For other versions of this document, see http://wikileaks.org/wiki/CRS-RL31591
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Order Code RL31591
CRS Report for Congress
Received through the CRS Web
Electronic Banking:
The Check Truncation Issue
Updated November 8, 2003
Walter W. Eubanks
Specialist in Economic Policy
Government and Finance Division
Congressional Research Service ~ The Library of Congress
Electronic Banking: The Check Truncation Issue
Summary
The clearing process for checks is more expensive than other methods of
payment which are cleared electronically, such as credit cards and Internet banking.
The main reason is that check clearing requires banks to physically present and return
checks unless they obtain legal agreements to clear electronically. The Check
Clearing for the 21st Century Act of 2003 (P.L. 108-100) eliminates the requirement
to physically return the original checks to the paying bank. Before the bill by the
same title became law, on April 3, 2003, the Senate held its first hearing on the Fed's
Check Truncation Act (CTA) proposal that was sent to banking committees of both
Houses in December 2001. On June 5, 2003, the House passed H.R. 1474 and
referred it to the Senate Committee on Banking, Housing and Urban Affairs. On
June 18, 2003, at a markup, the Senate Banking Committee approved its Check
Truncation Act of 2003 (S. 1334) and on June 27, 2003, the full Senate passed S.
1334 and incorporated it in H.R. 1474. On October 1, 2003, House and Senate
conferees reported H.R. 1474 (Conference Report H.Rept. 108-291). On October 28,
2003, President Bush signed the Check Clearing for the 21st Century Act (P.L. 108-
100) into law, which is now also known as Check 21 Act.
Estimates of cost savings from moving to electronic check clearing vary widely
because estimates of the cost of using a check and the number of checks written each
year remain in dispute. Consequently, estimates of cost savings range from $1.4
billion annually for truncation alone to $68 billion for replacing checks with
electronic payments. In testimony at the hearing of Senate and House banking
committees in the 108th Congress, the Fed's CTA in the Senate and H.R. 1474 in the
House were supported by the Federal Reserve Board, which testified that it would
like to remove some of the consumer protection provisions that were in its 2001
proposal because they were unnecessary. The Fed argued that the regulatory costs
these provisions would place on banks would outweigh the consumer benefits. Still,
the bill is supported by America's Community Bankers, the American Bankers
Association, the Consumer Bankers Association, and the Financial Services
Roundtable.
The opposition to the Check 21 Act came from the Consumers Union, supported
in its testimony by the Consumer Federation of America, the U.S. Public Interest
Research Group, and the National Consumer Law Center. The Consumers Union
argued that the Act would make it impossible for an estimated 45.8 million U.S.
households who are currently getting their paper checks back to continue to do so.
These consumers would be less protected from fraud under the Act than under the
existing check clearing process when there are disputes about check payments. The
Consumers Union's suggested changes in the proposed legislation would
significantly increase consumer protection. At the same time, these changes would
increase financial institutions' costs of voluntarily adopting check truncation. Other
witnesses argued that those banks with decades of using truncated checks have not
experienced many disputed check payments, and when they did they were quickly
resolved.
This report will be updated as legislative and financial developments warrant.
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Paper Check Clearing Processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Electronic Check Presentation and Truncation . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Truncation by an Intermediary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The Check Clearing for the 21st Century Act (H.R. 1474, P.L. 108-100) . . . . . . . 9
Consumer Groups' Reaction to H.R. 1474 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Possible Objections to Universal Check Truncation . . . . . . . . . . . . . . . . . . . . . . 12
List of Figures
Figure 1. The Paper Check Clearing Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Figure 2. Check Truncation at the Bank of First Deposit . . . . . . . . . . . . . . . . . . . 6
Figure 3. Check Truncation by an Intermediary . . . . . . . . . . . . . . . . . . . . . . . . . . 7
List of Tables
Table 1. Estimated Per Check Payment Costs and Benefits of Check Truncation
Over the Paper Check Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Electronic Banking:
The Check Truncation Issue
Introduction
The United States banking system processes approximately 42.5 billion checks
annually, but only a fraction of these checks is processed electronically by check
truncation. Check truncation occurs when the check is stopped before it reaches the
paying bank and the check clearing process is completed electronically. (The term
bank is used to include commercial banks, savings institutions, and credit unions.)
