, Effective Date: July 1, 2006
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