New Combatants in The E-Check Wars

  Since bursting onto the payments scene in the late 1990s, electronic check payments at the point of sale have mushroomed. Merchants handled more than 200 million e-checks during 2002's first half, more than 300% above the same period in 2001, according to Herndon, Va.-based Nacha-The Electronic Payments Association.
  The appeal of e-checks to merchants and consumers is convenience. By electronically capturing the bank routing number and the customer's account number off a blank check as it is fed into a POS terminal and entering the purchase amount, merchants no longer need to wait for consumers to fill out a check. Instead, within seconds, they hand the customer an electronic copy of the receipt just as they would a credit card receipt, along with the original check. By sparing the consumer the chore of filling out a check at the point of sale, the checkout process is smoother, which makes the consumer happy.
  E-check transactions have become about as fast as making a purchase with a credit or debit card ("The Enduring Check," November, 2002). This fact has not been lost on the card associations or the electronic funds transfer networks, which have targeted checks as a major competitor. Collectively, they have invested billions to build payment card networks that provide real-time authorization to merchants. But after years of eroding check volume, the advent of e-checks has blown a big hole in the marketing strategy to position plastic as a superior alternative to checks.
  Rather than slug it out in a costly marketing battle with such established e-check processors as Houston-based Telecheck Inc. and Alpharetta, Ga.-based Certegy Inc.'s Certegy Check Services, Visa U.S.A. and several regional EFT networks have decided that "if you can't beat 'em, join 'em."
  In 2002, Visa rolled out its POS Check, a real-time electronic check-authorization service that financial institutions are just now starting to provide. The service piggybacks off the VisaNet network. Eighteen months earlier, a consortium of banks, EFT networks, and transaction processor Concord EFS Inc. formed SafeCheck, which uses EFT networks to provide check-authorization services to merchants.
  What differentiates Visa POS Check and SafeCheck from competing electronic-check authorization services is their ability to provide real-time confirmation that the consumer has the funds in his account to cover the purchase. Transactions also can be settled on a same-day basis, which means merchants can receive funds within 24 hours.
  These are significant advancements over the traditional method of authorizing e-checks against a negative file and settling transactions through the automated clearing house. Authorizing against a negative file, no matter how large the database of information, still leaves the door open for a check to be returned for non-sufficient funds. In addition, it takes two to three days to settle a transaction through the ACH.
  "One of the risks with running an electronic check through the ACH without real-time authorization is how do you know the funds are in the account or that the account is even open until after the fact," says Stessa Cohen, research director of financial services for Stamford, Conn.-based Gartner Inc. "Nor does the ACH provide expedient settlement. Visa and SafeCheck provide a guarantee that the account exists, funds are available to cover the transaction, and that merchants get paid in about a day. All this benefits merchants."
  Direct Connection
  Visa and SafeCheck are leveraging their direct connection to member banks that hold consumer demand-deposit accounts (DDAs) to provide real-time authorization and 24-hour settlement. Visa members manage about 90% of the DDAs in the United States, according to Cohen.
  SafeCheck includes the three largest EFT networks, respectively: Concord's Maitland, Fla.-based Star Systems, Woodcliff Lake, N.J.-based NYCE and Houston-based Pulse. SafeCheck's 11 member banks include Winston-Salem, N.C.-based BB&T Corp., and Charlotte, N.C.-based Wachovia Corp.
  "We are making a minor modification to use an existing network to handle MICR (the magnetic ink character recognition letters and numbers on checks) data rather than card data," explains Dante S. Terrana, director of business development, POS Check Service for Visa U.S.A. "We are basically doing what we already do in the card world with checks."
  Visa's highest level of service determines whether an account is open and guarantees funds are available to cover a specific purchase. By verifying the availability of funds, banks are liable in the event the customer withdraws all available funds from the account after verification.
  The middle tier of service verifies that an account exists, but does not guarantee the availability of funds. The most basic level is check conversion. No account verification is performed. In both cases, merchants assume the risk if the check bounces. These services are aimed at purchases made by customers in good standing with the merchant and lower dollar transactions, respectively. Merchants can apply different levels of authorization to individual transactions based on dollar amount and other criteria. As a result, banks are expected to offer tiered pricing.
  If the customer's bank is not part of the VisaNet system, the transaction is routed through the ACH. Visa has enlisted several payments processors, such as San Francisco-based BankServ, to provide authorization for checks written on accounts from banks not participating in Visa POS Check.
  SafeCheck debits funds from the account at the time of transaction, just like a personal identification number-based debit card transaction. Hence, underfunded accounts are denied authorization. Certegy provides risk-management services, such as fraud detection.
  "Real-time debit means less float, which means merchants get paid faster," says Barbara Span, vice president of brand management for Star Systems, which has rolled out SafeCheck under the Star brand. "It also helps merchants spot red flags that indicate fraud."
  Retailers lose between $12 billion and $15 billion annually to bounced checks, about 85% of which is attributable to fraud, according to industry experts. Fraud losses are increasing by about 7% a year. Part of the problem is that sophisticated graphics software has made it easier for criminals to produce counterfeit checks with legitimate account numbers stolen off the Internet or elsewhere.
  "Guaranteeing funds are available at the time of purchase can help reduce fraud by preventing authorization on an account that may already be empty," says Span. "If the merchant makes use of risk-management models and checks consumer identification on the front end, fraud can be further reduced."
  Less fraud also lowers operating costs, a point Visa is emphasizing in its marketing pitch. Merchants pay $1.22 on average to handle and process a paper check, according to Visa. About 55% of that amount is to cover the risk associated with bounced checks.
