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Fed Torpedoes ECIs Despite Strong Industry Support

Thursday, December 27, 2018 ( /

The Fed has put the kibosh on clearing fully-electronic checks through the Reserve Bank System, despite strong industry support. Proponents aren’t giving up just yet, though.
The Federal Reserve appears to have closed the door on widespread adoption of fully-electronic checks, despite widespread industry support. Proponents of fully-electronic checks, however, aren’t giving up just yet.

The Fed last month adopted a batch of amendments to Regulation J (the rule set that governs the collection of checks and other items through Reserve Banks), including one that would ban financial institutions from clearing electronically-created items (ECIs) through the Reserve Bank System. The amendments take effect on January 1.

The Fed’s decision appears to run counter to broad industry support for ECIs. A request for public comments on the proposed ECI ban, floated earlier this year, elicited 14 letters in opposition, including a joint letter submitted by numerous businesses, financial institutions and industry associations. Only 3 comment letters supported the move to ban the clearing of ECIs through the Reserve Bank System.

A poll of visitors to also revealed strong industry support for ECIs. Over the last 12 months elicited over 220 responses to the Poll Central question “Should the payments industry allow fully-electronic checks?” Sixty-eight percent said yes; just 31% said no.

ECIs are like paper checks in every respect except that they originate as electronic messages, which eliminates the need to truncate paper checks which significantly compresses the clearing cycle. In fact, experts note, it is not uncommon for ECIs to clear and post on a same-day basis. No one knows for certain how many ECIs clear through the banking system on a daily basis, since they are generally indiscernible from electronic image files of checks that start out as paper. An analysis last year by the firm All My Papers suggested about 80 million ECIs clear through the banking system each year. Most ECIs are business payments, explained David Walker, president of Tiller Endeavors, LLC.

The Fed in explaining its decision said ECIs do not fit Uniform Commercial Code (UCC) and regulatory definitions of checks since they never exist in paper form. It also said that its decision to ban ECIs from the Reserve Bank System would not stop banks from agreeing to clear ECIs between one another. However, since a significant share of checks clear through the Reserve Bank System – 45 percent on the forward collection side and 68 percent of returns, according to the Fed’s data – most experts expect FIs will not encourage business clients to use ECIs in lieu of issuing paper checks.

Walker said he was disappointed by the Fed’s ruling, and he questioned the rationale for the Fed’s decision. “The arguments they gave frankly don’t make any sense,” he said. And he pointed to actions taken by the Fed following passage of the Check 21 Act to support inter-bank clearing of electronic check images, despite the lack of legal standing under the UCC and the Fed’s regulations. In fact, he noted, it took the Fed 12 years to define check images in its regulations, and that action was taken in the absence of similar UCC provisions.

“The Federal Reserve’s use of its authority to create new payments (check images) helped to create billions of dollars in savings for banks, the Federal Reserve and the U.S. economy. The Board is encouraged to use its existing authority and take similar action to define and support ECIs,” Walker and industry consultant Phyllis Meyerson wrote in a letter to the Fed.  “This supports the Board’s goal of moving to a real-time payment system and addresses its goal of bringing significant benefits to end users.”

ECIs as Route to Faster Payments?
Walker and Meyerson, both former executives of the Electronic Check Clearing House Organization, wrote the letter in response to a Fed request for comments on actions needed to support interbank settlement of faster payments.

The Fed has been pushing for faster payments for several years with an eye toward real-time settlement of business and consumer payments. And while several private sector initiatives have emerged that leverage electronic network technologies to support faster payments, most merely simulate real-time payments. And all are based on a credit-push approach to payments, where a business or consumer authorizes their bank to push (send) money to a biller or other entity. The ACH is commonly used for credit-push payments. A check, and by extension an ECI, represents a debit-pull payment: the payee instructs their FI to collect (pull) money from the payor’s FI account.  

Walker and Meyerson, in their comment letter, urged the Fed to rethink its singular focus on a credit push approach to faster payments. “Business end users have consistently found credit push payments unacceptable for more than three decades, so the road to business ubiquitous use of a new, credit push payment will be long and expensive, if ever successful,” they wrote. “Therefore, the Board is urged to consider a new payment system that includes both credit push and debit pull payments to meet end-user requirements of both consumers and businesses.”

Walker and Meyerson noted that substantial investments have been made by the Fed and the industry to support the electronic clearing of checks since passage of the Check 21 Act. “The only part of the current check system that continues to be paper-based is the writing of the check by the payor and delivering the check to the payee,” they wrote. “Given the existing infrastructure, the transition to a fully electronic payment system that uses the Check 21 infrastructure would be fast and inexpensive.”

The letter continued, “Once electronic payments such as ECIs are supported by the Board, businesses could achieve significant financial savings without significant new cost or business disruption with a much greater certainty of financial return. That value could potentially be used to fund the next transition to an online, real-time credit push payment system should that become acceptable to businesses. Otherwise, the value could be used to fund the transition to an online, real-time debit pull payment system.”

The Fed’s comment period on actions supporting faster payment initiatives closed earlier this month. A summary of comments should be published sometime next year, after which the Fed is expected to propose specific new actions to support faster payments.

Visit Poll Central and Vote
The Poll Central query featured in this article has been reset and can now be taken again. New results will be published next year. In the meantime, visit Poll central and vote on the featured query for January "What are your top 3 RDC Priorities for 2019?"

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