United States Government Accountability Office

GAO Report to Congressional Committees

CHECK 21 ACT 

Most Consumers Have 

Accepted and Banks 

Are Progressing 

Toward Full Adoption 

of Check Truncation 

October 2008 

 

GAO-09-8
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

October 2008

CHECK 21 ACT

Consumers Have Accepted and Banks Are 

Progressing Toward Full Adoption of Check 

Highlights of GAO-09-8, a report to Truncation 

Congressional Committees 

Although check volume has 

declined, checks still represent a

significant volume of payments that

need to be processed, cleared, and

settled. The Check Clearing for the 

21st Century Act of 2003 (Check 21) 

was intended to make check 

collection more efficient and less 

costly by facilitating wider use of 

electronic check processing. It 

authorized a new legal

instrument—the substitute check—

a paper copy of an image of the 

front and back of the original 

check. Check 21 facilitated 

electronic check processing by

allowing banks to use electronic 

imaging technology for collection 

and create substitute checks from 

those images for delivery to banks

that do not accept checks

electronically. Check 21 mandated 

that GAO evaluate the 

implementation and administration 

of the act. The report objectives are

to (1) determine the gains in

economic efficiency from check 

truncation and evaluate the 

benefits and costs to the Federal 

Reserve System (Federal Reserve) 

and financial institutions; (2) 

assess consumer acceptance of the

check truncation process resulting 

from Check 21; and (3) evaluate the

benefits and costs to bank 

consumers from check truncation. 

GAO analyzed costs for the check 

operations of the Federal Reserve 

and a group of banks, interviewed 

consumers about their acceptance 

of and costs and benefits of

electronic check processing, and 

analyzed survey data on bank fees. 

The Federal Reserve agreed with 

the overall findings of the report. 

Check truncation has not yet resulted in overall gains in economic efficiency 

for the Federal Reserve or for a sample of banks while Federal Reserve and 

bank officials expect efficiencies in the future. GAO’s analysis of the Federal 

Reserve’s cost accounting data suggests that its costs for check clearing may 

have increased since Check 21, which may reflect that the Federal Reserve 

must still process paper checks while it invests in equipment and software for 

electronic processing and incurs costs associated with closing a number of 

check offices. However, GAO found that the Federal Reserve’s work hours 

and transportation costs associated with check services declined from the 

fourth quarter of 2001 through the fourth quarter of 2007. Several of the 10

largest U.S. banks reported to GAO that maintenance of both paper and 

image-based check processing systems prevented them from achieving overall 

lower costs, although they had reduced transportation and labor costs since 

Check 21 was enacted. Check imaging and the use of substitute checks 

appear to have had a neutral or minimal effect on bank fraud losses. 

Most bank consumers seem to have accepted changes to their checking 

accounts from check truncation. In interviews with bank consumers, the 

majority of them accepted not receiving their canceled checks and being able

to access information about their checking account activity online. Several 

reported that they did not need the “extra paper” from canceled checks and 

that image statements and online reviewing was more secure than receiving

canceled checks. Eleven percent of the 108 consumers still preferred to 

receive canceled checks. Most consumers reported that they were not 

significantly concerned about their ability to demonstrate proof of payment 

using a substitute check or check image rather than a canceled check and few

reported that they suffered errors from the check truncation process. Also, 

GAO found that the federal banking regulators reported few consumer 

complaints relating to Check 21. 

To the extent that banks have employed check truncation, bank consumers 

have realized benefits and costs relating to faster processing and access to 

account information. GAO found that some banks have extended the hours for 

accepting deposits for credit on the same business day, which can result in 

faster availability of deposited funds for consumers. Based on consumer 

interviews, consumers have benefited from receiving simpler imaged account 

statements and immediate access to information about check payments. 

Check 21’s expedited recredit (prompt investigation of claims that substitute 

checks were improperly charged to accounts and recrediting of the amount in 

question) also is considered a consumer benefit. However, based on our 

consumer and bank interviews, it appears that a small number of consumers 

have filed expedited recredit claims. Based on analysis of survey data on bank 

fees, GAO found some consumers may incur fees related to receiving canceled 

checks and images. Since 2004, fees for canceled checks appear to have 

increased, while fees for images appear to have remained relatively flat. 

To view the full product, including the scope 

and methodology, click on GAO-09-8. 

To view the E-supplement, click on 

GAO-09-09SP. For more information, contact 

Yvonne D. Jones at (202) 512-8678 or 

jonesy@gao.gov. 
Contents 

Letter 1

Results in Brief 4

Background 7

Check Truncation Has Not Resulted Yet in Overall Gains in 

Economic Efficiency for the Federal Reserve or for Banks, but Is 

Expected to Produce Efficiencies in the Future 15 

Most Bank Consumers Appeared to Have Accepted Changes to 

Their Checking Accounts from the Check Truncation Process 

Resulting from Check 21 27 

Bank Consumers Have Realized Benefits and Costs Relating to

Faster Check Processing and Access to Information about Their 

Checking Accounts 33 

Agency Comments and Our Evaluation 40 

Appendix I Objectives, Scope, and Methodology 43 

Appendix II Econometric Analysis of Check 21 for Economic

Efficiency in the Federal Reserve’s Check Services 51 

Appendix III Comments from the Board of Governors of the 

Federal Reserve System 58 

Appendix IV GAO Contact and Staff Acknowledgments 60 

Tables 

Table 1: Demographic Characteristics of Consumers Interviewed 46 

Table 2: Definition of Institution Size Categories 49 

Table 3: Summary Statistics of Some Selected Variables 53 

Table 4: Estimation of Logarithm of Total Check Operating Cost, 

1994–2007 55

Page i GAO-09-8 Check 21 Act
Figures 

Figure 1: Paper-Based Check Collection and Processing 8 

Figure 2: Example of a Substitute Check 10 

Figure 3: Check Image Processing 11 

Figure 4: Distribution of the Number of Noncash Payments 13 

Figure 5: Number of Check Images Deposited and Received and 

Number of Substitute Checks Printed, June 2006–June 

2008 14

Figure 6: Federal Reserve’s Transportation Costs for Check 

Services, 1994–2007 19 

Figure 7: Federal Reserve Total Work Hours in Check Services, 

1994–2007 20

Figure 8: Bank Consumer Preferences for Reviewing Check 

Payments Activity 28 

Figure 9: Bank Consumer Concern about Demonstrating Proof of 

Payment Using a Substitute Check or Image Statement 30 

Figure 10: Errors Reported by Bank Consumers Involving Canceled 

Checks and Image Statements 31 

Figure 11: Check Enclosure and Imaging Fees, Banks and Savings 

and Loans, 2001–2006 38 

Page ii GAO-09-8 Check 21 Act
Abbreviations 

ABA American Bankers Association 

ACH automated clearing house 

ATM automated teller machine 

BEA Bureau of Economic Analysis 

BLS Bureau of Labor Statistics 

Check 21 Check Clearing for the 21st Century Act of 

 2003 

EBT electronic benefits transfer 

ECCHO Electronic Check Clearing House 

 Organization 

EFAA Expedited Funds Availability Act of 1987 

Federal Reserve Federal Reserve System 

Federal Reserve Board Board of Governors of the Federal Reserve 

 System 

ICL image cash letter 

Informa Informa Research Services 

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. The published product may be reproduced and distributed in its entirety 

without further permission from GAO. However, because this work may contain 

copyrighted images or other material, permission from the copyright holder may be 

necessary if you wish to reproduce this material separately. 

Page iii GAO-09-8 Check 21 Act
United States Government Accountability Office

Washington, DC 20548 

October 28, 2008 

Congressional Committees 

In the last 10 years technological innovations and consumer and business 

preferences for electronic payments have transformed the U.S. retail 

payments system from a largely paper-based system to one that mostly 

uses electronic transactions. In 2007, the Federal Reserve System (Federal 

Reserve) reported that electronic payments, including credit and debit 

cards, exceeded two-thirds of all noncash payments while the number of 

checks written declined from more than 37 billion checks in 2003 to 33 

billion checks in 2006.1

 Although check volume has declined, paper checks

still represent a significant number of payments that need to be processed, 

cleared, and settled. The paper-based collection system for checks has 

been a labor-intensive process because at each step in the collection 

process, the paper check has had to be physically handled and transported 

before being settled. 

The Check Clearing for the 21st Century Act (Check 21), enacted in 2003,

was intended to make the check payment system more efficient and less 

costly by facilitating wider use of electronic check processing without 

demanding that any bank change its current check collection practices.2

 At 

the time that Check 21 was enacted, most banks could not leverage their 

investments in imaging technology to collect checks electronically 

because the legal framework for the check collection system constrained

the efforts of many banks to use it.3

 Prior to Check 21, a bank was required 

to present an original paper check to the bank where the check was 

payable—the paying bank—for payment unless the paying bank had 

agreed to accept presentment in some other form. This required the bank 

presenting the check—the collecting bank—to enter into agreements with 

 1

The Federal Reserve System, 2007 Federal Reserve Payments Study: Noncash Payment 

Trends in the United States 2003-2006 (Washington, D.C.: Dec. 10, 2007), 6. The study is

part of an ongoing effort by the Federal Reserve System to measure trends in noncash

payment in the United States. 

2

Pub. L. No. 108-100 (Oct. 28, 2003). For this report, we refer to commercial banks, thrifts, 

and credit unions collectively as banks. 

3

A check image is an electronic or digital image of an original check that is created by a 

depositor, a bank, or other participant in the check collection process. 

Page 1 GAO-09-8 Check 21 Act
all or nearly all of the banks to which it presented checks. Because of this

impediment, banks were deterred from making the necessary investments 

to collect checks electronically. 

Check 21 addressed this situation by authorizing a new paper negotiable

instrument, called a substitute check, that when properly prepared is the 

legal equivalent of the original check. Any bank that transfers, presents, or 

returns a substitute check warrants that the substitute check contains an

accurate image of the front and the back of the original check at the time 

the original check was truncated and a specific legend stating that the 

substitute check is a legal copy of the original check and can be used in 

the same way one would use the original check. Check 21 does not require 

the banks to adopt electronic check processing, but enables banks that 

want to truncate or remove the original paper checks from the checkcollection system to do so. Check 21 facilitated electronic processing by 

allowing banks to use electronic imaging technology for collection and 

create substitute checks from those images for delivery to banks that do 

not accept checks electronically. Substitute checks are considered an 

intermediate step toward a matured electronic check processing system, 

in which the goal should be the electronic exchange of payment 

information and check images between banks. 

Check 21 mandated that we evaluate the implementation and

administration of Check 21. To respond to the Check 21 mandate, the 

objectives of this report are to (1) determine the gains in economic 

efficiency from check truncation and evaluate the benefits and costs to 

banks and the Federal Reserve from check truncation;4

 (2) assess 

consumer acceptance of the check truncation process resulting from 

Check 21; and (3) evaluate the benefits and costs to consumers from 

check truncation under Check 21. 

To determine the gains in economic efficiency from check truncation and 

evaluate the benefits and costs to financial institutions from check 

truncation, we separately analyzed costs for the check operations of the 

Federal Reserve and a group of banks. Using data from the Federal 

Reserve’s cost accounting system, we applied an econometric cost model 

to estimate the effects of different variables, such as the volume of checks 

 4

For this report, we define economic efficiency as an economically efficient production that

is organized to minimize the ratio of inputs to outputs. Production is economically efficient 

when goods are produced at minimum cost in money and resources. This typically occurs

where input prices are used to find the least-expensive process. 

Page 2 GAO-09-8 Check 21 Act
processed, wages, and other costs incurred by the Federal Reserve, on 

total check processing costs from 1994 through 2007. While the Federal

Reserve has consistent cost accounting data, the banking industry does 

not. Accounting for costs associated with check processing varies across 

the banking industry, preventing a similar analysis for private-sector costs. 

Instead, we sent a data collection instrument to and interviewed officials 

from the 10 largest banks by deposit size as of March 2008 in the United 

States and a group of smaller banks. The 10 banks account for a significant 

volume of checks presented (in 2007, about one-third of all checks paid). 

We asked about costs related to paper check processing, the investment 

that banks incurred to exchange check images, the cost savings that banks 

achieved (including labor and transportation) with image technology, and 

the impact of check imaging and substitute checks on losses from 

fraudulent checks. We sent the data collection instrument to the 10 banks

and received a response from 9. For the bank that did not respond, we 

interviewed an official representing the bank at an early stage of our 

engagement. We conducted follow-up interviews with a number of the 

institutions requesting clarification of their responses. In addition, we sent 

the data collection instrument to 12 smaller banks, which had assets 

ranging from less than $500 million to $5 billion. Our selection criteria 

included whether the banks were located in metropolitan or 

nonmetropolitan areas and were on the Electronic Check Clearing House 

Organization’s (ECCHO) list of participating members. From this group of 

12 banks, we received five completed forms. We conducted follow-up 

interviews with three of the smaller banks. To assess bank consumer 

acceptance of the check truncation process resulting from Check 21, we 

conducted in-person interviews with 108 consumers. The consumers 

represented an approximate distribution of the U.S. adult population 

across broad categories (age, education, and income). Consumers had to 

meet certain other conditions: having primary responsibility in the 

household for balancing the financial account that allows paper check

writing and having received canceled original checks in paper form with 

the checking account statement at some point since 2000. However, the 

consumers recruited for the interviews did not form a random, statistically 

representative sample of the U.S. population; therefore, we could not 

generalize the results of the interviews to the relevant total population. 

The interview questions covered topics, such as how consumers reviewed 

their checking account activity, their acceptance of the check truncation 

process, and any problems or errors they might have had with their 

checking accounts since Check 21. This report does not contain all the 

results from the consumer interviews. We reproduced the text from our 

structured interview instrument and tabulated the results from the 

questions in Questions for Consumers about Check 21 Act (GAO-09-09SP). 

Page 3 GAO-09-8 Check 21 Act
To evaluate the benefits and costs to bank consumers from check 

truncation, we interviewed Federal Reserve Board staff, representatives 

from Consumers Union, the Consumer Federation of America, and the 

U.S. Public Interest Research Group, and bank officials to identify possible 

benefits and costs. We also analyzed a study by the Board of Governors of 

the Federal Reserve System (Federal Reserve Board) that assessed the 

banking industry’s implementation of Check 21. To determine whether 

bank consumers incurred fees for receiving canceled checks and check 

images since Check 21, we reviewed survey data on bank fees for 2001 

through 2006 collected by Informa Research Services Inc., a private-sector 

firm. 

