MidYear Meeting August 1 3, 2004 Philadelphia, PA

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Mid-Year MeetingAugust 1 3, 2004Philadelphia,
PA
Check 21
Dave Kurrasch, President Global Payments
Advisors, Inc. Alameda, CA
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Topics

• Myths and Reality
• Overview of Act
• Rules Versus Act
• Deposits Services
• Implementation Impacts - General
• Summary and Questions

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Check 21

• Check Clearing for the 21st Century or Check 21
• Federal Reserve Bank sent CTA to congress 12/2001
• Bill passed unanimously in House and Senate
• Signed by President Bush, October 28, 2003
• Enabling regulation due by July 28, 2004
• Effective date of October 28, 2004

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Check 21 Quiz

• Multiple choice, which one, if any, apply

• Mandates Check Truncation
• Mandates the destruction of the original check
• Grants electronic check images the same legal
  status as the original check
• Grants Substitute Checks (IRDs) the same legal
  status as the original check

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Check 21 Myths

• Its my understanding that Check 21 will require
  the destruction of the physical check by the
  depository bank.
• the passage of legislation that will give
  electronic check images the same validity as
  paper checks for clearance and settlement.

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Check 21 Myths

• Check Clearing for the 21st Century grants check
  images the same legal status as paper checks for
  purposes of clearing and settlement.
• This proposed legislation will allow a
  collecting bank to clear its check-based
  transactions through check image exchange
  presentment.

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Legislation Overview

• Origin
• Proposed by the Federal Reserve Bank as new law
• Momentum for concept after 9/11
• Desire to reduce the transportation expense and
  time associated with check clearing
• Federal Reserve Bank Objectives
• Facilitate check truncation
• Foster innovation in check collection systems
  without mandating receipt of checks in electronic
  format
• Facilitate increased use of check images in check
  clearing process
• Authorize banks to create a paper substitute from
  an electronic image or an original paper check
• Improve the overall efficiency of the nations
  payment systems

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Myth and Reality

• Myth
• Check 21 validates exchange of check images
• Reality
• Check 21 does not address exchanges under
  agreement such as Electronic Check Presentment or
  Image Exchanges
• Confusion
• Check 21 depends on use of image technology for
  substitute checks, but.
• Does not cover image exchanges between banks or
  their customers

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Check 21 - The Reality

• Only applies to substitute checks
• Image reprints of original paper checks
• Use of substitute checks does not require
  agreement between the parties
• Does not apply for products and services under
  other agreements

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Check 21 - The Reality

• Designed to encourage check truncation by
  removing key barrier to truncation
• Allows unilateral decisions to truncate checks
• Unlike current environment with requirement to
  obtain agreements from all the parties
• Provides for the replacement of a paper check
  with a substitute paper check
• For those customers that have not agreed to check
  truncation or electronic check files
• But without mandating the receipt of electronic
  transactions

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Eligible Checks ??

• ALL CHECKS are eligible for replacement with
  substitute checks, for example
• Retail checks
• Non retail checks
• Government warrants
• Treasury checks
• Money orders
• Controlled disbursement
• Payable through drafts
• Etc.

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Substitute Checks

• Designed to be processed exactly as if it were
  the original paper check
• Substitute Check is legal equivalent of original
  check for all purposes
• Contains image of front and back of check
• Conforms to industry standards
• MICR
• Physical characteristics of check
• Suitable for automated processing
• Must accurately represent all information on
  original check
• Bears legend
• Includes all endorsements
• Includes identification of party creating it

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Substitute Check/IRDImage Replacement Document
Front
ANSI X9.90 DSTU
Back
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Check 21 Warranties

• Bank that creates substitute check warrants
• Substitute check meets all requirements for legal
  equivalency
• No double debit

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Check 21 Indemnification

• Bank that creates substitute check and each
  subsequent bank indemnifies all parties in the
  collection or return process for loss if loss is
  due to receipt of substitute check instead of
  original check
• Consequential damages rest with bank that creates
  Substitute Check, if breach of warranty
• Bank that creates Substitute Check can limit
  liability, if it produces original check or copy
  of original check on request

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Check 21 Expedited Re-credit

• Expedited Re-credit for Consumers
• Consumer may make claim under Act for Substitute
  Check that was not properly charged or for
  warranty claim
• Consumer suffered loss
• Original check or copy of original check
  necessary to determine validity

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Check 21 Expedited Re-credit

• Expedited Re-credit for Consumers
• Bank may withhold availability in Reg CC like
  exception situations
• New accounts, excessive ODs, or cause to believe
  fraud
• Bank may withhold availability for 45 days
• Bank must notify Consumer of delay in
  availability
• Bank cannot charge OD fees for five days
• Expedited Re-credit Procedure Between Banks

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Check 21 Expedited Re-credit
Consumer Statement
40 DAYS
120 DAYS
CLAIM
CLAIM

