NOVEMBER 2004 E-PAYMENTS AND CHECK 21: The Future Color of Money


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  • This presentation is designed to address what is happening to the world of paper payments - cash and checks - and how electronic money may be the only kind of money left in a few years. I will also address what effect the newly enacted Check 21 legislation will have on the remaining paper checks, and what impact it might have on governments, key points your agency will need to address, how to maximize your receipts and disbursements and how to minimize your deposit work. [Please note that in this presentation we will use the term “checks” to refer to both checks and warrant instruments.]
  • The number of checks processed by the Federal Reserve decreased for the fourth consecutive year in 2003. In its 90th Annual Report to Congress, the Federal Reserve System reported that it processed 15.81 billion checks in 2003, a 4.7 percent decline from 2002. Significantly, the 2003 rate of decline was the steepest of the past four years, more than doubling the 2002 rate of decline of 1.9 percent. In contrast to check volume, the Federal Reserve’s commercial Automated Clearing House (ACH) volume increased by 12.1 percent in 2003 to 5.59 billion payments. Commercial ACH payments include Direct Deposit of payroll, Direct Payment of consumer bills, business-to-business payments, and e-check payments such as online bill payments and accounts receivable check conversion. In the government sector, both the Federal government and state governments are mandating that taxpayers with large tax liabilities pay via the ACH. This shift in volume has significant cost implications. The unit cost to the Fed to process a check in 2003 increased by 13.3 percent, from 4.5 cents in 2002 to 5.1 cents in 2003. The Fed’s unit cost to process an ACH payment decreased by 15.4 percent, from 1.3 cents in 2002 to 1.1 cents in 2003. In 1995, the Fed’s unit costs for checks and ACH payments were virtually identical, but now the unit cost for a check is nearly 5 times as much as for an ACH payment.
  • And ACH volume is still going up. The Automated Clearing House Network grew by almost 21 percent in the 1st Quarter of 2004 compared to a year ago, according to NACHA statistics. More than 2.14 billion transactions were conducted during the quarter, worth more than $5.27 trillion. These figures represent growth rates of 20.9% and 5.5%, respectively, over the same quarter of 2003. There were 1.04 billion debits and 1.10 billion credits in the 1st Quarter, for a total of 2.141 billion transactions. Again you can see by these statistics that smaller dollar transactions are beginning to move to ACH. The large dollar government payments have been mandated for awhile, now smaller dollar transactions are moving to electronic.
  • Here’s a quick look at the growth rates over the last 7 years – ACH on the rise, checks in decline.
  • Besides ACH, other electronic payment alternatives are also on the rise. Credit card payments will increase to be 8.9% of total payments by 2008 Debit cards will increase to 1.5% of total payments Governments are playing a key role in pushing the transition to stored value cards – a fabulous, secure alternative to checks for distributing benefits to people without checking accounts It started with EBT(Electronic Benefit Transfer) systems aimed at food stamp recipients - 48 states now have EBT systems for food stamp distribution. And many states are looking to expand the use of this system for different types of benefit disbursements Child support is an area that will benefit greatly from stored value technology - Payments are being disbursed to custodial parents via stored value cards in four or five states, with others quickly moving in that direction
  • Other, virtual payment systems are also starting to stick. E-wallets, like Amazon’s 1-click, or Microsoft’s .net Passport are on the rise. As more consumers move to purchasing goods on the web, these technologies will increase in popularity.
  • With all this change, here’s the challenge for governments, and any business frankly- how to offer a range of payment options and interaction channels without requiring huge investments in systems upgrades or bringing down the back office. Perhaps the ideal world is something like this – a vendor(bank) steps in and creates a data repository that can handle all payment types and the associated data – and can deliver it in a single stream to the existing government or business back office system. This way, the burden of of keeping pace with technology and offering new payment methods and delivery channels rests with the vendors – who, presumably because they are providing similar solutions for many entities, can do it more cost effectively.
  • Okay, so volume is moving to electronic payment alternatives, but 15.8 billion checks is still a heck of a lot of paper. So now I’ll talk about ways the banking system can convert these check transactions to electronics. I’ll talk about Check 21 – new legislation that’s about to be enacted, as well as other ways banks are planning to convert checks to electronics, like electronic check presentment and ACH check conversion.
