COMMUNITY
BANKING SPECIAL REPORT
Paperless & Restless:
Smaller Institutions Need the Large
to Catch Up
BY CLINT SWIFT
Much
of the industry’s experience in
imaging checks resides with smaller institutions.
The business case is easier to make and
the technology can more than meet their
needs. In order to be able to exchange
images on a grand scale, however, these
image trailblazers need the large banks
to become equally image-enabled.
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SYNOPSIS | Many
small institutions have been imaging
checks for years, enjoying the savings,
efficiencies and new product opportunities
possible in a paperless environment.
Those that aren’t yet image-enabled
are expected to be coaxed along by
continued Fed consolidation and rising
paper processing prices. But small
organizations’ plans for image
exchange suffer from the sluggish pace
of large banks, whose own adoption
requires significant investment and
process re-engineering.
When the history is written
about how the paper check met its demise,
the community bank will not command an
insignificant role. As players in an industry
where the largest organizations set the
pace in most activities, small financial
institutions see a sweet irony in their
deployment of imaging technology and readiness
for check image exchange.
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Hundreds of community
and mid-tier regional banks have been successfully
running in an imaged environment for almost
a decade. Banks in the Midwest have been
exchanging images for over two years with
annual volumes in the millions. “We
are waiting for the bigger banks to get
on board,” wrote Cheryl Yavornitzki
in a BAI conference blog. Yavornitzki is
a vice president, retail delivery systems,
with Fidelity Bank, a $1.6 billion-asset
institution in Wichita, Kan.
From her previous experience
with a larger Wichita bank, Yavornitzki
understands the big bank hurdle. As an
operations officer at $8 billion Fourth
Financial Corp. in Wichita, she couldn’t
afford an in-house image archive. The
business case at smaller Fidelity, however,
is straightforward.
“When I looked
at it a dozen years ago, we couldn’t
afford to do it because we couldn’t
cut enough costs. Community banks don’t
have that issue,” says Yavornitzki. “Our
bank processes about 50,000 items a night.
For our bank, an image archive for seven
years’ worth of items costs about
$38,000.”
Fidelity’s story
is common. Many community banks and credit
unions started capturing images decades
ago to switch customers from returned paper
checks, achieve internal efficiencies or
offer customers image-based products and
higher service levels that could be achieved
only by eliminating paper processing.
They discovered that
the relatively small volumes of checks
they processed permitted them to implement
the technology in-house at an acceptable
cost, often by buying modular, full-featured
software packages, or move to image via
facilities management or full outsourcing.
“Small banks are
really excited about the fact that, for
a single reason such as getting imaged
statements or saving some internal processing
costs, they made a business decision that
they now can leverage without significant
additional cost to begin exchanging images,” says
J.R. Abbott, senior director, client relationships,
for Profit Technologies Corp., a global
performance-improvement firm based in Davidson,
N.C.
Today, as news reports
mark the sluggish march of the nation’s
largest banks toward all-electronic processing
and check image exchange, many in the industry
regard the small banks and credit unions
that make up 90% of the nation’s
financial institutions as the real leaders
in the migration from paper to digital
clearing and settlement.
Small
Can Be an Advantage
The majority of community
banks, according to the Independent Community
Bankers of America (ICBA), are now using
check image technology. As of August 2004,
65% of community banks were using check
image technology internally and 29% more
were planning to evaluate the technology
within the next 12 to 18 months, according
to ICBA data. Nine percent reported that
they were using an image exchange network
and 66% were planning to evaluate one.
“Community banks
don’t have the internal barriers
to overcome or the system interoperability
issues that the larger financial institutions
have,” says Viveca Ware, director,
payments policy, at the ICBA. “While
community banks don’t have dollars
to burn, they don’t bear as much
of the technology risks as some of the
larger financial institutions that have
very customized systems.”
Mark Craig, former general
manager of CheckClear, LLC, Oklahoma City
(a unit of Marshall & Ilsley Bank,
which owns and operates Endpoint Exchange),
says community financial institutions were
probably the first market group to realize
that the paper-processing system was “busted” and
that they were absorbing the brunt of the
damage.
“They didn’t
have the economies of scale to take advantage
of the price per item in moving a giant
volume of cash letters,” says Craig,
who left CheckClear in May. “It didn’t
take them long to ask: ‘If we’re
creating these images, why are we still
mailing and transporting the paper?’ They
began implementing technologies to process
electronically.”
One result was Endpoint
itself, whose members number about 3,400
community banks and credit unions. It has
been in operation since 2002.
Profit Technologies’ Abbott
says a community bank can implement an
electronic cash letter at very low cost
and in very little time — especially
with the help of upstream correspondents.
