In 1996, an estimated 64 billion checks were written in the United States. Approximately 30 to 35 percent of these checks were “on-us” checks—that is, checks for which the collecting bank (any bank except the paying bank handling the item for collection) and the paying bank (the bank on which the check is drawn) are the same entity. On-us checks never enter the interbank check-collection process. The remaining 65 to 70 percent (about 45 billion checks in 1996) of the checks written were interbank checks. Interbank checks are cleared and settled through an elaborate check-collection process. The check-collection process includes, among other steps, check presentment and the final settlement of checks. Check presentment occurs when the checks are delivered to the paying banks for payment and the paying banks must decide whether to honor or return the checks. Final settlement of checks occurs when the collecting banks are credited and the paying banks are debited, usually through accounts held at either Federal Reserve Banks or correspondent banks. In the check-collection process, depositary banks generally sort deposited checks by destination and dispatch them for collection. Depositary banks can physically present paper checks to paying banks through several methods: direct presentment of the paper checks to the paying banks; exchange of paper checks at clearing houses in which the depositary banks and the paying banks are members; presentment of the paper checks through intermediaries, such as correspondent banks or Federal Reserve check offices; or some combination of the above methods, such as depositary banks using correspondent banks to collect checks and the correspondents collecting those checks through local clearing houses or Federal Reserve check offices. When paying banks decide not to pay certain checks, they must return the dishonored checks to the depositary banks. Under the Uniform Commercial Code (UCC), the paying bank generally has until midnight of the day following presentment (“midnight deadline”) to return dishonored checks or send notices of dishonor. (The UCC and other laws and regulations governing the check-collection processes are described below.) Banks use this period to decide whether or not to pay checks. Dishonored checks are returned for several reasons, such as insufficient funds in the check writer’s account, issuance of a stop-payment order on the check, or because the check was written on a closed account. Banks vary considerably in their policies for making pay/no pay decisions and may view these decisions as a matter of customer service. Thus, even if banks have earlier information indicating that some checks may have to be returned, using the entire period permitted by the UCC may enable the bank to honor the check. The paying banks may return dishonored checks, commonly referred to as return items, directly to the depositary banks, through clearing house associations, or to any returning bank (a bank handling a returned check), including the Federal Reserve Banks. Although most paper checks are physically presented to the paying banks, checks can be presented electronically by agreement with paying banks. When checks are electronically presented, the MICR data are electronically transmitted by the presenting bank to the paying banks and the receipt of these data constitutes presentment, rather than the paying banks’ receipt of the paper checks. The paper checks may be sent to the paying banks at a later time or may be “truncated” or held, at some point in the collection process, depending upon the terms of the applicable electronic presentment agreement. When checks are truncated, the check writers do not receive the cancelled checks. Checks can be truncated at depositary banks or at intermediary banks, such as Federal Reserve Banks or correspondent banks. The check-collection process is regulated by a complex system of laws and regulations. The primary laws affecting checks are Articles 3 and 4 of the UCC, as adopted in each state; EFAA; and the Federal Reserve Board’s Regulations CC and J. The UCC is a set of model laws that govern commercial and financial activities. Efforts have been made to encourage each of the 50 states to enact UCC articles in a uniform manner. The UCC’s Articles 3 and 4 govern negotiable instruments, including checks and bank deposits, and collections, respectively. Article 4 was revised in 1990, in part, to promote the efficiency of the check-collection process by making the provisions of Article 4 more compatible with the needs of an automated system and to facilitate the adoption of programs allowing for the presentment of checks by electronic transmission of information. Although the UCC allows for the use of electronic check presentment, paying banks still have the legal right to insist on paper presentment. EFAA, which is implemented through Regulation CC, limits the time that banks can hold funds deposited into customer accounts before these funds must be made available for withdrawal. Regulation CC, which preempts the UCC or other state law to the extent that either is inconsistent with Regulation CC, also governs the