When Hank Farrar became a champion of check "electronification"-a term used to describe various interim steps in the migration from checks to electronic payments, like check imaging and electronic check presentment (ECP)-he thought it would be a good idea if electronic check initiatives could be wired into ATM networks. After all, checks, like most ATM transactions, are debits against demand deposit accounts (DDAs) at financial institutions. And many of the same financial institutions that hold ownership positions in the major ATM networks are also members of the New York Clearing House, the nation's oldest check clearinghouse and Farrar's employer at the time. But conventional wisdom in the payments business has been that the systems that drive ATMs (a retail banking operation) cannot be linked in a real-time fashion with check processing (a wholesale bank operation).
Farrar was skeptical, and he wasn't alone. It's a tenet of banking that many in retailing-where bad check losses top $10 billion a year-have questioned as well. After all, plenty of retailers accept debit cards at the point of sale, effecting debits to customers' DDAs. Why not provide the same connectivity for check services so retailers can have a better handle on the negotiability of checks that are being tendered at the point of sale?
To be sure, some bank and check services companies have tried to bridge the information gaps between POS debit and check acceptance systems. Primary Payment Systems, launched by the STAR ATM/POS network in 1993 and now owned by a group of banks and networks, operates a database of account numbers and status information for more than 100 million checking accounts at in excess of 100 financial institutions operating across more than 40 states, including most of the biggest banks in the country. Both banks and check authorization firms use the PPS database to ferret out potential bad checks-those that are drawn on closed or dormant checking accounts. But the service offers merely a historical perspective-participating banks transmit updates of account status information to the PPS database just once a day.
So, two years ago when Farrar was named president and chief operating officer of Small Value Payments Co. (SVPCo), a limited liability company that is owned by the New York Clearing House and 22 of the nation's largest banks, he set his staff of programmers to the task of figuring out how the company's electronic check programs could be connected into bank ATM networks and gain real-time access to DDA information.
Then Farrar did something else that was a bit unorthodox for a check clearing house: he invited International Check Services (ICS), a Riverdale, NJ, firm that offers check authorization, guarantee and POS truncation services, to help test and perfect the fix his programmers came up with.
The result is SafeCheck, an initiative sponsored by SVPCo and 11 of its member banks that lets retailers verify online and in real-time from the point of sale that checks are legitimately drawn on accounts containing sufficient funds to cover the transactions. "From both a risk and efficiency standpoint, this is a quantum leap in the payments arena," says Chris O'Hara, president and chief operating officer of ICS.
During the first three days of the test this summer, which involved ICS merchant customers in New Jersey accepting checks drawn on First Union Corp., O'Hara says ICS verified $700,000 a day in checks through SafeCheck. It was able to discover that 1% of those checks were drawn on closed accounts, another 1% were totally bogus (i.e., the accounts were non- existent) and 2% were written on accounts with insufficient funds at the time of payment. "This clearly indicates that a significant savings opportunity exists for merchants" with this service, says O'Hara.
Farrar, meanwhile, sees SafeCheck generating new revenue opportunities for banks and the ATM networks they own. While the details of SafeCheck pricing have not been worked out, Farrar says the fees will be split amongst network operators, SVPCo and the banks that provide access to DDA systems. Two ideas that are under consideration: a transaction fee plus a percentage of the face value of the transaction (akin to the pricing on credit card transactions); and a simple flat fee-about 26 cents a transaction is mentioned as a possibility. The fees would be paid by merchants using the service, and eventually could supplant the per item fees they pay now to check authorization companies and the banks that process check deposits.
"We need critical mass and penetration first," Farrar says.
As of August two banks-First Union and BB&T Corp., a Winston-Salem, NC- based company with banks in seven states and the District of Columbia-had committed to work with SafeCheck, as well as three ATM networks-NYCE, in the Northeast, PULSE, in the Southwest, and STAR, with operations from Florida to California. Farrar says SafeCheck is now being used to verify about 100,000 checks a month.
Check verification, however, is only the first step in what Farrar, O'Hara and others see as a huge step toward eliminating the paper shuffles inherent in check payments.
"Eventually, we see the check becoming a disposable debit card," Farrar says. "This is a tremendous breakthrough and will eventually change the nature of check transactions at the point of sale."
Translation: real-time, online debiting of consumer checking accounts at the point of sale.
Farrar sees this as a superior offering to automated clearinghouse (ACH) initiatives that convert POS checks to ACH debits. POS check conversion, as that process is known, takes two days to complete: a check converted at an ACH debit today does not result in good funds being credited to the merchant's account until two business days later. That's a lot faster than the paper check clearing process, which can take a week or more to complete, but not as fast as online debiting.
Several companies, including BankServ Inc. of San Francisco, TeleCheck Services, the check services unit of Atlanta-based First Data Corp., and E- Funds Corp., the recent e-payments spin-off of Deluxe Corp., have made substantial inroads with POS check conversion. At least 50,000 merchants (mostly Mom and Pop operations) have subscribed to ACH-based conversion services from these three companies. And in June, BankServ announced that its service had been selected for testing by Price Chopper, Schenectedy, NY. With 97 stores spanning six Northeastern states, Price Chopper becomes the largest retail chain to date to use a POS check conversion service. (See related story, on check conversion provider BankServ, page 43 of this section "Building An Internet Payments Platform")
In addition to speed, Farrar believes SafeCheck will have a pricing advantage over ACH-based check conversion services. In the ACH world, he notes, both the originating and receiving banks are assessed transaction fee. While the bank originating a debit may not mind paying a fee on a transaction initiated on behalf of its merchant customer, a check writer's bank is paying the same fee and losing access to customer funds more quickly than if the check was processed as a paper item. The SafeCheck model has fees flowing to the check writer's bank as compensation for making its DDA system available to the service. "The price incentive makes it much more attractive for banks to participate," Farrar says.
For merchants, the value of SafeCheck isn't just that the service offers an online link to bank DDA systems. O'Hara of ICS says companies such as his can add value to the service by performing the advanced mathematical routines that form the basis of check authorization and guarantee services. For example, many merchants, especially grocers, are accustomed to accepting checks from so-called "pre-pay day shoppers," who may not have sufficient funds on deposit at the moment a check is written but are counting on the fact that their paycheck will be deposited before the check is presented for payment.
"In about 1 to 2% of cases we see, the check writers are counting on float," O'Hara explains. "And in about 75% of those cases, the funds are available within 24 to 72 hours." Many merchants don't want to turn away those customers, but they want to make sure that the odds favor those customers' checks eventually clearing, he notes. Combining SafeCheck with traditional check authorization services helps on that count by allowing merchants to delay presentment.
It's a good deal for bankers as well as merchants. "The beauty of this service is that it serves all markets better," O'Hara says.