Time for a Clean Sweep?

By Clint Swift

From its opening lines, the Check Clearing for the 21st Century Act makes clear that Congress sought to encourage exchange of digital check images instead of paper for presentment. Now that Check 21 is in effect, the nation's banks and credit unions are getting down to the real business of the Act — re-engineering the nation's check processing system.

Bankers, consultants and technology suppliers see Check 21 as the catalyst for massive change, in which cavernous operations centers housing multi-million dollar, 60-foot-long reader-sorters will go dark; transportation of checks by plane and truck will trickle to an end; and consumers will go online to examine cancelled checks instead of looking for them in statements. In the short term, those huge operations centers will be replaced by smaller regional offices. In the long term, even regional sites may be largely supplanted by scanning at ATMs, muscular teller workstations and corporate customers' sites.

Dove Consulting, SVPCo and others have estimated that image exchange could help wring $2 billion a year out of check processing costs, but the catch is that all the paper must go. To realize the dream, the financial services industry will have to bring mid-tier and community banks on line, overcome hurdles involving fraud and customer culture shock and resolve debates over remote capture, check-image quality and the role of local and national image archives.

Remote Capture

Image exchange is at the core of Check 21's goals for U.S. check processing. But to extract maximum advantage from the new legislation, financial institutions will need to re-engineer check processing, not just automate it further. Given rapid developments in small-scanner capture technology, the biggest opportunity may lie in "remote capture," which refers to imaging that takes place outside the traditional back office. Most of the focus on remote capture currently is at the branch level — although enabled competitors are known to be aggressively wooing corporate customers with corporate capture.

"I envision a world of electronic capture at various points as close to the original check presentment point as possible," says Bob Hunt, senior analyst at Needham, Mass.-based TowerGroup Inc., emphasizing the potential of capture (and proof and encoding) at teller stations, ATMs and corporate customers' offices. "There's big money in it for banks that re-engineer their processes." Advantages include shortened collection cycles; elimination of many transportation costs; extended windows for preparing outgoing cash letters; earlier notification of potential fraud; and potentially fewer staff needed for sorting, balancing, bundling and delivering paper items.

Remote capture is the beginning of the end for large-scale, centralized check processing, according to John Lettko, chairman and CEO of Viewpointe Archive Services, LLC, Charlotte.

"As that happens, banks will have the opportunity at the point of presentment to do a lot more validation and authorization of that item so that you don't have any need for back-office processing," he says. "In fact, if you can capture and authorize a check in real time at the point of presentment, then it's not a long way to go to real-time clearing of that item."

J.P. Morgan Chase & Co. is putting the final touches on what is believed to be the largest installation of a teller capture system, while Washington Mutual Inc. is rolling out a system at branch back counters that reduces the necessity of integration with teller systems and eases concerns about slowing customers' progress through branch waiting lines (see Banking Strategies, May/June 2004).

However, outsourcer Fiserv Inc., Brookfield, Wis., has modeled branch capture for more than 100 of its 1,700 clients and found it cost-effective only about 10% of the time. Even with Check 21 and the ability to eliminate time-critical transportation cost, that's likely to rise to only 30%, says Ted Umhoefer, senior vice president, product management and industry relations.

Some business cases for branch capture don't work because of deposit-source issues, transportation costs, cutoff windows, dollar value of items or volume of items. Sometimes the problem is simply cost. Scanners and software can run $1,500 to $2,500 per teller PC.

Another factor is time. Scanners need to correctly read the information on each item, pushing the proof role onto the teller line. The risk is that a bank chooses the "wrong" equipment — technology that correctly scans only 80% of items, for instance. That could cause customer transaction times to soar as tellers correct amounts that were improperly read, says John Meyer, director of operations for the EZTeller unit of Harland Financial Services.

Now that Check 21 is strengthening the business case for imaging and exchange, bankers are re-examining capture at ATMs, where the industry has been imaging checks on a limited basis for more than a decade. Imaging at the ATM is a means of providing consumers evidence that a deposit was completed accurately and a way of reducing fraud. The next step is to pass the image to the bank's back office so the financial institution can process the transaction without waiting until the paper is pulled out of the ATM.

Diebold Inc. has more than 1,000 image-capable ATMs installed in the U.S., and where financial institutions have tested the technology, consumers have responded favorably, said Peg Bost, director of financial institutions marketing for Diebold in Canton, Ohio. The process boosts consumer confidence that the transaction has been completed accurately by displaying the check image on the screen and printing it on the receipt, according to Bost. To stimulate use, a bank might offer a later cutoff time and comparable availability for deposits whether they're made at the ATM or the teller window. Imaging at the ATM appeals for its potential to migrate more transaction volume to the self-service channel, enabling banks to better transform branches into sales centers.