  • On October 28, 2004, the Check Clearing for the 21 st Century Act goes into effect. The original legislation that was before Congress dealt more with Image Exchange and attempts to establish legislation that would create a mandate for all financial institutions to accept and process images in lieu of the paper checks. The legislation was difficult to move forward simply due to the complexity of the process and the reality that 14,000 financial institutions had to embrace common image technology. The events of September 11 th were a key catalyst in moving this legislation forward. On September 11, all planes stopped moving and trillions of dollars of paper checks sitting in the bellies of airplanes or on the ground, waiting to be cleared. The Federal Reserve realized that the physical transportation component of check clearing could bring significant risk to the US payment systems. Congress got behind a modified version of The Check Truncation Act and the result was Check 21 – a simplified version that essentially establishes the legal equivalence between a “substitute check” and the original check. Of course the legislation delves into the attributes of this substitute check, which we will cover in a moment, but this relatively simple approach has significant implications and opportunities to the check processing world. It fosters check truncation, without requiring that everyone accept images, allowing for the physical check to be imaged, transported electronically, and re-printed for presentation to the paying bank.
  • Check 21 basically defines the legal equivalence of a “substitute check” and the original item. By design is by-passes the significant adoption barriers of the requirement that the entire industry adopt common image technology. But, what Check 21 does not do is address Image Exchange. Image Exchange, where the depositing bank and the paying bank can agree to exchange images of the checks verses the physical checks can still occur, but only by special agreement (usually defined within a clearing house association). Check 21 DOES NOT define that a check image of the original item is the legal equivalent of the original check, only that a substitute check is the legal equivalent. And this substitute check is a paper check-like instrument. What this simple definition does allow is for a depositing bank to elect on their own to image 100% of their transit items at some point of capture in their operations, eliminate significant transportation costs and/or delays in their operations, and for paying banks that are not in a image exchange agreement, allow them to re-print the check as a substitute check (likely geographically closer to the paying bank) and present for payment. This substitute check also simplifies the deployment of image exchange, as the paying bank can now accept images of all their items and re-print substitute checks to include in DDA statements for their customers demanding items back in their statements.
  • So what is a substitute check? Must be an image of the front and back of the check, must be a legible copy MICR ink document, capable of being processed by standard industry equipment, and the MICR line must match that of the original item Identifies that it is a substitute check and identifies the bank that is indemnifying it under the rules
  • Sample Substitute Check ANSI X9.90 is the standard (still in development) Substitute checks under Check 21 will be called Image Replacement Documents (IRD). Front and back, legible, all endorsements and identifies the bank creating the item. MICR matches that of the original check (routing number, account number, check number) plus an identifier in position 44 (the number “4”) that indicates that this is a substitute check.
  • So what’s so great about substitute checks? Using them does not require an agreement between parties. So, I as a bank, can make a decision to use them to accelerate independently of the bank receiving the substitute. Any party must accept it whether it be the banks in the forward collection process, or in the return item process ALL checks may be converted to substitute checks – anything, consumer, commercial, government, traveler’s checks – anything.
  • So, substitute checks can prove to be a very versatile tool in the collection of paper checks . . . Although the cost to image, transmit and re-print has to be weighed against the costs that are avoided (such as transportation costs) or the value created if the item can be settled faster. Also, certain operational benefits can be created by handling images. A common example is using substitute checks to by-pass transportation delays. Say you have an item in California drawn on a New York bank. Significant delays exist, not only in travel time, but the time zone is working against you. This process would allow you to capture the item in California, transmit it electronically to NY, re-print the substitute check in NY and present it for payment, possibly a day sooner. The handling of return items (such as stop payments or NSFs) is a costly and time consuming process. The original item must be culled out from the prior day’s work to return it to the depositing entity. In the future, banks will be able to re-print a substitute check from their image archive and return the substitute. Deposits at remote branches or ATMs could be captured, transmitted and re-printed for faster settlement and avoidance of transportation delays or frequent servicing expense.
  • ECP has been happening for quite some time and is growing substantially, but today’s process is still dependant on the physical delivery of the checks. In this arrangement, the paying and depositing bank agree to exchange the MICR information from their checks before the physical items are delivered, usually at least one day sooner. So for example, JP Morgan has checks drawn on B-of-A, so we transmit the MICR data to them tonight (up until 11 p.m.), B-of-A debits their customer accounts that night (a day sooner than the traditional process would allow), and settles with JP Morgan the following day based upon presentment and balancing to the physical items. This process allows banks to use lower cost transportation than we normally would. The physical items are then available the next day for enclosure in DDA statements, returns due to stop payments or NSF’s, etc. Today, it is common practice to exclude Controlled Disbursement Accounts from this late day posting, as we typically have SLAs that require us not to debit their account after 10 a.m. This process requires that the paying and depositing bank have separate agreements between them to do the ECP exchange.