We conducted this performance audit from September 2007 to October 

2008 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives. See appendix I for a more 

detailed discussion of our scope and methodology. 

Check truncation has not yet resulted in overall gains in economic 

efficiency for the Federal Reserve or for selected banks, but Federal 

Reserve and bank officials expect efficiencies in the future. The 

expectation for electronic processing of checks was that it would lead to 

gains in economic efficiency—that is, removing paper from the payment 

stream would lead to lower costs. However, our analysis of Federal 

Reserve cost accounting data does not demonstrate that the Federal 

Reserve’s costs for processing payments have decreased—which may 

reflect that the Federal Reserve must still maintain its ability to process 

paper checks, while it invests in equipment and software for electronic 

check processing and incurs costs associated with closing a number of 

check processing sites. But, we also found that the total work hours 

associated with the Federal Reserve’s check processing operations 

decreased by approximately 48 percent from 2.1 million hours for the 

fourth quarter of 2001 to 1.3 million hours for the fourth quarter of 2007 

and the transportation costs associated with check processing operations 

decreased by about 11 percent from the fourth quarter of 2001 to the 

fourth quarter of 2007. Estimates of whether costs were lower for banks as 

a result of Check 21 varied considerably, reflecting the diverse ways in 

which they handle checks and payments and differences among cost 

accounting systems. For example, several of the 10 largest banks noted 

Results in Brief 

Page 4 GAO-09-8 Check 21 Act
that maintaining a dual paper-electronic infrastructure to date had 

prevented them from achieving overall lower costs, although they also had

seen reduced transportation and labor costs. As Federal Reserve officials 

noted, the willingness of private banks to invest in the equipment needed 

to process checks electronically demonstrated the bank’s expectation of

lower costs. The banks said that they expect that eventually costs would 

be lower. According to our interviews with three smaller banks, they 

generally have migrated all of their check volumes to electronic 

processing rather than operating two processing systems and have seen 

lower costs for transportation and labor. Since cost accounting systems 

vary among banks and many were unwilling to share proprietary data on 

their costs, it was not possible to estimate the industrywide cost effect of 

check truncation. Check imaging and the use of substitute checks appear 

to have had a neutral or minimal effect on bank fraud losses. 

Most bank consumers seem to have accepted changes to their checking 

accounts from the check truncation process. In one-on-one, in-person 

structured interviews with 108 bank consumers living in three cities, we 

learned that the majority of these consumers accepted not receiving their 

canceled checks and being able to access information about their 

checking account activity online. Eleven percent of these consumers still 

wanted to receive canceled checks with their account statement. In 

addition, most consumers reported that they were not concerned 

significantly about their ability to demonstrate proof of payment using a 

substitute check or check image rather than a canceled check. Few 

consumers reported that they experienced errors from the check 

truncation process. In addition, we found on the basis of our review of 

consumer complaints that the federal banking regulators reported few 

complaints about Check 21. Of the approximately 35,000 consumer 

complaints submitted to the four federal banking regulators in 2006 and 

2007, 172 were related to Check 21 issues. The primary consumer 

complaint was that the account holder wanted to continue receiving 

canceled checks. These findings appear consistent with findings in the 

Federal Reserve Board’s April 2007 report to Congress on Check 21. 

Specifically, the Federal Reserve Board reported that less than 1 percent 

of all complaints received by the federal banking regulators were related

to Check 21.

To the extent that banks have implemented electronic check processing, 

bank consumers have realized both benefits and costs relating to faster 

processing and access to information about their checking accounts. We 

found that some banks reported that they have extended the cut-off time 

for accepting deposits for credit on the same business day, which can

Page 5 GAO-09-8 Check 21 Act
result in faster availability of deposited funds for consumers. However, the 

funds availability requirements of the Federal Reserve Board’s Regulation

CC have not been amended as a result of Check 21. Regulation CC limits 

the time that banks can hold funds deposited into customer accounts 

before these funds must be made available for withdrawal. In its April 2007 

report, the Federal Reserve Board concluded that much broader adoption 

of new technologies and processes by the banking industry must occur 

before check return times could decline appreciably and thereby permit a 

modification of the funds availability deadlines. However, Check 21 has 

contributed to acceleration of the pace of the Federal Reserve’s 

consolidation of check processing offices, which has increased the 

proportion of checks that are classified as local. As a result, a large 

number of consumer checks are now subject to shorter maximum hold 

periods by banks under Regulation CC. Many bank consumers have 

realized other benefits including simpler statements (that is, consumers 

said it was easier to review images on a few sheets of paper than handle 

many canceled checks) and immediate access to information about 

payments. Bank and industry association officials also noted benefits of 

check truncation, such as better customer access to check images and 

accelerated customer deposit availability. Check 21’s expedited recredit 

provision (requiring banks to complete their investigation of a consumer’s 

claim that a substitute check had been improperly charged to their 

account within 10 business days and recredit the consumer’s account for a 

specified amount pending completion of the investigation) is considered a 

consumer benefit. However, on the basis of our consumer and bank 

interviews, it appears that a small number of consumers have filed 

expedited recredit claims. Some consumers also may incur fees if they 

elect to receive canceled checks and check images. Based on a survey of 

large retail banks conducted by Informa Research Services from 2001 to 

2006, fee amounts for receiving canceled checks generally have increased,

while fees for image statements appear to have remained relatively flat. 

The Informa data also indicated that these banks charge different amounts 

depending on the type of checking account. 

We provided a copy of a draft of this report to the Federal Reserve Board, 

which provided us with written comments that are reprinted in appendix

III. It agreed with our overall conclusion that, over the past four years, the 

banking industry has made substantial progress toward establishing an 

end-to-end electronic check-processing environment. In commenting on 

this report, it noted that the Federal Reserve Banks expect that by yearend 2009, more than 90 percent of their check deposits and presentments 

will be electronic. They also commented that the ongoing transformation

to electronic check-processing environment has not been without cost. As

Page 6 GAO-09-8 Check 21 Act
noted in our report, the Federal Reserve Banks have reduced their 

transportation costs and work hours associated with their check services. 

And, according to the Federal Reserve Board, they earned a net income of

$326 million for providing check services from 2005 through 2007. The 

Federal Reserve Board concurred with a number of consumer benefits 

identified in the report: faster funds availability on check deposits due to 

later deposit deadlines, quicker access to account information, and 

improved customer service. In addition, we sent a draft of this report to 

the Federal Deposit Insurance Corporation, Office of the Comptroller of 

the Currency, and Office of Thrift Supervision. Only the Office of the 

Comptroller of the Currency provided us with technical comments, which 

we incorporated as appropriate. We provided sections of the draft of this 

report to bank officials for their technical review and several of them 

provided us technical comments, which we incorporated as appropriate. 

This section of the report describes the paper- and electronic-based check 

collection processes, presents statistics on the use of electronic and 

nonelectronic payments and types of check processing, and describes the 

Federal Reserve’s role in check collection. 

Interbank checks are cleared and settled through an elaborate checkcollection process that includes presentment and final settlement.5

 Check 

presentment occurs when the checks are delivered or images transmitted 

to the paying banks for payment and the paying banks must decide 

whether to honor or return the checks (see fig. 1). Settlement of checks 

occurs when the collecting banks are credited and the paying banks are 

debited, usually through accounts held at either the Federal Reserve or 

correspondent banks. 

Background 

Check Collection Process 

 5

Interbank checks are those in which the bank of first deposit and the paying bank are 

different. On-us checks are deposited or cashed at the same bank on which they are drawn. 

Page 7 GAO-09-8 Check 21 Act
Figure 1: Paper-Based Check Collection and Processing

Check deposited

#001

$102.57 Collecting bank Paying bank

Item processing

Bank branch

location

ATM Customers

#001

$102.

57

467

#001

$102.

57

467

Source: GAO (analysis); Art Explosion (images).

In the paper-based check collection process, banks of first deposit 

generally sort deposited checks by destination and dispatch them for 

collection. Banks of first deposit physically can collect a paper check 

through several methods: 

• Direct presentment of the paper check to the paying bank; 

• Exchange of the paper check at a clearing house in which the bank of first 

deposit and the paying bank are members; 

• Collection of the paper check through an intermediary, such as a 

correspondent bank or a Federal Reserve Bank; or

• Some combination of the above methods. 

When a paying bank decides not to pay a check, the bank typically returns

the dishonored check to the bank of first deposit. Under the Uniform 

Commercial Code, the paying bank generally has until midnight of the day 

following presentment (“midnight deadline”) to return dishonored checks 

or send notices of dishonor.6

 The paying bank may return a dishonored 

check, commonly referred to as a return item, directly to the bank of first 

deposit through a clearing house association, if applicable, or through a 

 6

See U.C.C. §§ 4-301, 302. The Uniform Commercial Code is a set of model laws adopted

and enacted by the states that govern commercial and financial activities. 

Page 8 GAO-09-8 Check 21 Act
returning bank (a bank handling a returned check), including the Federal

Reserve. 

Regulation CC was promulgated by the Federal Reserve Board in 1988 to

implement the Expedited Funds Availability Act of 1987 (EFAA), which 

establishes the maximum periods of time that banks can hold funds 

deposited into accounts before those funds must be made available for 

withdrawal. Among other things, the EFAA and its implementing 

Regulation CC generally require banks to make funds from local checks

available by the second business day after the day of deposit; funds from 

nonlocal checks must be available by the fifth business day after the day of 

deposit.7

At each step, the check must be processed physically and then shipped to

its destination by air or ground transportation. Some have suggested that 

truncating paper checks, or stopping them before they reach the paying

bank, could result in lower costs to process checks and benefits to both 

the banking industry and the public. Under Regulation CC, the term 

“truncate” means to remove an original check from the collection or return 

process. Instead, the recipient receives a substitute check; or by 

agreement, information relating to the original check (including data taken 

from the magnetic ink character recognition line of the original check or

an electronic image of the original check), whether with or without the 

subsequent delivery of the original check (see fig. 2).8

 7

See 12 C.F.R. § 229.12. Local checks are checks in which the bank of first deposit and the

paying bank are located in the same Federal Reserve check-processing region. Nonlocal 

checks are checks in which the bank of first deposit and the paying bank are located in

different Federal Reserve check-processing regions. 

8

12 C.F.R. § 229.2(ddd). 

Page 9 GAO-09-8 Check 21 Act
Figure 2: Example of a Substitute Check

145 JAMES C MORRISON

MARY B MORRISON

1765 SHERIDAN DRIVE

YOUR CITY, STATE 04001

Pay to the

order of

This is a LEGAL COPY of your

check. You can use it the same 

way you would use the original 

check.

Do not endorse or write below this line.

$

DOLLARS

Memo

Date 00-6789/0000

008902

YOURBANK

YOURCITY, STATE 12345

DO NOT WRITE/STAMP BELOW THIS LINE

FOR FINANCIAL INSTITUTION USE ONLY

ENDORSEEX

ORIGINAL

DOCUMENT

FOR DEPO

SIT ONLY

FIR

ST UNION NATIONAL BANK

ACCOUNT 1234567890123

NORTH POLE, INC.

>031000011< 01/02/2002

7815830233

JAN - 2 02

031000011

FIRST NATL SVC 013

PHILADELPHIA PA 01022002

7815830233

0530-60183 01032002

WACHOVIA BANK, N.A. CDC

CHARLOTTE, NC 1175-002

1800539446

Front

Back

Source: ECCHO.

Electronic Check 

Processing and Imaging 

Technology 

Essentially, check imaging is a process through which a paper check is 

scanned and a digital image is taken of the front and back of the paper 

check. The paper check may then at some point be destroyed and the 

images may then be stored in an archive maintained by the bank for 

Page 10 GAO-09-8 Check 21 Act
retrieval if needed. When a paper check is imaged depends on the 

structure of a bank’s back office operations. Some banks have the 

capability to image a paper check at their branches, while others transport 

the paper to centralized locations where the paper is imaged. Once the 

images are taken, an image cash letter (ICL) is assembled and sent to the 

paying bank directly or to an intermediary (such as the Federal Reserve, a

correspondent bank, or an image exchange processor) for ultimate 

presentment to the paying bank (see fig. 3). Since Check 21 was enacted, 

imaging technology has been further refined so that it is possible for a 

bank to image a paper check at its branches or automated teller machines

(ATM)—commonly referred to as branch or ATM capture. In addition, 

some banks are beginning to offer a service to their customers called 

remote deposit capture where merchants can scan the paper checks they

receive and electronically deposit those images at the bank. 

Figure 3: Check Image Processing

Check deposited

#001

$102.57 Collecting bank Paying bank Bank branch

location

ATM Customers

#001

$102.

57

467

#001

$102.

57

467

Source: GAO (analysis); Art Explosion (images).

Transmitted electronically Transmitted electronically

As discussed in the introduction to this report, electronic check 

processing was hampered by certain legal impediments that Check 21

addressed. Moreover, as we reported in 1998, perceptions about consumer 

preferences for receiving canceled checks also deterred electronic check 

processing.9 Because, under Check 21, checks drawn on any particular 

bank can be truncated by any bank across the country, banks cannot 

 9

GAO, Retail Payments Issues: Experience with Electronic Check Presentment, 

GAO/GGD-98-145 (Washington, D.C.: July 14, 1998). 

Page 11 GAO-09-8 Check 21 Act
return the original canceled paper checks to their customers once they are 

imaged. At the time of our 1998 report, Federal Reserve officials and bank

officials with whom we spoke expressed a belief that many consumers 

wanted their canceled checks returned.

10

Recent Trends in Check 

Use, Overall Electronic 

Payments, and Electronic 

Processing of Checks 

The popularity of the paper check as a retail payment instrument in the 

United States is waning. The Federal Reserve has estimated that the 

number of checks used in the United States peaked during the mid-1990s 

at around 50 billion checks per year.11 In its 2007 study the Federal Reserve

highlighted the decline in check usage as a retail payment instrument. It 

reported that both the number of checks written and checks paid declined 

from 2003 through 2006. In 2006, 33.1 billion checks were written 

compared with 37.6 billion checks in 2003 and paid checks decreased from 

37.3 billion checks to 30.6 billion checks in the same period. The number 

of checks written differs from checks paid because paper checks that have 

been converted into automated clearing house (ACH) payments were 

included in the figure for checks written.12 Additionally, the Federal 

Reserve concluded that the share of retail payments made electronically 

was growing, while the share of check payments of total noncash 

payments was declining. Electronic payments, including debit and credit 

cards, ACH payments (including check conversions), and electronic 

benefit transfers (EBT) amounted to two-thirds of the total number of 

noncash payments, which in 2006 totaled 93.3 billion.13 The share of check 

payments declined from 46 percent in 2003 to 33 percent in 2006 (see 

fig. 4). 

