Check Clearing Houses
Financial institutions clear and settle checks in different ways depending on whether the checks are "on-us" (checks deposited at the same institution on which they are drawn) or interbank or transit checks (the payer and payee have accounts at different financial institutions). On-us checks do not require interbank clearing or settlement. Interbank or transit checks can clear and settle through direct presentment, a correspondent financial institution, a clearing house, or other intermediaries such as the Reserve Banks.
Under direct presentment, depository financial institutions can present checks directly to the paying financial institution. The paying financial institution may settle with the depository financial institution through a pre-arranged settlement agreement or by sending Fedwire® funds transfers through the Reserve Banks. See the IT Handbook Wholesale Payment Systems Booklet for a discussion of Fedwire®.
Correspondent financial institutions, acting on behalf of other depository financial institutions (known as respondents), can settle the checks they collect by using accounts on their books or by using their Reserve Bank reserve account. Smaller depository institutions typically use the check-collection services of correspondent financial institutions or the Reserve Banks.
Financial institutions can also clear checks through a Reserve Bank or through an independent clearing house where they have formed voluntary associations that establish an exchange for checks drawn on them. With the advent of Check 21, a number of vendors have begun to offer processes and systems for imaging, transferring, archiving, and retrieval of checks. Many financial institutions participating in check clearing houses use the Federal Reserve's National Settlement Service (NSS) to effect settlement for checks exchanged each business day. See www.frbservices.org/nationalsettlement/index.html.
Legend: Solid lines represent the flow of information and dashed lines represent the flow of funds.
Figure 2: Check Clearing and Settlement
Figure 2 depicts the typical interbank check clearing and settlement process through a Reserve Bank or clearing house. In step 1 the consumer uses a check to pay a merchant for goods or services. The merchant, after obtaining authorization for the check, accepts the check for payment. Check authorization is typically performed by a third-party service provider. At the end of the day, the merchant accumulates the checks and deposits them with its financial institution for collection (steps 2 and 3). Depending on the location of the paying institution, the funds may not be available immediately. For deposited checks payable at other financial institutions, the merchant's financial institution uses direct presentment for processing or sends the checks to a Reserve Bank, clearing house, or correspondent financial institution (steps 4 and 6). The check or an electronic presentment file is sent to the consumer's financial institution, and the financial institution's account at the correspondent or Reserve Bank is debited (steps 5 and 7). The original or a qualifying substitute check is needed for presentment unless agreed to otherwise.
Return items are checks that are rejected by the paying financial institution for reasons such as insufficient funds, a closed account, a stop-payment order, fraudulent signature, or failure of the paying financial institution. Return items are a major risk associated with the acceptance of check deposits. The institution that takes a check for deposit may be exposed to credit risk if it releases funds to the depositor and the paying financial institution later returns the check because its customer does not have sufficient funds or for other reasons.
Regulation CC obligates financial institutions to make deposited funds available for customer withdrawal in accordance with mandatory schedules. Thus, a depository financial institution may be required to make funds available to the customer before an unpaid check is returned to the depository financial institution. When the depository institution receives a return item, it will charge back its depositing customer's account for the item although it had already made the funds available to the customer.
Remote Deposit Capture
The Automated Clearing House (ACH)