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More Clearing Choices for Local Banks
BY KAREN EPPER HOFFMAN
Regional clearing networks provide community banks an alternative to the Fed and big-bank image exchanges.
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SYNOPSIS | Working through area bankers? banks, small institutions are forming their own regional check image-clearing networks, which offer a more efficient and less expensive way to clear local items. Industry experts say the emergence of these regional networks will boost image exchange, but could take business away from the Fed.
As the move to electronify paper checks finally hits its stride, small banks are discovering a new way to exchange their imaged items with other banks in their local areas—by creating regional clearing networks.
These networks have been springing up over the past year in the Midwest and the Northeast. Known colloquially as ‘On we networks,’ a term that has been trademarked by LendingTools.com, one of the first vendors to spearhead the concept, they’re typically set up by a regional bankers’ bank. Community banks can use the bankers’ bank to clear their imaged items directly without having to go through a Federal Reserve site or an image exchange operated by the large banks, such as New York City-based SVPCO, part of the Clearing House Payments Company LLC, Viewpointe, also of New York, and Endpoint Exchange LLC of Oklahoma City, Okla.
For community banks, these networks offer the promise of a more efficient and cost-effective way to trade imaged items, particularly with neighboring banks. Experts say local items can represent as much as 80% of the check volume for a community bank. “We recognized that community banks needed to find a way to get their checks cleared locally rather than sending them all around the country,” says Lisa Valentine, vice president of payment systems for the Wichita-based Bankers’ Bank of Kansas, one of the first bankers’ banks to establish its own regional network.
The convenience of a regional network is even more compelling three years after the passage of the Check 21 legislation, which spurred the recent growth in check imaging. Small and mid-size banks particularly are struggling with the delicate and increasingly costly balancing act of managing both paper-based and imaged transactions. Regional clearing could give their image efforts a much-needed boost by reducing their costs on those local items and encouraging local partners to adopt image, experts say.
“A large bank can afford to operate with direct sends and can build all those direct links themselves,” says Robert Hunt, research director for the retail banking practice at TowerGroup Inc. of Needham, Mass. “It’s those smaller community banks that need to rely on someone else.”
For the bankers’ banks, or correspondent banks that act as “community hosts” for these image networks, the benefit is incremental revenue and closer ties to their community bank customers. For larger banks, such as Charlotte-based Bank of America Corp., these networks constitute a welcome centralization of clearing options (see “A ‘Photo Negative’ of the Big Bank Exchanges”).
Perhaps the only potential loser in this win-win situation could be the Federal Reserve, experts say (see “A Place for the Fed?”). The Fed will arguably lose a substantial piece of its own check processing volume, which has continued to dwindle as big banks have been pumping more of their items through their own exchanges.
To be sure, it’s early days yet for regional networks. The market will determine whether the concept works out as intended. But most experts say this development does have the potential to help move the entire industry that much faster along the path to fully imaged exchange.
Think Globally, Clear Locally
The premise of regional clearing networks is simple and not completely dissimilar to the more formalized image exchange network concept spearheaded by the big banks. Regional bankers’ banks or correspondent banks act as the clearing and settlement centers for the small banks in their region. They typically offer an automatic exchange of items cleared between partners in the network. Even return items and adjustments can often be processed and settled electronically. Pricing for the presenting bank is said to be as little as half the cost of going through another channel, such as a national big-bank exchange or the Federal Reserve.
“This is particularly good for the small banks, $1 billion and under in assets, and may even make sense for some larger banks,” Hunt says. “For those that don’t want to make a major investment, this gives them another price-competitive alternative to outsourcers or the Fed.”
These arrangements promise to substantially reduce costs for the participating banks that want to send and receive imaged items because so many of these community banks are largely exchanging with similarly sized banks in the area. Why should a small town bank in the Midwest send an image file to a national exchange or a far-flung regional Fed office, the reasoning goes, if the check is written against an account at a bank down the street? In addition to facilitating exchange with neighboring banks, these regional networks are striking up relationships with big bank processors and national image exchange services using their combined volume to elicit better pricing.