 10GAO/GGD-98-145. 

11Geoffrey R. Gerdes and Jack K. Walton II, “The Use of Checks and Other Noncash 

Payment Instruments in the United States,” Federal Reserve Bulletin (August 2002), 360. 

12In a check conversion, the paper check is used only as an information source and is

converted into an ACH payment so that it can be processed on the ACH network. The ACH

is an electronic batch processing system by which payment orders are exchanged among

banks. By agreement, consumer checks can be converted into ACH payments by merchants

at the point of sale or by billers that receive check remittances. Checks that are converted 

into ACH payments never enter the check collection system. The Federal Reserve reported 

that 2.6 billion paper checks were converted into ACH transactions in 2006. 

13EBT was devised in the 1980s to meet the needs of the U.S. Department of Agriculture’s 

Food Stamp Program. Its initial purpose was to transfer federal benefits electronically to

eligible recipients under certain entitlement and grant programs. 

Page 12 GAO-09-8 Check 21 Act
Figure 4: Distribution of the Number of Noncash Payments 

1% EBT

Credit card

Debit card

ACH

Checks (paid)

23%

19%

11%

46%

Source: The 2007 Federal Reserve System Payment Study.

2003 2006

1% EBT

Credit card

Debit card

ACH

Checks (paid)

23%

27%

16%

33%

While check use has declined, check processing increasingly has become 

electronic. As shown in figure 5, from June 2006 through June 2008, the 

number of imaged checks deposited by collecting banks and received by 

paying banks has grown steadily. In June 2006 banks deposited 206 million 

checks as images compared with June 2008, when banks deposited 1.1 

billion checks. Similarly, the number of checks received as images by the 

paying banks has grown. In June 2006, paying banks received 89 million 

items; by June 2008, they received almost 852 million items. However, the 

number of substitute checks has not declined, but has increased from 117 

million in June 2006 to 283 million in June 2008. These checks represent 

paper that must be presented physically to paying banks through the 

collection system. 

Page 13 GAO-09-8 Check 21 Act
Figure 5: Number of Check Images Deposited and Received and Number of Substitute Checks Printed, June 2006–June 2008

0

200

400

600

800

1,000

1,200

06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06

Number in millions

Source: GAO analysis of ECCHO data.

2006 2007 2008

Month and year

Image items

received by 

paying 

institution

Substitute 

checks

received by 

paying 

institution

Checks sent 

for collection 

via image

Federal Reserve’s Role in 

Check Collection and Its 

Consolidation of Check 

Offices 

The Federal Reserve operates a comprehensive, nationwide system for 

clearing and settling checks drawn on banks located throughout the 

United States. These offices accept paper check deposits and transport the 

paper checks to the paying bank. Since the effective date of Check 21, the

Federal Reserve sends and receives images between banks. The Federal

Reserve offers imaged check products—commonly referred to as the 

Check 21 products (Fed Forward, Fed Receipt, and Fed Return)—for a fee 

to banks that use its check collection services.14 According to the Federal

Reserve Board’s 2007 Annual Report, of the approximately 10 billion 

checks (about one-third of the total 30.6 billion paid checks) processed 

 14FedForward is a service in which checks are deposited electronically for collection using 

image cash letters. (Cash letter is a group of checks packaged and sent by a bank to 

another bank, clearinghouse, or a Federal Reserve office. A cash letter is accompanied by a 

list containing the dollar amount of each check, the total amount of the checks, and the 

number of checks sent with the cash letter.) FedReceipt is a service in which the paying

bank agrees to the electronic presentment of checks with accompanying images. 

FedReturn is a service in which checks to be returned are sent in image cash letters to the

Federal Reserve, which will return the checks either in an electronic file or as substitute 

checks to the banks of first deposit. 

Page 14 GAO-09-8 Check 21 Act
through the Federal Reserve in 2007, 42.2 percent were deposited as 

images and 24.6 percent were received using Check 21 products. Further, 

in the month of July 2008, the proportion of checks deposited and 

presented as images using the Federal Reserve’s Check 21 products 

increased to 77.8 percent and 54.4 percent, respectively.

As a result of the declining check volumes, the Federal Reserve developed 

a long-term plan for restructuring its check processing operations. In 2003, 

the Federal Reserve had 45 check offices. Since then, the Federal Reserve

has closed a number of offices or gradually eliminated its check 

processing operations. In June 2007, the Federal Reserve announced that

its check services system would be consolidated into four regional check 

processing sites. As of September 30, 2008, the Federal Reserve had 15 

check offices and was working toward the objective of maintaining four 

offices at Atlanta, Cleveland, Dallas, and Philadelphia by the end of the 

first quarter of 2010. Given the significant declines in paper check deposit 

volumes, the Federal Reserve’s Retail Payments Office believes that the 

Federal Reserve likely will accelerate the consolidation schedule even 

further, reducing its check processing offices to perhaps one office by 

mid-2010. 

Check truncation has not resulted yet in overall gains in economic 

efficiency for the Federal Reserve or for the banks we surveyed, but 

Federal Reserve and bank officials expect efficiencies in the future. The 

expectation for electronic processing of checks was that it would lead to 

gains in economic efficiency—that is, removing paper from the payment 

stream would lead to lower costs. Our analysis of Federal Reserve cost 

accounting data suggests that its costs may have increased since the 

passage of Check 21, which may reflect concurrent maintenance of its 

paper processing infrastructure, investments in equipment and software 

for electronic check processing, and incurred costs associated with 

closing check processing sites. Estimates varied on whether costs were 

lower for private banks as the result of the check truncation that Check 21

facilitated, reflecting differences in the ways in which different banks 

handle checks and payments and differences among cost accounting 

systems. For example, several of the 10 largest banks noted that 

maintaining a dual paper-electronic infrastructure to date had prevented

them from achieving overall lower costs, although they had seen reduced

transportation and labor costs. Check imaging and the use of substitute 

checks appear to have had a neutral impact on banks’ fraud losses. 

Check Truncation Has 

Not Resulted Yet in 

Overall Gains in 

Economic Efficiency 

for the Federal 

Reserve or for Banks, 

but Is Expected to 

Produce Efficiencies 

in the Future 

Page 15 GAO-09-8 Check 21 Act
We found and the Federal Reserve’s budget documents report that check 

truncation has not decreased Federal Reserve costs, although it 

contributed to decreased labor hours and transportation costs in Federal

Reserve check services. To distinguish the effects of check truncation 

from other factors influencing the Federal Reserve’s total costs for check 

clearing services, we modified econometric cost functions that Federal 

Reserve economists have used to assess the effects of check volumes on 

total costs. In particular, we sought to distinguish the effect of the 

increased use of check truncation following passage of Check 21 on total 

costs from the concurrent effects of

Federal Reserve Cost 

Accounting Data Do Not 

Indicate Gains in 

Economic Efficiency to 

Date, Partly Due to 

Maintenance of Dual Paper 

and Electronic Processing 

Systems 

• the decrease in the number of checks written in the United States, 

• changes in the volume of checks processed by the Federal Reserve, 

• the Federal Reserve’s consolidation of its check services, and 

• costs of labor, software, and other expenses associated with the check 

processing services. 

With this consolidation of check offices, the Federal Reserve has incurred 

an estimated $115 million in costs from 2003 through 2007, including 

severance and other payments, which would increase total check services 

costs. However, the Federal Reserve did recover all costs for its check 

services from 2005 through 2007.15

Consistent with our results, the Federal Reserve’s annual budget reports 

from 2006 through 2008 reported that the Federal Reserve’s budget for 

check services experienced cost overruns. Most recently, the 2008 annual

budget review reported that the expense overrun was due mainly to 

greater systemwide costs in preparation for additional restructuring of 

check services (costs included $34.0 million for accrual of severance, 

equipment impairments, and other expenses).16 The 2007 annual budget 

 15Under the Monetary Control Act of 1980, Pub. L. No. 96-221 (March 31, 1980) (12 U.S.C.

248a) the Federal Reserve is to set fees charged to banks for providing priced services 

including check services to recover, over the long run, all direct and indirect costs of providing the services plus imputed costs, including the interest on items credited before 

actual collection (float), and a private-sector adjustment factor set to reflect costs that a

private-sector firm would face. See 12 U.S.C. § 248a. 

16Board of Governors of the Federal Reserve System, 2008 Annual Report: Budget Review

(Washington, D.C.: May 2008), 16. 

Page 16 GAO-09-8 Check 21 Act
review noted total expenses for check services were to increase to $11.0 

million reflecting higher costs for Check 21-related supplies and 

equipment, as well as additional resources necessary to facilitate further 

consolidation into five regional check-adjustments sites.17

Similarly, the 2006 annual budget review reported: 

“Total check service expenses were budgeted to increase by $5.7 million, or 0.9 percent

from the 2005 estimate. The increase reflects one-time costs to prepare further 

consolidations of check operations, as well as other initiatives underway to improve the

efficiency of check operations, including investments in Check 21 technology to 

accommodate increased volumes.”18

The Planning and Control System (PACS) is the Federal Reserve’s cost 

accounting system for recording expenses, which includes the costs of its 

check operations. We analyzed PACS data on check processing to 

determine whether electronic check processing had an effect on total 

processing costs. Our analysis builds on previous research by economists 

in the Federal Reserve.19 The analysis includes estimation of econometric 

cost functions using quarterly data from first quarter of 1994 through the 

fourth quarter of 2007. We chose 1994 as the beginning point for the 

analysis based on conversations with Federal Reserve officials about the 

data and in order to provide adequate coverage for the period before and

after enactment of Check 21. These cost functions estimate the effects that

different explanatory variables may have on total Federal Reserve costs 

for check services. Explanatory variables include the total volume of 

checks processed, the introduction of electronic processing or the volume 

of checks processed electronically, the number of return items, the 

number of Federal Reserve check processing offices, whether Check 21

 17Board of Governors of the Federal Reserve System, 2007 Annual Report: Budget Review

(Washington, D.C.: April 2007), 17-18. 

18Board of Governors of the Federal Reserve System, 2006 Annual Report: Budget Review

(Washington, D.C.: April 2006), 22. 

19See for example, Ernst R. Berndt, The Practice of Econometrics: Classic and

Contemporary (Mass: Addison-Wesley Publishing, 1996), chapter 3; Robert M. Adams, Paul

W. Bauer, and Robin C. Sickles, Federal Reserve Bank of Cleveland, “Scope and Scale 

Economies in Federal Reserve Payment Processing,” Working Paper 02-13 (November 

2002); David B. Humphrey, “Scale Economies at Automated Clearing House,” Journal of 

Bank Research (Summer 1981), 71-81; and Paul W. Bauer and Dianna Hancock, “Scale 

Economies and Technological Change in the Federal Reserve ACH Payment Processing,” 

Federal Reserve Bank of Cleveland Economic Review (1995) vol. 31, no. 3, 14-29. 

Page 17 GAO-09-8 Check 21 Act
was in effect, and wage and price indexes. The cost functions permit 

isolation of the effect of Check 21 from the effects of other variables on 

the Federal Reserve’s total costs for check services. 

The results do not demonstrate any gains in economic efficiency as 

measured by lower costs in the Federal Reserve’s check operations for the 

period since the passage of Check 21 through 2007. In particular, the 

variable that would measure a change in total costs following the effective 

date of Check 21 did not have a statistically significant effect on total 

costs.20 See appendix II for a more detailed discussion of the estimated 

cost functions. In part, the results reflect costs associated with the 

concurrent closing of the Federal Reserve’s check processing sites. While 

these closings should reduce costs in the long run, restructuring expenses 

incurred as part of the closings (such as severance pay for workers) 

represent up-front costs. 

The need to maintain dual infrastructures for paper and electronic check

services also may explain the results. While Check 21 removed a barrier to 

electronic processing by creating the substitute check, Check 21 did not 

require that paper be removed from the process. So, the Federal Reserve 

continues to process paper checks and must maintain the infrastructure to 

process paper checks as it invests in new equipment to electronically 

process checks. Further, the creation of the substitute check also required 

investment in new equipment to print those instruments. For instance, a

Federal Reserve Retail Payment Office official noted that the high-speed 

printing machines for substitute checks cost approximately $200,000 each

and the Atlanta processing site had purchased about 12 of these 

machines.21

Although the move to electronic check services apparently has not led yet 

to overall cost savings, the Federal Reserve has seen decreases in 

transportation costs and work hours. With reduced paper volumes 

accompanying check truncation, the Federal Reserve’s transportation 

 20However, the magnitude of the cost effects that are based on this analysis vary 

considerably with different functional forms and are particularly sensitive to the

explanatory variables included in the estimation process. Further, many of the explanatory

variables are highly correlated, which inherently limits efforts to differentiate their effects 

on total costs. This issue, to which the econometrics literature refers as mulitcollinearity, 

also implies that the results could change if data on subsequent quarters were added. 

21The Retail Payments Office, located at the Federal Reserve Bank of Atlanta, directs the 

Federal Reserve’s Banks’ retail payment activities. 

Page 18 GAO-09-8 Check 21 Act
costs for check services decreased approximately 11 percent from the 

fourth quarter of 2001 through the fourth quarter of 2007 (see fig. 6). 

Figure 6: Federal Reserve’s Transportation Costs for Check Services, 1994–2007 

0

5

10

15

20

25

Dollars in millions

Source: GAO analysis.

1994

1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Year and quarter

Check 21 Act

Nominal transportation costs

Transportation costs in 2007 dollars

The Federal Reserve also has seen a decrease in the number of work hours 

for check services. Total work hours dropped from 2.6 million in the 

fourth quarter of 2001 to 1.3 million in the fourth quarter of 2007, a 

decrease of approximately 48 percent (see fig. 7).

Page 19 GAO-09-8 Check 21 Act
Figure 7: Federal Reserve Total Work Hours in Check Services, 1994–2007 

0

0.5

1.0

1.5

2.0

2.5

3.0

Work hours (in millions)

Source: GAO analysis.

