The future of the check: how Check 21 and emerging technologies will change our payments system.

• Author: Kelly, Archie B.
• Position: Check 21

As government finance professionals are aware, our national payments system is now undergoing significant evolutionary changes. In the past decade, adoption of electronic payment technologies in both the public and private sectors has accelerated, and dependence on the check as our nation's primary payment mechanism is declining. Consider the following statistics:

* In its 90th Annual Report to Congress, the Federal Reserve System reported that it processed 15.8 billion checks in 2003, 4.7 percent less than in 2002. This was the steepest rate of decline in the past four years. Meanwhile, the Fed's check processing unit cost increased to 5.1 cents, up 13.3 percent from 2002.

* The Fed reported that in 2003 it processed 5.6 billion commercial Automated Clearing House payments, an increase of 12.1 percent over 2002. Meanwhile, the unit cost to process an ACH payment decreased to 1.1 cents, a 15.4 percent decline from 2002. In 1995, the unit costs for checks and ACH were virtually identical. Today, checks are nearly five times as expensive to process as ACH payments.

* In 2003, for the first time in U.S. history, consumers made more purchases in stores by electronic payment than by cash and checks. According to a December 2003 report by the American Bankers Association and Dove Consulting, in-store shoppers used electronic payment methods for 51 percent of their purchases. Debit cards accounted for 31 percent of the total volume, virtually dead even with cash at 32 percent. Consumers used credit cards for 21 percent of their purchases, checks for just 15 percent.

The federal government has been one of the primary drivers of the move to electronic payments. A new federal initiative, the Check Clearing for the 21st Century Act, promises to greatly accelerate this migration. Check 21, as the act is commonly known, was passed into law last year and goes into effect October 28. The objectives of Check 21 are to facilitate check truncation, foster innovation in the check payment system without mandating the receipt of checks in electronic format, and improve the nation's payment system overall.

In this article, we examine what Check 21 is and how it will work, how U.S. financial institutions are addressing the act, and how Check 21 and emerging electronic payment technologies will change our national payments system. We also offer some specific suggestions on what government finance professionals can do to prepare for Check 21 and the electronic payments future.

WHY CHECK 21?

One of the principal lessons learned from the terrorist attacks of September 11, 2001, was that our national payments system, like our national security system, needed to be strengthened to deal with terrorism. One of the immediate consequences of 9/11 was a disruption of the check clearing process, which relies on airplanes to physically transport checks all over the country to paying banks. For four days after September 11, all flights nationwide were grounded, which meant that millions of checks sat in airplanes parked on runways at airports across the nation and could not be presented to paying banks.

To prevent a liquidity crisis, the Federal Reserve continued to provide credit for these checks on its usual availability schedules, in effect supplying an enormous loan to the banking system. How enormous? On just one day, Wednesday, September 12, the float on deposited checks credited to depositors but not debited from check writers totaled almost $23 billion. This was about 30 times the average float for the previous 10 Wednesdays.

These events made it clear that the current legal requirement to physically present checks to paying banks was a potential weakness in our payments system. To eliminate this vulnerability and strengthen and improve the efficiency of the U.S. payments system, the Federal Reserve and leading private sector financial institutions proposed changes to check clearing regulations so that checks would no longer need to be physically transported between banks. These proposals became the basis for Check 21.

HOW CHECK 21 WORKS

Check 21 provides a legal basis and a process for replacing the physical...