Check 21 Northeast Treasurers Conference

1
Check 21 Northeast Treasurers Conference
August 24, 2004

• Len Goodman
• Senior Vice President
• Director of Product Management
• Sovereign Bank

2
What is Check 21?

• Convergence of Ideas and Events
• Growing interest in streamlining the nations
  check collect system through image exchange
• Events of 9/11 exposed our vulnerability the
  check collection system ground to a halt
• Federal Reserve Bank responded by proposing new
  legislation

3
What is Check 21?

• What is Check 21?
• Check Clearing for the 21st Century Act
• A new federal law effective October 28, 2004
• Proposed by the Federal Reserve
• First time the Fed has ever proposed legislation
• A body of law that creates and governs the use of
  a new negotiable instrumentthe substitute
  check
• Federal Reserve Board is charged with developing
  the operating regulations
• Final regulations delivered late July
• Will become part of Regulation CC, established to
  implement the Expedited Funds Availability Act of
  1987

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What is Check 21?

• The purpose of Check 21
• Foster innovation in collection system without
  mandating receipt of checks in electronic format
• Increases use of check images in the check
  clearing process, but image exchange is not
  covered or required by the Act
• Facilitate check truncation by authorizing
  substitute checks
• Authorizes banks to create a paper substitute
  check from an electronic image of the original
  paper check
• Improve efficiency of nation's payment system
• Eliminates the need to transport paper checks for
  presentment between banks

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What is Check 21?

• What does Check 21 do?
• Allows financial institutions to truncate checks
  at any point in the collection or return process
• Creates a new legal document (substitute check)
  that
• Has all the rights and obligations given to the
  original check
• Can be used for proof of payment or for any
  reason that would normally require an original
  cancelled check

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What is Check 21?

• What does Check 21 do? (contd)
• Requires banks to accept substitute checks
• Permits any bank in the check collection process
  to insist on paper, in which case a substitute
  check would be created
• Supercedes applicable state and local laws

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What is Check 21?

• Check 21 does not
• Mandate or address check imaging and check image
  exchange
• Encourage banks to truncate checks and convert
  them to ACH debits
• Account Receivable Conversion (ARC) is an ACH
  process that converts checks to electronic debits

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Check 21 vs. ARC

• Check 21
• Facilitates check truncation through the creation
  of substitute check
• Governed by Check Clearing for the 21st Century
  Act
• All checks are eligible for truncation as long as
  they can be processed electronically or
  reconverted to a substitute check
• Customer authorization not required
• Customers can not opt out
• ARC (Account Receivable Conversion)
• Facilitates check conversion by converting checks
  to ACH debits
• Governed by the Electronic Funds Transfer Act,
  Federal Reserve Regulation E and by NACHA rules
• Business checks cannot be converted to ACH
• Requires customer authorization or notification
• Consumers can opt out

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Potential Industry Benefits

• Faster Check Collection
• Electronic presentment, including transmission of
  images with local printing and presentment of
  substitute checks, means funds can be collected
  more quickly
• Branch, ATM, and Corporate Site check image
  capture reduces or eliminates check transportation

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Potential Industry Benefits

• Faster Check Return Processing Reduced Fraud
  Loss
• Electronic outsorting and presentment of images,
  including use of substitute checks for return
  processing, means faster return of advanced funds
• Access to check images as soon as the items enter
  the collection stream means banks and customers
  can identify potential frauds early
• Ensures operational continuity in the event of
  natural or man-made disasters
• Further eliminates the need to store cancelled
  checks

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Current Check Processing

• Checks are physically transported across town or
  country before they can be cleared
• Weather and transportation delays can pose
  serious problems for check clearing
• Many challenges in processing checks were
  encountered as a result of 9/11

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Processing Substitute Checks

• Banks will scan paper checks and send those
  images instantaneously through the clearing
  system
• At the other end of the electronic process, a
  substitute check might be printed and presented
  to the paying bank if they are unable to accept
  images
• Any party in the collection chain that cannot
  accept images can insist on paper, which will
  result in the creation of a substitute check

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Substitute Check

• What is a substitute check?
• A paper reproduction of the original check that
  contains an image of the front and back of the
  original check, and is suitable for processing in
  the same manner as the original check.

