Check-Based Payments

Checks are the traditional method that consumers can use to access their accounts.  A check contains the names of the payer and the payee, the payer's account number, amount of the check, and the name and routing number of the paying financial institution.  The magnetic ink character recognition (MICR) line at the bottom of the check enables high-speed reader/sorter equipment to process checks.  Before financial institutions process checks, they encode the amount of the check in magnetic ink at the bottom of the check.  Check formats are governed by standards developed by the Accredited Standards Committee (ASC) on Financial Services, X9B Committee, which works under procedures sanctioned by the American National Standards Institute (ANSI). For further information, see the American National Standards Web site at

Check processing has undergone a transformation during the past five years; a trend that is expected to continue for the next several years.  Until recently, consumers in the United States used checks more often than any other retail payment instrument other than cash.  However, in an increasing number of payment situations, checks are no longer the most convenient payment instruments for consumers, or the most cost-effective payment method for financial institutions and merchants.  Checks comprise a decreasing percentage of the total noncash payment volume in the United States.  Many consumers use checks merely for person-to-person transactions that are not conducive to electronic payments, and have shifted to electronic payments for POS transactions and bill payment.  In addition, a significant volume of checks are converted to ACH debits at POS and at lock-box operations.

Legal developments have affected the processing of checks as well.  Check 21, which became effective on October 28, 2004, has succeeded in reducing check processing times as well as the float period previously associated with physical processing.  By authorizing the use of a new negotiable instrument called a substitute check, Check 21 facilitates the broader use of electronic check processing.

A properly-prepared substitute check is the legal equivalent of the original check and includes all the information contained on the original check.  The law does not require financial institutions to accept checks in electronic form, nor does it require financial institutions to use the new authority granted by the act to create substitute checks.  The law permits financial institutions to truncate Truncation is the process of removing a paper check from its processing flow.  In truncation, both sides of the paper check are scanned to produce digital images.  If a paper document is needed, these images are inserted into specifically formatted documents containing a photo-reduced copy of the original checks called a "substitute check." original checks, process the check information electronically, and deliver substitute checks to financial institutions that wish to receive paper checks in lieu of electronic alternatives.

For many financial institutions, implementing a Check 21 strategy involves a significant investment in new hardware and software as well as the reengineering of check processing routines.  Consequently, financial institutions should deploy Check 21 with appropriate risk management, including strategic planning, project management, and vendor management.  Check 21 requires the bank The term "bank" includes any depository institution as defined in 12 U.S.C. 461 (b)(1)(A). that creates a substitute check, the reconverting bank, to warrant that there will not be duplicate presentments of the check (or copy or representation thereof) and that the substitute check is an accurate representation of the original check as of the time the original check was truncated.  Such substitute checks must meet specific requirements to be treated as a legal equivalent, and the bank that creates a substitute check must indemnify other parties for losses that result from their receipt of a substitute check instead of the original check.

Financial institutions implementing a Check 21 strategy must consider new processes for imaging checks, transferring files of imaged checks, and archiving and retrieving imaged checks.  For example, a number of financial institutions are implementing remote check capture systems in their branches and processing centers as a means of significantly reducing check transit costs.  Some financial institutions are providing selected customers with remote check capture devices.  Examiners are encouraged to review the FFIEC's guidance for Risk Management of Remote Deposit Capture.  See for FFIEC Guidance on Risk Management of Remote Deposit Capture.

Another important catalyst for the changes taking place in payment systems is electronic check conversion, a process in which information from a check is used to create an ACH debit.  The conversion may occur at a retailer's POS, or at lock-box processing centers to which a consumer mails checks.  Electronic check conversion is similar to, but separate from, the check substitution process authorized by Check 21.  Instead of using the image of a paper check, as in the Check 21 process, the recipient uses the account and financial institution information contained on the consumer's check to create a new electronic payment through either the ACH or debit card networks. It is important to note that check conversion requires appropriate disclosures to the check writer and is not available for all checks.

ACH electronic fund transfers between financial institutions are not considered check transactions; thus, they are not subject to laws governing check processing.  Rather, they are governed by the rules of the ACH that processes the electronic fund transfer.  ACH transactions to or from consumer accounts also are subject to the provisions of the Federal Reserve Board's Regulation E, Electronic Fund Transfers.

Evolution of Electronic Check Collection

Two general models of electronic check collection are emerging as a result of the passage of Check 21.  Each model has its advantages and disadvantages.  In one model, check images including the MICR payment information are transmitted to the paying financial institution.  These institutions do not have to rely on multiple image archive providers (with whom they may have no direct contractual relationship) to obtain check images for customer online banking services and back-room operations.

In a second model, only the MICR information is transmitted to the paying financial institution while the check images are stored in remote archives that can be accessed on demand.  The MICR information on a check could be transmitted through a dedicated network or possibly the ACH network.  A small number of centralized check-image archives could be more cost-effective and might not increase risk appreciably or degrade customer service.

As electronic check collection methods evolve, efficiencies may develop to make one method superior to the other.  Notwithstanding, electronic check collection methods will continue to pose certain risks.  Frequently-used services that utilize both image and ACH technologies are remotely created checks (RCCs), electronically created payment orders, and remote deposit capture (RDC).  Each of these is discussed in the sections that follow.


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Remotely Created Checks