In the race to meet the deadline for the Check Clearing for the 21st Century Act, some financial institutions are closer to the finish line than others. For them, Check 21 offers an opportunity to innovate and improve processes. For others, the Oct. 28 Check 21 deadline looms as a reminder of how far they still have to go to comply.
As with any change, there are obstacles to overcome. For banks preparing for an electronic checking environment, these obstacles include sufficient image quality, the threat of fraud and the need to gain customer acceptance. Concerns about these issues have grown as the Check 21 deadline approaches, and the debate over the pros and cons of image replacement documents (IRDs) has gotten louder.
"There are good factors about them and bad factors," according to Robert Hunt, an analyst with Needham, Mass.-based TowerGroup. "The best thing is that [Check 21] allows banks to create images for presentment. It allows for a transition without forcing banks to change technology." They can simply utilize technology in which they have already invested, like scanners and printers, to create substitute checks.
"The bad point," Hunt continues, "is that the ultimate system is still electronic. It complicates the process because there are now three ways to present the check." With the availability of the original paper check, the IRD and now the electronic presentment of checks online, banks must ensure that their systems can handle each transaction type. And, in addition to the fact that not all banks will be ready by the October deadline, the processing costs of IRDs are still unknown, Hunt adds.
Quality Is Job One
The No. 1 concern of many banks is the quality of image replacement documents. Low-quality IRDs can be disastrous - they can prevent checks from clearing and can damage customer satisfaction. For banks that will adopt the use of image exchange, the quality of IRDs is critical.
First Tennessee Bank (Memphis, $23 billion in assets) is among the institutions that are ready for Check 21, according to Taylor Vaughn, the bank's senior vice president and manager of the treasury department. In the top 20 percent of the industry in terms of Check 21 preparedness, First Tennessee is not only ready to print substitute checks; it is set to exchange images with participating banks by the October deadline, says Vaughn, who adds that the bank is concerned about how image quality will impact check processing.
"We are concerned with image quality because, if we receive a bad image, we are going to have to pass that on to our customer in an image statement," he says. "Or, if we print an IRD, the IRD wouldn't be of sufficient quality to cut the mustard for clearing that check." Printing a poor-quality image, or exchanging that image, can cause problems with the availability of funds, Vaughn continues. "There are liability concerns with being able to negotiate that check if the image of it is not good."
If a bank creates a poor-quality IRD, for example, the MICR line may not be recognizable. This can increase the cost of check processing, instead of reducing it, as Check 21 intended, according to Vaughn.
Climbing the Learning Curve
There are several problematic scenarios that can develop during the image process, Vaughn notes, including human error. For example, an employee can send an image file twice, mistakenly thinking that the first attempt did not go through. "There are operational errors that can happen along the way that we are going to have to get used to managing," he points out. "There are going to be new and different operational errors from what we are already doing."
Though Vaughn acknowledges that the potential for errors exists in the current paper-based processing of checks, he says that banks need to be particularly diligent in monitoring the electronic truncation of checks because the image process for substitute checks is still fairly new to bank employees. "There are certainly errors that can already happen in the paper world," he says. "But we are going to have to be diligent in monitoring, identifying and correcting these problems as they occur" in the new electronic environment.
While Check 21 requires financial institutions only to print and accept substitute checks, it does not require them to invest in technology to embrace an electronic world. Still, Vaughn suggests, banks can prevent image problems by investing in the right technology. "Being able to do the capturing of images is important," he says. "How good your devices are to capture these images dictates the quality of that image."
Banks have to invest in proper recognition technology and technology that assures proper transmission capabilities, Vaughn explains. In addition, because check images consume more file space, banks must ensure that their infrastructures are capable of handling the larger file volume.
According to Andrea Klein, vice president, financial services industry market, Oracle (Redwood Shores, Calif.), one way to address the storage volume issue is to store data and images in one place. "It cuts down on the storage that they need," she says. It also saves time by eliminating the need to search twice for a single piece of information. Banks "are storing it together, so the net amount of storage is going to be less and retrieval time is less," Klein asserts.
Already a major concern in the financial services industry, the threat of fraud is heightened in an electronic environment. There is no shortage of counterfeiters willing to create fraudulent checks, and there will be criminals interested in creating fake substitute checks, notes Paul Obermeyer, senior vice president, manager of operations group, Comerica Bank (Detroit, $55 billion in assets).
By paying close attention to the image quality of the original check, the ability to protect the integrity of substitute checks and images to be exchanged can be improved, Obermeyer says. Transitioning the image capturing and IRD process deliberately and efficiently will allow financial institutions to worry less about the risk of fraud, he adds.
"In any change there is risk," Obermeyer says. "We have to be extremely vigilant for potential new opportunities for attack. We should be able to detect those new threats and respond accordingly."
One way to detect those threats is to closely monitor check activity and customers' behavior patterns. "We have the systems in place today to detect counterfeit," Obermeyer says. "They are not based upon the visual review of that item, but they are based upon parameters that we use to monitor the nature of the account activity. We monitor the typical patterns that a customer uses with regard to their checking account: what kinds of items they write, what frequency do they write them with and what amounts do they write them for. We also pay attention to the sequence number of their checks."
Banks must also be aware of the threats of identity theft and counterfeiting that a customer's electronic signature can pose, according to Obermeyer. "As an industry, we need to look at the digital signing of check images at the individual check image level to be sure that when an image is introduced into that network that it is in fact the image that was originally captured and that image has not been altered at any point in the image capture stream," he says.
The process of image exchange, Obermeyer adds, also creates an opportunity for fraud. "I think that is a potential vulnerability that we have as we adopt electronic means of exchange," he relates. "We as an industry should adopt standards around that and ensure for our customers that by migrating to the electronic exchange network, we are not exposing any more privacy risks that we don't currently have today. We probably will reduce risks if we do it right."