10 DAYS
10 DAYS
Check, Copy or
Sub Ck
RECONVERTING BANK
PAYING BANK

• Paying bank must provide consumer with original
  check, copy of original check or re-credit within
  10 days of claim up to 2,500 per check
• Amounts gt 2,500 must be recredited to consumer
  within 45 days
• Paying bank must make claim to reconverting bank
  within 120 days of transaction that gave rise to
  claim
• Reconverting bank must provide re-credit,
  original check or copy within 10 days of paying
  bank claim

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Other Provisions

• Consumer Awareness
• Bank to notify consumer of
• How substitute check is legal equivalent
• Expedited re-credit rights
• Notification required only to consumers who
  receive original or substitute checks
• Federal Reserve Bank Regulations
• Fed may prescribe regulations to carry out
  provisions of Act
• Safe harbor language for Consumer Awareness

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Check 21 and Rules

• Need for Image Rules Beyond Check 21
• Check 21 is image based will encourage image
  exchanges, but
• Electronic exchanges are not covered by Check 21
  require agreements
• Warranties and indemnification of Act made by
  reconverting bank not carried back to original
  imager of item

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Check 21 and Rules

• Risk Under Check 21 - Collections

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Check 21 and Rules

• Risk Under Check 21 - Collections

X9.37
CHECK
At Risk
and/or
Sub Ck
Sub Ck
Image
COLLECTING BANK (BOFD)
CUSTOMER
PAYING BANK
RECONVERTING BANK
Reconverting bank makes warranties
indemnification
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Check 21 and Rules

• Risk Avoidance

X9.37
CHECK
and/or
Image
COLLECTING BANK (BOFD)
PAYING BANK
RECONVERTING BANK
CUSTOMER

• Rules covers these relationships

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Check 21 and Rules

• Need Both Check 21 Rules

• Proposed Reg acknowledges need for agreements
• Need a common, national set of image exchange
  rules

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Looking Forward.

• Check 21 is simply a gateway to greater
  opportunities and efficiency
• Substitute checks are not the final solution
  they are a bridge to full image exchange, lower
  payment risk and greater efficiencies
• Short term generally minimal impacts
• Long term major repercussions

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Check 21 Remote Capture
TODAY
TOMORROW

Lockbox, Branch Deposit ATM, Courier
Capture at Your Offices/Stores
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Electronic Deposit Process
Electronic Image Files Acceptance
Presentment, Settlement, Information
Customer
Information Exceptions
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Deposit Channels

• Nationwide Lockbox Locations
• Remote Office Capture
• Cash Vaults
• Point of Sale
• International locations

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Expanded Image Services

• Once checks are image enabled, most items should
  be available via existing and newly established
  image services.
• Online access of deposited and paid items
• CD-ROM services
• Return Items through Return Items Module
• Image File Delivery for disbursements and
  depository
• Extended archiving for online access

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Implementation

• Remember..
• It is optional to create a substitute check
• It is required to accept a substitute check from
  another financial institution

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Implementation

• Retention of the original check is not specified
  in the legislation, nor do we expect it to be
  specified in the Regulations. The liability
  associated with the use of a substitute check and
  volume is the likely driver behind how each bank
  will choose to establish its retention and
  destruction policies over original checks.
• Checks imaged by commercial establishments will
  be retained and destroyed under the individual
  terms of the image depository agreement

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Bank Implementation

• For normal bank deposits, banks will primarily
  use traditional considerations for deciding when
  to use a substitute check versus an original
  check
• clearing time,
• dollar amount
• cost of clearing (including the cost of printing)
• Commercial customers will greatly influence the
  demand for substitute checks and the movement of
  image exchange through market demand for new
  payment services

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Check Processing Expected to Drop Sharply
(Number of checks by processing method, billion)
45
-
40
35
30
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Image Exchange
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IRD
Paper Clearing
-
15
10
5
-
ARC
0

-
Assumes that in 2005 image- enabled players send
1/3 of their volume as an image, 2/3 in 2006, all
volume by 2007. Source NACHA, Tower Group,
SVPCo, McKinsey Payments Practice.
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New Bank Applications

• Introduce efficiencies
• Outgoing return items
• Incoming return items (in conjunction with image
  exchange)
• Branch ATM remote capture take the paper out
  of the critical path

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Immediate Impacts - Disbursement Services

• No guarantee you will receive original checks
  from your bank. A bank must accept a legal
  substitute check if presented to it by another
  financial institution and it wont necessarily
  have access to the original.
• Substitute checks replace original checks. We
  expect that substitute checks will assume legal
  equivalency status, just as certified photos do
  today.
• The time to clear check transactions will
  decrease in some instances
• Daily cash forecasting capabilities should remain
• Early morning Controlled Disbursement reporting
  will continue
• More electronic retrieval options access to more
  items

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Immediate Impacts to Depository Services (cont.)

• Return Items
• Check collectors will not necessarily see
  original returned checks instead substitute
  checks may be returned
• Acceptability of substitute checks for collection
  efforts
• How is the Substitute check legally binding in
  court (best evidence versus legal equivalency)

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• Questions?
• Discussion.