Electronic Banking: The Implementation of the Check 21 Act

Electronic Banking: The Implementation of the Check 21 Act

Order Code RL32668
CRS Report for Congress
Received through the CRS Web
Electronic Banking: The Implementation
of the Check 21 Act
November 9, 2004
name redacted
Specialist in Economic Policy
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

Electronic Banking: The Implementation
of the Check 21 Act
Summary
On October 28, 2003, President Bush signed the Check Clearing for the 21st
Century Act into law (P.L. 108-100, “Check 21 Act”) to become effective on October
28, 2004. In the Check 21 Act, Congress gave the Board of Governors of the Federal
Reserve System (Fed) the responsibility to prescribe regulations necessary to
implement the provisions of the act. On July 26, 2004, the Fed published its final
regulations for the Check 21 Act. The purpose of the act is to allow banks to take
advantage of the potential cost savings of processing checks electronically. The final
regulations facilitate the wider use of electronic check processing without demanding
that any bank change its current check-collecting practices. It does this by
authorizing the use of the substitute check. Check 21 makes a substitute check the
legal equivalent of an original check for all persons and all purposes including any
provision of federal or state law if a bank has provided the warranties, and if the
substitute check: (1) accurately represents all of the information on the front and back
of the original check at the time the original check was converted electronically, and
(2) bears the legend, “This is a legal copy of your check. You can use it the same way
you would use the original check.” It is important to note that this law makes each
bank financially responsible for any substitute checks it handles.
If a consumer suffers a loss due to the use of a substitute check, the consumer
has the right to make a recredit claim, which the consumer may file with the bank
holding his or her account. If the bank determines that the consumer’s claim is valid,
the bank will recredit the consumer’s account for the amount of the consumer’s loss,
up to the amount of the substitute check, plus interest if the account is an interest-
bearing account, no later than the end of the business day after the banking day on
which the bank makes that determination. If the bank determines that the consumer’s
claim is not valid, because the substitute check for which the consumer made the
claim was in fact properly charged to the consumer account, the bank must send
notice to the consumer no later than the business day after the banking day on which
the bank makes that determination.
This report begins with a brief background of the check truncation issue,
including a brief legislative history of the Check 21 Act. The next section discusses
what Check 21 does and does not do. Next, it discusses the key rules and procedures
of the Fed’s final regulations. These rules range from the provisions governing the
substitute check to the expedited recredit for consumers and banks. The report also
examines consumer protection provisions that were incorporated in the law and those
that were left out. The section on banks adopting electronic check clearing suggests
that the costs will slow adoption, and the conclusion suggests that Check 21 is not
likely to reduce paper check clearing significantly in the short run. Other methods
of electronic payments, however, will reduce paper check clearing more rapidly.
This report will be updated as legislative and financial developments warrant.

Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Some of What the Check 21 Act Does, and Does Not Do . . . . . . . . . . . . . . . 2
Key Implementation Rules and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . 3
General Provision Governing Substitute Checks . . . . . . . . . . . . . . . . . . 4
The Reconverting Bank Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Substitute Check Warranties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Substitute Check Indemnity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Comparative Negligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Expedited Recredit for Consumers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Procedure to File a Claim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Recredit Pending Investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Expedited Recredit for Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Disclosure Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Consumer Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
The Already Declining Use of Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Banks’ Adaption to Check 21 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Electronic Banking: The Implementation of
the Check 21 Act
Background
The general purpose of the provisions of the Check Clearing for the 21st Century
Act (Check 21 Act) is to allow banks to take advantage of the efficiencies and the
potential cost savings of processing checks electronically. (The term bank as
specified in the act is used to include commercial banks, savings institutions, credit
unions, and the bank-like functions of the U.S. Postal Service and the U.S. Treasury.)
The U.S. banking system processes more than 40 billion checks annually, but only
a fraction of these checks is processed electronically. The cost savings of electronic
processing are unknown, because estimates of the cost of using a check and the
number of checks written each year remain in dispute. As a result, estimates of cost
savings range from $1.4 billion annually for truncation1 alone to $68 billion for
replacing checks with fully electronic, straight through processing.2
Most of the savings from clearing checks electronically come from eliminating
some or all of the handling, sorting, and physically transporting of checks to the
paying bank. Under the law before Check 21, a bank that presents a check for
payment must present the original check. The paying banks could get around this
law, according to the Uniform Commercial Code (U.C.C.) sections 3-501(b)(2) and
4-100, by negotiating processing agreements that make it unnecessary to physically
present the paper check. But, since the benefits of electronic check clearing are not
uniformly dispersed among the participants, banks have found it difficult to obtain
these agreements, thus constraining the widespread adoption of various forms of
electronic check clearing. The most efficient form of electronic check clearing is one
in which there is no paperwork in the process. This is called straight through
processing (STP). The recipient of a check is paid electronically by debiting the
payer’s bank account as soon as the check is presented. The Check 21 provisions fall
short of STP. Consequently, the cost savings are not as great as some other
alternative electronic clearing processes, such as Internet bill-pay, or debit card
payments.
1Check truncation occurs when the check is stopped before it reaches the paying bank
and the check clearing process is completed electronically. In some check truncation
processes the paperwork is not eliminated. Following the electronic payment, the
check is sent to the paying bank. If paperwork is required to complete the process,
there will be less cost savings.
2See CRS Report RL31591, Electronic Banking: The Check Truncation Issue, by (name red
acted), and Joanna Stavins, “A Comparis
on of Social Costs and Benefits of Paper Check
Presentment and ECP with Truncation,” New England Economic Review, July/Aug. 1997,
p. 33.

CRS-2
The Legislation
On December 17, 2001, the Federal Reserve Board (Fed) sent a proposed Check
Truncation Act (CTA) to both the House Financial Services Committee and the
Senate Committee on Banking, Housing and Urban Affairs. The Fed’s proposed
legislation would have authorized the creation of “substitute checks,” an
electronically produced instrument that allows banks to truncate the original check
clearing process and complete the process with an electronically generated image
replacement document (IRD), a substitute check. The customers would receive the
substitute check, which would be the legal equivalent of the original check. The
concept was supported by America’s Community Bankers, the American Bankers
Association, the Consumer Bankers Association, and the Financial Services
Roundtable. They argued that the legislation would enable the industry to garner
cost savings and speed up the check clearing process for consumers. The opposition
to the bills came from the Consumers Union, supported in its testimony by the
Consumer Federation of America, the U.S. Public Interest Research Group, and the
National Consumer Law Center. They wanted consumers’ accounts to be fully
protected from disputes caused by the use of substitute checks. The consumer would
be made whole while the dispute is being resolved.
On June 5, 2003, the House of Representatives passed H.R. 1474, the Check
Clearing for the 21st Century Act of 2003 and sent it to the Senate Banking
Committee. On June 27, 2003, the full Senate passed the Check Truncation Act of
2003 (S. 1334). The major differences between the bills were mainly in the area of
consumer protection. The Senate CTA was more generous than the House bill in its
consumer protection provisions. For example, S. 1334 gave consumers 40 days to
file an expedited recredit claim, while H.R. 1474 would have given 30 days. In
addition, the Senate’s CTA shifted the burden of documentation more to the banks
and less to consumers than the original H.R. 1474. The Senate incorporated its S.
1334 into H.R. 1474 before going into conference with the House. In conference, the
House agreed to the Senate’s changes and H.R. 1474 was passed by Congress. On
October 28, 2003, President Bush signed the Check Clearing for the 21st Century Act
into law (P.L. 108-100) to become effective on October 28, 2004. In the Check 21
Act, Congress gave the Fed the responsibility to prescribe regulations necessary to
implement the provisions of the act. On July 26, 2004, the Fed published its final
regulations for the Check 21 Act.3
Some of What the Check 21 Act Does, and Does Not Do
The Check 21 Act facilitates the wider use of electronic check processing
without demanding that any bank change its current check collecting practices. It
does this by authorizing the use of the substitute check, which is a new negotiable
paper reproduction of an original check that contains an image of the front and the
back of the original check, and is suitable for automated processing. It contains a
magnetic ink character recognition line (MICR-encoded) in the same manner as the
original check. Any bank that transfers, presents, or returns a substitute check
warrants (or confirms) that (1) the substitute check contains an accurate image of the
3 See [http://www.federalreserve.gov/boarddocs/press/bcreg/2004/20040726/default.htm].