He says Charlotte-based Bank of America
Corp.; Wachovia Corp., also based in Charlotte;
Compass Bancshares, Birmingham, Ala.; SunTrust
Banks, Inc., Atlanta; and Zions Bancorp,
Salt Lake City; already are playing seriously
in the correspondent market. He says many
community banks would be forced to deal
with correspondents to process substitute
checks, which in most cases will be beyond
their in-house capability.
“A small bank’s
entry into image exchange typically is
nothing more than a per-item fee that might
compare very favorably with the fee that
the Federal Reserve charges,” he
says. Further, large correspondents that
have to bear huge costs of imaging technology
are looking at item processing for community
banks as revenue sources that could help
them recoup some of their investment.
Community banks ready
to take the plunge into imaging have choices,
says Robert Hunt, a senior analyst at Needham,
Mass.-based TowerGroup Inc. They can keep
check processing in house, upgrade and
pick from a wide variety of suppliers.
Or they can go to a Fiserv, Inc.; Metavante;
Unisys Corp.; Fidelity Information Services or another third party and hire expertise
in image processing.
“And I think that’s
the key,” Hunt says. “It’s
hard for the community banks to develop
the expertise and retain it. On the other
hand, it’s easier for a community
bank to make the move (outsource) or upgrade
if they want to stay in house.”
During the four years
that ICBA has surveyed its members on processing
issues, the proportion of banks that has
outsourced check processing has remained
roughly the same — one in three.
Big
Brings its Own Challenges
Big banks image enable
internal processes more slowly than small
banks because the obstacles are different. “One
of the biggest problems for the larger
institutions is that their paper streams
touch so many other operations in the bank,” says
Fred Herr, senior vice president, retail
payments office, Federal Reserve Bank of
Atlanta. “In a smaller institution,
many times all your software is written
and maintained by one vendor, so when they
come in and make a change, it’s somewhat
easier to integrate.”
Hunt agrees that big
banks are moving to image exchange more
slowly than anticipated because some are
re-engineering statement rendering and
other processes, and that represents a
lot of work for institutions built on siloed
software from dozens of providers and legacy
hardware platforms from a dozen more. For
other big banks, the problem is corporate
positive-pay customers that fear image
processing will bypass fraud safeguards
or commercial clients that want to negotiate
issues such as how to split float gains.
Big banks have to call on those customers
and gain their agreement when instituting
change, and it adds to the difficulty.
Bill Saffici, vice president,
payments, Broofield, Wisc.-based Fiserv,
says the problem is not simply image-enablement
of an application such as Day 2, but the
integration of it with account-processing
systems. “It’s the combination
of legacy systems, huge check volumes,
multiple routing numbers, the sheer number
of projects they’re working on at
once, often because of acquisitions that
are still being integrated,” he says.
The time it takes a
big bank to integrate check-imaging systems
with upstream processes such as Day 2 and
accounting is one reason those banks have
focused on sending images, rather than
receiving them. When they begin receiving
large volumes of check images, they want
to be able to process them internally as
electronic items. Craig says there are
3,400 Endpoint Exchange clients ready not
only to send check images but to receive
them, meaning they have integrated electronic
item processing with upstream processes
such as returns, adjustments and posting.
Experience
Counts
In February, First Bank
Richmond (Indiana), $565 million in assets,
demonstrated the nimbleness of a community
bank when it became one of the first banks
to transmit check images electronically
to the Federal Reserve. The bank used software
from Financialware, Inc., Carmel, Ind.,
to create the image cash letter, speeding
the clearing process and cutting courier
costs.
Financialware CEO Charley
Myers says the hesitancy some community
banks have about check image exchange results
from conflicting claims and misinformation
about everything from liability to complexity. “Candidly,
there’s nothing to be afraid of.
If you’ve got a way to capture the
paper and you’ve been doing this
for any amount of time, then it’s
really about creating a properly formed
file to send off to trading partners.”
Larry Turner, chief
information officer of First Bank Richmond,
says bank size plays little role in readiness
for image exchange. Rather, it’s
experience that matters. “If the
bank didn’t foresee this five or
six years ago, it would be very difficult
for it to be ready at this point,” he
says.
Turner says First Bank
began waging war on paper in 1997, when
it implemented document imaging to solve
a paper storage problem. Then it bought
an NCR 7780 capture transport and began
check imaging, storing the images so staff
could retrieve them on a computer screen
to assist customers. At about the same
time, the bank went to image statements.
Later, it implemented online reports for
bank staff.
In addition to the cost
savings from check imaging, First Bank
Richmond seeks to use the technology to
shift away from safeguarding customers’ physical
dollars to protecting their data. Turner
says the bank is exploring the business
case for imaging and storing important
documents for commercial and retail customers
such as a manufacturer’s contract
or a consumer’s birth certificate
and will.
