Checks Get a (Mild) Electronic Jolt

  Check use at the point of sale continues to decline, but not at the pace experts once predicted. NACHA-The Electronic Payments Association estimates that consumers still present 6.4 billion checks at checkout lanes each year.
  Some merchants are reducing their check costs by converting the paper to an electronic transaction, though retailer reaction to check electronification is mixed. Some experts had thought check conversions would encourage consumers to use debit cards because clerks hand checks processed electronically at the point of purchase (POP) back to shoppers, but consumers continue to present checks.
  Others thought check conversions, which are processed through the automated clearinghouse system, would catch on among retailers looking to reduce paper-handling costs, but they have not caught on.
  In 2004, 219 million checks at checkout were converted into POP electronic ACH debits, or about 3.4% of all checks presented at checkout lanes. That is 7.9% more than the 203 million checks converted in 2003, but it still leaves merchants processing the vast majority of checks the old-fashioned way, as paper from start to finish.
  That is a shame, say proponents of POP check conversion, who praise the process' ability to lower overall costs for many retailers by avoiding interchange and decreasing fraud.
  Approved in 2000 by NACHA, POP check electronification, also commonly called echeck or check conversion, occurs when a cashier runs a customer's check through a small reader to capture the data on the magnetic ink character recognition (MICR) line. That information then can be used to route the ACH transaction to the issuer for settlement.
  The cashier has the customer sign a transaction slip, then hands the check back to the customer. The merchant's processor batches the check information with data from other checks for presentment later as electronic, ACH transactions.
  Electronic checks are much cheaper to process than paper checks. But the costs of the front-end equipment and optional add-on fraud-prevention services are "all over the board" based on a retailer's size and risk-management needs, says one processor.
  This helps explain why adoption of check conversion at the point of sale is so low. "With check conversion, we had very significant growth right out of the gate, but in the last year or so, that growth has leveled off," says a NACHA spokesperson. "It's not a very easy thing to implement for retailers that process a lot of checks."
  Basic MICR readers cost about $150, cheap enough for most retailers to deploy in every lane for simple check verification. Check verification, also called authorization, is when MICR data flow to a third-party service that checks risk parameters for the likelihood that a check will clear.
  Whether merchants decide to move beyond that to send an actual check transaction to a processor in electronic form instead of paper depends on a number of factors, including whether their products and customer bases tend to invite fraud activity.
  Smaller retailers often hire third parties to upgrade their software to enable their store's payment equipment and networks to convert checks to electronic transactions. They also are more likely to use stand-alone terminals instead of integrated systems.
  Many mid-size and larger retailers, however, do their own software upgrades in house, and their information-technology staffs have a lot on their plates, says Kris Winckler, senior vice president of check services for Electronic Clearing House Inc. (ECHO), a Camarillo, Calif.-based processor. "For the medium and large retailers, doing that programming is probably the biggest impediment to rolling it out," he says. "There are other projects, like gift cards, in a limited IT budget that get ahead of it."
  SuperValu Inc., which operates 700 supermarkets under various names, for example, has had difficulty justifying the cost. "We've been through the numbers two or three times, included all of our costs, and we can't make the numbers fly," says Jacki Snyder, senior business consultant for the Minneapolis-based company. "That is why we have not proceeded with doing any kind of pilot with POS conversion." Snyder discussed the topic during a presentation at NACHA's Payments 2005 conference in April.
  Peter Nash, director of credit and collections for Woonsocket, R.I.-based CVS Pharmacy, also spoke at the conference. He said CVS, like many retailers, has high cashier turnover, which makes check conversion less attractive because of the extra training required to convert checks and explain the process to customers.
  Nash and Snyder both said that losses from check fraud in their stores already are low enough to make additional fraud prevention not worth the extra cost.
  Merchants with high fraud rates may prefer to use a real-time check-verification and settlement service. Visa USA and the Star electronic funds transfer network unit of First Data Corp. offer such programs, called Visa POS Check and Star Check Direct respectively.
  The programs can peer into a customer's account to confirm funds availability for a paper check, and then debit those funds in real time before the customer leaves the store. The services add another layer of fees and are not widely adopted, but some merchants claim the savings from fraud prevention outweigh the costs.
  If the customer's financial institution participates in the Star or Visa network, the customer's check can be processed similar to a debit card transaction. If a customer's financial institution does not participate in one of those networks, the consumer's check is batched to be processed as an ACH transaction later. Either way, the clerk still has the customer sign for the sale, then hands the check back to the customer.
  Increasing losses from bad checks drove Cole National, owner of Pearl Vision and Things Remembered Inc., to begin testing the Visa POS Check service with real-time debiting in late 2002. The company still uses the service. ECHO helped Cole set up a conversion process.