CRS-3
front and the back of the original check and a legend stating that it is the legal
equivalent of the original check, and (2) that no depositary bank, drawee, drawer or
indorser4 will be asked to pay a check that is already paid. A substitute check for
which a bank has made these warranties is the legal equivalent of the original check
for all purposes and all persons.
The Check 21 Act does not require any bank to use electronic check processing,
receive electronic presentation, or create substitute checks, nor does it make
electronic check images or electronic information the equivalent of the original
checks. However, after October 28, 2004, any bank or other person that requires an
original check must accept the substitute check as a legal equivalent in satisfaction
of that requirement. Consequently, all banks are affected, even though they are not
required to create substitute checks, or change their check processing equipment or
practices. To illustrate, a bank that simply receives a substitute check created by
another bank automatically warrants that substitute check when it tries to deliver that
item for presentation, collection, or return to provide that item to its customer. As
a result of the Check 21 Act, any bank that receives consideration for a substitute
check or a presentation of a substitute check that it transfers, presents, or returns is
also responsible for indemnifying5 any person who suffers a loss due to the receipt
of that substitute check instead of the original check. Now that the Fed has released
its final Check 21 regulations, all banks are required to provide a disclosure that
describes substitute checks and substitute check rights to consumers who could
receive substitute checks.
Key Implementation Rules and Procedures
Congress gave the Fed the responsibility to prescribe regulations as it
“determines to be necessary to implement, prevent circumvention or evasion of, or
facilitate compliance with the provisions of the Act.”6 On December 22, 2003, the
Fed approved a proposed rule to amend Regulation CC, which regulates bank funds
availability for check collection.7 The Fed added a subpart D that contains the
requirements a substitute check must meet to be the legal equivalent of the original
check. Subpart D covers the reconverting bank’s duties, the warranties and
indemnities associated with the substitute check, expedited recredit for consumers
and banks, liability for violations of part D, and the interaction between subpart D
and existing federal and state laws. The Federal Reserve Board also proposed new
model notices for consumer awareness disclosure and other consumer notices
regarding substitute checks as required by the Check 21 Act. The following is a brief
summary of a selection of these rules and procedures.8
4The Fed uses the word “indorse” as a variant of endorse throughout its regulations.
5The bank must make compensation for incurred losses, or damages.
6P.L. 108-100, sec. 15.
7 Regulation CC is the result of the Expedited Fund Availability Act of 1987 (EFAA), which
established stringent check-hold rules.
8 Board of Governors of the Federal Reserve System, Regulation CC: Docket No. R1176,
(continued...)

