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Fed Helping Banks Embrace Check 21
Fed Helping Banks Embrace Check 21
By Dr. Anthony M. Santomero

Evolving technologies and customer preferences have made quite an impact on the payments system. The Federal Reserve vigorously supports this evolution through our advocacy of a legal and regulatory framework enabling greater innovation in the marketplace and greater efficiency and reliability in payments. Check 21 is an example of such legislation. 

Now, with Check 21 set to become effective Oct. 28, the Fed is looking forward to working with banks to realize all the efficiencies the new legislation offers.
Innovation and Efficiency
The goal of Check 21 is to foster innovation in the payments system and to enhance efficiency. It does this by facilitating check truncation (the removal of the original paper check from the check collection process and replacement of it with electronic information related to the original check and electronification via imaging) without making it mandatory. Check 21 accomplishes this simply by authorizing the use of a new negotiable instrument – the substitute check.

The substitute check must contain payment information identical to that on the original check and must be in a specific machine-readable format. Properly created, the substitute check is the legal equivalent of the original check. Under Check 21, a collecting bank can truncate and image the original checks it receives for deposit, process the checks electronically and then print and deliver substitute checks at a location near the paying bank for presentment.

It is worth emphasizing that Check 21 does not require collecting banks to truncate or image checks, nor does it require paying banks to accept electronic images. Check 21 requires only that paying banks accept substitute checks as well as originals. Whether they accept the substitute checks in paper form or electronic form is strictly their decision.

The expectation is that Check 21 will increase electronic presentments and foster the electronification of checks at the earliest possible stage of processing. The speed at which this evolution occurs is hard to predict. Like the use of the check itself, it is likely to be a gradual process.

Check 21 and Reliability
The industry buzz has long expounded on the efficiency gains from the electronification of checks, but mitigating risk is another key benefit. Check 21 will help alleviate the danger of checks being lost or delayed during transport. As clearing time shrinks, credit risk is also reduced.

From the Fed's perspective, reducing the risks associated with the physical transportation of checks is an important benefit of Check 21. Our experience in the aftermath of Sept. 11 focused attention on this issue. The interruption of air travel – and check transportation – in the days after the Sept. 11 attacks pushed the Fed's check float over $47 billion, more than 100 times the normal level.

The Fed sought to find opportunities to reduce the dependency on transportation and approached Congress in late 2001 with the proposal that would become Check 21.

Many banks already use check imaging, both to streamline internal operations and to enhance customer services. Check 21 offers banks the option of using those images to collect from any paying bank by presenting a substitute check. Whether exercising this option makes economic sense, of course, depends on the relative cost of presenting a substitute check rather than the original, either directly or through a third-party provider.

Banks that use imaging must also make some important decisions about aggregating and archiving. As banks begin to receive electronic files from more institutions, it may make sense to outsource these activities to a third-party provider.

Some banks are not using imaging yet because the internal efficiencies and customer service benefits do not justify the cost. With Check 21, the expanded opportunity to transmit images for presentments may make imaging cost-effective.

But even if imaging does not make sense for some banks, Check 21 will require even non-imaging banks to accept presentments of substitute checks. That means bank customers will likely be getting back some substitute checks with their statements. Banks must plan for how they will familiarize customers with these new instruments and address their concerns.

When a check is truncated at its bank of first deposit and a substitute check is created, the collection process is enhanced by expediting presentment, improving availability and eliminating transportation costs. But consider an extension of this process, one in which presentment of the substitute check is replaced by an image. In this case, further benefits are extended to the paying bank. Accepting images for deposit eliminates back-office capture of the check as well as the inconvenience of transporting paper checks.

Now suppose the bank of first deposit receives images from its own ATMs, from its own branch offices or even from its corporate customers. Image capture earlier in the process will further benefit the bank by eliminating check transportation and the need for proofing and encoding and processing with check sorters. 

The Fed is investing in technologies that enhance Check 21. We want to provide all customers, regardless of size or location, the opportunity to embrace and take advantage of the many benefits of Check 21 – without significant investment on their part.

The Reserve Banks have recently upgraded and standardized their check platforms so that their bank customers will have access to the same check processing and adjustment services at all of their locations. Philadelphia installed the common platform in the fourth quarter of last year.
New and Improved Products
The Reserve Banks are rolling out a variety of new and improved products, services, and solutions designed to support banks' best use of their new options under Check 21. Our new image deposit services will have improved availability over our current paper deposit products. Also, we will convert paper items to images, where we can expedite collection.

Our national archiving service, FedImage, is already available. We are expanding our capability to produce substitute checks, and we intend to increase our web services.

Over time, Check 21 will provide financial institutions opportunities to broaden deposit options and extend deposit cut-off hours. This will have an effect on the Federal Reserve, too. As the Fed increases its processing efficiencies, it will pass the gains on to its bank customers in the form of accelerated availability and enhanced deposit deadlines. The Fed and its bank customers are both involved in and affected by the changes imposed by the recent legislation, and the Fed is prepared to respond to Check 21’s implications for itself and for the banking industry it serves.

We will continue to develop our products and expand our electronic capacity in response to the market's evolution and our customers' needs. At the same time, we will take steps to foster an environment for improved payments-system efficiencies and vibrant private-sector innovations. Check 21 is an important step toward this goal, but it is by no means the final step. 

The infrastructure and convention of check processing will evolve, generating new check products and services and new ways to deliver them. We at the Fed look forward to working with banks to achieve a common goal: realizing all of the efficiencies of Check 21.          

Dr. Anthony M. Santomero is president of the Federal Reserve Bank of Philadelphia. He may be reached at

Posted on Thursday, September 30, 2004 (Archive on Wednesday, December 29, 2004)
Posted by kdroney  Contributed by kdroney


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