  • The Image Exchange process is designed around the ECP process, except for that instead of delivering the physical items the next day, images are exchanged. The paying bank then deals with the image instead of the paper items. Again, this is an area whereby Check 21 simplifies the process, as DDA enclosure items can now be created via substitute checks for accounts that are not truncated, yet allow for the exchange of images for all items. Significant pilots are planned for in 2004 between the 8 lead banks in SVPCo. Image Exchange does not facilitate a same-day-settlement window as it exists in the physical check world, so until this is adopted, larger value checks may continue to be presented physically (as the original check or as a substitute check) if earlier settlement windows can be met.
  • And finally, the last option available today to get rid of physical checks is ACH check conversion. This is truly the “CONVERSION” of a check payment (UCC Check law) to an ACH payment (Regulation E). Essentially the NACHA rules state that if you put a notice on your monthly bill that states “paying by check authorizes us to convert your payment to an electronic check” establishes ACH authorization. The biller takes the account information, including the check number from the check and formats an ARC ACH transaction and settles it through the ACH. The original check must be destroyed within 14 days, and an image retained for 2 years. The benefits of check conversion are faster settlement (all settle the next day), fewer NSF items as banks tend to post ACH items before checks, faster return item notification, and a lower cost payment channel. If the consumer is present (for example at the cash register at Wal-Mart, or in your payment center), you are required to get written authorization (similar to a credit card receipt), capture the info form the check to create the POP ACH record, and hand the consumer back their voided check. ACH checks are limited to US Dollar checks drawn on consumer accounts only. So, if you have a large mix of business payments, or your customer pay with cashiers checks or money orders, these items can not be settled this route. This is where the addition of image exchange and Check 21 Substitute Checks help create a 100% solution.
  • To help level-set how and when these new settlement options will be used, we will talk through three different payment scenarios and discuss the payment settlement options that are available. Scenario: Retail lockbox consumer payment for $100 accepted in Phoenix, AZ, retail lockbox site, drawn on Fleet Bank, NY Option 1 – use commercial airline package service, settles in one to two days Option 2 – ACH Check conversion – this is a consumer item, the service provider put the disclaimer on the bill, so assuming it’s not a money order or cashier’s check, it can be converted to an ACH transaction and settled the next day. Option 3 – need to point out that this is future as we have limited endpoints reachable through this method today Option 4 – at today’s low interest rate environment, the value of expediting settlement by one-day on a $100 check is roughly $0.003 (3-mils).
  • (This slide builds with each mouse-click to disclose each option) Scenario: Wholesale lockbox payment for $10MM accepted in Pasadena wholesale lockbox site drawn on Fleet Bank, NY Option 1 – likely use chartered Lear Jet to ensure prompt delivery, settles in one day . . Due to travel times and time zone differences, impossible to reach a same day window. Option 3 – need to point out that this is future as we have limited endpoints reachable through this method today Option 4 –To make this scenario interesting, I highlight that it is 2:00 in the morning in Pasadena, 5:00 a.m. in NY, and there is no physical way to get the check to NY in time to make a same day settlement window . . . But an image of this check could be electronically transmitted and re-printed as a substitute check within 60 seconds, opening up the window to make a same day settlement presentment at Fleet. at today’s low interest rate environment, the value of expediting settlement by one-day on a $10MM check is roughly $280, probably enough to justify the substitute check expense.
  • (This slide builds with each mouse-click to disclose each option) Scenario: Corporate client collecting $250 in-person and drop box payments in numerous locations, consumer and corporate payments Key points on options 2 – 4: Option 1 – traditional method – corporate client maintains a local depository relationship in every market, the branch manager deposits receipts daily, notifies headquarters, and the headquarters initiates a wire or ACH to draw those funds from the local bank to the headquarter’s bank. Option 2 - ACH model only works for consumer checks Option 3 – need to point out that this is future as we have limited endpoints reachable through this method today Option 4 – many times local office deposits are held overnight and the deposit made the next day, and/or, you have large armored car courier expenses. Substitute checks allow you to electronically deposit 100% of the items into a central account. Electronification allows you to potentially eliminate local depository accounts, ZBA’s, cash concentration sweeps, etc. as the electronic deposits could be made to your central corporate account, streamlining these processes and expediting settlement of funds. This process could take a significant layer of cost out of your cash management structure, and potentially justifies the expense of capturing images in your office and settlement via substitute check
  • (This slide builds with each mouse-click to disclose each layer) So, as we consider these new payment options and put them into a best-fit analysis model: ACH check is the best utility for low-value consumer remittance payments. If you are delaying a decision to move to ARC because of the pending image exchange environment, you should not . . . ACH can deliver value now, and as we have discussed today, it will take years for wide spread image exchange to be in place. This is however an 80% solution, as you can only handle consumer checks. Image Exchange is the next best fit, will be available for all items (business and consumer), but again, limited endpoints are available for the foreseeable future. Substitute checks are best for exception items that are not drawn on image exchange ready banks, and for large dollar checks that can be settled faster – our $10MM check example. Substitute checks will also be used to speed up the return check process.