The Federal Reserve Board (the Fed) has proposed legislation that would authorize
the creation of "substitute checks," an electronically produced instrument, that would
allow banks to truncate the original check clearing process and complete the process
electronically with the substitute check. The customers would receive the substitute
check, which would be the legal equivalent of the original check.
If all checks were replaced by electronic transactions, the exact cost savings
would still be unknown, because estimates of the cost of using a check and the
number of checks written each year remain in dispute. Consequently, estimates of
cost savings range from $1.4 billion annually for truncation alone to $68 billion for
replacing checks with electronic payments. A significant part of the savings comes
from eliminating the handling, sorting, and physically transporting of checks to the
paying bank. To clear checks electronically, banks must negotiate processing
agreements that make it unnecessary to physically present the paper check. Since the
benefits are not uniformly dispersed among the participants, banks have found it
difficult to obtain these agreements, thus constraining the widespread adoption of
electronic check clearing.
Legislation
On October 28, 2003, President Bush signed the Check Clearing for the 21st
Century Act into law (P.L. 108-100). The act is also known as Check 21 Act. The
legislation behind it goes back to the the 107th Congress. In December 2001, the
Federal Reserve Board drafted the Check Truncation Act (CTA) and sent it to both
the House Financial Services Committee and the Senate Committee on Banking,
Housing and Urban Affairs to be introduced in Congress. On October 2, 2002, the
Check Truncation Act of 2002 (S. 3034) was introduced by Senators Tim Johnson
and Thomas R. Carper. Prior to that time, on September 25, 2002, the Subcommittee
on Financial Institutions and Consumer Credit of the House Financial Services
Committee held a hearing on the Check Clearing for the 21st Century Act (H.R.
5414), introduced on September 19 by Representatives Mike Ferguson and Harold
E. Ford Jr. The bills, H.R. 5414, and S. 3034 and the Fed's proposed bill, are almost
identical. They would eliminate the requirement to physically return the original
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checks to the paying bank and therefore make it easier for more banks to voluntarily
adopt electronic check clearing instead of continuing to use the paper check clearing
process. The main difference between the Fed's proposal and H.R. 5414 was that
the Fed's proposal had greater consumer protection against unauthorized debits.1
After the hearing held on September 25, 2002, no further action was taken in the
107th Congress.
In the 108th Congress, on April 3, 2003, the Senate held its first hearing on the
Fed's Check Truncation Act proposal that was received in December 2001. The
Federal Reserve Board's Vice Chairman Roger W. Ferguson Jr testified that the
board would like Congress to remove some consumer protection provisions that were
in its 2001 bill. "Upon further reflection, the Board has now concluded that the
significant compliance burdens imposed by these provisions on banks that receive
[the electronically produced] substitute checks outweigh the small incremental
benefits that the provisions would provide to the consumers."2 The vice chairman
did not provide a new bill, but instead pointed out that "Nonetheless, Congress may
conclude that the expedited recredit provisions for consumers should be included in
the legislation. In that case, . . . it should not go beyond the provisions proposed by
the Board."3
On April 8, 2003, the Subcommittee on Financial Institutions and Consumer
Credit of House Financial Services Committee held a hearing on H.R. 1474, the
Check Clearing for the 21st Century Act of 2003. The bill was introduced by
Representatives Melissa Hart and Harold E. Ford Jr. on March 27, 2003.
Substantively, the bill was not changed between the two Congresses. Vice chairman
Ferguson's statement to the Committee was essentially the same as was the one
presented to the Senate Banking Committee. On May 21, 2003, the House Financial
Services Committee in its consideration and markup session amended H.R. 1474 and
ordered it to be reported by voice vote. The amendment is a clarification amendment
made by Representative Artur Davis. It would allow a consumer to make a claim for
an expedited credit without possessing the substitute check.
On June 27, 2003, the full Senate passed the Check Truncation Act of 2003
(S. 1334) and incorporated it in H.R. 1474. At a markup on June 18, 2003, the
Senate Committee on Banking, Housing, and Urban Affairs approved S. 1334.