The concept has proved compelling enough over the past year to win over several of the country’s more than 20 bankers’ banks and other correspondent banks, most of which are still in the process of asking their respondent banks to join their respective networks. These include the Bankers Bank of Oklahoma City, Okla.; Minneapolis-based United Bankers’ Bank; Bankers’ Bank of Kansas; Arkansas Bankers’ Bank of Little Rock; Bankers’ Bank Northeast, Glastonbury, Conn.; and Quad City Bank & Trust of Moline, Ill.
The correspondent banks that act as hosts receive some incremental revenue for running these exchange networks, although neither the correspondent banks nor the vendors will say exactly how much. But the bankers’ banks say operating the network also creates closer ties with the community bank customers to whom they provide other services, such as international and domestic wire transfers, cash optimization and cash letters.
Many of the bankers’ banks were established within the last couple of decades. Bankers’ Bank of Kansas, for example, celebrates its 20th anniversary this year while Bankers’ Bank of the Northeast has been around for 10 years. Yet, most of these bankers’ banks have deep saturation in the community bank market in their own regions. For example, United Bankers’ Bank provides services to more than 700 banks and has relationships with 90% of the community banks in Arkansas, according to Eric Goering, president of Wichita, Kansas-based LendingTools.com.
“Each correspondent bank has markets where they’re strong and where they can be successful,” Goering says.
Valentine says that Bankers’ Bank of Kansas was already handling cash letter services for 180 banks in its region, most ranging in asset size from $10 million to $200 million, and was one of the first to set up an OnWe Network with LendingTools.com. The Kansas bankers’ bank has more than 20 banks on its network, clearing more than three million items a month, with another 80 banks in the implementation stage. Valentine says she expects 120 banks to be fully implemented on the network this year.
Cheryl Yavornitzki, electronic payments relationship manager for LendingTools.com, asserts that community banks using a regional network can reduce their expense for clearing an item by about half the typical price of 3.3 cents. “We can leverage the fact that the two clearing partners are in the same town,” Yavornitzki says.
These economics particularly attract community banks in the Midwest, which are more likely to be exchanging checks with other small banks in their area, as opposed to larger super-regional or national banks that are more heavily concentrated on the coasts. Stewart Peretz, executive vice president of Norcross, Ga.-based Avalon International, another regional network vendor, says that 80% of the checks received in Oklahoma banks are also drawn on Oklahoma banks. “That means that they can control 80% of their clearing costs,” he says. “This is about owning your own destiny.”
Early Days
Even as regional clearing proponents tout how these networks could help revolutionize check clearing, the reality remains that these networks are still in a very nascent stage. Pete Sposito, president and CEO of Bankers’ Bank Northeast, says that one hurdle these networks face in the short term is that there are still too many small banks that don’t yet accept image.
TowerGroup’s Hunt says he thinks that check imaging is beginning to hit “critical mass” and that these regional networks should help pull many of the laggards along. Still, even when the banking industry becomes fully imaged-enabled by about 2010, he predicts that regional clearing exchanges will account for, at most, 15% of U.S. check volume.
And growth has its own problems. Valentine of Bankers’ Bank of Kansas says that the relationships, pricing and connectivity may become more difficult “as we start weaving different networks together.” To help facilitate smoother working arrangements, Goering says Len-dingTools.com has created its own “OnWe Guidance Council.” The council is made up largely of bankers who participate in the regional clearing networks as hosts or participants supported by LendingTools.com. It sets rules for the exchange of items (the networks already generally operate by ECCHO rules) and business process agreements to determine how returns and adjustments should work, according to Goering.
John Feldman, senior vice president for image and electronic payment services at Bank of America, says “anything that drives check electronification is a good thing for the industry. All this living in a dual-processing system—with both paper and image—and having a foot in each camp is difficult. Anything that moves us faster to image is a good thing.”
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