1994

1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234 1234

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Year and quarter

Check 21 Act

The Largest U.S. Banks 

Still Maintain Dual Paper 

and Image-Based Check 

Processing Systems for 

Check Collection and 

Noted Issues Affecting 

Costs and Implementation 

Since the transition to imaging has been gradual throughout the banking

industry, the 10 largest U.S. banks still are maintaining paper-based 

processing systems. As previously noted, Check 21 did not require banks 

to take any action other than the acceptance of the substitute check. The

10 largest banks in the United States, based on deposit size, generally have 

large national branch networks and process large volumes of checks; 

consequently, they have a financial incentive to reduce the amount of 

paper they have to sort and transport. In 2007, these banks individually 

had at least 350 million paper checks deposited by their customers and 

some of them had considerably higher deposits, up to approximately 5 to 7 

billion checks. 

But, the 10 banks have achieved various levels of electronic processing. 

Two of the 10 banks have not converted their check processing systems to

imaging, but plan to do so by early 2009 and 7 banks have migrated to 

check imaging to some extent, but with imaging volumes at various levels. 

As of 2007, on the basis of our data collection instrument, the check 

volume of the seven banks that sent electronic check images ranged from

almost 4 to 60 percent of their overall check deposits, although imaged 

Page 20 GAO-09-8 Check 21 Act
volumes have been growing for some of the seven banks. However, the

seven imaging banks are maintaining dual processing systems to collect on

checks deposited at their institutions. If a bank cannot receive an image, a 

bank or an intermediary must either print a substitute check of the image

or present the original paper check.

Officials from four banks provided us with information on how the 

continued use of paper presentment has affected their transition to check

imaging and their level of cost savings. Federal Reserve officials noted that

the willingness of private banks to invest in the equipment needed to 

process check electronically demonstrated the bank’s expectation of 

lower costs. One bank official told us that the bank still has to print 

substitute checks for presentment to the small institutions that cannot

receive images, which adds to the bank’s costs. Another bank noted that 

for banks that would prefer to receive only paper, it will deposit the image 

with either the Federal Reserve or another intermediary that then will 

print the substitute check to present for payment. An official representing 

this bank stated that the bank has to incur the additional cost of printing a 

substitute check or, if it goes through an intermediary, to pay the 

intermediary’s prices. The same bank official added that maintaining paper 

operations has delayed the ultimate potential savings from electronic 

check processing because the bank had to keep in place its transportation 

network to continue delivering paper checks. A third bank official 

reported to us that fees paid to clear checks would be reduced as more 

and more banks converted to imaging. Finally, a bank official from the 

fourth bank advised us that mid-size and regional banks were behind in 

their conversion to imaging because they are too large to outsource their 

check business, but not large enough to have a financial incentive to invest 

in check imaging technology. Thus, they continued to use local 

clearinghouses where they could exchange their checks at very low costs. 

This official noted that these banks need a reasonable business case for 

investing in check imaging. 

The declining volumes of paper checks also may be inhibiting the 

migration of some banks to check imaging. As previously noted, from 2003 

through 2006, the number of checks paid had declined from about 37 

billion to over 30 billion checks. According to one bank trade association, 

some banks are still undecided about converting to imaging because they 

recognize that check volume is declining and wonder why they should 

invest in check processing technology. During our interviews, some of the 

seven imaging banks raised the issue of declining check volumes as an 

additional complication preventing some banks from converting to check

imaging. Officials from the Federal Reserve acknowledged while the 

Page 21 GAO-09-8 Check 21 Act
volume of checks is declining, paper checks would continue to be used 

long enough to warrant banks’ investments in the technology for a more 

efficient check processing method. In both the paper-based and the imagebased check processing systems, the bank of first deposit bears most of 

the cost of check collection; thus, it has the most financial incentive to 

convert to an image-based system. In addition, under EFAA, the bank of 

first deposit is required to release funds to the depositor within specified 

time periods; thus, it has an additional incentive for speeding up 

processing.22 The paying bank has the least market incentive to migrate to 

imaging because it does not incur the costs for collection, such as 

transportation and clearing fees. 

Officials representing some of the four banks with the highest volumes of 

check image deposits and receipts raised concerns with us that some 

banks are refusing to migrate to the new imaging technology and some 

action may be needed to encourage them to do so. One official told us that 

paying banks should be paying more of the cost of check processing so 

that they would have a financial incentive to receive images. The official

specifically stated that a group of banks has refused to implement the 

technology and accept images. Another bank official said that from 

approximately 5 to 7 percent of banks have refused to convert to imaging 

and may need regulatory pressure to adopt the technology. 

Largest Banks That 

Migrated to Imaging 

Achieved Cost Savings in 

the Areas of 

Transportation and Labor, 

but also Incurred 

Technology Costs 

Under a paper-based check system, paper checks have to be sorted and 

transported at every step until they are presented to paying banks; as a 

result, transportation and labor are among the banks’ highest costs. From 

our analysis of responses to our data collection instrument, officials from 

largest banks told us that labor was their largest category of expenditures 

related to check processing followed by transportation. However, none of

the seven banks that process checks electronically expect transportation 

to be a large expenditure category for future processing operations if 

imaging technology is fully implemented. 

According to our bank interviews, air transportation networks of some of 

the largest U.S. banks have been reduced. Four banks (those with the 

highest volumes of check image deposits and receipts) have reduced 

 22Pub. L. 100-86, title VI, Aug. 10, 1987, 101 Stat. 635 (12 U.S.C. 4001 et. seq.). The funds 

availability schedules are set forth at 12 U.S.C. 4002. The Federal Reserve’s implementing 

regulations are set forth at 12 C.F.R. Part 229 (Regulation CC), Subpart B. 

Page 22 GAO-09-8 Check 21 Act
intrabank and interbank transportation routes for checks, particularly air

routes. By the end of 2009, two of the four will have eliminated their air 

transportation networks entirely. However, three of the four banks have

not reduced costs for couriers and local transportation to the same extent

as for air transportation because they still transport paper to central 

processing offices or to local clearinghouses. 

We were told by two bank officials we interviewed that as more paper 

checks are imaged at the branch level, the ground transportation costs of 

banks should be reduced. One bank official advised us that the earlier the 

bank can transmit the check information to its processing system and 

capture the checks as images, the lower the bank’s costs. The official

added that the bank is working toward implementing branch “capture” 

(that is, conversion to an image) because the institution achieves better 

float management and eliminates courier transportation from its cost 

equation.23 Another bank official told us that because his bank’s 

transportation costs (for paper checks going from the branches to the 

central processing office) would not be reduced until the branches could 

capture check images; the bank had developed a pilot program for capture 

in a few branches. Although imaging was expected to result in savings in 

labor and transportation, the costs associated with installing and 

maintaining imaging equipment and the need to continue to maintain 

paper processing and clearing capabilities has prevented the realization of 

cost savings. According to a third bank, it is unclear when it will recover 

its significant investment in imaging equipment, image archives, and image 

exchange enhancements, if ever, due in part to the absence of universal 

adoption of check imaging. 

In contrast, we were told that transportation costs for banks that have not 

migrated to electronic processing may increase because as the overall

volume of paper checks declines (due to check imaging and consumer 

preference) transporting the remaining checks will become more 

expensive on a per check basis. According to Federal Reserve officials, 

when fewer banks require the services of a particular transportation 

network, per-check transportation costs will increase for those banks still 

using the services because the network is transporting a smaller number 

of checks. The costs for the last bank on a specific route will be very 

expensive. According to one Federal Reserve official, in the future 

 23In this instance, float refers to the interest associated with the quicker collection of funds 

associated with check deposits. 

Page 23 GAO-09-8 Check 21 Act
overnight mail may be the only practical option for these banks. In 

congressional testimony, the Director of the Federal Reserve Board’s 

Division of Reserve Bank Operations and Payment Systems stated, “As 

banks improve their technological capabilities, they can reduce their 

reliance on air and ground transportation, especially shared transportation 

arrangements. The banks that remain tied to paper checks will continue to 

bear the costs of those arrangements.”24

Furthermore, bank officials told us that they had additional technology 

costs when they converted to a check imaging system. To exchange 

checks electronically with other banks, banks needed to adapt their 

systems both to send and receive images. The technologies required for 

electronic check processing include hardware and software to image 

checks, archive images, and transmit image cash letters for collection. 

From the analysis of responses to our data collection instrument, six 

banks projected that the technology costs would continue to be in the 

“great” or “greatest” range for the foreseeable future. On the basis of our 

interviews, the two largest imaging banks have recovered or will recover 

the investments they made for check imaging by 2009. An official 

representing one of the three banks stated that the bank recovered its 

investment in imaging mostly through savings in labor and transportation. 

Moreover, the bank had less equipment, lower maintenance costs on the 

remaining equipment, and needed less back office space because of 

electronic processing. The banks that have not recovered their 

investments still were investing in image archive and image exchange 

enhancements. 

Similar to the Federal Reserve, banks have to deal with substitute checks 

and, thus, may be required to invest in the printing of substitute checks. 

From the analysis of responses to our data collection instrument, officials

representing banks that have deposited images categorized expenditures 

for the printing of substitute checks in the “some” to “very great” range. In 

a follow-up interview, one bank official told us that the bank decided to

outsource the printing because it decided not to make the investment 

since substitute checks were a temporary measure and would not be used 

once all institutions were image-enabled. Thus, this investment did not 

make sense for the bank. Another bank official acknowledged that 

 24See Subcommittee on Financial Institutions and Consumer Credit, House Committee on 

Financial Services, Testimony of Louise L. Roseman, Director, Division of Reserve Bank

Operations and Payment Systems, 109 Congr. 1st sess., April 20, 2005. 

Page 24 GAO-09-8 Check 21 Act
substitute check printing has cost the bank hundreds of thousands of 

dollars to implement. 

A Few Smaller-Size Banks 

Have Seen Lower Costs for 

Transportation and Labor 

from Electronic Check 

Processing 

Smaller banks also have been migrating to electronic check processing. 

But, according to our interviews with three smaller banks (in this case, 

one bank and two credit unions), they have migrated all of their volumes 

to electronic processing rather than operating two processing systems, as 

the largest banks have been doing. In addition, the three smaller banks 

told us that they typically will use a third-party processor, an image 

exchange processor like Endpoint Exchange, the Federal Reserve, or 

another intermediary, such as a correspondent bank. For example, a credit 

union deposited and received images through the Federal Reserve Banks, 

while a medium-size bank, with assets of $4.4 billion, deposited and 

received images through an image processor and correspondent. 

Officials representing the smaller banks told us that it may be easier for 

small banks to completely migrate to imaging because their check volumes 

are minuscule in comparison to the volumes of the largest banks and their 

back offices generally are less complicated than those of the largest banks. 

The bank with $4.4 billion in assets received approximately 15 million 

checks for deposit in 2007, compared with the 10 largest banks in which 

the bank with the lowest volume of check deposits had 350 million checks 

deposited. Moreover, generally when these institutions migrate to check

imaging, they acquire the imaging services of their intermediary or 

processor rather than creating their own. 

In our interviews, representatives of the smaller banks described how 

check imaging had affected their operations and costs. The bank with 

assets of $4.4 billion reduced its costs by reducing its transportation 

network. According to a bank official, the bank also expects to secure cost

savings from its local courier routes in the future. But, the bank had to 

invest in software to transfer check images to its correspondent bank. An

official from a small credit union told us that check imaging allowed it to 

reduce its labor costs by half, after spending almost $6,000 for technology. 

Another credit union told us that they were able to eliminate three fulltime equivalent positions because check processing and related operations 

(such as researching customer issues on payments) became more 

efficient. According to an official at the credit union, while the institution 

made some investments in technology and software, it had recovered the 

investment costs because of the staff reductions. 

Page 25 GAO-09-8 Check 21 Act
Based on a recent American Bankers Association’s (ABA) survey of their 

members about fraud in deposit accounts, the analysis of responses to our 

data collection instrument, and our interviews with banks, we found that 

the use of substitute checks and check imaging has had a neutral effect on

fraud losses.25 In 2007, the ABA reported in its survey of members, more 

than 92 percent of the bank respondents answered that they had not 

incurred any losses from substitute checks in 2006. Of the 8 percent of 

banks that responded that they had incurred both fraud and non-fraud 

losses from substitute checks, more than 80 percent also responded that 

these losses did not occur because the instruments were substitute checks 

instead of original checks. 

Use of Substitute Checks 

and Check Imaging 

Appears to Have Had a 

Neutral Effect on Fraud 

Losses 

From the analysis of our responses to our data collection instrument, the 

six largest banks that have migrated to electronic check processing noted

that check imaging and the use of substitute checks had not affected the 

prevalence of losses from bad checks and that imaging has had a neutral 

or minimal effect on check fraud. Officials representing two of these banks 

explained in subsequent interviews that in the post-Check 21 world, since 

checks are being processed faster banks can catch a fraudulent item 

sooner. A third official told us that he had seen a slight decline in fraud 

losses since Check 21. Finally, from the analysis of the responses to our 

data collection instrument, four of the largest banks noted that they had

not taken additional actions to alleviate the potential threat of losses from 

images of bad checks. 

 25ABA Deposit Account Fraud Survey Report 2007 Edition. The survey was conducted 

from February through July of 2007. According to the report, a total of 176 institutions

returned completed survey forms and most of the information presented in the report was 

for calendar year 2006. 

Page 26 GAO-09-8 Check 21 Act
On the basis of our structured bank consumer interviews, we found only a 

small percentage of consumers who preferred to receive canceled checks 

with their checking account statement. Of the bank consumers we 

interviewed, 12 (or about 11 percent) wanted their canceled checks 

returned, while 37 (or about 35 percent) preferred to use online banking

capabilities to review their check payment activity. In general, consumers 

expressed a variety of preferences for how banks should provide them 

with the most complete information about their check payments activity. 

Also, most of the consumers were not concerned significantly about being 

able to demonstrate proof of payment using a substitute check or check 

image rather than a canceled check. Few of the consumers reported that 

they suffered errors from the check truncation process. In addition to 

conducting consumer interviews, we reviewed consumer complaint data 

provided by federal banking regulators and found relatively few consumer 

complaints relating to Check 21. 

We found that a small percentage of bank consumers in our structured 

interviews preferred receiving canceled checks, while the remaining 

consumers preferred reviewing their check payments activity online or in

a less paper-intensive format, such as image statements. As we reported in

an earlier report, perceptions about consumer preferences for the receipt

of their canceled checks deterred the adoption of electronic check 

processing.26 Based on the bank consumers we interviewed, it appears that 

their preference for canceled checks is diminishing. In our interviews, 

consumers expressed a variety of preferences for how banks should 

provide them with the most complete information about their check

payments activity (see fig. 8). 