  Last year, ECHO was able to route 12% of Cole's transactions as check debits through the Visa POS system. ECHO processed the rest itself through the ACH network because the check presenters' financial institutions were not part of Visa POS. (Visa says 23% of financial institutions now participate, but projects that will grow to 50% by the end of the year.)
  Costs Reduced
  The services reduced Pearl Vision's bad-debt costs by 63% and Things Remembered's bad debts by 41%.
  Neither ECHO nor the other service providers interviewed would disclose the costs of their services.
  When real-time check debiting first hit the market, some retailers worried that customers would complain about the lack of float. Some consumers like to be able to pay for groceries or other products by check a few days before payday. That is less of an issue now, says a spokesperson for First Data, which soon will offer Star Check Direct's service to customers of its TeleCheck check-processing business.
  "Even TeleCheck kept float in its [electronic] check processing," the spokesperson says. "As consumers are more familiar with using their debit cards, float is less important than it used to be."
  Many processors still help retailers avoid bounced electronic checks by waiting to re-present checks returned for insufficient funds to coincide with likely paydays such as Fridays or the 1st or 15th of the month, Winckler says.
  Some retailers have not supported electronic check conversions because NACHA requires them to hand converted checks back to customers. Despite assurances from some processors and vendors that MICR information and a signature are sufficient for collections on bad checks, many retailers do not like the idea of relinquishing the paper checks without first capturing their images in case of later disputes or collection needs.
  John Arato, vice president and manager of the retail products unit of MagTek Inc., a Carson, Calif.-based equipment vendor, says sales of his company's MICR readers, as well as check imagers, are up "significantly" over last year. He declined to provide specific numbers.
  However, many retailers with several lanes consider check-imaging equipment too expensive to deploy in every lane. "The cost involved is at least $300 to $400 a lane," Arato says.
  Imaging Option
  Though few are doing it, retailers can keep paper checks to scan later with a single back-office imager then pass on the electronic ("truncated") images of the fronts and backs of paper checks under the federal Check Clearing for the 21st Century law, called Check 21. One advantage to Check 21 is that it allows business, travelers and welfare-benefits checks and money orders to be converted electronically at the point of sale.
  NACHA conversion rules do not allow this, and cashiers need to recognize and keep such checks for later processing. But retailers and processors admit to accidentally routing ineligible checks through the ACH network from time to time.
  Ideally, retailers who do capture check images some day will be able to pass the images through the entire system electronically. But since Check 21 took effect in October, many banks still have not updated their systems to receive captured electronic images. So the images must be reprinted to paper as substitute checks, which reduces efficiency and increases cost.
  "You can create and send a substitute check to all banks, but receiving electronic images is optional for a receiving bank," says Joseph F. Keller, president and CEO of Minneapolis-based processor Solutran Inc. He says a few retailers are starting pilots in which all checks are truncated then processed as electronic images or printed as substitute checks under Check 21. But the procedure will not attract interest among many retailers until enough banks can receive the images electronically.
  Tom Kettell, vice president of marketing for RDM Corp., an Eden Prairie, Minn.-based processor and vendor of MICR readers and image scanners, says retailers and billers who have embraced check electronification are pushing financial institutions to update their systems accordingly. "We're seeing a market pull where retailers are pulling financial institutions into check electronification," he says.
  To address the shortcomings of both conversion and truncation, NACHA is considering rules to allow for a hybrid procedure called back-office conversion. This would allow retailers to keep the paper checks customers present that they might later convert to electronic transactions and perhaps images using a single, back-office scanner. Then their processors, instead of harried cashiers, could decide which checks to send through the ACH network and which to process as substitute checks under Check 21.
  The concept is receiving mixed reviews.
  Solutran's Keller, who is a member of NACHA's Electronic Check Council, believes retailers would welcome the change. "If the rules are changed to allow for back-office conversion, you're going to see a rapid mass conversion by retailers," he says.
  Influencing Factors
  Any rule change would have to be carefully considered and tested, Keller adds, saying that some on the council hope to see a store pilot by the end of this year, which could lead to a permanent rule change if the findings are favorable.
  Electronic Clearing House's Winckler, however, does not believe back-office conversion is the answer because it does nothing to help decide whether to accept a check. "It makes sense to make the back office as well as the [POS] authorization systems integrated in order to effectively control fraud," he says. And back-office conversion leaves retailers with the risk of protecting more paper checks until they can destroy them.
  Whether retailers adopt check conversion, check truncation, back-office conversion or just wait for paper checks to die out depends on technology, rules and cost. "The legislation and technology are out there, and they allow for a lot of things to happen, but economics is the driver," Keller says.
  E-PAYMENTS
   Name Method
  Point of Purchase POP, Conversion, E-Check ACH
  Truncation Check truncation, Check 21 Check imaging
  Source: NACHA
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