Investing in Imaging
By Chris Costanzo
While most large banks, at least, are ready to implement Check 21, additional investments are needed to reap all the benefits of electronic payments.
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From a technology spending point of view, Check 21 is mostly a non-event for the nation's banks — as long as the discussion is confined to implementing the law itself.
Interpreted more broadly, however, the Check Clearing for the 21st Century Act could spark a profound shift in the nation's payment system from paper- to electronic-based transactions, entailing substantial technology investments by financial institutions.
But first things first. When Check 21 goes into effect on Oct. 28, it will only require that financial institutions be able to accept so-called "image replacement documents," or IRDs, as "substitute" checks and notify customers of their existence. Strictly speaking, this does not translate into a tech spending boom.
Most notably for small institutions, for example, there is no requirement to adopt electronic imaging technology, although deposit intermediaries must be able to process paper IRDs created by other institutions. Most of the larger banks, meanwhile, have been preparing for imaging for several years and have already installed multi-million dollar image capture systems. "The investment's been made, so our budget is actually going down," says Thomas Rea, an executive vice president and manager of transaction processing services at Minneapolis-based U.S. Bancorp.
These near-term factors are reflected in a yearend 2003 survey by ESP Consulting Inc. in Salisbury, Md., which found that only 16% of banks, large and small, expect to spend more on check processing this year than they did in 2003. Thirty-five percent said spending will remain unchanged, and 12% actually predicted a lower amount. Thirty-six percent were unsure.
That's not to say banks won't have to keep their checkbooks handy, as there are still some important Check 21-related investment decisions looming. While Check 21 itself doesn't require significant investment, the implications of the law get to the heart of what the future payments environment will look like and the role individual institutions will play within that environment.
There is, for example, the effort by some banks to electronify their "Day Two operations," which refers to the corrections, overdrafts and other exception items needed when checks don't pass through reader-sorters on the first go-around. Making these second-day operations image-capable is not mandated by Check 21, but it would help institutions move more quickly to displace paper from the processing system. Likewise, installing imaging equipment in the branches has nothing to do with the legislation President Bush signed last October, but it does promise to improve service and cut costs in the long run by eliminating some back-office functions.
Viewed from that perspective, these post-Check 21 decisions may fit more into the "required" category. Anything that reduces the amount of paper in the system will help financial institutions realize more of the long-term benefits of electronification, estimated at about $2.1 billion in annual savings industry-wide.
The catch is that no bank by itself, no matter how image-capable, can benefit fully from that process unless most of the industry goes along, or at least links up with outsourcers who make those investments, as many community banks are now doing. "You hate to spend a lot of money on infrastructure and wait two to three years while everyone catches up," says Mitchell A. Christensen, executive vice president for payment strategies at Wells Fargo & Co. "Yet, at the same time, it pays to move forward."
Investment Paths
With Check 21 imposing a clear-cut deadline, most institutions are looking to achieve a basic level of image-readiness by the time the law goes into effect. Fifty-three percent of the nearly 500 banks surveyed by ESP Consulting said they expect to participate in image exchange by 2004. The study also noted, "The larger the bank, the more likely it has moved into active preparation."
ESP president Leon Majors describes the industry's push into imaging as "a cascading investment." The first round — some of which began as long as 10 years ago — came when banks decided to image-enable check capture sites and develop facilities to store the images. The next wave will occur when banks begin installing equipment to capture check images at outlying locations, such as branches and automated teller machines.
Between these two waves — and the current focus for many large banks — is the preparation for image exchange and the image-enabling of Day Two activities. These two initiatives "absolutely go hand-in-hand," says Steven Ledford, president of Global Concepts Inc. in Atlanta. "You can't do image exchange if you don't have image-based exception and return item processing. That's where most hard-dollar investment is going right now."
J.P. Morgan Chase & Co. exemplifies this trend, having installed the cameras and equipment required to capture images back in 1997 and 1998. Over the next few years, the New York-based bank concentrated on filling its archive with images and enabling access to them from different parts of the bank, such as the branches and call centers.
Next on the to-do list for Morgan Chase is reengineering its second-day operations so these adjustments and exceptions can be executed with images rather than paper. "We need an image-based workflow in the back office," says Tom McGuire, a senior vice president and the enterprise operations services executive. "That is where the vast majority of institutions see the pressure to invest."
Detroit-based Comerica Inc., for example, began investing in imaging about 10 years ago, ahead of Morgan Chase. Yet, it is basically at the same juncture now: upgrading the Day Two process. "We've never fully image-enabled it," says Paul Obermeyer, a senior vice president and the manager of operation services. "That's where we're focusing a tremendous amount of energy."
A contrasting example comes from U.S. Bancorp, which image-enabled its Day Two operations before installing image-capture equipment in the larger processing operation. "We did it backwards," Rea acknowledges, although there were some unique circumstances.
Following its announced merger with Firstar Corp. in October 2000, integrating dual check-processing systems became a high priority at U.S. Bancorp. Simultaneously tackling a massive imaging project would have posed "too big a risk," Rea says, so the bank adopted imaging only for the less critical Day Two operations.