Most Bank 

Consumers Appeared 

to Have Accepted 

Changes to Their 

Checking Accounts 

from the Check 

Truncation Process 

Resulting from Check 

21 

A Small Percentage of 

Bank Consumers Preferred 

Receiving Their Canceled 

Checks 

 26GAO/GGD-98-145. 

Page 27 GAO-09-8 Check 21 Act
Figure 8: Bank Consumer Preferences for Reviewing Check Payments Activity 

2% Combination of paper checks, substitute checks, and on-line review

1% Combination of substitute checks and paper checks

2% Substitute checks

2% Combination of all

3% Combination of substitute checks and check images

Combination of substitute checks and on-line

Combination of paper checks and check images

Combination of paper checks and on-line review

Check images

Paper checks

Combination of check images and on-line

On-line

11%

10%

7%

7%

5%

35%

16%

Source: GAO.

Would you choose only one of these methods, a combination of these methods, or something else?

Note: Percentages are based on responses from 107 bank consumers. 

In particular, 12 of the 107 consumers, or about 11 percent, told us that 

they preferred receiving their canceled checks with their checking account 

statement.27 Some of these consumers believed that canceled checks were 

better for recordkeeping and more secure than electronic images in terms 

of protecting their privacy. Others in this group stated they wanted to be

able to review their handwriting and other details of the canceled paper 

check to ensure that the checks were not counterfeit or the signatures 

forged. However, most bank consumers we interviewed accepted the use

of online banking to review their check payments activity. Specifically, 37

of the 107 consumers, or about 35 percent, told us that they preferred 

 27For this specific question, one interview participant did not respond to the question. Thus, 

the total number of responses for this question was 107, not 108. 

Page 28 GAO-09-8 Check 21 Act
reviewing check information and images online.

28 Several consumers 

stated that they did not need the “extra paper” from canceled checks and 

image statements and that online reviewing was more secure than 

receiving canceled checks. Some consumers stated that they enjoyed the 

convenience of reviewing their check payments activity online at any time. 

Twenty-eight of the 107 consumers, or 26 percent, preferred a combination 

of the various methods (check images, online review, paper checks, and 

substitute checks). 

Most Bank Consumers 

Were Not Concerned 

Significantly about 

Demonstrating Proof of 

Payment Using a 

Substitute Check or Check 

Image 

Most bank consumers reported that they were not concerned significantly 

about demonstrating proof of payment despite the changes to their 

checking accounts resulting from check truncation. For example, a 

consumer might pay a debt using a check, but the creditor might not 

properly record the payment, and then ask the consumer to demonstrate 

proof that he or she paid. Under the check truncation process, the 

consumer most likely would have access only to a substitute check or an 

image of the canceled check and not the original, canceled check. 

In our structured interviews, we asked consumers about their experience 

with demonstrating proof of payment. We found that 33 of the 108 

consumers, or about 31 percent, had never been required to demonstrate 

proof of payment using canceled checks, substitute checks, or an image 

statement. We found that 58 of the 108 consumers, or about 54 percent, 

had used a canceled check to demonstrate proof of payment. We also 

found that 33 of the 108, or about 31 percent, had used a substitute check 

or image statement to demonstrate proof of payment. Most of these 

consumers reported that they had no difficulty using a substitute check or

image statement, but some consumers reported that creditors would not 

accept an image showing only the front of the check so the consumer had 

to get copies of the front and back of the check from the bank. 

We then asked consumers whether they were concerned about having to 

demonstrate proof of payment using a substitute check or image statement 

rather than a canceled check. We found that 53 of the consumers, or about 

49 percent, were “slightly” or “not at all” concerned about their ability to 

demonstrate proof of payment using a substitute check or image statement 

 28Furthermore, 69 of the 108 consumers, or about 64 percent, stated that they conducted 

some type of online banking, including activities such as account balancing, bill payment,

and funds transfers.

Page 29 GAO-09-8 Check 21 Act
(see fig. 9). In particular, many of these consumers were confident that a

substitute check or image statement contained all of the information 

necessary to demonstrate proof of payment. However, 35 of the 

consumers, or 32 percent, were “extremely” or “very” concerned about 

using a substitute check or image statement. Many of these consumers 

were concerned that having an image of only the front of the check might 

not be sufficient, particularly if they had experienced such difficulty in the 

past. 

Figure 9: Bank Consumer Concern about Demonstrating Proof of Payment Using a 

Substitute Check or Image Statement 

Extremely concerned

Very concerned

Moderately concerned

Slightly concerned

Not concerned at all

19%

18%

15%

27%

22%

Source: GAO.

Note: Percentages may not total to 100 percent due to rounding. 

Few Bank Consumers 

Reported That They 

Experienced Errors from 

the Check Truncation 

Process 

Few of the bank consumers we interviewed reported that they suffered 

errors from the check truncation process. We asked consumers whether 

they had experienced errors such as double-posting of an item, a forged 

signature on a check, a counterfeit check, or some other error involving 

canceled checks, substitute checks, and image statements.29 The 

consumers reported more errors involving canceled checks than 

substitute checks or image statements. Specifically, 28 of the 108 

 29Double-posting or duplicate payment of a check refers to the same check being presented

to the paying bank twice. 

Page 30 GAO-09-8 Check 21 Act
consumers, or about 26 percent, reported an error involving a canceled

check and using it to resolve the error. In contrast, only one consumer we

interviewed reported suffering an error related to double-posting of a debit 

and using a substitute check to resolve the error. Also, 7 of the 74 

consumers who reported that they received image statements, or about 9 

percent, reported errors involving an image statement and using it to 

resolve errors they experienced. See figure 10 for the distribution of 

reported errors involving canceled checks and image statements. 

Figure 10: Errors Reported by Bank Consumers Involving Canceled Checks and Image Statements 

1% Counterfeit

check

Double-posting

of an item

Other

Forged signature

on one of your

checks

None

1% Counterfeit check

1% Other

4% Double-posting

of an item

3% Forged signature

on one of your checks

None

11%

9%

5%

74%

Source: GAO.

91%

Have you experienced any of the following

potential errors involving your cancelled check?

Have you experienced any of the following

potential errors involving a check image?

Note: Percentages in the first graphic are based on responses from 108 bank consumers.

Percentages in the second graphic are based on responses from 74 bank consumers. 

Based on interviews with trade association and service vendor officials, 

we found that some banks have been correcting errors associated with 

double-posting of a check before consumers experience them. They told 

us that double-posting initially was a significant problem for banks as they 

adopted check truncation technology. However, they also noted that many

banks have now incorporated protection in their computer system to 

identify duplicates before they reach the consumer, so that many 

consumers never see them when they review their bank statements. 

Page 31 GAO-09-8 Check 21 Act
We found that a small percentage of consumers complained to the federal

banking regulators about matters relating to Check 21.30 In its April 2007 

report, the Federal Reserve Board found that less than 1 percent of all 

complaints received by federal banking regulators related to Check 21. 

The results of our review of consumer complaint data on Check 21 

corroborated the Federal Reserve Board’s conclusion. Specifically, we 

reviewed consumer complaint data from the four federal banking 

regulators from October 28, 2004, through March 31, 2008, and found 172 

complaints were submitted about Check 21. In comparison, in each year 

from 2005 through 2007, the regulators received approximately 35,000

consumer complaints overall. Of the 172 complaints relating to Check 21, 

we found that 78, or about 45 percent, were from consumers who wanted 

to continue receiving canceled checks. The federal banking regulators 

responded to such complaints by noting that banks have no legal 

requirement to return canceled checks to consumers and that the return of 

canceled checks was dependent on the contractual agreement between 

consumers and their banks. However, in these instances, the data showed 

that the interested banks generally agreed to send canceled checks to 

consumers whenever possible. In addition, another 30 of the 172 

complaints, or about 17 percent, were from consumers concerned about 

the quality or clarity of image statements. Some of the banks we 

interviewed also mentioned image quality as a prominent consumer 

complaint, but we learned that they continue to seek a solution to image 

quality problems. 

Federal Banking 

Regulators Reported Few 

Consumer Complaints on 

Check 21 

 30We used data from the Federal Deposit Insurance Corporation, the Office of the 

Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Reserve 

Board. We were unable to obtain specific consumer complaint data related to Check 21 

from the National Credit Union Administration. 

Page 32 GAO-09-8 Check 21 Act
To the extent that banks have implemented electronic check processing, 

bank consumers have realized both benefits and costs relating to faster 

processing and access to information about their checking accounts. 

Faster check processing has helped some banks extend the cut-off time 

for same-day credit on deposits, which can result in faster availability of

deposited funds. In addition, bank industry officials and some of the 

consumers we interviewed believe it is beneficial to receive simpler 

checking account statements with check images rather than canceled 

checks. Also, bank industry officials cited benefits to consumers from 

immediate access to information about checking account activity and 

improved customer service. In addition, consumers can benefit specifically

from a provision of Check 21 because they have the right to expedited recredit of their checking accounts if banks make certain errors associated 

with substitute checks. However, on the basis of our consumer and bank

interviews, the extent to which consumers have benefited from expedited

re-credit is unclear. We also found that some consumers may incur fees 

related to receiving canceled checks and check images with their checking 

account statements. Based on our review of available data from 2001 

through 2006, it appears that fees for canceled checks have increased and

fees for check images have remained relatively flat. In addition, the 

amount of the fees can vary depending on the type of checking account 

the consumer maintains. 

We found that banks may have extended the cut-off time for accepting

deposits for credit on the same business day, due to the check truncation 

process and other check-system improvements. Generally, banks had 

established a cut-off hour of 2:00 p.m. or later for receipt of deposits at 

their main or branch offices and a cut-off of 12:00 p.m. or later for deposits 

made at ATMs and other off-premise facilities.31 These cut-off times 

provided the banks with necessary time for handling checks and 

transporting them overnight to paying banks. The check truncation 

process and check imaging provide collecting banks with additional time 

to present checks to paying banks. As a result, banks may be able to 

establish a later cut-off hour, which would give consumers more time to 

deposit funds at the bank for same-day credit. 

Bank Consumers 

Have Realized 

Benefits and Costs 

Relating to Faster 

Check Processing and 

Access to Information 

about Their Checking 

Accounts 

Some Bank Consumers 

May Experience Extended 

Cut-off Time for Deposits, 

but Broader Adoption of 

Electronic Processing by 

Banks Would Be Needed to 

Shorten Funds Availability 

Deadlines

Bank officials told us that they have started to adjust their cut-off times in 

some geographic areas in response to the growth of check truncation. Of 

 31See 12 C.F.R. 229.19(a)(5)(ii). 

Page 33 GAO-09-8 Check 21 Act
the seven largest U.S. banks that have started to migrate to check imaging, 

five told us that they have extended some of their deposit cut-off times at 

certain branches. For instance, one bank on average extended its cut-off

time by 2 hours in the Northeast, and another bank had plans in place to 

make a similar 2-hour extension in selected markets. A third bank told us

that it has extended the cut-off time for accepting deposits for credit on 

the same business day at certain ATMs to 8:00 p.m. in several major cities 

such as Atlanta, Chicago, Los Angeles, and New York. 

Although some consumers may have additional time for making deposits, 

they may not be able to withdraw their funds any sooner because the 

funds availability schedules of Regulation CC have not been amended 

following enactment of Check 21. The Federal Reserve Board recently

concluded that much broader adoption of new technologies and processes 

by the banking industry must occur before check return times can decline 

appreciably and thereby permit a modification of the funds availability 

deadlines.32 The Federal Reserve Board found that the banks of first 

deposit learn of the nonpayment of checks faster than they did when 

EFAA was enacted, but banks still do not receive “most” local or nonlocal 

checks before they must make funds available for withdrawal.

33

However, the Federal Reserve’s decision to consolidate its checkprocessing regions has had a direct effect on consumers in terms of the 

availability of their deposited funds under Regulation CC. Specifically, the 

consolidations have increased the proportion of local checks and thereby 

reduced the maximum permissible hold period from 5 business days to 2 

business days for many checks. As previously noted, the Federal Reserve’s 

check-processing regions are being consolidated into four checkprocessing regions by the first quarter of 2010. Because the processing 

regions are larger (and will become even more so), the number of local 

checks has been increasing. 

In addition, based on the Federal Reserve Board’s study and our own 

research, it appears that banks are making depositor funds available 

earlier than EFAA-established funds-availability schedules. Specifically, 

the Federal Reserve’s Check 21 study found that banks make about 90 

percent of all consumer deposits of local and nonlocal checks available 

 32Board of Governors of the Federal Reserve System, Report to the Congress on the Check

Clearing for the 21st Century Act of 2003 (April 2007), 17. 

33Check Clearing for the 21st Century, 15. 

Page 34 GAO-09-8 Check 21 Act
more promptly than required by EFAA.34 Moreover, it found that banks 

make funds available from the majority of consumer check deposits within 

1 business day.35 We reviewed the customer account agreements for 5 of 

the 10 largest U.S. banks and found that the general policy for each bank is

to make funds available to consumers on the business day after the day of

deposit. 

Many Bank Consumers 

Have Realized Other 

Benefits Related to Access 

to Information about 

Check Payments 

Bank industry officials and some consumers we interviewed noted that 

consumers may realize other benefits relating to access to information 

about check payments. For example, bank consumers may receive simpler 

checking account statements using image technology. So-called “image 

statements” include a sheet of paper with multiple pictures or images of 

checks that were written by the consumer and processed since the last 

statement. In our interviews with 108 bank consumers, 75 consumers, or 

about 69 percent, stated that they received image statements. When asked 

about their preferred method of receiving information about check 

payments, 11 of the 108 consumers interviewed, or about 10 percent, 

stated that they preferred receiving image statements over canceled 

checks or online review of check payments activity. Some of the 11 

consumers told us that they preferred receiving image statements because, 

while they wanted a paper record of their check payments activity, they

preferred not to handle and store canceled checks. 

Bank consumers who prefer to manage their checking account 

electronically also might realize benefits from immediate access to 

information about check payments. With the check imaging process and 

online access to their checking accounts, consumers can review check

payments and images of their paid checks as soon as they are posted to 

the account and may recognize a problem sooner. With paper check 

processing, consumers must wait until the checking account statement 

arrives in the mail to review their check payments activity. Also, improved 

access to information can be beneficial to consumers when they need to 

work with the bank to resolve a problem. Bank industry officials and some 

consumers we interviewed noted that consumers may realize other 

benefits relating to access to information about check payments. 

