The biggest change of the banking law in years becomes effective in October 28,2004. This "enhancement" is called Check
21! You will probably have higher checking account services fees if you are a customer of the Federal Reserve System. Upgrading
is mandatory and automatic for all personal and business checking customers. Sir Alan is now learning from Microsoft. Let’s
cut to the chase, and see what Sir Alan has created for us.
THE HISTORY OF CHECK 21
On December 21, 2001, Chairman Greenspan sent the original Check 21 proposal to both the Senate and the House Banking Committees.
The Check Clearing for the 21st Century Act (Check 21) was signed into law on October 28, 2003, and will become effective
on October 28, 2004. Check 21 is designed to foster innovation in the payments system and to enhance its efficiency by reducing some of the legal impediments
to check truncation. The law facilitates check truncation by creating a new negotiable instrument called a substitute check,
which would permit banks to truncate original checks, to process check information electronically, and to deliver substitute
checks to banks that want to continue receiving paper checks. A substitute check would be the legal equivalent of the original
check and would include all the information contained on the original check. The law does not require banks to accept checks
in electronic form nor does it require banks to use the new authority granted by the act to create substitute checks.
CHANGES TO CHECK 21 SINCE ORIGINAL LAW PASSAGE
The Federal Reserve Board on Monday approved a proposed rule to amend Regulation CC and its commentary to implement the
Check Clearing for the 21st Century Act (Check 21 Act). The Check 21 Act was enacted on October 28, 2003, and becomes effective
on October 28, 2004.
To facilitate check truncation and electronic check exchange, the Check 21 Act authorizes a new negotiable instrument called
a "substitute check" and provides that a properly prepared substitute check is the legal equivalent of the original check
for all purposes. A substitute check is a paper reproduction of the original check that can be processed just like the original
check. The Check 21 Act does not require any bank to create substitute checks or to accept checks electronically.
The Board's proposed amendments: (1) set forth the requirements of the Check 21 Act that apply to banks; (2) provide a
model disclosure and model notices relating to substitute checks; and (3) set forth bank indorsement and identification requirements
for substitute checks. The proposed amendments also clarify some existing provisions of the rule and commentary.
The Board's Federal Register notice is attached. Comment on the proposed rule is requested by March 12, 2004.
PROBABLE EFFECTS OF CHECK 21 AS ESTIMATED BY THE AICPA!
As we move toward a truly electronic society, what we once demanded in print is changing before our eyes. Electronic delivery
is affecting almost every industry, and banking is no exception. In fact, many banks have already begun truncating checks
by delivering photocopies of checks or by sending a list--detailing the check number, the amount, and the clearing date--and
holding on to the originals instead of sending them back to consumers. On October 28, 2004, the Federal Reserve will authorize
entities in the check clearing process to take this one step further. Any entity in the clearing check process will be able
to truncate checks and forward an electronic copy of the check. When this occurs, the electronic image of the check must be
capable of being transformed into a "substitute check" or a printed, electronic image of the original that will now be recognized
as the legal equivalent of the original check.
The check truncation concept had been around for many years, and many drawer banks truncated checks in their monthly statements
to customers. The passage of the Check Clearing for the 21st Century Act, or Check 21 Act, was helped by the terrorist attacks
of 9/11. The grounded planes cost the banking industry billions of dollars as check processing was grounded as well. Electronic
delivery means banks will no longer have to fly checks all over the country, and consumers may receive copies of their checks
instead of cancelled paper checks. While the Act is voluntary, most banks are expected to take advantage of potentially significant
cost savings, with the larger institutions leading the pack. It is expected that the process will take a number of years before
it becomes ubiquitous.
The intent of the Act is to cost-effectively and efficiently streamline check processing by enabling the electronic processing
of checks. The ability to process checks electronically will decrease processing time, transportation costs, and the possibility
of items lost or destroyed in transit. Checks will clear in hours instead of days because a substitute check can be accepted
as legal. And although the process is voluntary for all banks in the clearing process, once one bank decides to create a substitute
check, all other downstream banks involved in the clearing process must use the substitute check.
Any bank in the check clearing chain can initiate "truncation" and create a substitute check. Whether the substitute check
is then forwarded physically or whether it is transmitted electronically will be determined by the agreements between banks
in the clearing system. Banks and institutions will also make their own policies on how long to keep the original check.
What is a Substitute Check?
The Check 21 Act authorizes a new negotiable instrument called a "substitute check." A substitute check is a paper reproduction
of the original check that contains an image of the front and back of the original check and bears a MICR line containing
all the information appearing on the MICR line of the original check. It conforms, in paper stock, dimension, and otherwise,
with generally applicable industry standards for checks; and is suitable for automated processing in the same manner as the
To create a substitute check, an electronic image of the original check is made. Once this happens, the original check
is truncated, or taken out of circulation. The substitute check contains a legend that reads "This is a legal copy of your
check. You can use it the same way you would use the original check."