  • These are primarily back office changes within the banking industry. . . But the shift to electronics allows these changes to be extended to your operations. While we expect all of these changes to result in better funds availability and lower costs, the industry is challenged with declining volumes, increased investments, and limited availability improvements.
  • You need to consider the following analysis to determine the impact and opportunities that this strategic shift to electronics can have on your cash management operations: Depository/Collections Is your internal deposit-gathering process (at agencies or at your remittance center-or lockbox) image enabled? If not, should you outsource to a vendor that is image-enabled? What volume of exception payments flows through your agency or remote offices that could be expedited via distributed capture solutions? What impacts could electronification have on your operations – if you can employ a distributed capture solution, can you extend your end-of-day cutoff time, reduce local depository accounts, simplify your in-branch collections?
  • We understand that many government entities require receipt of original paid documents in their bank statements. In some cases there are statues that govern this requirement; however, in other cases the “need” for original documentation has been established due to long-term practices. If you issue warrants, do you have a need to further capture and process these items to provide output – various reports, electronic posting files, or sorts for delivery to agencies? On the other hand, as you service your constituents, do you require an original document for proof of payment? The payment industry is changing: The majority – on average 65% - of consumers and businesses do not get their checks back In some cases the original check was converted to an electronic item – ARC NACHA transaction Soon, even for constituents who receive their checks, they may receive an IRD. If so, you may want to think about changing business processes to eliminate reliance on an original document.
  • Image Exchange is the ideal end-state model that will allow for significant reengineering in the check processing world and significantly reduce costs associated with transportation. However, movement to the end-state will take years as everyone must be capable of accepting images. Check 21 helps bridge this gap, as banks that are unable to accept images can be presented substitute checks, allowing the depositing bank to handle all items as image-based in their own operations. However, in the interim, and particularly in today’s low interest rate environment, the usage of Substitute Checks will likely be limited to large value items that can be settled faster, or items that can avoid significant transportation delays, and for the automation of NSF/exception items. Also, a large percentage of checks are for small dollar values, so until image exchange is more broadly adopted, we will likely be processing checks the old-fashioned physical way for some time to come.
  • Banks are and will continue to take advantage of these new clearing alternatives to optimize the collection of funds. The alternative chosen will be based - the dollar value of the item, the time required to clear the item the cost to clear the item and endpoint clearing options (such as can the item be reached via an image exchange, same-day cutoff windows, etc.) New bank products are emerging like: Image Cash Letters – where the customer will transmit to your vendor their cash letter in image format and we optimally clear the items Distributed Capture Solutions – where your vendor places capture devices in agency offices or operations to capture and transmit an image of their checks and facilitate an electronic deposit. This could help eliminate the need for you to maintain numerous local depository accounts and the delays associated with cash concentration processes.
  • Most changes to your lockbox services should be behind the scenes whereby your vendor uses the new collection tools to expedite the settlement of funds and lower clearing costs. The image settlement process will lead to later day cut-off’s as well as faster notification of returned items.
  • While faster settlement of deposited items results in a potential reduction in disbursement float, the handling of disbursements in an all-image environment can help lower your costs and improve customer service. As we have discussed, larger value checks that can be settled faster via substitute checks will be the likely first usage of Check 21, and these checks are typically drawn on controlled disbursement or warrant accounts. Growth in Image Exchange activity will likely have limited impact to CDA accounts, however, as more items move to image exchange, adoption of image-based disbursement tools is important to your ability to manage your account. Your vendor should be prepared to handle substitute checks in all of its disbursement products . . . And they should have tested Payee Positive Pay in this environment, and of course depending on image quality, should be able to identify the payee. All of your vendor’s disbursement solutions should be image enabled, to help you transition to the image world.
