What's Next for Electronic Checks?

  Growth rates in electronic check transactions at the point of sale are slowing down. While many opportunities remain, the rapidly changing market's future is anything but certain.
  For a brief shining period, electronic check presentment at the point of sale was one of the payment sector's most rapidly expanding services. But that era appears to be ending.
  After NACHA-The Electronic Payments Association in 2002 established rules for converting checks to automated clearinghouse transactions, activity exploded with annual volumes increasing from 32 million in 2000 to 204 million in 2003 (chart, page 42).
  While growth still is occurring, the rate of increase has slowed substantially. After a 50% gain in 2002, volume was up 22% last year. And with approximately 113 million of the so-called point-of-purchase-or POP according to NACHA's codebook-check transactions sent through the ACH during the first half of 2004, the growth rate is likely to drop again this year.
  The POP activity accounts for about 3% of the checks written at the point of sale, Herndon, Va.-based NACHA reports. The average dollar amount is $77.
  "The electronification of checks at the point of purchase will not continue to increase significantly because it's based on self-defeating technology," says Robert Hunt, senior analyst at TowerGroup, a Needham, Mass.-based financial-industry research and consulting firm acquired this year by MasterCard International. "Customers eventually will pull out a credit or debit card for the payment because they know the retailer does not really want to take a check."
  During a typical POP transaction, the consumer-depending on the retailer's preference-will either hand the cashier a blank or filled-out check. The clerk then will run the item through a terminal that captures the routing and account numbers. Retailers with the proper technology also can take an image of the check for security purposes before handing the paper back to the customer.
  Consumers then sign a debit authorization, which is akin to putting their signature on a credit card receipt. Check data are electronically sent to the merchant processor or acquirer in real time or by batch mode.
  The information is used to create an ACH transaction that typically results in the funds being debited from the consumer's account by the next day. Merchants often receive payment within three days.
  Electronic conversion is attractive because a retailer's bank typically will charge several cents less to process an ACH transaction than a check, and there are fewer returns for non-sufficient funds because most institutions will post an ACH debit quicker than a check transaction, says Dan Miner, NACHA senior director, electronic check and risk management services. Many banks also charge retailers more for a bad check than a returned ACH transaction.
  Merchants also will learn of a returned ACH item within a couple of days, compared to five to 10 days for a check, Miner notes. That enables retailers to feed the transaction information into a negative database sooner, reducing credit risk.
  More Accuracy
  "We are usually able to move money into a merchant's account within a 24- to 48-hour period because there is no need to wait for the physical document to appear before settling a transaction," says Ed Myers, president of the Las Vegas-based gaming and check-services unit of Global Payments Inc., an Atlanta-based merchant processor. "Scanning the check at the POP also increases accuracy by removing the likelihood that a store clerk with mistype numbers into the processing system."
  While banking rules give merchants only one opportunity to redeposit a returned check, an ACH debit can be redeposited twice, increasing the prospect that adequate funds will be in the customer's account when the item is resubmitted. Retailers or their acquirers also often can resubmit the debit during likely payday periods, such as on a Friday or the 15th of a month.
  Miner says the initial users of electronic check conversion primarily were small and medium-sized merchants. Such retailers often are willing to embrace newer payment systems because they typically only have a handful of checkout lanes to equip with the technology, which lowers their start-up costs
  "Large retailers with integrated cash-register systems have much more to gain-and also much more to lose-by switching to a new form of payment," he says. "Because the stakes are higher, many bigger merchants are standing back and gauging the level of consumer acceptance and the success rates from check conversion. Some are creating business cases and looking to get their projects approved by management."
  Despite the relatively small amount of check conversion activity, the application's growth potential remains immense. While consumers' increasing use of debit cards and other forms of electronic payments are rapidly eroding check volumes, about 39 billion items still were processed in 2003.
  TowerGroup's Hunt says check transactions are dropping between 3% and 4% annually, but projects volumes in 2010 still will reach 30 billion. Yet, moving the majority of that activity to electronics at the point of sale will be difficult.
  Because it still is relatively easy for crooks to create bogus checks-and to keep one step ahead of the law by developing new counterfeit items as soon as the bad-check data are added to negative files-fraud will remain, and that makes electronic conversion less attractive to some retailers, he says. And many consumers who prefer the longer float associated with traditional paper check transactions also will remain resistant to the procedure.
  "Electronic conversion at the point of sale still is not very prominent and a major reason is because funds are cleared sooner than before," says Dan Venkatesan, product marketing manager for Moneris U.S., a Buffalo Grove, Ill.-based merchant acquirer and processor owned by Canada's RBC Financial Group and BMO Financial Group, parent companies of Royal Bank of Canada and Bank of Montreal, respectively. "While once there was a five-day float, electronification takes it down to one or two days."
  Though consumers may prefer old-fashioned paper, many payment firms nonetheless are betting that electronics will ultimately prevail. Quicker funds settlement is a key feature of Visa USA's Point of Sale Check Service. Developed in 2001 to add further activity to the VisaNet payments network, the service is designed to convert checks into electronic funds transfer transactions at the checkout.
  Only checks drawn on accounts held by Visa member institutions that are connected to the service can be translated into EFT transactions. Because just 20% percent of the U.S. demand-deposit account base is live on the system, VisaNet only is used for about 11% of the service's 1.5 million monthly transactions, says Dante Terrana, Visa director of business development. The remaining volume is sent through the ACH.
  Terrana says he expects the number of accounts eligible to participate in the Visa service to increase about 20% over the next year, and predicts overall system volume will reach 21 million transactions in 2004.
  "There is quite a learning curve as the merchants that join the system will have to change their host system or electronic cash register system at the point of sale," he says. "However, prior to June 2003 there was only about 10,000 monthly transactions, so interest is increasing."
