What's Check 21?

Introduction to Money

While electronic forms of payment, for example EDI (electronic Data Interchange), ACH (Automated Clearing House), debit and credit card transactions have gained considerable popularity in the United States, good old-fashioned paper checks are far from extinct. In fact, according to a report by the Federal Reserve, more than 30 billion paper checks  were written in the United States in 2007.

Now, one might argue that a dollar is a dollar whether it is received via check or electronic transmission. However, consider the following:

- Paper checks require more labor to process and therefore are more costly than electronic forms of payment. According to Federal Reserve, processing a paper check costs an average of 4.5 cents, while processing an electronic payment costs only 1.3 cents per item.

- A paper check must pass through multiple touch points (that is, lockbox, banks) to be cleared, it can often take several days for funds to actually be available for spending. With electronic transfers, funds are generally available within the same business day and often instantaneously.

Now, back to that dollar example, wouldn't you rather have 98.7 cents today than 95.5 cents three days from now? Consider a scenario  of the old system:

I make payment to a store with a personal check. The Check data - MICR (Magnetic Ink Character Recognition) - is captured for internal accounting purposes. The check still has to be physically sent to the bank for clearing. On the average, it takes the bank three to four days from the date of receipt to clear the check and make funds available to the store.

The biggest benefit of the electronic transmission is the check truncation capabilities.  The store can electronically transmit their checks, collected from its customers, to the bank at the end of each business day, rather than physically transporting them there. This significantly speeds up the check clearing process, the same day on the average.

The net effect is that electronic transmission improves the store cash flow dramatically. Faster money is better money.

Check Truncation - According to the Merriam-Webster dictionary, the word truncate means to shorten or cutting off. In the banking and finance industry, check truncation is the terminology used to describe the physical removal of paper checks from payment and deposit processes.

If you are old enough to remember the days of receiving a monthly bank statement with an envelop full of cancelled checks, then you easily understand the impact of truncation. Now, instead, that bank statement comes with a few pages of check images. Some banks have even stopped sending check images, opting to provide a secure, online site to post the images for review.

In essence the idea of check truncation is to stop the paper check from having to go through the entire financial system. Without check truncation, the paper check will move all the way from the account of the depositor, back to the monthly statement of the check writer.

Ultimately, that check will travel through the Federal Reserve System, involving transport by truck, plane, and rail. According to Federal Reserve calculations, approximately 126 million pounds of paper checks were transported across the United States in 2003, showing that transport costs alone could be staggering.

Along with that, the Federal Reserve System estimated that a check processed for payment without truncation can be handled as many as 12 times before that payment is finally accomplished, and labor costs become considerable as well.

Check 21 captures the value of check truncation - On Oct. 28, 2004, the Check Clearing for the 21st Century Act - better known as check 21 - went into effect. Check 21 legislation enabled banks, credit unions, and other financial institutions to leverage truncation in order to process more checks electronically. Thus, this process enables banks to reduce not only the cost of transporting tons of checks each year, but also the associated labor costs of physically handling paper checks.