Two intersecting trends are driving more and more financial institutions to consider outsourcing their check handling operations, just as the imminent arrival of check image exchange promises to slash the costs of processing paper checks.
The industry is gearing up for the widespread use of digital check images for clearing and settling transactions. It is anticipated that this will be much cheaper than processing the actual paper items, but many banks are beginning to realize it will take a hefty investment to reap any financial benefit from this shift.
At the same time, the overall volume of paper checks is plunging now that more consumers are making purchases with debit cards and paying bills online. As a result banks must spend to support a shrinking business. Or, they can get out altogether.
"From a cost standpoint, when all was said and done we determined it would be more cost-effective to outsource than it would be to buy our own equipment and do it all ourselves," said Vickie Sibbitt, a senior vice president with the $82 million-asset Farmers and Commercial Bank in Holden, Mo.
Instead, last month Farmers turned over its item processing to Fiserv Inc., which says it is the largest third-party check-processing vendor.
"We're seeing a lot more interest in outsourcing," said Mark Damico, the president of Fiserv's item processing group. The Brookfield, Wis., company processes checks for roughly 1,700 financial institutions, and prospective clients are calling every week, Mr. Damico said. "Our pipelines are more full than ever."
Most banks are already archiving images of cancelled checks instead of returning the paper items to customers, and a few have started settling transactions by transmitting electronic files to one another instead of transporting the actual paper item from place to place.
The rapid implementation of image technology is transforming check processing, and offers numerous opportunities for savings, including lower transportation and labor costs and faster settling. And banks that do not move into imaging may well find themselves left behind by the rest of the industry, Mr. Damico said. All these advantages are appealing, but they can also be expensive, which is why many banks are turning to outsourcing.
At first Farmers and Commercial was leaning toward in-house image processing, and it hired a consultant to help out. But the bank balked when it saw that equipping its check sorter with image-capable camera equipment would cost more than $100,000, Ms. Sibbitt said.
"That was a lot of additional money to invest," she said.
At bigger banks the expense is much higher. Mr. Damico said it can cost upward of $500,000 to add image cameras to the sorters used by large banks; adding in the software expenses can bring the price of upgrading one sorter close to $1 million, and the largest banks might have several dozen of the machines.
Robert Seltzer, the president of Meta Software Corp., a Cambridge, Mass., check processing consulting services firm, said that some banks will find it gradually harder to make a business case for this investment because the number of checks in the industry is shrinking, and that will ratchet up the unit costs for each check moving through the system.
Not only are consumers writing fewer checks, Mr. Seltzer said, but many items are removed from the process by billers that can scan the items and turn them into automated clearing house transactions. With roughly 42 billion paper checks moving through the banking system this year, he said, it costs about a dime to process each one.
But check volume could fall as much as 45% over the next seven years, pushing up the per-item cost to 14 cents. An extra 4 cents may seem small, but not when multiplied by an anticipated 23 billion checks in 2010. "There's no question that unit costs are going to increase," Mr. Seltzer said. "This is going to be a real challenge."
Polly Thorsness, the senior vice president for operations at Community First Bankshares in Fargo, N.D., said the prospect of rising per-item costs prompted the $6 billion-asset bank to ditch in-house item processing. It had previously handled half of its check volume itself and outsourced the rest to Fiserv, but by next month Fiserv will be handling all of the bank's checks.
"As we started to put the numbers together, we just said that it would be cheaper to outsource," Ms. Thorsness said. "With outsourcing, the minute our volume goes down, our costs go down."
Jack Prim, the president of Jack Henry & Associates Inc., an outsourcing provider in Monett, Mo., said his firm has been ramping up its item processing operations so quickly that it has had to open seven new processing sites in the past three years. It now has 17 sites nationwide and they handle about 30 million items a month for banks - against less than 15 million five years ago.
"Banks began to look at outsourcing as a way to offer image services," Mr. Prim said. "Image will require a fairly significant investment in hardware and software, so I think that a lot of them prefer" to outsource.