Exchanging
Images
Today, one of the main
drivers of check image enablement among
banks of any size is image exchange. One
widely accepted estimate is that the industry
could wring more than $2 billion out of
check-processing costs if banks could clear
and settle using electronic data rather
than ship paper checks across the continent.
But getting rid of the
paper means getting it out of big and small
banks. Robert Merkle, marketing manager,
Conix Systems, Manchester Center, Vt.,
estimates that small banks control half
or more of the nation’s checking
accounts, and he observes that those banks
determine whether they will employ images
or paper (in the form of substitute checks)
to clear. As long as banks are clearing
with substitute checks, they still face
the costs of transporting paper.
Endpoint processes about
six million image items per month. But
big banks are coming on line relatively
slowly, well behind initial estimates of
how long it would take them to ramp up
volume. For example, the 21 large-bank
owners and members of SVPCO, the national
check processing business of the Clearing
House Payments Co., New York, represent
about 60% of commercial bank deposits.
But SVPCO image check exchange volume today
is only a trickle — about 2.5 million
items a month — compared to its potential.
That presents a problem
for community banks and credit unions that
are ready to exchange images. Endpoint
has stated that it wishes to increase exchange
volume to 100 million items a month by
December 2005, but TowerGroup’s Hunt
says that more big banks will have to be
able to receive many more images if Endpoint
Exchange is to meet its goal. Exchanging
among themselves, the small banks simply
don’t represent the volume required,
he says.
Drivers
Behind Image Exchange
Each bank — including
the biggest ones — needs to evaluate
check imaging with an eye to local conditions.
Conix’s Merkle says he had a conversation
with a customer about a clearing house
in the Chesapeake Bay area whose prices
are so low that even a bank that processes
a million items a day in paper might not
find a good business case for moving to
image.
“There’s
no real advantage, from a float perspective,
over their local clearing house,” he
says. “When you’re a local
bank, 95% to 98% of your checks may be
local.”
Crunch
Coming?
TowerGroup’s Hunt
agrees that a visible segment of community
banks is still evaluating. But he says
cost will soon force most of those to get
on board and, in the meantime, they don’t
represent enough volume to slow the national
migration to image exchange.
“The cost of processing
paper has a fixed element — the trucks
and planes of the transportation network — and
the per-item cost of processing paper is
going to rise,” Hunt says. “But
I don’t see the small banks as holding
back the big volume.”
Craig believes crunch
time could arrive as early as the third
quarter of 2005, when he foresees community
banks feeling real pressure on courier
and transportation costs, which will boost
the business case for image check processing.
ICBA’s Ware doesn’t
believe community banks are experiencing
a cost increase yet. “I think that’s
due to some artificial elements in the
market right now, such as the overcapacity
that many of the correspondent banks have,” she
says. “They’re not inclined
to increase their pricing right now because
they want to keep the business and some
revenue is better than no revenue.”
Similarly, she is not
certain that rising courier costs have
trickled down sufficiently to create big
pressure on community banks. Developments
such as big banks pulling check volume
off air transit routes are not going to
be readily apparent to a lot of community
banks immediately because their checks
probably aren’t riding on those planes
today.
Greg Schratwieser, CEO
of International Consulting, Inc. (ICI),
Arlington, Va., worries that unit-cost
pressures have the potential to create
expensive surprises for community banks
that take a wait-and-see approach to check
imaging. He cites the example of a West
Coast client whose transportation costs
skyrocketed over three months after a pair
of huge banks pulled hundreds of pounds
of checks off a west-to-east Airnet jet
courier route.
“They just don’t
realize that it’s going to happen
in big chunks,” Schratwieser says.
He says the danger is
that by the time the bank discovers that
its check transportation costs have soared
out of control, it may be facing a process
that involves three to six months for education,
evaluation, procurement, etc., and another
six to 12 months for implementation. A
related risk is that by that time, the
bank’s best potential partners among
solution providers will have a long waiting
list of banks in the same trap, says Schratwieser.
Endpoint’s Craig
says he already sees a difference in the
receptiveness of community banks he talks
to about electronic exchange. “As
far as the aversion to even wanting to
listen to a proposal, that has disappeared,” he
says. “If we get a real increase
in transportation costs during the third
quarter, one-third of those financial institutions
without an image strategy will have business
cases completed and will be waiting to
pull the trigger.”
That first wave will
be able to be in some phase of electronic
check trading by the end of the year, Craig
says. The rest — the last to adopt — will
have to wait until 2006.“It’s
going to cost them quite a bit of money
to push paper for that period,” he
says.
Meanwhile, Wichita’s
Fidelity appears to be determined to be
in step when the rush to image exchange
finally materializes. It is testing forward
image transmission with Endpoint Exchange.
It’s getting ready to test with the
Fed. And it just met with suppliers to
review options for introducing check capture
at the teller windows.
Questions
or comments about this article? Post
them at the Banking
Strategies blog.
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