collection and return of checks. Regulation J governs checks collected through the Federal Reserve System. EFAA and Regulation CC establish the specific funds availability schedules for checks. Generally, funds are to be made available for withdrawal within 2 business days after the day of deposit for local checks and within 5 business days for nonlocal checks. Local checks, in general, are those for which the depositary bank and the paying bank are located in the same Federal Reserve check-processing region. Nonlocal checks, in general, are those for which the depositary bank and the paying bank are located in different Federal Reserve check-processing regions. EFAA and Regulation CC also require that the first $100 of a depositor’s aggregated checks and certain other types of checks, such as Treasury, state and local government, or cashier’s checks, are to be made available for withdrawal by the next business day after the day of deposit. Under EFAA and Regulation CC, banks are permitted to hold checks longer for, among other things, checks over $5,000 or suspicious checks. In certain circumstances, such as when banks have reasonable cause to believe that certain checks are uncollectible or when an account is new, the banks may delay the availability of funds. In such a case, the banks must notify the customers, explain the delay, and indicate when the funds will be available. To identify and describe the ECP services offered to U.S. banks, we interviewed officials from the Federal Reserve Board and FRBM and reviewed Federal Reserve Board documents that described the Federal Reserve’s ECP services. We also interviewed officials at the New York Clearing House Association (NYCHA), the Electronic Check Clearing House Organization (ECCHO), and the American Bankers Association (ABA). To determine the volume of checks that were electronically presented in the United States from 1995 to 1997, we collected data from the Federal Reserve Banks on their ECP services. To calculate the percentage of the ECP volume in the U.S. interbank check-collection market, we used the number of interbank checks cited in the January 1998 report by the Committee on the Federal Reserve in the Payments Mechanism. The number of interbank checks is an estimate because the actual number of checks that are cleared through clearing houses and correspondent banks, and by direct presentment, as well as the number of on-us checks, is unknown. To determine how ECP affects the length of time it takes for a dishonored check to be returned to a depositary bank, we used data from a survey coordinated by the Federal Reserve Board and conducted by four Federal Reserve offices. At our request, the Federal Reserve collected information on the return cycle time for a small sample of items that were initially presented by either paper check or electronic transmission and that were returned as dishonored through four Federal Reserve check offices. This information was collected for a sample of 2,258 return items, primarily during the week of January 12 through 16, 1998. The four check offices were selected because they had higher-than-average ECP volumes. Also, the Federal Reserve Board applied the same ECP return item survey to FRBM’s additional ECP service, ECCS, which is offered only to banks located in the Upper Peninsula of Michigan. For comparison purposes, we also collected comparable check-return data from 10 judgmentally selected banks in the Upper Peninsula of Michigan that do not participate in ECCS. Because the sizes of the samples were small and not selected on a random basis, we could not make any statistical generalizations regarding the entire banking industry or the Federal Reserve’s ECP services on the basis of these surveys. Since the samples were selected during an 1-week period at 4 Federal Reserve check offices, we could not ascertain whether our results would differ if the samples were taken over a longer period of time or collected at more of the Federal Reserve’s 45 check offices. Furthermore, our results may not fully reflect differences among paper presentment and ECP services because the checks are not assigned to these processes on a random basis, but rather on the basis of each paying bank’s decisions. It is reasonable to expect that paying banks make decisions to accept electronic presentment based on a number of criteria, such as price and availability of services. Thus, the returned checks collected from the different presentment methods may well have different characteristics; these could, in turn, affect the time required for their return if they are dishonored by the paying bank. This nonrandom selection process limited our ability to determine whether ECP services available nationwide had any effect on check return cycles. To determine potential legal and operational impediments to ECP, we interviewed officials at several large banks, the Federal Reserve Board, the Federal Reserve Banks of Minneapolis and Boston, and NYCHA. We asked these officials how certain provisions of the UCC’s Articles 3 and 4, EFAA, and the Federal Reserve Board’s Regulation CC and other issues may impede increased ECP use.