Now that the House and Senate have approved separate check truncation bills-and a conference committee is negotiating the final details-it's all but certain that the long-awaited check truncation legislation will soon become law.
The law is likely to be a watershed event-on par with the introduction of MICR (magnetic ink character recognition) and the development of the Automated Clearing House (ACH)-because it will give a full processable copy of a check the same legal status as an original draft. This will result in unprecedented new opportunities to streamline operations and reduce costs.
For financial institutions, the full savings will occur in a two-stage process. Here's what's likely to occur:
Once the bill becomes law, many collecting institutions are likely to start sending substitute paper drafts to the paying institution. The legislation will still require the paying institution to handle the paper-based substitute drafts, which will have the same legal status as the original. The major difference is that collecting institutions can transmit an electronic image of a draft to a location close to the paying institution, avoiding the time and handling expense currently involved in collecting original items. By law, the substitute draft will be required to contain an exact reproduction of the front and back of the original draft, complete with MICR line and all of its routing data. If you doubt the efficiency of transmitting a copy of a check across the country, reprinting it and presenting it for payment, think about the ease with which contracts are completed by fax and electronic mail.
The truly significant changes and cost savings will occur over the next few years, when paying institutions realize that even greater costs savings are possible by agreeing to accept a digital image of the original draft and eliminating the paper substitute altogether.
Credit Unions Will Benefit First
Initially, credit unions are likely to be the biggest initial beneficiaries from digital image technology because the industry's business practices have evolved differently than those of commercial banks. Because most credit union members deposit very few papers checks, the credit unions themselves don't have large investments in check processing equipment and thus have less to lose by switching to digital image technology. The switching costs are far lower for credit unions than those of large commercial banks.
On the other hand, money-center banks and other large processing institutions, which collect millions of items a day, face a significant investment to convert existing check handling operations to large-scale digital image processing. The critical issue for those institutions is whether expense reduction in presenting original items in digital form can justify their large initial investments.
Credit unions, on the other hand, can reap a disproportionate benefit from digital image truncation by simply adapting their existing systems to receive images from the larger institutions, like the Federal Reserve, which already converts images. Moreover, because credit unions rarely return drafts in member statements, there will be far less member resistance to eliminating physical checks or receiving printed copies of digital images. For many banks, which still return checks, it will take longer to educate customers away from receiving original items.
By processing digital images of drafts electronically, credit unions can begin phasing out sorting equipment (or sorting charges from their processors)-a major goal for operations executives for decades. Sorters are expensive to run and maintain, and most processors typically purchase the machines in pairs to provide fail-safe redundancy. In contrast, digital image transfers eliminate the need to run incoming drafts through sorters.
Member Benefits Abound
For credit union members, the proposed legislation transfers the burden of record-keeping to the paying institution. The law would enable members to obtain copies from their credit union directly. In fact, the legislation is likely to accelerate the process by which financial institutions post electronic copies of paid items on websites, where they can be easily and securely accessed by consumers.
The result is that members-as well as institutions-will be able to resolve payments disputes much faster because the images of original items will be easier to retrieve.
Another big benefit of digital image transfer is that it can reduce the likelihood of fraud. A paper draft is much more vulnerable to fraud than an electronic transaction flowing through a secure network. As more institutions move to electronic images of drafts, the ability of fraudsters to work their mischief on paper documents diminishes significantly.
All of these benefits, as well as unforeseen others that will emerge over time, mean that credit unions ready to seize the day will have a historic opportunity to remake their business and improve service to members.
Gerard F. Milano is Chief Executive Officer of the Western Payments Alliance, a regional payments organization serving more than 1,000 financial institutions, including 600 credit unions. Mr. Milano can be reached at 415-433-1230 or gmilano wespay.org.