  • NOVEMBER 2004 E-PAYMENTS AND CHECK 21: The Future Color of Money

    1. 1. E-PAYMENTS AND CHECK 21: The Future Color of Money Patricia O’Donnell, Vice President NOVEMBER 2004
    2. 2. This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan. The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. [The information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects.]* Notwithstanding the foregoing (but subject to any applicable federal or state securities laws), JPMorgan and the Company may disclose to any and all persons, without limitation, the tax treatment and tax structure of any transaction contemplated hereby and all materials (including opinions or other tax analyses) relating thereto, so long as such disclosure is not made prior to the earlier of (x) public announcement of discussions relating to the transaction or of the transaction itself and (y) the execution of an agreement to enter into the transaction. JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors. JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by J.P. Morgan Securities Inc. and its banking affiliates. JPMorgan deal team members may be employees of any of the foregoing entities. [*To be used in a presentation not involving an actual or potential change in control]
    3. 3. What is happening in the world of paper payments? <ul><li>“ Ups and downs” </li></ul><ul><li>Increasing ACH volume </li></ul><ul><li>Growth rates at the Federal Reserve </li></ul><ul><li>Rise in card-based payments </li></ul><ul><li>Virtual payment systems </li></ul>
    4. 4. “ Ups and downs” Checks are down and costs are up ACH is up and costs are down <ul><ul><li>The number of checks processed by the Federal Reserve decreased for the fourth consecutive year in 2003. It processed 15.81 billion checks in 2003, a 4.7% decline from 2002.* </li></ul></ul><ul><ul><li>The unit cost to the Fed to process a check in 2003 increased by 13.3%, from 4.5 cents in 2002 to 5.1 cents in 2003. </li></ul></ul><ul><ul><li>The Fed’s commercial ACH volume increased by 12.1% in 2003 to 5.59 billion payments. </li></ul></ul><ul><ul><li>The Fed’s unit cost to process an ACH payment decreased by 15.4%, from 1.3 cents in 2002 to 1.1 cents in 2003. </li></ul></ul>* The 2003 rate of decline was the steepest of the past four years, more than doubling the 2002 rate of decline of 1.9%. Source: NACHA
    5. 5. Increasing ACH volume ACH dollar volume ACH transaction volume Source: NACHA
    6. 6. Growth rates at the Federal Reserve ACH and check growth rates, 1997-2003 Source: NACHA
    7. 7. Rise in card-based payments <ul><ul><li>Payment cards include standard credit cards, debit cards, and stored value cards. </li></ul></ul><ul><ul><ul><li>Credit card payments will increase from 6% of payments in 2003 to 8.9% by 2008. </li></ul></ul></ul><ul><ul><ul><li>Debit card payments will increase from 0.8% to 1.5% during the same time period. </li></ul></ul></ul><ul><ul><ul><li>Legislation requires government benefits payments to be distributed electronically by 2007. </li></ul></ul></ul><ul><ul><ul><ul><li>Child support payments are being disbursed via stored value cards in four or five states, with others quickly adopting. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>48 states, the District of Columbia, the U.S. Virgin Islands and Puerto Rico have online food stamp EBT systems. California is in the process of expanding statewide. </li></ul></ul></ul></ul>Sources: Building Payments into e-Government Initiatives , PayStream Advisors (Fall 2003), Centers for Medicare and Medicaid Services Web site
    8. 8. Virtual payment systems <ul><ul><li>Virtual payment systems include digital cash and electronic wallets. </li></ul></ul><ul><ul><ul><li>Lack of standards and protocol and the inability of governments to track movement of funds have inhibited acceptance of digital cash payments. </li></ul></ul></ul><ul><ul><ul><li>E-wallets, however, are on the rise. Constituents do not like to fill in the same information over and over; e-wallets provide government agencies with a secure storage place for credit card data, owner identification, e-cash, and owner contact information. </li></ul></ul></ul><ul><ul><ul><ul><li>Examples of e-wallets in the private sector include Amazon’s “1- Click”, Microsoft’s .NET Passport and Yahoo! Wallet. </li></ul></ul></ul></ul>Sources: Electronic Payments Primer, National Electronic Commerce Coordinating Council (October 2002)
    9. 9. Multi-channel taxpayer access to government Integrate core remittance processing, e-payment, VRU, and call center competencies Allows full multi-channel access to government services Provides single stream of payment and remittance data
    10. 10. Moving Checks to Electronics <ul><li>Check 21 Overview </li></ul><ul><li>What does Check 21 include? </li></ul><ul><li>Substitute checks: examples, use and acceptance and why </li></ul><ul><li>Electronic check presentment: physical vs. image delivery </li></ul><ul><li>ACH check conversion </li></ul>