  Gap Inc., which last year became the service's first national customer, is generating many of the additional transactions, Terrana says. Additional participation typically correlates to merchants' proximity to the financial institutions that are part of the system.
  Live Visa members include Bank of America, U.S. Bancorp, Wachovia Bank, Navy Federal Credit Union, First National Bank of Omaha, State Employees Credit Union of North Carolina, Southtrust and Branch Banking and Trust. Retailers in smaller towns without the presence of such large institutions-and whose customers primarily have checking accounts in banks that are not connected to the service-are less likely to participate, Terrana says.
  Terrana won't divulge program fees, but says pricing varies based on the level of service. The lowest cost is for simple check conversions. Retailers also can add a verification application that confirms funds are in the customer's account to cover the transaction, as well as a payment guarantee service.
  Because a segment of the population always will want to pay by check at the point of sale, many payments-industry participants say the electronic conversion market will remain active. But the procedures adopted by retailers likely will evolve.
  Bipin Shah, president and chief executive of Genpass Inc., a Fort Washington, Pa.-based payments processor, projects that all checks eventually will be converted to debit transactions, which he says are the fastest and safest types of payments.
  "Checks are totally outdated and there is no reason you can't create a real-time transaction by converting the MICR line to debit numbers," he says. "But it will take a massive effort for that to occur nationally because the real benefactor will be the merchant and not the banks." The MICR-or magnetic ink character recognition-line is the group of numerals on a paper check that identifies the paying or drawer bank, the customer's account number and check serial number.
  The electronification of checks also may eventually occur in the retailer's back office, analysts say. In some instances they may leverage a procedure called remote image deposit, in which the merchant creates an image of the check and transmits it in a batch to the bank for deposit.
  In another scenario, customers would provide a filled-out check to the cashier at the point of sale. But instead of creating an ACH transaction and returning the item to the consumer, the merchant would later process the check in the back office.
  Such a method could reduce the amount of processing technology needed at each checkout counter, and eliminate the need to train cashiers to explain to customers that only consumer checks are eligible for conversion, Miner says. He adds that it is unlikely that NACHA will take any such steps before 2006.
  Merchants already are actively converting to electronics checks that are mailed to lockboxes. There were more than 220 million conversions in 2003, and NACHA projects more than 1 billion of the so-called ARC transactions will occur this year.
  Helping to further push the payments industry away from paper was the passage by Congress last year of the Check Clearing for the 21st Century Act. Also known as Check 21, the legislation, which became effective Oct. 28, enables banks to electronically send machine-readable copies of checks to the Federal Reserve for processing. While such electronic check presentment primarily benefits financial institutions by adding processing efficiencies, some analysts say it also could eventually spur the remote depositing of checks by more merchants.
  Getting more retailers to participate in electronic check conversion programs will largely be dependent on the marketing efforts of merchant acquirers and independent sales organizations, analysts say.
  "There is a lengthy education cycle when introducing any new payment procedure," says George Reich, president of Irving, Texas-based National E Commerce Corp., an electronic check processor and owner of the E-Chex service. "There currently doesn't seem to be aggressive selling of check electronification. But there is a need to eliminate paper in the system, so the procedure is a definite asset to the merchant."
  Reich says after experiencing 600% growth rates in the first few years of check conversions, E-Chex's volume now is increasing between 20% and 30% annually. The company provides electronification of checks, authentication, and transaction guarantee services for payments sent through the ACH.
  Sluggish retailer interest in the service also is the result of miscommunication by many sellers who were not clear on the rules, settlement times and benefits of electronic check transactions, he says.
  "That led to dissatisfaction on the merchant side, which got back to the sales forces, and some then backed away from pushing the product," Reich says. "But we have come full circle and there now is a better understanding of how the procedure works."
  Indeed, Phil Kumnick, senior vice president of POS applications and merchant services for Tempe, Ariz.-based Vital Processing Services, which offers the Visa check conversion product to its merchant-acquirer customers, says he expects more ISOs to successfully market the service to their existing customer bases.
  "As with all new products you need time to generate traction and electronic check conversion has only been occurring since Y2K when retailer reinvestment in POS systems began," he says. "It is starting to emerge because checks still account for a substantial amount of payments, and merchants need tools that most efficiently process transactions and can speed customers through the checkout."
  And as more retailers use the service, manufacturing economies of scale will result in lower equipment costs, leading additional merchants to install systems, Kumnick predicts. Indeed, Global Payments' Myers says over the last few years the cost of check scanning and imaging devices has fallen to $700 to $800 from $2,500, and machines that just read MICR and routing numbers are available for $400 to $500.
  VeriFone Inc., a Santa Clara, Calif.-based terminal vendor, reports that it has shipped more than 200,000 debit and credit card terminals that feature a built-in check imaging application.
  "Electronic conversion technology even can extend the life of checks by making the processing so efficient that there is no need to get rid of the payment items," says Paul Rasori, VeriFone vice president of North American marketing.
  Retailers also could become more supportive of check acceptance as additional technologies are developed to further limit fraud, notes O.B. Rawls IV, president of Hypercom North America, a unit of Phoenix-based Hypercom Inc. and a manufacturer of POS devices that support check readers. Rawls expects biometric devices with fingerprint readers to authenticate check writers to begin appearing at more merchant locations over the next 12 to 18 months.
   "Scanning checks at the point of sale is a great concept for fraud reduction," Rawls says. "Identify theft and identity fraud will drive a new mindset for additional technologies."
  After bursting out of the blocks, growth in check conversion activity at the point of sale has slowed considerably. But the benefits to merchants from transforming paper items into electronic transactions make it likely that the market ultimately will find its second wind.