At many banks, the re-engineering of check processing will be extended past the branch to corporate-customer work sites. But while corporate capture can save time and money, customers who gain the ability to capture their own check images will be fair game for predators that include distant banks and non-banks. One legacy of Check 21 is that geography no longer makes a local bank's deposit product superior. Large customers that bank in multi-ple regions will soon seek to consolidate accounts, reducing fees and management requirements.

Mary Hockridge, senior vice president, marketing, for NetDeposit, Salt Lake City, believes that corporate capture will evolve more quickly than the other remote-capture options and that it represents the biggest threat to banks that have not capitalized on the electronic payments evolution. "Certain sectors of the corporate market will take advantage of electronic payments earlier and will disintermediate their banks from the traditional deposit clearing relationship," she says.

For legal and technological reasons, banks are expected to give corporate-capture candidates the same level of scrutiny they apply when determining those customers' credit limits. Banks are accountable for the images they introduce into the payments system, so the prudent practice will be to amend deposit agreements to ensure that liability for poor-quality images is reflected back to the companies that create them. Unlike their links to branches, banks' connections to corporate customers will be a shared responsibility, so financial institutions are motivated to carefully review telecommunications bandwidth, security, privacy and fraud-detection issues.

Open Issues

While the path to a re-engineered check-payments system may seem clear — if long — in some places it is still a rocky, uphill climb. The issues include check image quality, fraud, customer acceptance and the role of the image archive (see "To Share or Not to Share," page 94).

The Financial Services Technology Consortium (FSTC), the Federal Reserve and various solutions providers have studied check-image quality issues, including whether images need to be grayscale or black and white to meet the requirements of high-speed check imaging and exchange. The effectiveness of electronic check processing requires images — including those on substitute checks — to be readable and to contain data in every key field such as the courtesy amount. The Act and the Federal Reserve's implementing rule require financial institutions to stand behind their images with their checkbooks, and a number of industry organizations are pursuing quality standards and assessment tools that can determine at extremely high speed whether an image is good.

But arriving at a standard is difficult. For example, image quality varies from device to device, says Mike Fenton, vice president of total recognition solutions for Parascript LLC, Boulder, Colo. Ordinarily, ranges are involved, and hardware and software manufacturers try to fit within the range so they can say they are within standard. The question, Fenton says, is: When a company is sending what the receiver judges to be poor-quality images, will the sender step up to the investment needed to improve the quality?

Previously, image or Internet statement customers have seen images of a consistent quality, Fenton says. Under Check 21, they'll see quality that's different from one check to another. "It will be very important for banks —really branches and call centers — on both the capturing and paying sides to know how to deal with that," he says.

NetDeposit's Hockridge says that many banks believe image-quality inspection must be performed on every item. That takes a lot of expensive computing power, and she believes that over the next couple of years, banks will back off that requirement as they gain experience with the process and with the quality of images supplied by their exchange partners.

Until the industry has more experience with check-image exchange, no one can say with confidence what the net impact of imaging will be on check fraud. Faster electronic clearing with images is expected to reduce the time it takes banks to determine whether a check represents good funds. But law enforcement officials have warned that the loss of fraud-deterring printing techniques and physical evidence such as fingerprints may make detection and investigations difficult and prosecutions less likely.

The industry will also need time to get a handle on new fraud schemes enabled by Check 21. "In two to five years, benefits will be limited due to batch posting and existing Day Two infrastructure," Hockridge says. "In five years and beyond, real-time posting, real-time exchange and settlement, and guaranteed settlement opportunities will become widespread."

New types of fraud detection will evolve as new types of fraud develop, but initially, according to EZTeller's Meyer, the greatest demand will be for Positive Pay systems. Positive Pay is used to compare presented checks to a file of issued checks.

Viewpointe's Lettko agrees that an industry move to a positive authorization system is needed. He expects migrating capture to the point of presentment to create an opportunity to mitigate fraud by using archive data and computer algorithms to improve the ability to verify that an account is active and a check is good.

"We think you can start out at a pretty basic level, looking at name, address, whether the account is open, whether we've seen the check before — velocity kinds of indicators that work so well in the credit business," he says.

Industry estimates vary on how long it will take images to dominate check processing, and one of the biggest unknowns is the culture variable.

"What we need is a critical mass of customers accessing check images through the Internet because it removes the pressure to put images on statements," says TowerGroup's Hunt. It may take years, but the efficient way of delivering images involves a centralized archive and Internet access, getting banks away from printing images, including in customer statements.

"Technology is one thing, but cultural issues are another," he says. "That's why it's going to take us a lot of time to work through this. It's not a problem of the technology but of how we use the technology and how we incent our customers to adopt the new technology."

Mr. Swift is a freelance writer and consultant based in San Antonio, Texas.

Copyright © 2004 by Banking Strategies, published by BAI.

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