CRS-4
General Provision Governing Substitute Checks. For a substitute
check to be the legal equivalent of an original check for all persons and all purposes
including any provision of federal or state law, a bank must provide the warranties,
and the substitute check must (1) accurately represent all of the information on the
front and back of the original check at the time the original check was truncated; (2)
bear the legend, “This is a legal copy of your check. You can use it the same way you
would use the original check.”
The Reconverting Bank Duties. A reconverting bank is (1) the bank that
creates a substitute check or (2) the first bank that receives a substitute check created
by a person that is not a bank and transfers either that substitute check or the first
paper or electronic presentation of the substitute check. This bank must ensure that
the substitute check (a) bears all indorsements applied by parties that previously
handled the check in any form (including the original check, a substitute check, or
another paper or electronic representation of the original check or substituted check)
for forward collection or return; (b) identifies the reconverting bank in a manner that
preserves any previous reconverting bank identifications; (c) identifies the bank that
truncates the original check.
Substitute Check Warranties. A bank that transfers, presents, or returns
a substitute check for which it receives consideration warrants to any subsequent
recipient, which could include a collecting or a returning bank, the depository bank,
the drawer, the drawee, the payee, the depositor, and any indorser that (a) the
substitute check meets the requirements for legal equivalent of the original check;
and (b) no depository bank, drawer, drawee, or indorser will receive presentment or
return of, or otherwise be charged for the substitute check, or the original check that
was already paid.
Substitute Check Indemnity. A bank that transfers, presents, or returns a
substitute check for which it receives consideration must indemnify the recipient and
any subsequent recipient (including a collecting or returning bank, the depository
bank, the drawer, the drawee, the payee, the depositor, and any indorser) for any loss
incurred by any recipient of a substitute check if that loss occurred due to the receipt
of a substitute check instead of the original check. In general, the amount of the
indemnity depends on the nature of the breach. If the loss is caused by a breach of
a substitute check warranty, the amount of the indemnity will be the amount of any
loss (including interest, costs, reasonable attorney’s fees, and other expenses of
representation) caused by the warranty breach. On the other hand, if the loss did not
result from a breach of a substitute check warranty, the amount of the indemnity is
the sum of the amount of the loss up to the amount of the substitute check and
interest, expenses (including interest, costs, reasonable attorney’s fees, and other
expenses of representation) related to the substitute check.
Comparative Negligence. If a loss results in whole or in part from an
indemnified person’s negligence or failure to act in good faith, the indemnity amount
8(...continued)
A va i l a b i l i t y o f F u n d s a n d C o l l e c t i o n of Checks, Fi nal Ru l e s ,
[http://www.federalreserve.gov/boarddocs/press/bcreg/2004/20040726/attachment.pdf].

CRS-5
described above should be reduced in proportion to the amount of the negligence or
bad faith attributable to the indemnified person.
Expedited Recredit for Consumers. A consumer may make a claim for
reimbursement if the consumer acting in good faith, asserts that (a) the bank holding
the consumer’s account charged that account for a substitute check that was provided
to the consumer (the consumer need be in possession of the substitute check at the
time he or she makes the claim); (b) the substitute check was not properly charged
to the consumer’s account or the consumer had a warrant claim with respect to the
substitute check; (c) the consumer suffered a resulting loss. The production of the
original check or a sufficient copy is necessary to determine whether or not the
substitute check in fact was improperly charged or whether the consumer’s warranty
claim is valid.
Procedure to File a Claim. The procedure for the consumer making a
recredit claim begins with filing the claim with the bank holding his or her account.
The claim should be submitted to the bank such that the bank receives the claim by
the end of the 40th calendar day after the later of (1) the calendar day on which the
bank mailed or delivered the periodic account statement that contains information
concerning the transaction giving rise to the claim, or (2) the substitute check giving
rise to the claim. The content of the claim should describe why the consumer
believes his or her account was improperly charged for the substitute check or the
nature of the warranty claim of the check. The claim should have a statement that the
consumer suffered a loss and an estimate of that loss. It should also have the reason
why production of the original check is necessary to determine whether or not the
charge to the consumer’s account was proper or the consumer’s warranty claim is
valid. Overall, the claim should have sufficient information to allow the bank to
identify the substitute check and to investigate the claim.
If the bank determines that the consumer’s claim is valid, the bank must recredit
the consumer’s account for the amount of the consumer’s loss, up to the amount of
the substitute check, plus interest if the account is an interest-bearing account, no
later than the end of the business day after the banking day on which the bank makes
that determination. The bank must send the consumer a notice that informs him or
her of the amount of the recredit and the date on which the recredited funds will be
available for withdrawal.
If the bank determines that the consumer’s claim is not valid because the
substitute check for which the consumer made the claim was properly charged to the
consumer’s account or that the consumer’s warranty claim for that substitute check
was not valid, the bank must send notice to the consumer no later than the business
day after the banking day on which the bank makes that determination. The notice
must include the original check or a sufficient copy, except where the consumer
agrees to accept an electronic image of the original check or sufficient copy
electronically (for example via the Internet).
Recredit Pending Investigation. If the bank has not taken any of the
required actions described above before the 10th business day after the banking day
on which the bank received the claim, it must by the end of that business day recredit
the consumer’s account up to the lesser of the amount of the substitute check or