Earlier, on June 5, 2003, the Senate Banking Committee received H.R. 1474, which
was passed by the House of Representatives the same day and referred it to the
Senate. The two bills are quite similar. The major differences between the bills are
mainly in the area of consumer protection. The CTA is more generous in its
1
See Nicole Duran, "Fed Makes Case for Check Truncation," The American Banker, Sept.
26, 2002, p. 1.
2
U.S. Congress, Senate Committee on Banking, Housing, and Urban Affairs, Federal
Reserve Board Proposal on Check Truncation, hearing, 108th Cong., 1st Sess. Apr. 3, 2003,
unpublished, Statement of Roger W. Ferguson Jr., Vice Chairman, Board of Governors of
the Federal Reserve System,
[http://www.senate.gov/~banking/03_04hrg/040303/ferguson.pdf], p. 6, last visited Apr. 8,
2003
3
Ibid. p. 8.
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consumer protection provisions. For example, the CTA gives consumers 40 days
to file an expedited recredit claim, while H.R. 1474 would give only 30 days. In
addition, the Senate's CTA would shift the burden of documentation more on the
banks and less on consumers than the House's bill.
On October 1, 2003, House and Senate conferees reported H.R. 1474(
Conference Report H.Rept. 108-291). The Conference Agreement adopted the
House provision of 30 days to file an expedited recredit claim providing that a
consumer who receives a substitute check does not have to have the check to make
a claim for expedited recredit. On documentation, the Conference Agreement
adopted the Senate provisions placing most of the burden on the banks, not the
consumers. A major sticking point was only indirectly related to the bills. It was
between the Federal Reserve Board and the AirNet System Inc., the nation's largest
check transportation company, over the Fed disclosure of its check transportation
costs. The Conference Agreement requires the Fed to disclose its expenses and
revenues for shipping commercial checks between processing facilities. The Fed
would have to publish the information in its annual report for 10 years, but would not
have to disclose specific prices. In addition, the act mandates a study on funds
availability including the percentage of total checks cleared in which the paper check
is not return to the paying bank. The Department of the Treasury is mandated to do
annual studies on depository institutions services efficiency and cost reduction. The
Comptroller General of the United States at the General Accounting Office (GAO)
is also mandated to study and evaluate the implementation and administration of
Check 21 Act and report the finding to Congress.
The Paper Check Clearing Processes
Figure 1 is a graphical representation of the existing paper check process. It
begins with a customer paying a store using a check; then the store deposits the
check in its bank, which may be different from the customer's bank. It is possible
that the customer and the store have accounts in the same bank, in which case the
check would be settled as an "on-us" item. In the processing of an on-us item, the
bank of first deposit would simply debit the customer's account and credit the store's
account in the amount of the check. It is estimated that 33% of the checks written in
the United States are on-us items.4 Assuming this check is not an on-us item, there
are a number of ways that banks may clear and settle checks among themselves by
the rules of interbank check settlement. The rules for interbank check settlement are
governed by articles 3 and 4 of the Uniform Commercial Code (U.C.C.) and by
Federal Reserve regulations J and CC.
After the store deposits the customer's check in its bank, the bank of first deposit can
return the check to the paying bank by mailing the check directly to the paying bank,
4
Joanna Stavins, "A Comparison of Social Costs and Benefits of Paper Check Presentment
and ECP with Truncation," New England Economic Review, July/Aug. 1997, p. 33.
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or by sending it through a third party intermediary (private clearinghouse,5 a
correspondent bank,6 or the Federal Reserve System). Whichever of these methods
the store's bank selects, in most cases, the check must be physically returned to the
paying bank before it pays the check. This means that checks must be physically
transported to the banks on which they were drawn before they are settled.
Consequently, the paper check clearing process is subject to transportation delays.
If the customer does not have sufficient funds in the account to cover the
payment to the store, the check is sorted out in the bank's backroom operations, and
is returned directly to the depository bank or to the intermediary that returns it to the
depository bank (Figure 1). Usually the depository bank returns the bounced check
to the store, while charging a fee for depositing a check with insufficient funds in the
account. The store then tries to collect from the customer. At the same time, the
paying bank charges the check writer a fee for having insufficient funds in the
account.