 34Check Clearing for the 21st Century, 13. 

35Check Clearing for the 21st Century, 13. 

Page 35 GAO-09-8 Check 21 Act
One of the expected consumer benefits of Check 21 is the right to 

expedited recredit, but the extent to which consumers have benefited is 

unclear. The expedited recredit provision is considered a benefit to 

consumers because other banking laws governing checks do not prescribe 

specific amounts or time frames by which banks must recredit a 

customer’s account.36 On the basis of our bank consumer and bank 

interviews, it appears that a small number of bank consumers have filed

expedited recredit claims. The right to expedited recredit exists if the 

consumer asserts in good faith that the bank charged the consumer’s 

account for a substitute check provided to the consumer and either the 

check was not properly charged to the consumer’s account, or the 

consumer has a warranty claim pertaining to the substitute check.37 The 

bank must recredit the customer’s account unless it has provided the 

customer the original check or a copy of the original check that accurately 

represents all information on the original check and demonstrated to the 

consumer that the substitute check was properly charged to the 

consumer’s account.38 

Check 21’s Expedited 

Recredit Is Considered a 

Consumer Benefit, but It 

Appears That a Limited 

Number of Consumers 

Filed for the Benefit 

On the basis of our consumer and bank interviews, it appears that a small 

number of bank consumers have filed expedited recredit claims. In our 

interviews with 108 consumers, 9 or about 8 percent of the consumers we 

interviewed, stated that they had received substitute checks with their 

main checking account statement, and none had exercised the right to 

expedited recredit. On the basis of the data provided to us by the 10 

largest banks through the data collection instrument (which are not 

representative of the entire industry), we found 3 banks received a small 

number of claims related to expedited recredit in 2007. Specifically, one 

bank reported that it fielded less than 1,000 claims; one received less than

 36See, e.g., Uniform Commercial Code Articles 4-401 and 4-402.

37Additional elements also must be satisfied. See 12 U.S.C. 5006(a) see also 12 C.F.R. 

§ 229.54. Warranties pertaining to the substitute check provide that the substitute check 

meets all the requirements for legal equivalence and that there is no duplicate payment of a

check. See 12 U.S.C. 5004; see also, Regulation CC, 12 C.F.R. §§ 229.52.229.53. 

38If the bank has not acted on the claim before the end of the tenth business day after the 

banking day on which the bank received the claim, it must provisionally recredit the

consumer’s account up to the lesser of the amount of the substitute check or $2,500. The

bank must recredit any remaining balance greater than $2,500 no later than the forty-fifth 

calendar day after the banking day on which the bank received the claim. 12 U.S.C. § 5006. 

Page 36 GAO-09-8 Check 21 Act
10 claims; and the third bank reported that it received 1 claim.39 In an 

interview, a representative of another bank told us that the bank had not

received any claims. Six other banks did not report any information on the 

number of claims received. 

Some Bank Consumers 

Can Incur Fees for 

Receiving Canceled 

Checks and Image 

Statements 

Some bank consumers can incur fees for receiving canceled checks and

image statements, and the amount can depend on the type of checking 

account the consumer maintains. We reviewed data regarding bank fees 

for canceled checks and image statements acquired from Informa 

Research Services in conjunction with a report on bank fees.40 The data 

indicated that the average amount of fees for obtaining canceled checks 

generally increased from 2001 through 2006, and the average amount of 

fees for obtaining image statements remained relatively flat. For example, 

as shown in figure 11, the average check enclosure fee more than doubled

from $1.42 to $3.11. During the same period, the average check imaging fee 

rose from $0.40 to $0.49.

41

 39We note that the bank with less than 1,000 claims is among the largest in the country, 

handling more than 3.2 billion checks in 2007. In addition, the institution reported that 75 

percent of the claims were resolved in the customer’s favor. 

40See GAO, Bank Fees: Federal Banking Regulators Could Better Ensure that Consumers

Have Required Disclosure Documents Prior to Opening Checking or Savings Accounts, 

GAO-08-281 (Washington, D.C.: Jan. 31, 2008). The Informa data typically were gathered 

from retail banks with large market shares in specific areas and are not statistically 

generalizable to other institutions. 

41Informa defined the check enclosure fee as the fee charged to have cancelled checks 

returned with the statement and the check image fee as the fee charged to have images of 

cancelled checks returned with the statement. 

Page 37 GAO-09-8 Check 21 Act
Figure 11: Check Enclosure and Imaging Fees, Banks and Savings and Loans, 

2001–2006 

0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2001 2002 2003 2004 2005 2006

Average fee (dollars)

Source: GAO analysis of Informa Research Services data.

Year

Check imaging fee

Check enclosure fee

The Informa data also indicated that banks may charge different amounts 

for check enclosures and check imaging depending on the type of 

checking account. Specifically, the Informa data indicated that primarily 

non-interest, free checking accounts had the highest fees for check 

enclosures and check imaging.42 The lowest check enclosure and check

imaging fees were found primarily with senior checking accounts.43 For 

example, in 2006 the average check enclosure fees for a non-interest, free 

checking account and a senior checking account were $3.75 and $2.45,

respectively, compared to $3.11—the average check enclosure fee of all 

accounts Informa surveyed. Furthermore, the average check-imaging fee 

for a non-interest, free checking account in 2006 was $0.84, and the 

average check-imaging fee for a senior checking account was $0.18, 

 42Informa defined a non-interest, free checking account as a free checking account that 

does not earn interest, has no monthly or transaction fees (such as debit per check fees or 

ATM/check card debit fees), and has no balance requirements. 

43Informa defined a senior checking account as a checking account exclusively for seniors

(persons age 65 or older) that can be interest or non-interest bearing.

Page 38 GAO-09-8 Check 21 Act
compared to $0.49—the average check imaging fee of all accounts Informa 

surveyed. 

A relatively small number of the bank consumers we interviewed reported 

that their bank charged a fee for obtaining canceled checks or image 

statements, and some of the banks we interviewed reported that they 

charged a fee for providing canceled checks. Specifically, 23 bank 

consumers, or about 21 percent of the consumers we interviewed, told us

that their bank charged a fee for obtaining canceled checks. Two 

consumers stated that they switched to online review of their check 

payments activity to avoid paying a fee for receiving canceled checks. 

Also, as we reported above, 12 of the 108 bank consumers we interviewed 

preferred receiving canceled checks to review their check payments 

activity. Moreover, 18 bank consumers, or about 17 percent, reported that

their bank charged a fee for obtaining image statements. Two of the banks 

we interviewed charged a fee if consumers wanted to receive canceled 

checks. For example, one bank stated that its customers paid $2 for 

receiving canceled checks if they also paid a monthly service fee, but other 

bank officials we interviewed stated that their banks did not charge a fee 

for image statements. 

In addition, faster check processing may cause consumers to lose “float.” 

Float is the time between the payment transaction and the debiting of 

funds from a bank consumer’s account. The check truncation process may 

result in checks clearing a consumer’s account more quickly than under 

traditional check processing. However, deposited funds may not be 

available to consumers more quickly because, as noted above, Regulation

CC’s funds availability deadlines have not changed. According to our 

recent report on bank fees, consumer groups and bank representatives 

believe that the potential exists for increased incidences of overdrafts if 

funds were debited from a consumer’s account faster than deposits were 

made available for withdrawal.44 However, we identified little research on 

the extent to which check truncation has affected occurrences of 

overdrafts and nonsufficient funds fees.45

 44See GAO-08-281. 

45See GAO-08-281. See also Eric Halperin, et al., Center for Responsible Lending, Debit Card 

Danger: Banks Offer Little Warning and Few Choices as Customers Pay a High Price for 

Debit Card Overdrafts (Jan. 25, 2007). 

Page 39 GAO-09-8 Check 21 Act
We provided a copy of a draft of this report to the Federal Reserve Board, 

which provided us with written comments that are reprinted in appendix

III. The Federal Reserve Board agreed with our overall conclusion that, 

over the past four years, the banking industry has made substantial 

progress toward establishing an end-to-end electronic check-processing 

environment. In commenting on this report, the Federal Reserve Board 

noted that the Federal Reserve Banks expect that by year-end 2009, more 

than 90 percent of their check deposits and presentments will be 

electronic. They also commented that the ongoing transformation to 

electronic check-processing environment has not been without cost. As 

noted in our report, the Federal Reserve Banks have reduced their 

transportation costs and work hours associated with their check services. 

And, according to the Federal Reserve Board, they earned a net income of

$326 million for providing check services from 2005 through 2007. The 

Federal Reserve Board concurred with a number of consumer benefits 

identified in the report: faster funds availability on check deposits due to 

later deposit deadlines, quicker access to account information, and 

improved customer service. In addition, they provided us with technical 

comments, which we incorporated as appropriate. We also sent a draft of

this report to the Federal Deposit Insurance Corporation, Office of the 

Comptroller of the Currency, and Office of Thrift Supervision. Only the 

Office of the Comptroller of the Currency provided us with technical 

comments, which we incorporated as appropriate. We provided sections

of the draft of this report to bank officials for their technical review and 

several of them provided us technical comments, which we incorporated 

as appropriate. 

We are providing copies of this report to other interested Congressional 

committees. We are also providing copies of this report to the Chairman, 

Board of Governors of the Federal Reserve System; Chairman, Federal 

Deposit Insurance Corporation; Comptroller of the Currency, Office of the

Comptroller of the Currency; Director, Office of Thrift Supervision; and 

other interested parties. We will also make copies available to others upon 

request. In addition, the report will be available at no charge on the GAO 

Web site at http://www.gao.gov. 

Agency Comments 

and Our Evaluation 

Page 40 GAO-09-8 Check 21 Act
If you or your staffs have any questions regarding this report, please 

contact me at (202) 512-8678 or jonesy@gao.gov. Contact points for our 

Office of Congressional Relations and Public Affairs may be found on the 

last page of this report. GAO staff who made major contributions to this 

report are listed in appendix IV. 

Yvonne D. Jones 

Director, Financial Markets and 

 Community Investment 

Page 41 GAO-09-8 Check 21 Act
List of Congressional Committees

The Honorable Christopher J. Dodd 

Chairman 

The Honorable Richard C. Shelby 

Ranking Member 

Committee on Banking, Housing, and Urban Affairs 

United States Senate 

The Honorable Barney Frank 

Chairman 

The Honorable Spencer Bachus 

Ranking Member 

Committee on Financial Services 

House of Representatives 

The Honorable Carolyn B. Maloney 

Chair 

The Honorable Judy Biggert 

Ranking Member 

Subcommittee on Financial Institutions 

 and Consumer Credit 

Committee on Financial Services 

House of Representatives 

Page 42 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and Appendix I: Objectives, Scope, and Methodology 

Methodology 

The Check Clearing for the 21st Century Act of 2003 (Check 21) mandated 

that GAO evaluate the implementation and administration of Check 21. 

The report objectives are to: (1) determine the gains in economic 

efficiency from check truncation and evaluate the costs and benefits to 

banks and the Federal Reserve System (Federal Reserve) from check 

truncation, (2) assess consumer acceptance of the check truncation 

process resulting from Check 21, and (3) evaluate the costs and benefits to

consumers from check truncation.1

To estimate the gains in economic efficiency from check truncation and 

evaluate the costs and benefits to banks from check truncation, we 

separately analyzed costs for the check operations of the Federal Reserve 

and for a selected group of banks. We used data from the Federal Reserve 

cost accounting system, known as the Planning and Control System or 

PACS, for the period beginning 10 years prior to the effective date of 

Check 21 (1994) through 2007. We modeled the Federal Reserve’s total 

check processing costs as different functions of variables, such as the 

volume of checks processed, the volume of returned checks, the number 

of Federal Reserve check processing offices, and the general indexes on 

wage and price. The specified cost functions allowed us to use standard 

econometric methods for estimating the effects of the variables on the 

Federal Reserve’s total check processing costs for 1994 through 2007. 

Because data on prices of input factors associated with Federal Reserve’s 

check processing operations are not available, we also used in our 

estimation data from the Department of Commerce’s Bureau of Economic 

Analysis (BEA) and the Department of Labor’s Bureau of Labor Statistics 

(BLS) as alternative measurements for the prices of these input factors. 

For example, we used average hourly earning for all private sectors from 

BLS as an alternative measurement for the Federal Reserve’s labor cost, 

BEA’s price deflator for equipment and software by nonresidential 

producers as an alternative measurement for communications equipment 

and transit cost, and BEA’s Gross Domestic Product price deflator as an 

alternative measurement for costs of all other input factors. We assessed 

the quality of all the above data and found them to be sufficiently reliable 

for our purposes. We also discussed Federal Reserve check processing 

costs and our econometric cost model with staff at the Federal Reserve. 

See appendix II for a detailed discussion of our econometric cost 

functions. 

 1

For this report, commercial banks, financial institutions, thrifts, and credit unions will be

collectively referred to as banks. 

Page 43 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

While the Federal Reserve has consistent cost accounting data, cost 

accounting varies throughout the banking industry, preventing a similar 

analysis for private-sector costs. To evaluate the costs and benefits to 

banks from check truncation, we focused our data collection and analysis 

on the 10 largest banks in the United States, based on deposit size as of 

March 25, 2008. The check volume at the 10 largest U.S. banks represents a 

significant segment of the check paid volume. In 2007, these banks 

presented almost 13 billion checks for collection out of approximately 30 

billion checks, which were paid in 2006. Thus, we determined that these 

banks should have a financial incentive to reduce the amount of paper that 

has to be sorted and transported. We created a data collection instrument 

to obtain qualitative cost information about the following issues: (1) the 

extent to which the banks deposited and received checks as images; (2) 

the primary costs related to paper check processing; (3) the extent of the 

investment that banks made to exchange check images; (4) the level of 

cost savings banks achieved, if any, including changes in labor and 

transportation costs through the use of image technology; and (5) the 

impact of check imaging and the use of substitute checks on the 

prevalence of bank losses from fraudulent checks. Officials from the 

Electronic Check Clearing House Organization, commonly known as 

ECCHO, also reviewed the data collection instrument. We sent it to the 10 

banks and received a response from 9. At an early stage of our 

engagement, we also interviewed an official representing the bank that did 

not provide a response. We conducted follow-up interviews with a number 

of the banks requesting clarification of their responses. 

