Two financial companies have defied conventional wisdom by establishing a direct connection for exchanging check images with each other, and others are planning to follow suit.
Most of the image-related momentum in the banking industry to date has been toward joining exchange networks. And one of the fundamental tenets of the exchange model is that it is impractical for every bank to establish direct connections with every other bank.
Frost Bank of San Antonio and Southwest Corporate Federal Credit Union of Dallas agree that it would be unwieldy to create a link with every bank to which they send transit items, but they say there is a strong business case for their private connection, which went live Aug. 5.
David Rahtke, the senior vice president for float management at Frost, a unit of Cullen/Frost Bankers Inc., said the direct link makes it essentially free to send image files to Southwest Corporate, and that it makes no sense to pay a network to deliver the 2 million checks they exchange every month.
"The business case just isn't there," he said.
Both companies have signed up with image networks to send items to other banks. Southwest Corporate is a member of Endpoint Exchange, the Oklahoma City network operated by Marshall & Ilsley Corp.'s Metavante Corp. Frost said this week that it is planning to exchange files through Viewpointe Archive Services LLC, the large shared archive used by some of the country's biggest banking companies.
Mr. Rahtke said he considered using Endpoint to exchange files with Southwest Corporate, but at a cost of about 2 cents a check, "it doesn't take long to get to where that doesn't make any sense." Frost is still considering joining Endpoint to transmit items to other banks.
Alenka Grealish, who manages the banking group at the Boston market research firm Celent Communications LLC, said the Frost-Southwest Corporate model makes sense. The two partners are exchanging a significant number of checks with each other, so "per-unit, it is cost-effective to have a direct connection," she said. "Why pay an intermediary if you don't need one?"
Ms. Grealish said that she has heard of other banks mulling the idea, and that the economics that appealed to Frost and Southwest Corporate could be just as appealing to other companies.
Brad Ganey, the director of item-processing services at Southwest Corporate, agreed that the model could make sense for others.
"If people have tremendous volume between each other, I think you'll see more direct connections," he said.
He also said his company might establish direct links to some other banks or credit unions. "This is the only relationship like this that we have now, but I definitely wouldn't close the door to doing more."
But Mr. Ganey also said that the model would not work on a large scale. It could be useful to have a few direct connections, but they would not be a substitute for using an image exchange network to reach banks to which he sends a small number of items, he said.
Jeff Vetterick, the general manager of Endpoint Exchange, says he does not view the emergence of direct connections as competition for this network. In fact, he said, he has been expecting them and even built them into his models for anticipated volume growth.
Endpoint has 2,500 members transmitting images across its network, Mr. Vetterick said; 800 more members are testing the system, and 1,200 that are establishing connections to it. About 6 million images flow across the network every month.
"There is room in the market for a bank to have a few pipelines to a few trading partners," he said. "It just makes sense."
Mr. Rahtke said it took about two months to set up the connection with Southwest Corporate; the files are sent across the Internet using a standard file transfer protocol. Frost has three item-processing centers. Its San Antonio site began sharing files with Southwest last week. The Dallas site began doing so Tuesday, and its Houston center started Wednesday.
The two companies each send four to five batches of checks a day, and it takes about 30 to 60 minutes to prepare and transmit each batch.
Mr. Ganey said the relationship was easy to set up, in part because both companies already use the same Dallas clearing house, the National Clearing House Association. In addition, both Frost and Southwest Corporate have been certified with the Federal Reserve banks to prepare image files using the industry-standard X9.37 format.
"This was about as painless a process as we've been through," he said. Southwest Corporate is using xVision software from Metavante's Advanced Financial Solutions Inc. to send and receive the files. Sam Kim, a spokeswoman for Metavante, said the software was designed to support direct connections between banks. Some customers have discussed setting up their own direct image links with some trading partners, she said. "Two very large banks are planning to do so, but I can't say who."
In some ways, the direct-connection model is reminiscent of earlier check-clearing approaches. Banks have long used direct presentment - physically delivering checks to their trading partners' doorsteps. Bob Hunt, a senior analyst for TowerGroup, the Needham, Mass., market research unit of MasterCard International, said that an electronic connection is simply a 21st-century version of that old system.
In fact, many banks are already familiar with electronic direct connections. Ms. Grealish said that one of the predecessors to image exchange networks was electronic check presentment, in which banks would transmit a digital summary of the checks they were sending to a trading partner, so the recipient could begin processing the checks while they were in transit.
Though many of these connections are still in place, they cannot be used for sending image files, so many banks that have used those connections are signing up with exchange networks, she said.
Taylor Vaughan, the senior vice president for treasury management at First Horizon National Corp. of Memphis, said it has evaluated the idea of direct connections, but decided against using them. First Horizon and SunTrust Banks Inc. were the first companies to settle checks through Viewpointe's image archive.
Mr. Vaughan said he cannot justify the cost of setting up a connection with a local bank, "because our transit costs are so cheap." Nor would it make sense to set up a link with any of the major banks that are already Viewpointe members, "because our communications link with Viewpointe has already been set up."
In fact, the direct model is inherently impractical when compared to the network model, he said. "I'm exchanging with hundreds of banks. Do I now have to connect directly to hundreds of banks? Ouch."