Figure 1. The Paper Check Clearing Process
Source: Federal Reserve of Boston.
5
A check clearinghouse is an association of banks to facilitate daily exchange of checks.
Checks drawn on one bank are offset against checks drawn on another.
6
Correspondent banks are banks having a direct connection or friendly relations with each
other.
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Which Bank Pays for Collecting the Funds. Under the Federal Reserve
rules, a large portion of the costs of the clearing process, those related to collecting
funds, falls on the depository bank -- the bank in which the check was first
deposited. The store's bank in the above example has to pay for any intermediary
check clearing charges and for transporting the check to the paying bank. The legal
requirement is that checks presented for payment must be paid at face value, even
though the depository bank incurs cost in collecting the funds. It should be noted that
the paying bank also incurs cost in paying the checks that are presented. However,
if banks have an equal amount of collection and payment, these costs on net could
tend to equalize among banks over time.
Paper Check Clearing Is Inefficient. Economists have argued that the
continued use of checks has made the society worse off, because it wastes resources
such as transporting checks by planes throughout the United States for collection.
A check in the process of collection creates inefficiency, because it pays no interest
(zero interest rate). As a result, the greater the difference between the market rate of
interest and the implicit interest rate of zero, the greater the income that can be
earned by using checks. This income is called the float. The float is income earned
by the check writer between the time a check is given as payment and the time it is
settled. The interest income earned from the float transfers income from the payee
to the payer. Even though the net benefit of the float between the payer and the payee
is zero (the payee's losses are the payer's gains), economists believe that the float is
costly to society. Check users employ real resources to exploit the float for
themselves. For example, the longer the plane takes to transport the check to the
paying bank the greater the income the payer earns from the float. Of course, from
the view of the check issuer, the float is not an inefficiency, but a benefit.
By one estimate (Wells), the cost to all parties involved in a check payment
could average about $1.60 (in 1993 dollars) more than the cost of a payment made
electronically.7 According to the Federal Reserve in 2001, government, households,
and businesses wrote about 42.5 billion checks.8 If the Wells estimate is correct, this
might indicate a saving of $68 billion if checks were replaced with electronic
payments. A different study (Stavins) estimated a net benefit of $1.4 billion from
electronic check clearing.9 It is generally accepted that there are potential savings to
be obtained by adopting electronic check clearing.
Electronic Check Presentation and Truncation
The electronic check clearing and settlement process is called electronic check
presentation (ECP). Check truncation is a subset of the broader term ECP.
Electronic check presentation is a check collection process whereby a check is
7
Kirsten E. Wells, "Are Checks Overused?" Federal Reserve Bank of Minneapolis
Quarterly Review, Fall 1996, p. 2.
8
S e e R e v i s e d R e t a i l P a yme n t s R e s e a r c h P r o j e c t a t w e b s i t e
[http://www.frbservices.org/Retail/pdf/RetailPaymentsResearchProject.pdf], last visited
Apr. 9, 2003.
9
Stavins, p. 37.
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cleared based on information contained in an electronic file or data, instead of the
actual paper check. At a minimum, the file contains the amount of the check and the
account number. The physical check may or may not follow the electronic file.
When the check is truncated, it is stopped before reaching the paying bank (the
check writer's bank, which is the bank holding the funds against which the check is
drawn). Thus, under ECP with truncation, the writer of the check does not get his/her
canceled check back. Instead, the transaction is indicated on the monthly statement
(Figure 2). A check returned for insufficient funds would be returned to the
depository bank electronically from the paying bank. The bank of first deposit
would be able to return the bounced paper check to its depositing customer, or
merchant, to support appropriate action against the paying customer.
Figure 2. Check Truncation at the Bank of First Deposit
Source: The Federal Reserve of Boston.