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Substitute Check

• Contains image of front and back of check
• Conforms to regulatory standards for substitute
  checks
• Contains MICR encoding check
• Accurately represents all information on original
  check
• Includes endorsements of all previous parties,
  including identification of the bank creating it
  (reconverting bank)
• Bears legal legend

This is a legal copy of your check. You can use
it the same way you would use the original check
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Substitute Checks

• All checks are eligible for replacement with
  substitute checks, for example
• Retail Checks
• Business/Commercial Checks (non-retail)
• Government Warrants
• Treasury Checks
• Congress did not include any special provisions
  for Treasury checks
• Money Orders
• Controlled Disbursement Checks
• Payable through Drafts

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Customer Impact

• What is the customer impact?
• Check return customers may receive substitute
  checks instead of original checks
• Image statements will contain images of
  substitute checks
• Return deposited items received as a substitute
  check can be redeposited, cashed, or referred to
  maker
• Customers will not be able to obtain original
  checks if they have been truncated
• Act does not require original check to be
  retained or provided to the customer. After
  October 28, 2004, customers requesting original
  checks could receive a substitute check.

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Customer Impact

• What is the customer impact? (contd)
• Future opportunity to expedite collections
  through on-site image capture
• Will require changes to fraud prevention
  techniques, which rely on paper
• Images and substitute checks eliminate the
  opportunity for paying banks to examine original,
  physical checks for validity
• Check security features made obsolete
• Watermarks
• Infrared Ink
• Weight
• Color
• Perforated edges

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Customer Impact

• What is the customer impact? (contd)
• Consumers have Expedited Recredit protection
  under Check 21
• Similar to protection under Reg E
• This protection DOES NOT apply to commercial
  customers
• Business customers are subject to the standard
  industry recredit policies, procedures, and
  timeframes currently in place

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Cash Management Product Impact

• Controlled Disbursement
• No immediate impact. Presentment times will not
  be impacted by substitute checks. However,
  substitute checks may reach presentment faster
  than original checks do today.
• Sovereign will not initially accept images at our
  Controlled Disbursement acceptance point, so we
  anticipate only minor impact on disbursement
  float
• IRIS
• Display full image of substitute check
• CD-ROM
• Display full image of substitute check
• Lockbox
• Display full image of substitute check
• Image Statement
• Display cropped image (check portion only)

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Fraud Mitigation Tools

• Rule based systems that detect unusual check
  activity (Sovereign - in place)
• Carreker ASI 15 19 Fraud detection software
  that looks for patterns in check clearing, such
  as check numbers out of range, amounts out of
  range.
• Positive Pay (Sovereign - in place)
• Electronic comparison of checks presented for
  payment against check issue records. Unmatched
  items are referred to maker for payment decision.

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Fraud Mitigation Tools

• Automated signature verification (emerging)
• Automatic comparison of signatures captured from
  signature cards to those on check images
• Image survivable security features (emerging)
• Embedded digital codes imperceptible to the eye,
  but readable by computers and software
• One or two dimensional bar codes and encrypted
  document identifications numbers
• Note
• You can help ensure image quality by purchasing
  image friendly checksthose without
  prints/designs/colors. These features may cause
  image quality issues beyond the banks control.

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Where is Sovereign?

• Preparing for October 28, 2004
• Updating systems to accept and process substitute
  checks
• Establishing Expedited Recredit procedures for
  consumers
• Training all bank team members
• Communicating to all customers via brochures, the
  Internet, and corporate outreach

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Where is Sovereign?

• Planning for the future
• Participate in image exchange programs for check
  collection and return
• Deploy Branch, ATM, and Corporate Site image
  capture systems
• Notes
• You may have heard about on-site corporate
  capture equipment that enables you to produce
  image files or substitute checks today.
• Legal agreements would need to be in place before
  Sovereign would accept images or substitute
  checks created by you or third parties on your
  behalf.
• We currently do not offer this service, but may
  in the future.

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Check 21

• Can banks opt-out?
• Can bank customers opt-out?
• Can governmental
  organizations opt-out?
• Do banks have to accept substitute checks
  presented to them?

• No

• No

• No

• Yes - Substitute checks are the legal equivalent
  of the original checks

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Check 21
Thank You