Banks have known for a while that it will take time to realize the cost savings and efficiencies that are supposed to result from the replacement of paper checks with digital images.
But they may not have had as powerful a symbol of that truth as the one they got last Friday, when the Federal Reserve banks released their pricing structure for check image processing. Surprise: In most cases, they will charge more per item for images than for paper checks.
Industry observers and participants expect the prices for images to come down quickly as transaction volumes build. But the structure does show that the dismantling of the paper check processing system and the migration to an electronic infrastructure are not going to come as cheap, or as fast, as many bankers might have expected.
"The paper infrastructure has been in place for many, many years and has become very efficient," said Steve Whitney, a senior vice president for retail payments at the Federal Reserve Bank of Boston. "The electronic environment is new and still does not have the critical mass" of volume that would be needed to reduce the processing costs.
Though he says that settling electronically will make the funds available as much as a day earlier than using paper items, the pricing structure still seems to contradict the idea that images are easier and less costly to handle. The Fed also released its prices for handling image replacement documents; the fees are significantly higher than those for processing paper checks.
Even though the prices seem to defy conventional wisdom, industry executives say they look reasonable.
The image pricing setup, which largely emulates the current one for paper checks, includes a tiered structure with rates that vary by the receiving bank's volume and by the time the items are submitted.
The service will be available Oct. 28, the day the Check Clearing for the 21st Century Act will take effect.
There is a single rate structure for all the Fed banks for processing images. The per-item fee for electronic files ranges from 1.5 cents, for a file submitted at the earliest deadline and destined for a high-volume receiving bank, to 18 cents, for a file submitted at the latest deadline and drawn on a low-volume receiving bank.
Pricing levels for the 1 a.m. deadline, which Mr. Whitney said is comparable to many of the last deadlines available for paper checks, range from 2.5 cents to 6 cents, depending on the receiving bank.
The fee for all electronic cash letters is $2, which is generally cheaper than the fees for paper-based cash letters that are typically in the $4 to $6 range.
The prices for handling paper checks vary at each Fed bank. At the Boston Fed, for example, paper check fees for mixed cash letters submitted by 12:30 a.m. range from 2.1 cents to 7.3 cents, Mr. Whitney said. The fees for cash letters with only items that need to be handled by the district's regional check processing center range from 1.8 cents to 4.7 cents.
Paper processing rates at several other Fed banks are comparable, or even lower. In Atlanta, a cash letter that is submitted by midnight and contains paper items that must be handled by the district's regional processing center will incur a fee of anywhere from 2.1 cents to 7 cents. Such a letter will incur a fee from 1.7 cents to 7 cents in Dallas and 1.1 cents to 7 cents in Minneapolis.
The Chicago Fed's structure is the exception to the rule that paper is cheaper to process. A paper item submitted by 1 a.m. and drawn on a high-volume bank will cost 3.3 cents, versus 2.5 cents for an image file.
Though the prices can be higher for electronic files, Mr. Whitney said, the service still offers several advantages, especially speed. Electronic items can be handled, and thus settled, more quickly and can be submitted later than paper. Though the exact times will vary, banks can typically expect electronic files to clear about one day faster, and in many cases this advantage could offset any price differential, he said.
"There is some portion of the current paper check population that will be happy to improve their collection by a day," he said.
In addition, because paper items must be physically moved from place to place, the Fed banks impose a hard cutoff time - generally between midnight and 1 a.m. - after which they will not accept checks for that day's processing, Mr. Whitney said.
However, because electronic files can be transmitted anytime, the Fed can accept the files much later, he said; banks could submit electronic cash letters as late as noon and still have the transactions settle that day.
Submissions that late will carry the highest fees, but there is no comparable fee for processing paper checks, because "you can't clear an item at 4 a.m. in the paper world," Mr. Whitney said.
Steve Schutze, who recently left the American Bankers Association and this week set up his own consulting firm, Foreword Financial, in Richmond, Va., said many banks will be able to take advantage of the lower prices for electronic files that come from submitting the items before midnight. The two least expensive pricing levels have deadlines of 9 p.m. (when the lowest fee is 1.5 cents) and 11 p.m. (when the lowest fee is 2 cents).
It is difficult for a bank to deliver paper checks this early, but electronic files can be submitted instantly, he said. "If I'm doing image processing, once I run the items through the sorter, they are ready to go. Why wait until midnight? I can make the earlier deadline."
The prices were designed to attract banks to electronic processing, Mr. Schutze said. "I think this is fairly aggressive pricing."
Viveca Y. Ware, the director of payments policy at the Independent Community Bankers of America, predicted that the prices will fall over time.
"I think they are struggling with a chicken-and-egg phenomenon," she said. "You must get the infrastructure in place, and you have got to get volume moving over the system, before you can get efficient pricing."
Mark Craig, the general manager of CheckClear LLC, the Metavante Corp. subsidiary that operates Endpoint Exchange, the only functioning image exchange network, said the Fed's pricing is in the same ballpark as his company's. However, Endpoint has a different rate structure: flat base fees offered throughout the day, with discounts based on the collecting bank's volume. The base fee is 1.5 cents for in-district items and 3 cents for out-of-district checks, he said.
"At first blush, it does seem surprising" that the Fed prices for image are in the same range or even higher than the paper processing prices, Mr. Craig said. However, the Fed is not likely to get huge image volumes initially, and it is obligated by statute to cover its operating costs, so the pricing structure "does make sense," he said.
The Small Value Payments Co. division of The Clearing House Payments Co., which has been setting up an image exchange network that many large banks are committed to using, has not released its rates.
Mr. Whitney said the Fed is putting together a list of banks that will be ready to receive electronic files next month. That list will likely include about 1,000 banks at first, though there is also a long list of banks that are setting up the connections necessary to receive image files from the Fed, he said. And nearly every bank he talks to has some kind of transition plan for eventually becoming image-ready.
And once volume goes up, the Fed will revisit the pricing issue, perhaps as early as next year, he said. "We are trying to encourage as much electronic processing as we can. The more electronic receivers there are, the more it benefits everybody."
Still, the overall transition to electronic processing will be long, Mr. Whitney said. "It will probably be another three to five years before we see a really significant critical mass, with more than half of check volume" being cleared as images. "Once we get over 50%, then we start to get a snowball effect," that will drive up volume.
And for banks that cannot receive images, the Fed must deliver either the original item, or, if the sending bank has submitted only an electronic version, an image replacement document. Because producing IRDs - essentially high-quality printouts of the images - is additional work, the prices for handling these items are higher than those for either paper checks or images. The rates follow the same structure as the one for electronic items, with volume- and time-based tiers, and prices ranging from 3.5 cents for early submissions to 25 cents for the latest ones.
Mr. Schutze said creating IRDs is a tedious process that complicates the processing system. "I'm surprised they weren't charging more than that."
