First Tennessee system aims to keep a lid on bounced checks.

ONE BANKER'S nightmare can be another's opportunity.

A check processing operation, for example, is a costly necessity at most banks. Worse still, the processing of return items can be a detailed, labor-intensive burden, worsened by the bite of the Federal Reserve's Regulation CC.

By tightening requirements for return item delivery, the introduction of Reg CC in 1988 turned those items into a financial time bomb, which would detonate if the checks were not returned properly within two to four days.

Despite these logistical difficulties, First Tennessee Bank has developed a national business in item processing, competing directly with the Federal Reserve.

In addition, the Memphis-based bank, with $9 billion in assets, is the Fed's only national competitor in return item processing, according to John G. Holmes, vice president and manager of document processing services at First Tennessee.

First Tennessee began its nationwide check clearing service, called First Express, in 1981, when the Federal Reserve started charging presentment fees for its check clearing service. The bank, which already did check clearing for others as a correspondent bank, teamed with Federal Express and other couriers to offer its own nationwide overnight check clearance.

Today, the bank clears more than one million checks daily between midnight and 3 a.m., sorting them down to the level of individual institutions. Mr. Holmes said the key to competing with the Fed, as well as regional rivals, is presenting the checks for early-morning clearing deadlines.

When Reg CC went into effect, First Tennessee decided to compete for the return item business as well. Now it processes about 12,000 return items a day. The bank handles the physical processing, including identifying the destination of each check. First Tennessee also assumes the financial risk of clearing the checks by Fed deadlines.

First Express offers different service options for different customers. A utility, for example, might ask First Tennessee to automatically try redepositing all bounced checks from its customers the next day.

According to Mr. Holmes, First Tennessee ranks among the top 70 banks in the nation in assets, but is among the top five in check processing. The others, he added, are money-center banks that handle large volumes on a purely regional basis.

The bank recently contributed to the development of new software that will improve the speed and accuracy of its return item processing. First Tennessee also is planning for its leap into image processing of checks.

For the time being, though, First Tennessee is focusing on return item processing. Less than 0.5% of all checks are returned, according to Mr. Holmes. But handling them, "normally costs 10 times per item what a normal check does. And it carries the most risk because of the deadlines."

The bank hopes its new software, called RIPS, for Return Item Processing System, will change that. Earnings Performance Group of Short Hills, N.J., which wrote RIPS, hopes other big banks agree and plug RIPS in as well. Then image processing will be next in line.

With its item processing business at stake, the bank was interested in developing a system that would standardize its approach, help it manage work-flow, cut costs, and speed up transactions.

"We felt that by helping EPG develop the product we could influence them to meet some of the requirements that we had, and at the same time allow them to develop a product that would offer advantages to other banks," said Mr. Holmes.

After employees from EPG and First Tennessee determined what the software package needed to do, EPG wrote the code to put it into practice. First Tennessee then became the test site for the new package.

Within seven months of the 1992 decision, RIPS was operational at the Memphis data center. The bank's other data center, in Knoxville, is scheduled to be on-line by the end of the year.

RIPS took advantage of the International Business Machines Corp. check processing equipment the bank already had, integrating that equipment with the return item processing application. The benefits of the system are many, according to Mr. Holmes. It integrates the hardware, software, and processes of three previous systems, cuts manual operations and costs, increases productivity, and is easier to maintain.

RIPS also is a management tool for First Tennessee. Mr. Holmes said the information used helps the bank measure the productivity of each employee, predict what days are likely to have a high volume and staff accordingly, analyze the fees charged to customers, and analyze which customers make which kinds of decisions about handling their return items.

The system also assists the bank in detecting kiting suspects, seeing which kinds of work take the most time, and picking out business customers that have the most problems with returns.

Neither First Tennessee nor EPG would comment on the costs or potential savings associated with the system. However, Joseph H. Halpin, EPG's chief executive officer, said installing RIPS will typically cost $200,000 to $250,000, and take six to nine months. Banks must handle about 10,000 return items a day to be likely clients, he estimated, but those that install the system could earn back the licensing fee in nine to 18 months.

In addition, RIPS positions First Express for the next step, image processing. "Standardizing our return item processing, consolidating our redundancy, reducing expenses and increasing productivity all was a stepping stone to image technology," Holmes said. "This is phase one."

In the world of check processing, image technology does not necessarily mean machines reading handwritten numbers. Simply having machines capture a picture of the front and back of checks, at very high speed, would allow employees to later call up items quickly and looked at them on screen, or even send images of checks to customers instead of the actual item.

"There is not an image system yet, as we see it, that will pick up productivity in balancing electronically. But ultimately, we will present images of checks," Mr. Holmes said.

The change is happening at this time because there are imaging systems now that can handle the tremendous volumes required for check processing. With earlier versions "some checks were burned up in transport," Mr. Halpin said.

The machines are also getting higher scores in reading handwritten numbers, which will mean additional applications. Robert Lauster, a principal with EPG, says IBM told one customer its machines are now reading 70% of the numbers presented. "Fifty percent is not good enough to justify some applications, but 70% would be," Mr. Lauster said.

First Tennessee clearly has its eye on other applications. "Check processing is a key strategic product. A lot of the products we plan, and already have, extend off our capabilities from the overnight check clearing product," Mr. Holmes said.

Mr. Halpin also can see opportunity in potentially troublesome situations -- if electronic transactions ever replace the ubiquitous paper checks, for instance.

"You still need a system to manage the return process, and our system will do that," Mr. Halpin said. "And we're working on exchanging images among banks."

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