Bankers are understandably wary of new regulations, especially those that alter the dynamics of fine-tuned lines of business. From its conception in the 1980s, the regulation known as same-day settlement has seen as one of those regulations.
It was apparent from the beginning that in addition to its intended results, the side effects of same-day settlement would include drastic shifts in check volume and major capacity concerns for commercial banks.
Some of the wariness subsided as many bankers began embracing a new payments technology - electronic check presentment - that will enable banks to rise above the more disturbing implications of the regulation.
Moreover, the electronic-presentment solution will exceed the best intentions of regulation's creators regarding the good of the payment system.
A Response to Reg CC
For just a few short years, the banking industry has been perfecting the process of electronic check presentment, or ECP.
The technology was created in reply to another another regulation, Reg CC. Implemented in the late '80s, Reg CC forced banks to grant expedited funds availability on checks - in many cases before it could be determined that the checks did indeed represent collectible funds.
Banks invented electronic check presentment to shortcut the presentment, collection, and return cycles. Electronic presentment substitutes a dual process for the traditional, cumbersome paper flow.
The dual process consists of electronic and paper workflows.
Under electronic presentment, a depository bank captures a check's payment information (the only part of the check that really needs to be expedited) and transmits it electronically to a paying bank.
The paying bank can determine quickly - before the depository bank must give the customer availability on the deposit - whether the check is good. Later, the depository bank can forward the paper check for reconcilement with the electronic file.
This is electronic presentment at its most basic, and many enhancements have followed.
For example, if the paying bank should discover that a check represented in an electronic presentment file should not be paid, it can create an ECP-based return notice (an RNote) that can be delivered to the bank of first deposit much more quickly than the returned check itself. Numerous variations and expanded applications of RNotes are in the product development stages.
How will electronic presentment figure in same-day settlement? As a powerful antidote to its unintended consequences.
Protections Lost
The main side effect of the same-day settlement regulation is that banks will no longer be able to invoke traditional measures for protecting their deposits and their processing shops from untimely and unmanageable presentments of checks from other banks.
Such measures have influenced specific deadlines for varying tiers of availability, processing, presentment fees, and specific relationships through correspondent accounts.
For decades, banks have viewed such measures as reasonable means of operating their check processing business - pricing access to their franchise (deposits) according to the value perceived by the buyer (the presenting bank) and creating predictable capacity requirements in their back-office processing.
Regulators have viewed the situation differently. Since the Monetary Control Act of 1980, regulators have sought to eliminate practices that delay presentment and to ensure that small banks have relatively unlimited access to the payment system. Thus presentment fees, early Presentment deadlines, and some disbursement services have been particular targets.
Same-day settlement essentially forbids the deposit management practices we have described. In January, when same-day settlement is implemented, banks will no longer be permitted to charge presentment fees or require a correspondent relationship.
But it is the remaining requirements of same-day settlement that have most worried many large check-clearing banks - especially those that offer controlled-disbursement services. They may have to accept deposits from any bank that wishes to make direct deposits.
Many banks will have good incentives to redirect their deposits from the Federal Reserve directly to these banks, now that fee and account requirements no longer exist as deterrants. In addition, the banks will have to settle with same-day funds on all these deposits, creating greater pressure to process and collect them more quickly than they are prepared to do.
It is a standard feature of most controlled-disbursement services that the bank first notifies its corporate customers of their initial funding requirements early in the morning.
In the past, most controlled-disbursement banks imposed a presentment deadline of 2 a.m. This gave them nearly six hours to process deposits and prepare timely balance reporting notifications.
Under the new regulations, these banks may well find themselves trying to process huge workloads (inflated by the relaxed presentment criteria) in a greatly compressed time frame.
One possibility is that the notification to the corporate customer will be delayed, thus diminishing the primary value of the service. Certainly it can be expected that delays caused by capacity' problems will force banks to report smaller amounts in the first report and larger amounts in the second.
Another possibility is that some of this work will be held over, and the corporate customer's funding requirement win be underreported. When the work is processed somewhat later, the customer's deposit will be found to have been insufficient.
An adjustment notification or an overdraft may be created at the customer's expense, or the bank may absorb the expense of funding the item for one day.
ECP to the Rescue
Obviously, these possibilities would effectively undermine the value of controlled-disbursement services. Customers would operate in extended ignorance of their funding positions and would deploy excess funds to cover unknown deposits or pay for unintended overdrafts.
Enter electronic check presentment, which fortunately has reached the point where it can be deployed on behalf of controlled-disbursement services.
If controlled-disbursement banks were to receive electronic deposits rather than paper deposits, they would have little difficulty in preparing corporate customer notifications to meet current deadlines.
From the corporate customer's standpoint, the effect would only be positive. Today, most customers receive two morning notifications of their funding requirements and naturally prefer that the much-later second notification be minimal.
Under electronic presentment's expedited process, it is probable that the first report will account for virtually all of the funding requirement. In addition, in order to maintain the value of the controlled-disbursement product, banks would continue to debit the corporate account upon receipt of the checks later in the day.
According to a recent study by J.D. Carreker and Associates involving 23 controlled-disbursement banks, controlled-disbursement items are a highly concentrated commodity. Fully one-third of the participating banks' controlled-disbursement items are received from the other 22 participants.
As a result, mutual cooperation, consisting of ECP exchanges, would probably prevent much of the controlled-disbursement capacity crunch that same-day settlement might otherwise engender.
As for the remaining volumes, two possibilities exist. They may be able to be accommodated without an increase in operational capacity, or the service improvements resulting from electronic presentment will enable controlled-disbursement banks to offer incentives for ECP transmissions.
Multiple Benefits
By employing electronic presentment on behalf of its corporate customers, the banking industry will earn the satisfaction of several jobs well done. They will have avoided an expensive blow to the efficiency of their processing. They will have secured important corporate customer relationships with an improved product.
They will have further expedited the flow of payment information throughout the payment system. And they win be able to claim the virtue of serving the spirit of a new regulation with a solution that exceeds its expectations.
Mr. Brubaker, executive vice president and senior operations officer at Boatmen's Banchshares, St. Louis, and Mr. Terkhorn, a managing director at Citibank, are directors of Eccho, the Electronic Check Clearing House Organization. Mr. Lewis, a managing director at the bank consulting firm of J.D. Carreker & Associates, Dallas, is on the staff of Eccho's executive director.