  "Real-time approval can help merchants spot fraud sooner and significantly reduce losses and operating costs," says Visa's Terrana.
  A Positive Impact
  Visa's service also is expected to be priced less than traditional check-guarantee services, which run about 1.5% of the transaction total. If a check bounces, processors providing check-guarantee services are responsible for collections.
  With Visa POS Check, the bank sets pricing for the service. Cincinnati-based Provident Bank plans to charge merchants between 13 cents and 18 cents per transaction.
  "Visa's service is likely to have a positive impact, but merchants are still going to have to pay ... for it," says Gartner's Cohen. "That means banks offering the service are probably going to have show merchants some type of a return-on-investment analysis."
  So far, merchant demand for account verification is modest. Omaha, Neb.-based First National Merchant Solutions, the 12th-largest acquirer, says about 25% of its merchants using Visa POS Check have requested funds verification. For merchants-especially grocers, which tend not to have high fraud losses-the question is do they want to pay to guarantee availability of funds for all checks written at the point of sale when they may only need to do so for a small percentage of check transactions.
  Bank of America is addressing this issue by allowing merchants to set parameters for when to verify availability of funds. For example, a check written for more than $100 may be subject to funds verification.
  Visa has commitments from 15 merchant acquirers to roll out its check-authorization service. They range from giant Louisville-based National Processing Co., the No. 2 acquirer that is majority-owned by Cleveland's National City Corp. and which is providing all three levels of authorization services to merchants, to Electronic Clearing House Inc., an Agoura Hills, Calif.-based merchant processor whose client base includes thousands of U-Haul outlets.
  Another 11 banks are committed to providing authorization of DDAs. Bank of America, First National Bank of Omaha, Provident Bank, and U.S. Bank provide merchant services and authorization.
  A Traction Issue
  While many acquirers are opting to attach their name to the service in lieu of the Visa brand, they are not shy about promoting VisaNet as the backbone of the service to merchants. "That we are using the VisaNet infrastructure hits home with merchants," says Susan Rue, a product manager with First National Merchant Solutions, the merchant-acquiring arm for First National of Omaha. "Merchants know the transaction data is traveling over a secure network. It also allows us to offer all-in-one settlement from a single terminal, which also plays well."
  As snazzy as Visa POS Check and SafeCheck appear at first blush, competitors point out that the success of each service depends on the ability of each organization to get enough participating banks to provide national DDA authorization to merchants.
  "It's really a traction issue," says Charles Drucker, president and chief executive of Telecheck. "If a merchant can only authorize four out of 10 checks through the service, they still have to come to someone like us to get authorization on the remaining checks. The key to their success will be how many banks participate on the DDA side."
  Telecheck, which is a subsidiary of Greenwood Village, Colo.-based First Data Corp., provides authorization using a database of 540 million checking account records and a negative file of 72 million records.
  Though the size of Visa's authorization database lags behind that of Telecheck, bankers predict the card association will narrow the gap quickly.
  "We are expecting more than 50% of Visa banks to participate in DDA authorization in a couple of years," predicts Jerry H. Meyer, senior vice president for Provident Bank, which offers the service to three large retailers. "Providing both authorization and merchant services is an advantage to us locally, but once outside our footprint it's more important that other members participate on the authorization side."
  Concerns also are being raised that real-time authorization may prompt merchants to deny authorization on checks written against deposited funds that may not have cleared before the check is written. It is not uncommon for consumers to write a check and then deposit funds to cover the transaction, knowing their account will not be debited for a couple of days.
  "Directly contacting a bank to verify the eligibility of funds may not be the best-case scenario," says Jeffrey Carbiener, senior vice president and general manager for Certegy Check Services. "Someone who deposits a check on Friday afternoon and writes a check for groceries that night might get declined, even though they are a good customer with a history of doing so. The aim is to prevent false positives."
  As processors relying on a proprietary database and risk-scoring models, Certegy and Telecheck base authorization decisions on consumer behavior patterns. Both companies claim the approach provides more flexibility than having banks authorize a transaction based on the availability of funds.
  "Merchants want sales, not denials," argues Telecheck's Drucker. "If approval standards vary by bank, some are going to be more stringent, which means a merchant may lose a sale to someone who simply miscalculated the availability of funds after a deposit."
  Visa counters that its banks have the flexibility to make adjustments in the authorization process when verifying availability of funds. Provident Bank, for example, allows merchants to factor in an extra day of float in the authorization decision process. Bank of America Merchant Services will consider the account balance and the time of a deposit posted when making an authorization decision.
  Not a Critical Factor
  "It is tougher to track a deposit that was not made directly to an account, but not impossible," says Kathleen D. Gowin, senior vice president of product development for Bank of America Merchant Services. "Our aim is to confirm the account has good funds available."
  SafeCheck, too, allows merchants to weigh the potential for float during the authorization process. Despite such precautions, Star's Span cites research that float is not a critical factor in a consumer's decision to write a check at the point of sale. A recent survey of 11,244 consumers conducted on behalf of the network revealed that just 9% said they write checks against float.
  "Research suggests most consumers write checks when they know they have the money to cover the transaction," says Span. "Still, we don't want a process that turns down consumers that desire float."
  Such flexibility is expected to play well with merchants and help with market penetration. The acid test, however, is whether Visa and SafeCheck can deliver on their promise of real-time authorization, faster settlement and reduced fraud without increasing turn-down rates.
  If they can, they will provide stiff competition to the check processors that dominate the market.