Transformation of the Check System: The ACH Example Transformation of the Check System: The ACH Example

April 9, 2007
Bankers Forum Hartford, Connecticut

Thank you for being with us this evening. I would like to offer an update on the ongoing transformation of the U.S. retail payments system.

Change in retail payments, and in the check collection system in particular, is occurring at an accelerating rate. This change brings some disruption, but it also brings progress. You may find it interesting to compare the change we are experiencing in the check system with the prior evolution of the Automated Clearing House system.

You may know the Automated Clearing House, or ACH, as the electronic payment mechanism through which your banks, and your customers, deliver direct deposit of pay and make recurring payments. More and more the ACH also is serving as the infrastructure for other electronic payment options, including on-line bill payment. The ACH is a very efficient electronic mechanism. However, it was not always so.

For many years the electronic ACH was not very electronic. Most banks were not connected electronically with each other, or even with the Federal Reserve in a way that would enable ACH payments to flow electronically.

Instead, we moved electronic payments by shipping reels of magnetic tape from place to place. If you had stood in the lobby of our Bank on an evening in the 1980's, you would have seen people coming in and going out carrying large metal cases, inside of which were their magnetic tapes with ACH payments. So the payments moved as fast as people could carry them.

Moreover, for the banks at greater distances from Boston, we delivered ACH tapes on trucks, the same trucks we deployed to deliver checks.

To go one better, we actually printed some ACH payments onto paper, for small-volume receivers in Maine, and delivered those "electronic" payments in paper form. So, when ACH was not very electronic, the Federal Reserve need 37 processing locations to support ACH services. Since physical delivery mattered, proximity to a processing site mattered.

Then, technology improved, we made significant investments, and we worked with our customers, to build an all-electronic ACH: no more tapes, no more paper, no more trucks. Instead, we moved to electronic transmissions to send and receive payments, and to an all-electronic internal operation.

Today our ACH runs on one central computer, and we have just 2 operational support centers nationally. You probably do not know where our ACH operations are. I will be happy to tell you, but the point is, you have no real need to know. It does not matter where your processing is done, how closely or how far away, in an all-electronic process.

Of course, today's infrastructure is a lot less expensive than the old one. ACH prices today are a lot lower than they were in the late 1980's. Funds availability for you as a bank collecting payments is better.

This look at how the ACH evolved is relevant because the national check collection system now is evolving in the same direction. Check collection is becoming electronic.

Actually, three big changes are occurring at the same time, and together they will transform the check collection system of the country.

First, American consumers and businesses are writing fewer checks.

Second, check collection is going electronic, spurred by the legislation, called Check 21, that became effective in the fall of 2004. Check 21 enables banks to convert checks into images, or digital pictures, and collect them electronically.

And third, billions of checks written are being converted into electronic ACH payments before they hit the bank collection system.

I will look quickly with you at all three of these changes.

In recent years the Federal Reserve has published two studies on the use of checks and other retail payment choices. The first reported data as of the end of 2000, and the second had data through the end of 2003. Later this year the Federal Reserve will complete and publish a survey with data through 2006. Meanwhile, our two published studies show declining numbers of checks, and growth in every electronic alternative.

The fastest rate of growth in recent years has been with debit cards. Credit cards and the ACH also are growing.

The rate of decline in the use of checks in the period from 2000 to 2003 was about 3 percent annually. I will be surprised if we do not see a greater rate of decline in our next survey.

The checks are going away. Still, we have a lot of them; maybe 30 billion or so annually. We will have billions of checks for years to come. They will be around long enough to warrant investment in a more efficient way to collect them.

Banks in New England and across the country are taking that step and realizing the benefits. Electronic check collection is evolving rapidly.

In January, 2005, just a little more than 2 years ago, the Reserve Banks were receiving for collection close to one billion paper checks per month. Meanwhile, we were receiving almost no electronic images of checks for collection since the Check 21 law had just taken effect in October, 2004.