We also sent the data collection instrument to 12 smaller institutions, 

which included credit unions, to understand the small bank experience 

with check imaging. These banks’ assets ranged from less than $500 

million to $5 billion and were selected from ECCHO’s list of participating 

members. In addition, our selection criteria included whether these 

smaller institutions were located in metropolitan or nonmetropolitan 

areas. We received completed forms from five of these institutions, but 

two had not migrated any of their volume to check imaging. We conducted 

subsequent interviews with the three institutions that had. We made 

several attempts to contact the nonrespondents through e-mail messages 

Page 44 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

and follow-up telephone calls. In addition, we interviewed officials from a 

corporate credit union and a banker’s bank.2

To assess consumer acceptance of the check truncation process resulting 

from Check 21, we conducted in-depth structured interviews with a total 

of 108 adult consumers in three locations (Atlanta, Boston, and Chicago) 

in May 2008. We contracted with NuStats, Inc., a private research and 

consulting firm, to recruit a sample of consumers who generally 

represented a range of demographics within the U.S. population in terms 

of age, education level, and income. However, the consumers recruited for 

the interviews did not form a random, statistically representative sample 

of the U.S. population; therefore, we could not generalize the results of the 

interviews to the relevant total population. Additionally, the self-reported 

data we obtained from consumers are based on their opinions and 

memories, which may be subject to error and may not predict their future 

behavior. Consumers had to speak English and meet certain other 

conditions: having primary responsibility in the household for balancing 

the financial account that allows paper check writing; having received

canceled original checks in paper form with the checking account 

statement at some point since 2000; and not having participated in more 

than one focus group or similar in-person study in the 12 months before 

the interview. We achieved our sample recruitment goals for all 

demographics, with the exception of the age category “65 plus” and the 

education category “some high school or less.” In addition, our sample 

comprised 64 women and 43 men. We considered that the impact of not 

achieving these goals on our work was minimal. See table 1 for further 

demographic information on the consumers we interviewed.

 2

Corporate credit unions are nonprofit financial cooperatives that are owned by natural 

person credit unions (that is, credit unions whose members are individuals), and provide 

lending, investment, and other financial services to these credit unions. Additionally, 

corporate credit unions offer automated settlement, securities safekeeping, data 

processing, accounting, and electronic payments services, which are similar to the 

correspondent services that large commercial banks have traditionally provided to smaller 

banks. Bankers’ banks were created as unique entities to provide community banks a 

noncompeting institution to offer correspondent and other financial services. 

Page 45 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

Table 1: Demographic Characteristics of Consumers Interviewed

Demographic Atlanta Chicago Boston Total

Income N % N % N % N %

Less than $25,000 9 23% 7 18% 5 17% 21 19%

$25,000 to $44,999 7 18% 10 26% 4 14% 21 19%

$45,000 to $64,999 10 25% 8 21% 7 24% 25 23%

$65,000 to $100,000 9 23% 10 26% 5 17% 24 22%

More than $100,000 5 13% 4 10% 8 28% 17 16%

Total 40 100% 39 100% 29 100% 108 100%

Age

25-34 7 18% 9 23% 7 24% 23 21%

35-44 10 25% 9 23% 6 21% 25 23%

45-54 9 23% 9 23% 6 21% 24 22%

55-64 8 20% 9 23% 6 21% 23 21%

65+ 6 15% 3 8% 4 14% 13 12%

Total 40 100% 39 100% 29 100% 108 100%

Education

Some high school or 

less 

4 10% 4 10% 0 0 8 7%

Completed high school 10 25% 10 26% 8 28% 28 26%

Some college 10 25% 11 28% 9 31% 30 28%

Completed college 11 28% 7 18% 8 28% 26 24%

Graduate school 3 8% 4 10% 3 10% 10 9%

Other education 2 5% 3 8% 1 3% 6 6%

Total 40 100% 39 100% 29 100% 108 100%

Source: NuStats, Inc.

During these interviews, we obtained information about the experience of 

consumers with, and their opinions about, changes to their checking 

accounts resulting from the check truncation process. Our interviews 

included a number of standardized questions, and more tailored follow-up 

questions as necessary to more fully understand their answers. All 

consumers were asked about their current experience with their checking 

accounts and preferred method of making retail payments. The interview

focused on consumer experience with canceled checks, substitute checks 

and check images, and the possible changes to their checking accounts 

since Check 21. More specifically, the structured interview of the 108 

consumers included questions on the following issues: (1) bank fees 

charged to them to receive canceled checks, substitute checks or image 

statements; (2) instances and subsequent resolution of errors involving

Page 46 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

their checking accounts; (3) their preferred method of receiving 

information from their bank about check payments activity (such as 

receiving their canceled checks, reviewing information online, or 

reviewing an image statement); (4) instances in which they had to 

demonstrate proof of payment using a canceled check or a check image 

and their resolutions; (5) their level of concern about using a check image 

as a proof of payment; and (6) whether their bank had extended its cut-off 

time for accepting deposits and the consumer’s opinion about the merits 

of such an action. In addition, we asked nine questions about the 

consumers’ experience submitting complaints to banks and federal 

banking regulators. This report does not contain all the results from the 

consumers’ interviews. We reproduced the text from our structured 

interview instrument and tabulated the results from the questions in 

Questions for Consumers about Check 21 Act (GAO-09-09SP). 

To evaluate the benefits and costs to consumers from check truncation, 

we interviewed staff from the federal banking regulators—the Board of 

Governors of the Federal Reserve, the Federal Deposit Insurance 

Corporation, the National Credit Union Administration, the Office of the 

Comptroller of the Currency, and the Office of Thrift Supervision—and 

collected consumer complaints about the implementation of Check 21 that 

were submitted to these agencies from October 28, 2004, through March 

31, 2008. Our analysis of the consumer complaint data helped us identify 

the issues that we pursued in our structured interviews of 108 consumers. 

While the regulators’ consumer complaint data may be indicative of the 

relative levels of different types of complaints, we did not rely solely on 

these data because these voluntary reporting systems rely on 

complainants to self-select themselves; therefore, the data may not be 

representative of the experiences of the general public. We also 

interviewed representatives from consumer advocacy groups, including 

Consumers Union, the Consumer Federation of America, and the U.S. 

Public Interest Research Group. Furthermore, we interviewed officials 

from the American Bankers Association and third-party processors. 

The data collection instrument discussed above also included questions 

about the potential benefits and costs of Check 21 for consumers. For 

example, we asked the banks for information about (1) their policies on 

returning canceled checks before and after Check 21; (2) the fees they 

charged to consumers for the return of canceled checks and image 

statements; (3) their assistance to customers in showing proof of payment

using a canceled check, a substitute check, or a check copy; (4) the 

instances of expedited claims they received on substitute checks and their 

resolution; and (5) the complaints they have received about matters 

Page 47 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

relating to Check 21 and whether they had changed their cut-off times for 

deposits at automated teller machines or branches in the last 2 years. 

In addition, we analyzed the conclusions and the methodology applied in 

the Federal Reserve Board’s Report to the Congress on the Check Clearing 

for the 21st Century Act of 2003, published in April 2007, to determine 

whether we could use the results in our report. The study constituted the 

Federal Reserve Board’s assessment of the banking industry’s 

implementation of Check 21 to date, as well as the continued 

appropriateness of the funds availability requirements of Regulation CC.3

We interviewed staff from the Federal Reserve Board about the 

methodology and conclusions in the report and we examined the design,

implementation, and analysis of the survey instrument used for the study.

We considered the overall strengths and weaknesses of the Federal 

Reserve’s data collection program, as well as specific questionnaire items 

relating to Regulation CC. On the basis of our review, we concluded that 

we could use the results in this report. 

To determine whether consumers may incur fees for receiving canceled

checks and check images since the implementation of Check 21, we 

reviewed and analyzed data purchased from Informa Research Services 

(Informa) that included summary-level fee data from 2001 through 2006.4

The data included information on check enclosure and imaging fees. 

Informa collected its data by gathering the proprietary fee statements of 

banks, as well as making anonymous in-branch, telephone, and Web site 

inquiries for a variety of bank fees. It also received the information directly

from its contacts at the banks. The data are not statistically representative 

of the entire population of depository institutions in the country because

the company collects fee data for particular institutions in specific 

geographical markets so that these institutions can compare their fees 

 3

Regulation CC implements both the Expedited Funds Availability Act of 1987 and the

Check Clearing for the 21st Century Act of 2003. Among other things, Regulation CC sets 

forth requirements that banks make funds deposited in transaction accounts like checking

accounts according to specified time schedules and banks disclose their funds availability 

policies to their customers. The regulation also establishes rules for the collection and the 

return of unpaid checks. Subpart D of the Regulation CC describes the requirements for

substitute checks, the reconverting bank’s duties, and expedited re-credit for consumers

and banks, among other things. 

4

We originally purchased these data in connection with our analysis of bank fees. For more

information, see GAO, Bank Fees: Federal Banking Regulators Could Better Ensure That

Consumers Have Required Disclosure Documents Prior to Opening Checking or Savings

Accounts, GAO-08-281 (Washington, D.C.: Jan. 31, 2008). 

Page 48 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

against their competitors. That is, surveyed institutions are self-selected 

into the sample or are selected at the request of subscribers. To the extent

that institutions selected in this manner differ from those which are not,

results of the survey would not accurately reflect the industry as a whole. 

Informa collects data on more than 1,500 institutions, including a mix of 

banks, thrifts, credit unions, and Internet-only banks. The institutions from 

which it collects data tend to be large ones that have a large percentage of

the deposits in a particular market. Additionally, the company has access 

to individuals and information from the 100 largest commercial banks. 

The summary-level data Informa provided us for each data element 

included the average amount, the standard deviation, the minimum and 

maximum values, and the number of institutions for which data were 

available to calculate the averages. They also provided these summarylevel data by institution type (banks and thrifts combined, and credit 

unions) and size (as shown in table 2). In addition, Informa provided us 

with data for nine specific geographic areas: California, Eastern United 

States, Florida, Michigan, Midwestern United States, New York, Southern 

United States, Texas, and Western United States.

Table 2: Definition of Institution Size Categories

Institution size Asset size 

Small institutions Assets of less than $100 million

Mid-size institutions Assets from $100 million to $1 billion 

Large institutions Assets of more than $1 billion

Source: GAO analysis of Informa Research Services data. 

We interviewed representatives from Informa to gain an understanding of 

their methodology for collecting the data and the processes they had in 

place to ensure the integrity of the data. Reasonableness checks were 

conducted in 2007 on the data and identified any missing, erroneous, or 

outlying data and Informa Research Services representatives corrected

any mistakes that were found. Also, in 2007, we compared the average fee 

amounts that Informa had calculated for selected fees for 2000, 2001, and 

2002 with the Federal Reserve’s “Annual Report to the Congress on Retail 

Fees and Services of Depository Institutions.” The averages were found to 

be comparable to those derived by the Federal Reserve. While these tests 

did not specifically include check enclosure and check image fees, they

did confirm our assessment of the Informa data system. Because the 

assessment conducted for our January 2008 report encompassed the 

Page 49 GAO-09-8 Check 21 Act
Appendix I: Objectives, Scope, and 

Methodology 

checking fee data we used, we determined that the Informa Research 

Services data were sufficiently reliable for our current report. 

We conducted this performance audit from September 2007 to October 

2008 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives. 

Page 50 GAO-09-8 Check 21 Act
Appendix II: E

21 for

Reserv

conometric Analysis of Check

 Economic Efficiency in the Federal 

e’s Check Services 

Page 51 GAO-09-8

Appendix II: Econometric Analysis of Check 

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

The Check Clearing for the 21st Century Act of 2003 (Check 21) was 

intended to make the check payment system more efficient and less costly 

by facilitating wider use of electronic check processing without 

demanding that any bank change its current check collection practices.1

Prior to Check 21, a bank was required to present an original paper check

to the paying bank for payment unless the paying bank agreed to accept 

presentment in some other form. This required the collecting bank to enter 

into agreements with all or nearly all of the banks to which it presented 

checks. Because of these impediments, banks were deterred from making

the necessary electronic check processing investments. Check 21 

addressed these impediments by authorizing a new paper negotiable 

instrument (a substitute check), which is the legal equivalent of the 

original check. Other than accepting the substitute check, the act does not 

require banks to adopt electronic check processing, but it enables banks 

that want to truncate or remove the original paper checks from the checkcollection system to do so more easily. Check 21 facilitates electronic 

check processing by allowing banks to use imaging technology for 

collection and create substitute checks from those images for delivery to 

banks that do not accept checks electronically. 

To assess the implications for economic efficiency in the Federal Reserve 

System’s (Federal Reserve) check processing since Check 21 took effect in

October 2004, we conducted a standard econometric analysis of the 

Federal Reserve’s quarterly accounting cost and volume data for the 

period from 1994 through 2007. This approach allowed us to model total 

check operating costs as a function of the total check presentment volume 

and the timing of Check 21, while separating cost effects from other 

relevant factors such as check return volume, number of check clearing 

offices, and labor wages.

Description of the 

Econometric Models 

As suggested by microeconomic theory of the firm, we model the Federal

Reserve’s total cost for its check clearing operations as a function of 

outputs and input prices as shown in equation (1).2

(1) 1nCt =α0 + ∑βk 1n (Pk) + α1 1n (Nt ) + α2 1n (Rt) + α3 1n(0t) + α4 DC21+εt

 1

For this report, we refer to banks, thrifts, and credit unions collectively as banks. 

2

Many microeconomic textbooks have detailed discussions on cost function. For example,

see Hal R. Varian, Microeconomic Analysis, 3rd edition (New York, N.Y.: W.W. Norton &

Company, 1993), chapter 5. 

Check 21 Act
Appendix II: Econometric Analysis of Check

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

The total check operating cost at time t (Ct) depends on the number of 

checks (items) processed during that period (Nt

) and the number of return 

items (Rt

). Total operating cost is expected to have a positive relationship 

with both the total number of items processed and the number of return 

items; that is, positive α1

 and α2 in equation (1).3

Concurrently with the growth in electronic processing, including check 

truncation, the Federal Reserve has been consolidating its check 

processing operations, reducing the number of check processing sites 

from 45 offices in 2000 to a planned 4 offices by early 2010. While a 

reduction in the number of check processing offices (Ot

) is expected to 

result in savings, the Federal Reserve has reported that it incurred 

consolidation and reorganization charges. Thus, the expected sign for the 

coefficient of Ot

 [α3 in equation (1)] is ambiguous; it may be positive in the 

case of a cost savings or negative in the case of an increase in total costs. 

