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Winds of Change are Blowing in the Banking Industry: Check Processing Overhaul Expected By John R. Blake, Jr., Esq.

Friday, February 11, 2005 - By: John R. Blake, Jr.

By John R. Blake, Jr., Esq.

As we hunker down to ride-out the winter doldrums, now might be a good time to review your banking cash management procedures, especially in light of a recent changes to the banking system intended to overhaul the way paper checks are processed.

The new law, known as Check 21 (12 U.S.C. §§5001-5018), went into effect on October 28, 2004, and is intended to increase the speed at which checks are processed through the banking system by eliminating paper checks from the process. The prior method of processing payments by check, and the one to which most people are accustomed, relied on physically moving the paper check from the financial institution where the check was deposited to the bank on which the check is drawn. The new law increases processing efficiency by allowing the payee's bank to convert paper checks into electronic images of the checks. The images are then transmitted electronically, thereby eliminating the need to physically send paper checks by air or ground carrier to the Federal Reserve Bank clearinghouse for processing.

The time savings in check processing is most apparent in the case of a payor on the East Coast and a payee on the West Coast. Moving the paper check across country increases the time required to credit the payment to the payee's account. With the widespread acceptance of the internet's use in completing banking transactions, processing paper checks electronically is a logical means to improve a system that relies on carriers that can be delayed by any number of causes (the implementation of Check 21 was in part a response to the events of September 11, 2001, where air travel was suspended for several days). Processing can now be completed in hours rather than days.

Although Check 21 will no doubt speed-up check processing, it could produce some unexpected results for those who rely on payment by paper check. Foremost, the period of float, or the time between tendering payment in the form of a check and the time the money is actually debited from the account, is reduced to hours rather than days. Those who count on the float period when paying by check now need to monitor their account balances more closely to ensure that there are sufficient funds in the account. Also, not all banks will adopt Check 21 at the same time. Although the law is now in effect, the time frame for implementation has been left to the individual banks. If a payor's bank does not process the payor's deposits electronically, but the payor's creditor's bank does, the result could be that the payor's checks are being processed faster than deposits, creating a timing problem.

Also, those who pay by check because of the paper trail, or those looking to collect on a bounced check, might be surprised to learn that the actual paper check is destroyed after it is converted to an electronic form. The law provides that the electronic copy, which is unalterable, serves as a substitute for the paper original. However, the original check with the signature of the drawer will not exist after it has been processed. The drawer can get a "substitute check," being the hard copy of the check's electronic form, and banks may include the substitute checks with their customer's monthly statement. Those accustomed to the historical completeness of having the original check returned for their records may want to keep a copy of their check before sending it.

The changes brought by Check 21 will no doubt bring the analog world of paper checks closer to the digital one. Any uncertainty about the change can be minimized by checking (no pun intended) with your bank to discover how it is handling the changes, and how they expect the process will affect its customers.