Although the largest U.S. banks have aggressively outsourced the processing of credit card and electronic bill payment transactions, almost all of these banks process checks in-house. With check volume declining and new technologies introduced to electronify the processing of checks, TowerGroup believes that banks should reexamine their transaction processing strategy and consider outsourcing some or all of their back-office check processing functions.
The increased acceptance of electronic payments such as debit cards, ACH direct deposits, and electronic bill payments resulted in U.S. check origination volume peaking in 1999 to 2000 at approximately 43 billion transactions. The actual banking industry capacity for processing checks is much higher, however, as banks typically must repass many of their transit items to sort the checks by cash letter destination.
TowerGroup estimates reflect the fact that check origination volume is now declining at an annual rate of 3 percent. Furthermore, the actual volume of checks processed by banks is declining at a greater rate due to the electronification of checks. Specifically, NACHA's point-of-purchase check truncation and account receivables check truncation initiatives are electronifying checks before they are deposited at a banking institution. Thus, despite an overall 3 percent drop in check origination, many banks are experiencing year-over-year declines in excess of 5 percent in check processing volume.
The implementation of Check 21 will significantly increase check processing overcapacity. Banks will replace the physical sorting of checks (by transit number) for presentment with digital sorting of the captured images. These images can then be forward presented for conversion to substitute checks or, if the paying bank has agreed to accept electronic presentment, they can be presented as images. TowerGroup estimates that this use of images for presentment will further increase check processing capacity by 20 to 30 percent over the next five years, resulting in an industry processing overcapacity approaching 50 percent. Clearly, banks will be able to scale back personnel as the processing requirements decline, but the facilities and equipment infrastructure costs will prevent them from realizing the full costs savings potential of image technology and Check 21 legislation.
Check 21:The Uncertain Path
The passage of Check 21 does not provide a clear path for banks to implement check truncation. The Act does not mandate the truncation of checks but allows depositing banks the option of truncating the physical check by creating an electronic "substitute check" for presentment to the paying bank. Under the legislation, the depositing bank or its agent can create a file with substitute images of the paper checks, transmit the file to a site near the paying bank, print the substitute documents, and deliver them to the paying bank. The legislation, then, allows depositary banks to truncate the physical check but maintains the ability of the paying bank to process the checks using existing equipment and paper-based processes. Banks, however, may mutually agree to accept electronic check presentments for some or all of their checks without requiring the substitute paper document (using check images for exception handling).
The requirement for presentation of a paper-based substitute document was clearly intended to provide smaller banks with the option of avoiding upgrading their equipment and software for processing electronic check presentments and image files. Many banks, however, are expected to agree to the electronic presentment of checks without requiring the physical production of a substitute check. This total elimination of paper-based processes is clearly the most efficient means of truncating and processing check-originated payments. TowerGroup believes that a gradual shift to full electronic check presentment will occur over a period of several years. In the meantime, banks will be presenting a combination of actual checks, printed substitute documents, and electronic files. These multiple modes of presentment will result in a shifting of equipment and processing requirements during the transition period, adding to the costs of in-house processing during this timeframe.