By January of this year, however, paper check deposits were down, to below 700 million per month, but deposits of electronic images had grown to nearly 250 million per month. The growth on the electronic side has been phenomenal.

Before the end of 2008, the Reserve Banks may be receiving more image deposits than paper deposits. We expect steadily lower overall volume, with electronic deposits taking over, and fewer and fewer paper deposits coming in the door.

We will have less paper going out the door, too. Banks have been quicker to collect checks electronically than to receive their check presentments electronically. However, once banks and their software and service vendors take the steps to receive checks in image form, they are able to take costs out of their back room operations. They do not have to sort incoming checks anymore, for instance.

Electronic presentment is growing rapidly now, about a year after electronic deposit started to grow rapidly. Our volumes of image presentment were very small just a year ago. Now, the Reserve Banks' monthly volume is about 100 million, roughly 14 percent of our total presentment volume. We expect our current volume to double before year-end. Within two years or so we expect to be presenting more images than paper checks.

These are projections for the Reserve Banks. The large correspondent banks say that they are moving in the same direction.

As check collection becomes increasingly electronic, we should expect our infrastructure to change, just as we saw the national ACH infrastructure change.

You know that last year we consolidated our Boston check operations into our Windsor Locks Office. Nationally, we have consolidated from 45 check operations to 22, with further consolidation ahead. This year we are scaling down our national air transportation network for shipping checks among the Reserve Banks, because we have fewer checks to ship, and because we can collect the checks faster electronically.

As we make these infrastructure changes, a bank still depositing and receiving paper will have some adverse effects from the longer distances to deliver and receive the paper, and from some reduction in funds availability. A bank depositing and receiving check images will be immune from these changes, can snooze right through them, and actually will be enjoying better funds availability and later deposit deadlines than ever were available in the paper-based system.

So far have seen that fewer checks are being written. We have seen that electronic check collection is growing rapidly.

The third big change is the conversion of checks into ACH payments. The outstanding example is the Accounts Receivable Conversion product, or ARC. This product has grown from nothing five years ago to more than 2 billion transactions in 2006.

Under ARC, a company with a lockbox operation to process consumer bill payments, such as mortgage and credit card payments, can receive the checks through the mail and convert them into ACH payments. Each payment is collected electronically, through the ACH, and shows up on the check-writer's bank statement as an electronic debit, usually labeled "ARC" , instead of as a paid check.

In this model, the consumer has not changed behavior; she still writes and mails a check. However, the check never comes into the bank collection system.

There is a new, similar ACH option just coming into the marketplace now. As of March 16 of this year, we have the Bank Office Conversion model, or BOC. This model allows a retailer to receive checks as payment, and then, in a "back office" operation, convert the checks into ACH payments and collect them electronically.

The BOC model brings to retail stores and other businesses essentially the same opportunity that the ARC model has brought to lockbox operations.

Here also, the consumer does not have to alter her behavior. She can pay by check at the cash register as before. The payment will hit her bank account as an ACH payment.

Some merchants have been asking for this product for quite awhile. The National Automated Clearing House Association, or NACHA, projects 3 billion BOC conversions by 2012.

You may have seen yet another ACH retailer option, called Point of Purchase, or POP. In this model the customer pays by check at the cash register, the check-out clerk captures the information from the bottom of the check, and the amount of the check, and then hands the check back to the customer. Again, the payment is collected electronically through the ACH.

POP has not grown rapidly, partly because it requires equipment at every register, partly because it can cause confusion and slow down the check-out line. However, some industry sources anticipate further growth.

So: check-writing is declining; check collection is going electronic; and checks are being converted into electronic payments.

It is clear that the costs to collect checks in paper form, whether through the Federal Reserve or through other channels, will increase as volumes decline. It is clear that collecting and receiving your checks electronically will save your banks money and speed the collection of funds for your customers. I encourage you to learn more about how to make use of Check 21 and gain the benefits of electronic check collection. Thank you.

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