But the fact that U.S. Bancorp met all its business case targets for the second-day processing is an encouraging sign for the rest of the industry. And along the way, Rea says, the bank was able to reduce the number of back-office processing sites, generating cost savings and efficiency gains.
Imaging Lite
Wells Fargo, another relative latecomer to check imaging, is forging its own path to electronification, a kind of "imaging lite." In an effort to spend as little money as possible on equipment for capturing images, the San Francisco-based bank plans to buy check images as it needs them from other banks that have already captured them. "There's no precedent for this," Christensen says.
Wells Fargo will still need to scan images of the checks it collects in its branches. But it plans to purchase images of its "in-clearings" — the on-us items it receives from other institutions — from organizations that handle many check images, such as the Federal Reserve Bank and Charlotte, N.C.-based Viewpointe Archive Services LLC. "It's almost like outsourcing some of our image capture," Christensen says. "The nice thing about images is that once someone captures them, they're very transportable. What's the point of us capturing them again?"
To some extent, Wells Fargo has created a hedge against the possibility that image exchange fails to take off industry-wide. In that event, Christensen says, the bank would simply "unglue" its agreements to purchase images, without having spent a lot of money on its own equipment.
In fact, Majors at ESP warns against assuming the entire industry will be fully image-enabled in the near future. Throngs of banks are simply waiting to see how image exchange pans out for the early adopters, he says. "They're waiting for the furor to subside, to see how it really works, so they can make intelligent decisions on what to do."
This is reflected in the responses of 225 financial institution executives to a recent BAI online survey. When asked to describe their company's Check 21 readiness, 40% of the respondents said they were still evaluating their options; another 17% were "in the process of just learning about Check 21." Only a fourth said they were actually implementing a strategy.
Majors suspects it could take as long as 10 years for full-image capability to reach most banks. The big banks, of course, are aiming to take full advantage of the law by Oct. 28. But the progress of the industry depends on what happens in the subsequent 18 months, he says. "If the benefits are proven, then it's a must-have and everyone will sign up. If not, the process will drag on."
The economics are compelling. Facing huge volume declines in paper checks, industry experts believe banks must find ways to save $2 billion by 2007, just to keep their current per-check processing costs from rising.
According to an analysis from Viewpointe, banks that do no imaging and are forced to use IRDs could see their unit processing costs rise to as high as between seven cents and 11 cents, compared with the current range of between six cents and eight cents for processing paper checks only. By contrast, full image processing for both Day One and Day Two would reduce per-unit costs to less than four cents.
And those benefits increase as more banks participate. A typical bank that image-enables its second-day processes could save between $1 million to $2 million annually, Viewpointe estimates. When that bank shares images within Viewpointe, those savings could triple to between $3 million to $6 million a year. And when a Viewpointe bank begins exchanging images with just five organizations outside the consortium, total annual cost savings could reach $17 million to $24 million per bank, the company says.
Business Case Challenge
Having pretty much nailed down the basics of image capture, and with pilot projects on image exchange in the works, the nation's large banks are looking past the Oct. 28 deadline to issues such as image quality and the potential for installing image equipment in branches and ATMs.
In today's mostly-paper processing environment, each bank that handles a paper check captures an image and stores it. If there's a problem with the quality of an image, a bank can call a number of other institutions to see their copy. With image exchange, there are fewer such fallbacks; the image may be captured only once, by the truncating bank. For the other banks in the processing chain, "you're going to be putting an image on your statement, going to your customer, that someone else captured," says Hank Farrar, the president of New York-based Small Value Payments Co., a bank-owned provider of payments services.
Attached to that issue are questions of liability. In today's world, a bank is liable for a check until it is delivered to the next bank. Who's responsible for the electronic image at each stage in the electronic clearing process?
To help avoid disputes, bankers are looking at image-quality software that helps guarantee that their institutions send each other high-quality images. They're also investing in research to help them determine acceptable levels of quality. For example, SVPCo has just wrapped up a joint study with the Federal Reserve and the Financial Services Technology Consortium to examine the difference in quality between images that are black and white, and those that are in shades of gray, according to Farrar.
The question of whether to equip branches with the ability to capture images, as opposed to handling that function in central locations, also has attracted a lot of interest. For one thing, banks could save on transportation costs by reducing the number of courier runs they make to their branches. Instead of picking up checks several times a day, for example, they could send images throughout the day. Branch personnel also would have access to the images for customer service purposes and be able to act more quickly to thwart potential fraud.
According ESP's late 2003 study, fewer than one-sixth of banks are currently able to scan images in their branches, and these are mostly the largest ones. But one-third of banks say they plan to begin branch image capture within two years.
While many banks are intrigued by the possibility of creating an electronic stream of checks as early in the process as possible, there are many unknowns, the biggest of which is whether it would pay off. The cost of installing image-capture equipment at each teller station, or even at each branch back office, is not insignificant. Plus, there are the telecommunications costs of transmitting all those images around.
Whether fewer courier runs and greater access to images would really make up the difference is a question that has not yet been answered. "The business case around that is a challenge for all banks," says Rea of U.S. Bancorp.
Ms. Costanzo is a freelance writer in Brooklyn, N.Y.