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Truncation by an Intermediary
If banks could not reach agreements among themselves on sharing the cost
savings of electronic check clearing, they could use an intermediary to do the check
truncations (Figure 3). The Federal Reserve currently truncates checks. In 2000, the
Fed truncated 20% of the checks it processed. The use of an intermediary reduces
the cost savings, since additional transportation, sorting and handling costs are
involved when compared to truncation at the bank of first deposit. For these services,
the intermediary charges fees that could be directly or indirectly passed through to
the banks and their customers. Under truncation by an intermediary, the backroom
operations of the first deposit bank would be basically unchanged, and the paying
bank's clearing and settling activities would be reduced, but not eliminated. The
Federal Reserve's suggested legislation would make it possible to use electronic
check clearing without agreements.
Figure 3. Check Truncation by an Intermediary
Source: Federal Reserve of Boston
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Table 1. Estimated Per Check Payment Costs and Benefits of
Check Truncation Over the Paper Check Process
In cents (¢) and percent of costs (%) benefits (%)
Costs
Depositing Customers Paying Customers
Loss of canceled checks and the float --
Cost is Unchanged -- 0.00¢(0%)
5.22¢ (78%)
First Depositing Bank Paying Bank
Infrastructure (hardware, software,
Additional operating costs -- 0.30¢
training, storage, research and additional
(3.5%)
operational costs) -- 0.87¢ (15%)
Intermediary
One time development, data processing and transmission costs 0.30¢ (3.5%)
Total Costs 6.69¢
Benefits
Depositing Customers Paying Customers
No loss of the float -- 1.60¢ (14%) No change in benefits -- 0.00¢ (0%)
First Depository Bank Paying Bank
Risk of fraud reduced, and lower Lower cost on: sorting, handling, postage,
transportation and operational costs -- return item processing, fraud
1.04¢ (9%) identification -- 7.12¢ (61%)
Intermediary
Fewer readers/sorter passes, no loss of the float on rejects or weather emergencies,
and cost saving on return items -- 1.90¢ (16%)
Total Benefits -- 11.66¢
Source: Figures taken from Stavins' Appendix B and percentages added.
Under ECP process, the estimated distribution of costs and benefits between the
banks and their customers seems to be the reverse of what it is under the paper check
process. Under the paper process for example, the paying customer gets the float and
the canceled check, while under ECP, the paying customer loses the float and does
not get the canceled check back. That makes it difficult for banks to adopt ECP
without an explicit agreement about how they will share the benefits. On net,
according to Stavins' study, represented in table 1, the paying bank's customers
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would suffer the greatest cost from moving to the ECP process with the loss of
canceled checks and the float. At the same time, the paying bank receives the
greatest benefit. That benefit would be large enough to compensate its customers for
their losses if it so chose and still leave it better off after adopting the check
truncation process.
For the depositing bank customers, their costs are unchanged and they benefit
from not losing the float. The depository bank's costs and benefits are estimated to
be closer to break-even, but the net benefit is also positive. The higher infrastructure,
storage, and operating costs are estimated to be slightly less than the benefit from
reduced risk of fraud, and return check handling.
Despite the net benefit of check truncation, only a small number of banks have
been using it. This could be explained by table 1. It estimates that total costs of
6.69¢ per transaction are exceeded by total benefits of 11.66¢. This clearly suggests
that there are net benefits of 4.97¢ per payment in using check truncation instead of
the paper check process. However, the distribution among participants in the check
truncation process is not as simple. The paying bank's customers incur 78% of the
costs and receive no benefit from changing from the paper check clearing process to
check truncation. On the other hand, the depository bank's customers gain more than
14% of the benefit. For the banks, the paying bank receives 61% of the benefits,
while the depository bank receives about 9% of the benefit. The intermediary benefits
from the check truncation at the first bank of deposit since the truncation process
would eliminate its handling of the paper checks. As a result, the intermediary
accounts for 16% of the benefits.
There may be a concern that, to the extent that check truncation shortens the
time for a check to clear, it may disadvantage those less wealthy individuals who live
paycheck to paycheck and count on the float in paying rent and other bills. While
such people would likely adjust to the new system, it may not be their preference.
To the extent that truncation reduces the availability of the float, fewer checks may
be written.