The Check 21 Act provides that a properly prepared substitute check is the legal equivalent of the original check for all
purposes. It does not require a bank to create substitute checks or to accept checks electronically. In addition, it includes
new warranties, an indemnity, and expedited recredit procedures that protect substitute check recipients. The substitute check
is expected to replace paper checks from the processing system over time. You will always be able to get substitute checks
from your financial institution but they may only be available upon request.
How will it affect me?
Although the effects of the Act will not happen overnight, there are several implications to be aware of.
As banks begin to truncate you will see fewer and fewer original checks as they are replaced by substitute checks. Also,
as banks begin to move towards electronic transmission, the physical substitute checks will be replaced by electronic images.
Decreased processing time means that there will be a reduction in the "float time," the amount of time between when you
write your check and when it clears. This can be a negative for consumers, because the speed of electronic transfers decreases
the "float" that enables consumers to keep their money in their account until the check they have written clears.
Deposit clearing rules are not affected by the Check 21 Act. Therefore, while the decreased processing time will reduce
the length of time that a check written on your account remains in the check clearing system before being charged to your
account, the length of time that a bank holds checks deposited into your account before crediting your account with the deposit
will vary depending on your relationship with your bank.
In disputes, substitute checks will be recognized as the original by the courts, retailers and other providers.
Detecting check fraud may be more difficult as a result of the Act. But the Federal Reserve maintains that since the original
check is no longer used for processing, the security of the electronic systems will reduce human access to your financial
information. In addition, the shorter processing time will allow the identification of check fraud or forgery more quickly.
However, proving alterations and forgeries may become more difficult if there is no access to the original paper and ink which
can provide important clues such as pressure points.
Implications for Auditors and for Businesses
Banks have never been required to return original checks to commercial clients. The new Act does not specify what must
be returned to the customer. That decision is left up to the bank. For instance, a bank may simply send a monthly electronic
list of checks and the dates they cleared with links to the electronic check image. However, a customer can require the bank
to return a "substitute check" if the customer has a need for a legal equivalent of the original check.
Because of the range of delivery options, understanding what a financial institution will return should be a top priority
for auditors and for management. Management should make it a top priority to speak directly with their financial institutions
to determine exactly what a bank will provide. Knowing exactly what a bank will disseminate and return will enable management
to revise, if needed, their internal controls over cash.
Since the Act specifically states that the substitute check has all the force and effect of the actual cleared check, auditors
may use a substitute check as evidential matter. In certain cases, an electronic check image will suffice depending upon an
auditor’s judgment and his or her assessment of fraud risks. Since the original check will no longer be available, auditors
should be aware of the Act and consider, while planning an audit engagement, what changes they may need to make to their audit
procedures. Both auditors and their clients should be prepared to have these discussions during audit planning.
More information… The Check 21 Act was enacted in October of 2003, and becomes effective on October 28, 2004. More
information on the Act, including Frequently Asked Questions can be found at http://www.federalreserve.gov/paymentsystems/truncation/default.htm
THE ECONOMIC CONSEQUENCES OF THE CHECK 21 ACT
Sir Alan has outdone himself with this legislation. He has not only lowered the check clearing costs for the banks, but
he has also created the probability of a large increase in fee income for the banks as many customers "bounce" checks. Yes,
the "float" is gone. Many consumers and small businesses have relied on the "float" to "get by" for years. This option is
soon extinct. There is also the possibility of major fraud with this new system (at least in the opinion of the AICPA). The
bean counters may be right on this potential problem. "But wait. There’s more!"
SIR ALAN’S MONETARY "PIECE DE RESISTANCE"
Sir Alan has played the liquidity card to defeat the recent slowdown in the growth of the money supply. Most readers are
familar with the monetary indicators and their interpretation. We diligently watch the rate of change in M1, M2, M3, etc.
However, the wild card in monetary calculation is velocity. The velocity variable is the rock that sank the Chicago School of Economics. Milton Friedman failed to incorporate velocity into his economic models. J. M. Keynes made
the same mistake. Ironically, Monetarists and Keynesians may have more in common than either one would ever acknowledge.
Sir Alan is ready to implement the upgraded velocity turbocharger. The termination of the float guarantees that the velocity
of the monetary measure M1 will go up. We are now entering the uncharted parts of the monetary universe at Warp Nine speed.
We may be doomed, but we will be liquid!
Wayne N. Krautkramer firstname.lastname@example.org