    11. 11. Overview <ul><ul><li>On October 28, 2004, the Check Clearing for the 21st Century Act, more commonly known as Check 21, becomes law. </li></ul></ul><ul><ul><li>Check 21 is a bill sponsored by the Federal Reserve Bank and signed into law by President Bush on October 28, 2003. It is also known as the Check Truncation Act. </li></ul></ul><ul><ul><li>This legislation was pursued as a result of the events surrounding September 11, 2001. </li></ul></ul><ul><ul><li>The Fed’s objectives: </li></ul></ul><ul><ul><ul><li>Facilitate check truncation and promote the use of electronics </li></ul></ul></ul><ul><ul><ul><li>Foster innovation without mandating receipt of images </li></ul></ul></ul><ul><ul><ul><li>Improve overall efficiency of the nation’s payments systems </li></ul></ul></ul>
    12. 12. What does Check 21 include? <ul><ul><li>C heck 21 c reates the legal equivalence of the original check and a “substitute check” . </li></ul></ul><ul><ul><li>Designed to encourage check truncation by removing key barriers </li></ul></ul><ul><ul><li>Excluded from legislation: </li></ul></ul><ul><ul><ul><li>Image exchange and ECP </li></ul></ul></ul><ul><ul><ul><li>Check safekeeping products </li></ul></ul></ul><ul><ul><ul><li>Other truncation products </li></ul></ul></ul>
    13. 13. Substitute checks <ul><ul><li>A substitute check is the legal equivalent of the original check for all purposes. </li></ul></ul><ul><ul><ul><li>Contains images of front and back of check </li></ul></ul></ul><ul><ul><ul><li>Conforms to industry standards </li></ul></ul></ul><ul><ul><ul><ul><li>Magnetic ink character recognition (MICR) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Physical characteristics of check </li></ul></ul></ul></ul><ul><ul><ul><li>Accurately and legibly represents original check </li></ul></ul></ul><ul><ul><ul><li>Suitable for automated processing </li></ul></ul></ul><ul><ul><ul><li>Bears image replacement document (IRD) and indemnity legend </li></ul></ul></ul><ul><ul><ul><li>Includes all endorsements, physical and electronic </li></ul></ul></ul><ul><ul><ul><li>Includes identification of creating party </li></ul></ul></ul>
    14. 14. Substitute check example ANS X9.90 specifications for an image replacement document (IRD)
    15. 15. Use and acceptance <ul><ul><li>The use of substitute checks does not require an agreement between parties. </li></ul></ul><ul><ul><ul><li>Any party receiving a substitute check must accept it, including the parties in forward collection process and in returns (unpaid) process. </li></ul></ul></ul><ul><ul><ul><li>All checks may be converted to substitute checks, including consumer and commercial checks, government checks, cashier checks, money orders, traveler’s checks, etc. </li></ul></ul></ul>
    16. 16. Why substitute checks? <ul><ul><li>Primary benefit is faster collection and return of checks. </li></ul></ul><ul><ul><ul><li>Banks could use image technology and print substitute checks closer to receiving banks eliminating transportation. </li></ul></ul></ul><ul><ul><ul><li>Banks could automate retrieval and processing of return items. </li></ul></ul></ul><ul><ul><ul><li>Branch and ATM deposits could be captured and image processed, eliminating transportation. </li></ul></ul></ul><ul><ul><ul><li>Use of substitute checks will allow banks to truncate 100% of transit items. </li></ul></ul></ul>Lockbox Image Substitute Check Paying Bank Bank Check Site Check
    17. 17. Electronic check presentment (ECP) with physical check delivery: today <ul><ul><li>This option facilitates more efficient processing by allowing the paying bank to electronically receive MICR data ahead of the physical checks. </li></ul></ul><ul><ul><ul><li>The paying bank debits their customer accounts on the day of receipt of the MICR file (a day sooner than normal). </li></ul></ul></ul><ul><ul><ul><li>Most banks hold commercial accounts from end-of-day posting and process the paper items the next day. </li></ul></ul></ul><ul><ul><ul><li>Physical items are delivered later, then are available for exception handling (NSF, stop payments, etc.), and may be returned with statements. </li></ul></ul></ul>
    18. 18. ECP with image delivery (image exchange): pilots this year <ul><ul><li>The Clearing House Vanguard Bank participants (eight lead banks) are scheduled to conduct image-based ECP pilots this year. </li></ul></ul><ul><ul><ul><li>Pilot programs will facilitate the same process as current ECP models, but instead of transporting physical checks, participants will exchange images of these items. </li></ul></ul></ul><ul><ul><ul><ul><li>Most banks will continue to exclude commercial items. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Images are available for exception handling (NSF, stop payments, etc.) and for statementing. </li></ul></ul></ul></ul><ul><ul><ul><li>The process will enable next-day (one-day) settlement with depositing banks. </li></ul></ul></ul><ul><ul><ul><li>We anticipate the development of a same-day-settlement image exchange window, but it does not exist today. </li></ul></ul></ul>