The Check Clearing for the 21st Century Act
(H.R. 1474, P.L. 108-100)
The main difference between H.R. 1474 and the Fed's Check Truncation Act
proposal is that H.R. 1474 has less consumer protection than the Fed's proposal. This
legislation would facilitate wider voluntary use of truncated checks, without
interfering with the check clearing process of institutions that do not currently have
truncation agreements. The Act would enable this by creating a new type of paper
document, a "substitute check," that would be the legal equivalent of the original
check. The substitute check would:
! contain an image of the front and back of the original check;
! conform to the industry standards for substitute checks;
! contain the magnetic-ink character recognition (MICR) line that
would permit the substitute check to be processed on check-sorting
equipment; and,
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! bear a legend that indicates that it is the legal equivalent of the
original check.
Using this substitute check, a bank would be able to truncate a check from a bank
with which it has no electronic exchange agreement by sending a substitute check
instead of the original check. As a result, check truncation would remain voluntary.
Banks that now use paper checks would be able to process either the substitute check
or the original checks without any modification in their check clearing process or
their back-office operations. The cost of check processing would be unchanged for
banks already using check truncation and banks that chose not to adopt check
truncation.
Much of the draft legislation spells out in detail the legal similarity between the
original check and the substitute check under the uniform commercial code. For
example, it would create a warranty structure to protect against losses associated with
the substitute check. The proposal would also create an indemnity structure to
address losses resulting from receiving a substitute check, rather than the original.
In addition, the draft legislation would provide an expedited recredit procedure.
Recredit is the act of giving credit to an account even though the documentation to
do so is being questioned. In short, the recrediting procedure allows customers'
accounts to be credited as soon as possible whether or not there are problems
associated with the receipt of the substitute checks instead of the original.
The expedited recrediting sections of the Fed's proposal and the Check Clearing
for the 21st Century Act are different. The Fed's proposal would give customers
involved in a transaction where a substitute check was used a one day right to a
recredit if they claim a check was improperly paid. That means that customer's
account could be recredited the amount of the improper payment by the close of the
next business day. In contrast, the Check Clearing for the 21st Century Act provides
for a recredit 10 days after a claim of an improper payment. Under both versions,
consumers using banks that have signed truncation agreements would not get this
recrediting right. Only customers of banking institutions that have not voluntarily
agreed to check truncation would have this right. Furthermore, under the Fed's
proposal, the time the consumer has to request a recredit of disputed funds was 60
days. Under the Check Clearing Act (P.L. 108-100), it would be 40 days.
Consumer Groups' Reaction to H.R. 1474
At both the Senate Banking Committee and the House Financial Services
Committee hearings on April 3, and 8, 2003, the strongest opposition to H.R. 1474
came from the Consumers Union. The views in its testimony were supported by the
Consumer Federation of America, the U.S. Public Interest Research Group, and the
National Consumer Law Center. The Consumers Union argued that the Act would
make it impossible for an estimated 45.8 million U.S. households who are currently
getting their paper checks back to continue to do so. It states that these consumers
would be less protected from fraud under the Act than under the existing check
clearing process when there are disputes about errors in the check payment process.
Specifically, the Consumers Union argue that there is a loophole in Section 6 of the
CTA that consumers could only see a recredit if they receive substitute checks from
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their bank. Banks could avoid giving consumers the recredit just by refusing to
return the substitute check to consumers.
At these hearings the Consumers Union made two recommendations to protect
the consumers under the proposed Check Truncation Act.
! Because all consumers are equally susceptible to harm from
processing errors, the recredit loophole in the proposed CTA should
be closed. The right of recredit should be expanded to apply in
every case where the original check is not returned to the consumer
and a check may have been improperly charged to the consumer's
account; and
! A comparative negligence standard is inappropriate to resolve harm
suffered by consumers due to processing errors. Banks should not
be able to use this standard to avoid liability, or to delay a
consumer's action for improperly paid checks that result from
processing errors. Therefore, as it relates to consumers, the language
relating to comparative negligence standard should be removed from
the CTA.10
At the hearing held in the 107th Congress on H.R. 5414, the Consumers Union
suggests changes in the proposed legislation that would significantly increase
consumer protection when checks are cleared electronically. These changes focus
mainly on the recrediting procedure.11 First, the Union would like to extend the
recredit provisions in the Act to all checks where the original checks are not returned
to the consumer and there is a claim of improper payment or a warranty claim. This
amendment would expand the indemnification coverage beyond the substitute checks
in the proposed H.R. 1474. It could extend coverage to more than 20% of all bank
checks that are currently not returned to customers and more than 80% of credit
unions' drafts that are also not returned to their members. Financial institutions are
expected to oppose this extension because it would significantly raise financial
institutions' cost of handling disputed checks and drafts.
