Rapid Changes in the U.S. Payment System

Preparing Your Organization to Respond

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The Check Clearing for the 21st Century Act

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The Check Clearing for the 21st Century Act

For Immediate ReleaseOffice of the Press Secretary

October 28, 2003

Statement on H.R. 1474 Statement by the President

Today I have signed into law H.R. 1474, the "Check Clearing for the 21st Century Act." This Act is intended to update and modernize the Nation's check payment and collection systems. Section 16(b) of the Act purports to require executive branch officials to submit to the Congress recommendations for legislative action. The executive branch shall construe section 16(b) in a manner consistent with the President's authority under the Recommendations Clause of the Constitution to submit for the consideration of the Congress such measures as the President shall judge necessary or expedient.

GEORGE W. BUSH

THE WHITE HOUSE,

October 28, 2003.

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The Check Clearing for the 21st Century Act

• Legislation’s Origin– Proposed by the Federal Reserve as new federal law

• Fed’s Objectives– To facilitate check truncation (the practice of holding a paper check at

the bank of first deposit or at an intermediary bank and electronically forwarding the essential information on the check to the bank on which it was written. A truncated check is not returned to the writer).

– To foster innovation in check collection systems without mandating receipt of checks in electronic format

– To improve the overall efficiency of the nation’s payments systems

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The Check Clearing for the 21st Century Act

• What Does Check 21 Really Do?

– Creates a new negotiable instrument called a Substitute Check document

– Substitute check documents facilitate full check truncation throughout the U.S.

– Prior to Check 21, only original checks could be presented for settlement to paying banks

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Check Collection

Paying BankBOFD

Intermediary

Paying BankBOFD

Substitute Check or Image

Substitute Check Collection

ImageCheck

Intermediary

Traditional Paper Collection

Check Check Check

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Return Item Processing

PAYING BANKBOFDRETREIVE CHECKS

Traditional Paper Return

Return Check Return Check

PRINT Sub CkPAYING BANKBOFD

CUSTOMER Return Substitute Check or Image

IMAGE

Substitute Check Returns

Return Substitute Check or Image

CUSTOMER

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Remote Depositing

BOFD

ATM

Transit Items

Traditional Paper Collection

BOFD

ATM

Substitute Check or Image

Substitute Check Collection with Branch Capture

Image

Check

Check Check

Branch

Branch

Transit Items

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Substitute Checks

• Designed to be processed exactly as if it were the original paper check

• Substitute Check is legal equivalent of original check for all purposes

– Contains image of front and back of check– Conforms to industry standards

• MICR• Physical characteristics of check

– Suitable for automated processing– Must accurately represent all information on original check– Bears legend– Includes all endorsements– Includes identification of party creating it

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Sample Substitute Check

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Eligibility

• ALL CHECKS are eligible for replacement with Substitute Checks, for example:

– Retail checks– Non retail checks– Government warrants– Treasury checks– Money orders– Controlled disbursement– Payable through drafts– Etc.

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Check 21 Myths

• Myth– Check 21 validates the exchange of check images

• Reality – Check 21 does not address exchanges under agreement such as

ECP or image exchanges

• Confusion– Check 21 is dependent on the use of image technology for Substitute

Check Documents but does not cover image exchanges between banks or their customers

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Check 21 – The Reality

• Designed to encourage check truncation by removing key barrier to truncation

– Allows unilateral decisions to truncate checks• Unlike current environment with requirement to obtain agreements from all the parties

– Provides for the replacement of a paper check with a substitute paper check

• For those customers that have not agreed to check truncation or electronic check files

• Does not mandate the receipt of electronic transactions

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Check 21 Considerations

• Bank’s can no longer guarantee check writers will receive their original paper checks back, substitute checks will be provided where the original check was truncated at another Bank through the clearing process

• Checks will likely clear faster, raising the risk that more checks will be returned

• Standard paper check stock security features may be rendered ineffective as checks are imaged and substitute checks created

• If a check is truncated, only a substitute check will be the legal equivalent of the original check to prove payment - not a photocopy

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Check 21 Considerations

• Cash Management Services Affected by Check 21:

– On-line check image viewing (truncated business check will be reduced to 67% of it’s original size on the substitute check)

– Controlled disbursement and check clearing patterns will change as banks move toward clearing checks via image exchange and electronic settlement

• With end-to-end electronic image check clearing and settlement, checks could clear on a same-day basis in the future

– Payee positive pay services (payee name will not be located in same position on substitute check as the original)

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Check 21 Considerations

• Customer Impact on 10/28/2004– Original checks may not be returned– Online images may include substitute checks– Float may decrease because checks may clear faster

• Customer Impact When Bank is Image Enabled– Original checks most likely will not be returned– Online images will include substitute checks– Float will decrease because checks will clear faster– Remote Image Deposit will be available

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Sample Substitute Check

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Payment System Fraud

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Payment System Fraud

• Check Fraud– $1.2 million in fraudulent checks enter the payment system everyday

– Annual check fraud losses according to the Nielson Report:• $20 billion in 2003

• $12 billion in 1996

• $5 billion in 1993

– The American Bankers Association reports fraud losses are increasing 25% per year

– Recent Uniform Commercial Code changes now have banks and their customers sharing responsibility for losses

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Payment System Fraud

• Check Fraud Loss Prevention Strategies– Understand your liability

• Read your bank contracts

– Use Positive Pay services

– Use ACH and paper filter/block services

– Utilize paper check stock rich with security features (8 or more) - avoid using blank laser check stock

– Make large dollar payments electronically with trading partners

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Payment System Fraud

• Check Fraud Loss Prevention Strategies– Migrate as many payments from paper check to ACH, Wires and

Cards as appropriate

– Utilize online banking services to review account activity daily

– Reconcile accounts promptly

– Secure and control your check stock

– Avoid including corporate officers signatures on annual reports and other public documents

– Don’t disclose your account number(s) on credit applications - provide your bank account officer’s contact information

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Where Can Your Organization Find Help?

UMB Bank: www.umb.comThe Mid-America Payment Exchange:

www.mpx.orgElectronic Checks (ACH): www.electronic-check.org

Check 21 : www.eccho.org www.epaynews.com

Fraud: www.FraudTips.net www.safechecks.com/bulletin.pdf

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QUESTIONS?

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THANK YOU