Check 21 Act: Most Consumers Have Accepted and Banks Are Progressing Toward Full Adoption of Check Truncation
Published: 2008-10-28T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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. 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. 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. 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  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 check- collection 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; (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  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).
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.
subsections: section_title: Background
paragraphs: 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.
subsections: section_title: Check Collection Process
paragraphs: Interbank checks are cleared and settled through an elaborate check- collection process that includes presentment and final settlement. 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.
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. 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  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.
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).
Do not endore or write below thi line.
section_title: Electronic Check Processing and Imaging Technology
paragraphs: 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  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.
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. Because, under Check 21, checks drawn on any particular  bank can be truncated by any bank across the country, banks cannot  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.
section_title: Recent Trends in Check Use, Overall Electronic Payments, and Electronic Processing of Checks
paragraphs: 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. 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. 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. The share of check  payments declined from 46 percent in 2003 to 33 percent in 2006 (see   fig. 4).
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.
section_title: Federal Reserve’s Role in Check Collection and Its Consolidation of Check Offices
paragraphs: 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. 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  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.
section_title: 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
paragraphs: 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.
subsections: section_title: 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
paragraphs: 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  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.
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). The 2007 annual budget  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. “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.”
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. 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  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. 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.
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   costs for check services decreased approximately 11 percent from the  fourth quarter of 2001 through the fourth quarter of 2007 (see fig. 6).
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).
section_title: 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
paragraphs: 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  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  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 image- based 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. 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.
section_title: Largest Banks That Migrated to Imaging Achieved Cost Savings in the Areas of Transportation and Labor, but also Incurred Technology Costs
paragraphs: 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  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. 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  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.”
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  substitute check printing has cost the bank hundreds of thousands of  dollars to implement.
section_title: A Few Smaller-Size Banks Have Seen Lower Costs for Transportation and Labor from Electronic Check Processing
paragraphs: 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 full- time 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.
section_title: Use of Substitute Checks and Check Imaging Appears to Have Had a Neutral Effect on Fraud Losses
paragraphs: 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. 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.
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.
section_title: Most Bank Consumers Appeared to Have Accepted Changes to Their Checking Accounts from the Check Truncation Process Resulting from Check 21
paragraphs: 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.
subsections: section_title: A Small Percentage of Bank Consumers Preferred Receiving Their Canceled Checks
paragraphs: 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. 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).
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. 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  reviewing check information and images online. 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).
section_title: Most Bank Consumers Were Not Concerned Significantly about Demonstrating Proof of Payment Using a Substitute Check or Check Image
paragraphs: 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  (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.
section_title: Few Bank Consumers Reported That They Experienced Errors from the Check Truncation Process
paragraphs: 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. The  consumers reported more errors involving canceled checks than  substitute checks or image statements. Specifically, 28 of the 108  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.
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.
section_title: Federal Banking Regulators Reported Few Consumer Complaints on Check 21
paragraphs: We found that a small percentage of consumers complained to the federal  banking regulators about matters relating to Check 21. 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.
section_title: Bank Consumers Have Realized Benefits and Costs Relating to Faster Check Processing and Access to Information about Their Checking Accounts
paragraphs: 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 re- credit 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.
subsections: section_title: 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
paragraphs: 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. 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 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  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. 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.
However, the Federal Reserve’s decision to consolidate its check- processing 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 check- processing 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  more promptly than required by EFAA. Moreover, it found that banks  make funds available from the majority of consumer check deposits within  1 business day. 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.
section_title: Many Bank Consumers Have Realized Other Benefits Related to Access to Information about Check Payments
paragraphs: 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.
section_title: Check 21’s Expedited Recredit Is Considered a Consumer Benefit, but It Appears That a Limited Number of Consumers Filed for the Benefit
paragraphs: 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. 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. 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.
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  10 claims; and the third bank reported that it received 1 claim. 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.
section_title: Some Bank Consumers Can Incur Fees for Receiving Canceled Checks and Image Statements
paragraphs: 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. 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.
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. The lowest check enclosure and check  imaging fees were found primarily with senior checking accounts. 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,  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. However, we identified little research on  the extent to which check truncation has affected occurrences of  overdrafts and nonsufficient funds fees.
section_title: Agency Comments and Our Evaluation
paragraphs: 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.
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.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: 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.
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.
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  and follow-up telephone calls. In addition, we interviewed officials from a  corporate credit union and a banker’s bank.
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.
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  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  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.  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.  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  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 summary- level 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.
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  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.
section_title: Appendix II: Econometric Analysis of Check 21 for Economic Efficiency in the Federal Reserve’s Check Services
paragraphs: 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.  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 check- collection 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.
subsections: section_title: Description of the Econometric Models
paragraphs: For this report, we refer to banks, thrifts, and credit unions collectively as banks.
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.
The total check operating cost at time t (C) depends on the number of  checks (items) processed during that period (N) and the number of return  items (R). 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 α and α in equation (1).coefficient of O [α 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, (α in the estimation.
Consistent with microeconomic theory, we expect an increase in input  prices (p) 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.
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.
section_title: Results
paragraphs: 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.
section_title: Results Using Total Check Presentment
paragraphs: 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. 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.
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  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). 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. 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.
section_title: Potential Limitations of the Analysis
paragraphs: 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. 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.
section_title: Appendix III: Comments from the Board of Governors of the Federal Reserve System
paragraphs: 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. 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.
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: 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.