    19. 19. ACH check conversion <ul><ul><li>Single-entry ACH debit, consumer checks only </li></ul></ul><ul><ul><ul><li>Check becomes “source document,” no longer a check, but an ACH regulation E transaction </li></ul></ul></ul><ul><ul><ul><li>Accounts receivable conversion (ARC) </li></ul></ul></ul><ul><ul><ul><ul><li>Check payment mailed to biller/lockbox or placed in drop box </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Notice on bill equals authorization </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Check is imaged and destroyed within 14 days; image retained for two years </li></ul></ul></ul></ul><ul><ul><ul><li>Point of purchase (POP) </li></ul></ul></ul><ul><ul><ul><ul><li>Individual presents check at pay window or point of sale </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Authorization required at time of transaction </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Consumer-as-keeper current model </li></ul></ul></ul></ul>
    20. 20. New Collection Alternatives: Low-Value Checks Scenario : Retail lockbox consumer payment for $100 accepted in Phoenix, AZ, retail lockbox site, drawn on Fleet Bank, NY <ul><li>Option 2 ACH check conversion : MICR captured in lockbox, settled via ACH next day </li></ul><ul><li>Option 4 Check 21 : unlikely scenario, as substitute check cost exceeds transportation costs, with no gain in availability </li></ul><ul><li>Option 1 Traditional check clearing : sent via commercial aircraft to clearing intermediary in New York, presented to Fleet next day, or in two days </li></ul><ul><li>Option 3 Image exchange (future) : streamlines banks and eliminates transportation; settled next day </li></ul>ILLUSTRATIVE
    21. 21. New Collection Alternatives: Large-Value Checks Scenario : Wholesale lockbox payment for $10,000,000 accepted in Pasadena, CA and drawn on Fleet Bank, NY <ul><li>Option 3 Image exchange (future) : streamlines banks, eliminates transportation; settled next day. </li></ul><ul><li>Option 1 Traditional check clearing : cash letter sent via contracted courier to intermediary in New York, presented to Fleet for settlement the next day </li></ul><ul><li>Option 2 ACH check conversion : not available for non-consumer items </li></ul><ul><li>Option 4 Check 21 : if check can be captured and transmitted as substitute checks to New York before 8 a.m., same-day settlement to Fleet </li></ul>ILLUSTRATIVE
    22. 22. New Collection Alternatives: Distributed Capture Scenario : Corporate client collecting $250 in-person and drop box payments in numerous locations, consumer and corporate payments Regional Site Branch /Local Depository Groups <ul><li>Option 3 Image exchange (future) : electronically deposit into headquarters </li></ul><ul><li>Option 4 Check 21 : If check cannot be exchanged or converted to ACH, capture at branch and deposit substitute check in concentration bank </li></ul><ul><li>Option 1 Maintain local depository relationships in every market, reconcile branch deposits, forecast cash and concentrate into headquarters </li></ul>ILLUSTRATIVE <ul><li>Option 2 ACH check conversion (POP or ARC) : consumer items (roughly 80 percent of items); no business items </li></ul>Distributed Capture Solution
    23. 23. New Collection Alternatives: Best Fit Analysis Non- image points Large- value checks Expedited clearing <ul><li>Substitute Checks </li></ul><ul><li>For larger value checks if expedited clearing is available, or if transportation costs or delays exceed cost of image handling. </li></ul><ul><li>For distributed-capture checks on non-image exchange banks. </li></ul>Low-value business or consumer payments Distributed capture business or consumer payments <ul><li>Image Exchange and ECP </li></ul><ul><li>Image exchange or ECP applies if expedited clearing is not available. </li></ul><ul><li>Low-value business or consumer payments </li></ul><ul><li>Distributed capture of business or consumer payments </li></ul>Low-value consumer remittance payments Distributed capture of consumer payments <ul><li>ACH Check </li></ul><ul><li>Low value consumer remittance payments via lockbox (ARC) </li></ul><ul><li>Low value consumer remittance payments in person (POP) </li></ul>Cost to Clear Volume
    24. 24. How will these new collection alternatives impact you? <ul><li>Key points </li></ul><ul><li>Items to assess </li></ul><ul><li>Strategic realities </li></ul><ul><li>Impact on collections </li></ul><ul><li>Impact on disbursements </li></ul>
    25. 25. Key points <ul><ul><li>The use of substitute checks does not require an agreement between parties. </li></ul></ul><ul><ul><ul><li>Check 21 and the evolution of other electronic channels (like image exchange) are primarily a back-office change affecting how banks clear and settle items. With electronification, these back-office changes can be extended to you via: </li></ul></ul></ul><ul><ul><ul><ul><li>Image cash letters and deposits </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Distributed capture solutions </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Expedited processing and notification of return items </li></ul></ul></ul></ul><ul><ul><ul><li>Electronification is expected to lower operating costs and expedite funds availability; however: </li></ul></ul></ul><ul><ul><ul><ul><li>Declining check volumes are contributing to rising costs. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>With 80% of items collected in one day, limited improvements in float are available. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The industry is years away from a widely adopted image exchange process. </li></ul></ul></ul></ul>