The coefficient of primary interest is that of Dc21, (α4

). The dummy variable 

Dc21 is constructed to have a value of 1 for periods on and after October 

2004 when Check 21 took effect and a value of zero otherwise. As Check 

21 was intended to facilitate electronic clearing of checks, the hypothesis 

is that after the effective date of Check 21 the Federal Reserve’s total 

operating costs would decrease; that is, a negative α4

 in the estimation. 

Consistent with microeconomic theory, we expect an increase in input 

prices (pk) will lead to an increase in total cost. For example, higher labor 

wage rates are expected to lead to higher total cost, seen as positive 

coefficients for input prices in the estimation. 

Based on econometric studies, including some that specifically considered 

economies of scale for check processing, we modified the basic approach 

of equation (1) to control for quarterly fluctuations and trends over time, 

and to consider the potential effects of Check 21 on the presence of scale 

economies in check clearing operations.4

 That is, we modified our 

 3

We do not account for float in the model. Float refers to the time between the payment

transaction and the debiting of funds from an account. 

4

Some of these studies include Ernst R. Berndt, The Practice of Econometrics: Classic and

Contemporary (Mass: Addison-Wesley Publishing, 1996), chapter 3; Robert M. Adams, Paul

W. Bauer, and Robin C. Sickles, Federal Reserve Bank of Cleveland, “Scope and Scale 

Economies in Federal Reserve Payment Processing,” Working Paper 02-13 (November 

2002); David B. Humphrey, “Scale Economies at Automated Clearing House,” Journal of 

Bank Research (Summer 1981), 71-81; and Paul W. Bauer and Dianna Hancock, “Scale 

Economies and Technological Change in the Federal Reserve ACH Payment Processing,” 

Federal Reserve Bank of Cleveland Economic Review (1995) vol. 31, no. 3, 14-29. 

Page 52 GAO-09-8 Check 21 Act
Appendix II: Econometric Analysis of Check

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

equation (1) to include a structural break associated with Check 21.5 This 

specification better reflects the cost effect of the technology shift from 

processing paper checks to processing checks electronically. A negative 

coefficient of the output variable multiplied by the dummy variable for 

Check 21 will imply a more cost-efficient cost structure for the period after 

Check 21; a positive coefficient will imply a higher cost structure. QTR, 

time and time2

 are dummy variables to control for quarterly fluctuation 

and trends over time. 

(2) lnCt

 = α0 + Σβk 1n (Pk) + α1 1n (Nt ) + α2 1n(Rt) + α3 1n(0t) + α4 DC21λ1time + λ2time2 

 3

 +Σφj QTR j + [αpo + ΣβPk 1n (Pk) + αp1 1n (Nt ) + αp21n(Rt) + αp3 1n(0t ) + αp4DC21]x Dc21

+εt 

 1 

Results We estimated equation (2) with quarterly data from the Federal Reserve’s

Planning and Control System (PACS) for the period from 1994 through 

2007. Table 3 shows the summary statistics for selected variables. 

Table 3: Summary Statistics of Some Selected Variables 

Variables Mean Maximum Minimum

Standard

deviation

Logarithm of total check operating 

cost 18.94 19.23 18.67 0.16

Logarithm of total presentment

a

22.05 22.21 21.61 0.17

Logarithm of check clearing offices 3.66 3.85 2.94 0.28

Logarithm of returned checks 17.50 17.69 17.14 0.16

Logarithm of price deflator for 

equipment and softwareb

4.62 4.76 4.55 0.08

Logarithm of wagec2.61 2.83 2.39 0.13

Logarithm of Gross Domestic Productd4.63 4.79 4.50 0.09

Source: GAO analysis of PACS data. 

a

Total presentment includes presentment by traditional paper checks, legacy paper checks, check

images, and substitute checks. 

b

The price deflator for equipment and software by nonresidential producers (2000=100). 

 5

Because the focus of our analyses is to examine the relationship between Check 21and 

total cost of check processing, we used a parsimonious specification of a simple log-linear 

cost function (equation 2) in our estimation instead of more sophisticated specifications in 

other studies. 

Page 53 GAO-09-8 Check 21 Act
Appendix II: Econometric Analysis of Check

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

c

Average hourly earning for all the private sector in 2000 dollars. 

d

Gross Domestic Product deflator (2000=100). 

Results Using Total Check 

Presentment 

We estimated the logarithm of total check processing cost against the 

logarithms of total presentment items—image, paper, legacy, and 

substitute—and other related variables.6 Table 4 presents the results. The 

basic specification in table 4, which does not account for a possible 

different cost structure in check processing, yields mostly statistically 

insignificant coefficients. However, the coefficient for the total number of 

items presented is significant and positive, implying that a 1 percent 

increase in total presentment will result in a 1.34 percent increase in total

cost. 

However, the coefficient for the Check 21 dummy variable (Check21),

while negative, is not statistically significant. This result does not provide 

any support for the hypothesis that the introduction of Check 21 led to a 

decrease in Federal Reserve costs, although it is not possible to determine 

the extent to which this may be driven by the concurrent consolidation of 

Federal Reserve check services sites. 

 6

Because deposit and presentment are almost mirror images of each other, we opt to use 

presentment as the independent variables in our estimations. 

Page 54 GAO-09-8 Check 21 Act
Appendix II: Econometric Analysis of Check

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

Table 4: Estimation of Logarithm of Total Check Operating Cost, 1994–2007 

Basic With structural break 

Description Coefficient Std. error Coefficient Std. error

Constant -23.41 21.16 -17.73 23.39

Logarithm of total presentment 1.34 0.43 0.84 0.58

Logarithm of total presentment*Check21 — — -0.25 1.21

Logarithm of returned checks 0.35 0.19 0.49 0.28

Logarithm of returned checks*Check 21 — — -0.95 0.90 

Logarithm of number of offices -0.098 0.17 -0.041 0.32

Logarithm of number of offices*Check 21 — — -0.13 0.48

Logarithm of wage 1.01 1.14 3.77 1.96

Logarithm of wage*Check 21 — — -5.42 4.37

Logarithm of price deflator for equipment and software 0.025 1.70 0.63 2.16

Logarithm of price deflator for equipment and software*Check 21 — — -3.65 9.14

Logarithm of Gross Domestic Product 0.99 3.99 0.55 4.48

Logarithm of Gross Domestic Product *Check21 — — 2.27 4.25

Check 21a-0.023 0.048 43.17 46.36

Quarter I dummy -0.008 0.036 -0.052 0.043

Quarter 2 dummy -0.036 0.019 -0.039 0.022

Quarter 3 dummy -0.0023 0.016 -0.006 0.018

Trend -0.017 0.028 -0.031 0.030

Trend squared 0.00039 0.00016 0.0004 0.00017

AR(1)b0.41 0.16 0.36 0.20

Number of observations 55 55 

R-squared 0.95 0.96

Adj R-squared 0.94 0.94

Log likelihood 107.43 111.75

F-statistic 61.83 42.57

D-W stat 1.68 1.71

Source: GAO analysis of PACS data. 

a

One on and after October 2004; zero otherwise. 

b

AR (1) is the coefficient of the first order of autocorrelation, which is to control of the correlation 

between the current and the previous periods. 

Table 4 also shows the results of the estimation incorporating a structural 

break in the cost function for periods before and after the act as described 

in equation (2). Though insignificant, the coefficient of total presentment 

is positive and less than 1, and the coefficient of the interacted variable of

Page 55 GAO-09-8 Check 21 Act
Appendix II: Econometric Analysis of Check

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

total presentment and Check 21 dummy is negative (-0.25). If significant, 

the sum of two coefficients would imply that the cost structure for the 

check operation in the post-Check 21 period would be different from the 

pre-Check 21 period. However, the relatively short time series data for the 

post-Check 21 period increase the standard errors for all the coefficients 

of the interacted variables. Also, although insignificant, the coefficient of 

the Check 21 dummy is positive, implying that the total cost, on average, is 

lower in periods before Check 21 than after. 

In addition to the estimation results shown in table 4, we estimated 

alternative functional forms used in other similar studies for the 

relationships in equation (2).7

 Because these functional forms generally

require constructing a substantial number of interacted variables, the 

subsequent multicollinearity and the limited data available make the 

results subject to high estimation errors and thus difficult from which to 

draw clear inferences. We also tested the effects on the estimates of 

imposing a constraint suggested by economic theory.8

 The standard errors

for most of the coefficient estimates decrease, suggesting a decrease in 

multicollinearity, but the results are otherwise similar to the results 

without the constraint in table 4. 

Potential Limitations of the 

Analysis 

While we believe that this analysis provides a reasonable basis for our 

findings and conclusions regarding the effects of Check 21 on Federal 

Reserve costs, we recognize the limitations inherent in the analysis. First, 

our econometric analysis only uses Federal Reserve data on check 

operations, which may not be representative of the operations of private 

financial institutions. Second, the time series data on post-Check 21 cost

and volume may not be long enough to reliably estimate the effect on cost 

of the accelerating use of electronic presentment and clearing, particularly

 7

For example, we estimated some parsimonious versions of the separable quadratic cost

function as used in the study by Robert M. Adams, Paul W. Bauer, and Robin C. Sickles,

Federal Reserve Bank of Cleveland, “Scope and Scale Economies in Federal Reserve 

Payment Processing,” Working Paper 02-13 (November 2002). 

8

This constraint of linear homogeneity is to ensure that the cost function is consistent with 

microeconomic theory—if one doubles the price of the input factors, one would expect to 

double total costs. Mathematically, it means that the sum of βk should add up to 1, 

 k=N 

 ∑ βk = 1 k=1 

To impose this constraint, we made some adjustments to the total costs and input price. 

See William H. Green, Econometric Analysis (Prentice Hall, N.J.: 1993), 503-507. 

Page 56 GAO-09-8 Check 21 Act
Appendix II: Econometric Analysis of Check

21 for Economic Efficiency in the Federal 

Reserve’s Check Services 

given the changes in technology embodied in electronic presentment and 

check truncation. These results are likely to change with additional 

quarters of data and the expected continuing increase in the electronic 

presentment as a share of the Federal Reserve’s check processing. 

Also, as previously mentioned, the Federal Reserve’s ongoing effort to 

close check clearing office facilities has resulted in one-time consolidation 

and reorganization charges. These charges are included in the total cost 

operating costs, and although we try to control for their effect by including

the number of offices variable, it is plausible that the positive sign of the 

Check 21 dummy in our estimations may be a result of these charges 

included in the total costs. Similarly, our analysis implicitly assumes that 

the Federal Reserve’s consolidation decisions are independent of the 

volume of checks that it processes. However, the data are not sufficient to 

explicitly model a relationship between the volume of checks and 

expectations about future volumes. 

Page 57 GAO-09-8 Check 21 Act
Appendix III: Comments from the Board of Appendix III: Comments from the Board of Governors of the Federal Reserve System 

Governors of the Federal Reserve System 

BOARD OF GOVERNORS OF THE 

FEDERAL RESERVE SYSTEM WASHINGTON, D.C. 20551

LOUISE L. ROSEMAN 

DIRECTOR 

DIVISION OF 

RESERVE BANK OPERATIONS 

AND PAYMENT SYSTEMS 

 October 16, 2008

Ms. Yvonne D. Jones 

Director 

Financial Markets and Community Investment 

United States Government Accountability Office 

441 G Street, NW 

Washington, DC 20548 

Dear Ms. Jones: 

 We appreciate the opportunity to comment on the GAO’s report titled Check 21 

Act: Most Consumers Have Accepted and Banks Are Progressing Towards Full Adoption of 

Check Truncation. We agree with the GAO’s overall conclusion that, over the past four years, 

the banking industry has made substantial progress towards establishing an end-to-end electronic 

check-processing environment. Today, more than three-quarters of checks deposited with the 

Federal Reserve Banks for collection are deposited electronically, and more than half are 

presented electronically. The Federal Reserve Banks expect that by year-end 2009, more than 

90 percent of their check deposits and presentments will be electronic. 

This ongoing transformation to an end-to-end electronic check-processing

environment has not been without cost. The banking industry and the Federal Reserve Banks 

have made significant technological investments to facilitate an electronic check-clearing system 

and have incurred incremental transition costs associated with processing both paper and 

electronic checks. The Federal Reserve Banks’ investments, however, have enabled them to 

significantly reduce their transportation costs and paper check-processing infrastructure. These 

cost reductions have been critical to the Reserve Banks’ ability to recover all of their actual and 

imputed costs of providing check services from 2005 through 2007 and earn a net income of 

$326 million. 

 We are pleased that consumers are beginning to obtain the benefits associated 

with Check 21 and that this major transformation from paper to electronic check clearing is 

being accomplished with few consumer complaints. The report reviews a number of these 

consumer benefits: faster funds availability on check deposits due to later deposit deadlines, 

quicker access to account information, and improved customer service. In addition, as the report 

notes, another important consumer benefit that has flowed from Check 21 has been a shorter 

maximum permissible hold period on an increasing number of check deposits. By facilitating 

the electronic collection of checks, Check 21 has enabled the Reserve Banks to close most of 

their check-processing offices, resulting in the consolidation of many Federal Reserve checkprocessing regions. Because Congress tied the determination of whether a check is local or 

nonlocal to whether the depositary bank and the paying bank are located in the same checkEmail: Louise.Roseman@frb.gov 

Phone: (202) 452-2789 • Fax: (202) 452-2746

Page 58 GAO-09-8 Check 21 Act
Appendix III: Comments from the Board of 

Governors of the Federal Reserve System 

-2-

processing region, many checks that were previously classified as nonlocal checks subject to a 

five-day maximum permissible hold are now classified as local checks subject to a maximum 

two-day hold period. It is likely that within the next several years, all checks will be classified as 

local, subject to the shorter permissible hold period. 

 Again, we appreciate the opportunity to review and comment on the GAO’s 

report and the efforts and professionalism of the GAO’s team in conducting this study.

Sincerely,

Page 59 GAO-09-8 Check 21 Act
Appendix IV: 

St

GAO Contact and 

aff Acknowledgments

Page 60 GAO-09-8

Appendix IV: GAO Contact and Staff 

Acknowledgments 

Yvonne D. Jones (202) 512-8678 or jonesy@gao.gov

The following individuals made key contribution to this report: Debra R. 

Johnson, Assistant Director; Joanna Chan; Philip Curtin; Nancy Eibeck; 

Terence Lam; James McDermott; Carl Ramirez; Barbara Roesmann; and 

Paul Thompson. 

Check 21 Act

GAO Contact 

Staff 

Acknowledgments 

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