Second, the Consumers Union argues that 10 days is too long for consumers to
not have access to the disputed funds due to the use of the substitute check. It
prefers the expedited recredit provisions in the Fed's proposal. That is by the close
of business the next day, the disputed amount of the payment (up to $2,500.00)
would be credited to the consumer's account. The purpose of the provision is to
reduce consumer inconvenience due to the use of the substitute check. However,
10
U.S. Congress, House Committee on Financial Services, Check Clearing for the 21th
Century Act of 2003, hearing, 108th Cong., 1st Sess. Apr. 8, 2003, unpublished, Statement
of Janell Mayo Duncan, Legislative and Regulatory Counsel, Consumers Union, also
Supported by Consumer Federation of America, U.S. Public Interest Research Group and
the National Consumer Law Center,
[http://financialservices.house.gov/hearings.asp?formmode=detail&hearing=204], last
visited Apr. 8, 20003
11
See [http://www.consumersunion.org/finance/checkwc102.htm], last visited Aug. 24,
2002.
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H.R. 1474 provides for a recredit after 10 business days, which the banking industry
argues is appropriate.
Third, Consumers Union would like to raise the expedited recredit amount from
$2,500 to $5,000. In H.R. 1474 and the Fed's proposal, checks for less than $2,500
would be recredited by the next business day, if the check is being disputed.
Consumers Union would like the expedited recredit limit raised to $5,000 because
the size of the amounts of these transactions is expected to increase over time. In
addition, the Union would like to shorten the number of days required to complete
the overall recrediting process to less than 20 days. Financial institutions, on the
other hand, prefer the longer time to clear up disputed checks in order to make sure
that corrections are made accurately. In short, the Consumers Union's changes
would protect consumers from the loss of the fraud protection provided by the right
to have the original check returned to them. This right is now protected by statute and
regulations. These suggested changes, however, could significantly raise the cost to
financial institutions to the point where it is no longer profitable to adopt check
truncation. In P.L. 108-100 the expedited recredit amount stayed at $2,500.
A counter to the Consumers Union's argument for protection against processing
errors is the fact that in cases where check truncations have been used for years
processing errors are practically nonexistent and when they occur they are quickly
resolved. Asked by Senate Banking Committee Chairman Richard Shelby (R-Ala.)
how many complaints she has received from credit union members about
electronically produced copies of checks, Alexander, President and Chief Executive
Office of the NIH Federal Credit Union, said that over a period of 14 years, she had
received none. In response to a question from Senator John Sununu (R-N.H.)
Ferguson, Vice Chairman of the Federal Reserve System, said that in his seven years
on the Fed board, he has never heard of a case in which checks were double-
debited.12
Possible Objections to Universal Check Truncation
Under the CTA, the adoption of check truncation or electronic check
presentation would still be primarily voluntary, even though it could significantly
reduce the cost of using checks. Many banks are not making agreements, because
while there might be substantial social benefits if most or all checks were truncated,
they and their customers may never be able to achieve sufficient benefits over the
present paper check system to justify expending the resources to adopt check
truncation. A major obstacle to universal adoption is the uneven distribution of costs
and benefits among the participants in the process. Many observers believe this
obstacle is unlikely to be overcome without a legally mandated cost distribution, as
is currently provided for in the paper check process. The proposed Check Truncation
Act would make legal any distribution agreement (or non-agreement) the banks
approve among themselves.
12
Richard Cowden, Consumer Groups Prefer Paper Checks, BNA Daily Report For
Executives No. 65. Friday April 4, 2003 Page A-15.
[http://pubs.bna.com/nwsstnd/ip/BNA/BAR.NSF/2002090b92a4a3bc85256743006da1ea
/2f92eebadf7bc66985256cff000fca1b?OpenDocument], last visited Apr. 9, 2003.
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