    26. 26. Items to assess <ul><ul><li>Depository and collections </li></ul></ul><ul><ul><ul><li>Is your internal deposit-gathering process of taxes, fees and licenses (at agencies or at your remittance center) image enabled? </li></ul></ul></ul><ul><ul><ul><li>What volume of exception payments flows through your agency or remote offices that could be expedited via distributed capture solutions? </li></ul></ul></ul><ul><ul><ul><li>What impacts could electronification have on your operations, such as end-of-day extensions, depository account consolidations, agency collections? </li></ul></ul></ul>
    27. 27. Items to assess (cont’d.) <ul><ul><li>Need for original items </li></ul></ul><ul><ul><ul><li>Do you have any requirements to receive and archive original cancelled (paid) checks or drafts? </li></ul></ul></ul><ul><ul><ul><li>Is this requirement based on legislative statue, perceived requirements or operational practices? </li></ul></ul></ul><ul><ul><ul><li>Do you have any needs to process original items on check processing or scanning equipment for additional output? </li></ul></ul></ul><ul><ul><ul><li>Do you require your constituents to produce an original paid check to prove payment of an obligation? </li></ul></ul></ul>
    28. 28. Strategic realities <ul><ul><li>Image exchange is the desired end-state, but is dependent on adoption by thousands of banks. </li></ul></ul><ul><ul><ul><li>Substitute checks may prove to be more expensive than traditional checks, and at current interest rates may prove feasible only for certain transactions: </li></ul></ul></ul><ul><ul><ul><ul><li>Large value with expedited settlement </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Items with transportation delays </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Automation of NSF items </li></ul></ul></ul></ul><ul><ul><ul><li>The Fed’s ultimate objective is to eliminate all float. </li></ul></ul></ul><ul><ul><ul><li>Check volumes are declining, putting more pressure on operating costs and site consolidations. </li></ul></ul></ul><ul><ul><ul><li>Most checks (91%) are under $1,000, and require physical check processing until image exchange is more broadly in place. </li></ul></ul></ul><ul><ul><ul><li>Movement to an all-image environment will take many years. </li></ul></ul></ul>
    29. 29. Impact on collections <ul><ul><li>Use of the following solutions will help optimize the collection of funds. These new clearing options position you to take advantage of this optimization process. </li></ul></ul><ul><ul><ul><li>Image cash letters </li></ul></ul></ul><ul><ul><ul><ul><li>Reduce transportation costs or delays </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Provide later cutoff times for deposits </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Perform image quality testing </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Optimize clearing and settlement </li></ul></ul></ul></ul><ul><ul><ul><li>Distributed capture solutions </li></ul></ul></ul><ul><ul><ul><ul><li>Capture images in remote agency offices </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Create/transmit deposits </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Optimize clearing and settlement </li></ul></ul></ul></ul>
    30. 30. Impact on collections (cont’d.) <ul><ul><li>Enhancements to wholesale and retail lockbox services </li></ul></ul><ul><ul><ul><li>Ability to expedite the clearing of items and pursue the optimal clearing channel, utilizing tools and methods discussed in the depository services section </li></ul></ul></ul><ul><ul><ul><li>Extension of end-of-day processing windows </li></ul></ul></ul><ul><ul><ul><li>Enhanced distributed capture solutions to also support integration of remittance data for Accounts Receivable posting </li></ul></ul></ul><ul><ul><ul><li>Faster notification of return items, including integration of original remittance data and return item images </li></ul></ul></ul>
    31. 31. Impact on disbursements <ul><ul><li>Expedited settlement of collection items impacts core disbursement products by reducing disbursement float. </li></ul></ul><ul><ul><ul><li>Controlled disbursement and warrant endpoints will be the likely targets for substitute checks attempting to reach same-day-settlement windows or high dollar group sort cutoffs for large value checks. </li></ul></ul></ul><ul><ul><ul><li>Most ECP and image exchanges will likely exclude controlled disbursement routing numbers (initially) and government routing numbers used for warrant processing. </li></ul></ul></ul><ul><ul><ul><li>Your provider should be prepared to support the seamless integration of substitute checks into its disbursement product set. The disbursement product set should be completely image-enabled with online and PC-based archival and reporting tools: </li></ul></ul></ul><ul><ul><ul><ul><li>Ability to view and print historical items from the archive or current-day exception items </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Allow customer service staff to access the image archive </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Archival via online services and CD-ROM </li></ul></ul></ul></ul>