CRS-6
$2,500, plus interest on that amount if the account is an interest-bearing account. The
bank must also send the consumer the notice mentioned above and recredit the
consumer’s account for the remaining amount of the consumer’s loss, if any, up to
the amount of the substitute check, plus interest if the account is an interest-bearing
account, no later than the end of the 45th calendar day after the banking day on which
the bank received the claim. Also, the bank must send to the consumer the required
notice, unless the bank prior to that time has determined that the consumer’s claim
is or is not valid and therefore followed those required procedures in that
circumstance.
Expedited Recredit for Banks. A parallel procedure for recrediting
consumers is set up for recrediting banks. A bank may make an expedited recredit
claim against an indemnifying bank, if the bank has received a claim for expedited
recredit from a consumer with respect to a substitute check. The procedure is that the
claimant bank sent its claim to the indemnifying bank such that the indemnifying
bank receives the claim by the end of the 120th calendar day after the date of the
transaction that gave rise to the claim. No later than the 10th business day after the
banking day on which the indemnifying bank receives the claim, it must (a) recredit
the claimant bank for the amount of the claim up to the amount of the substitute
check, plus interest, if applicable; or (b) provide the information to the claimant bank
regarding why the indemnifying bank is not obligated to comply.
Disclosure Requirements. Each bank is required to provide a brief
disclosure statement to each customer who receives paid checks with a periodic
account statement that describes a substitute check and its legal equivalency to an
original check; and the consumer’s recredit rights that apply when a consumer in
good faith believes that a substitute check was not properly charged to his or her
account. The disclosure statement must be distributed no later that the first regularly
scheduled communication with the consumer after October 28, 2004. But the bank
need not give separate disclosures to each customer on a jointly held account. These
disclosure provisions were crafted to overcome potential consumer confusion about
a process with few or no visible benefits for them.
Consumer Protection
Consumer protection was a critical consideration in the development of the
Check 21 law from the Fed’s initial legislative proposal in 2001. This is evident in
the extensive provisions concerning warranties, indemnities and expedited recredits
for consumers and banks. The strongest opposition to the Check 21 Act came from
the Consumers Union (CU). Its views, in testimony, were supported by the
Consumer Federation of America, the U.S. Public Interest Research Group, and the
National Consumer Law Center. The CU argued that the act would make it
impossible for an estimated 45.8 million U.S. households who are currently getting
their paper checks back to continue to do so. 9 CU stated that these consumers would
9U.S. Congress, House Committee on Financial Services, Check Clearing for the 21th
Century Act of 2003, hearing, 108th Cong., 1st Sess. Apr. 8, 2003, unpublished, Statement of
Janell Mayo Duncan, Legislative and Regulatory Counsel, Consumers Union, also
(continued...)

CRS-7
be less protected from fraud under the Check 21 Act than under the existing check
clearing process when there are disputes about errors in the check payment process.
Consumers would no longer be able to verify their signatures and the accuracy of the
amounts paid to payees from the original checks.
The Consumers Union suggested changes in the proposed legislation that would
significantly increase consumer protection when checks are cleared electronically.
These changes focused mainly on the recrediting procedure.10 First, the CU wanted
to extend the recredit provisions in the act to all checks where the original checks are
not returned to the consumer and there is a claim of improper payment or a warranty
claim. This amendment would expand the indemnification coverage beyond the
substitute checks in the Check 21 Act. It could extend coverage to more than 20%
of all bank checks that are currently not returned to customers and more than 80% of
credit unions’ drafts that are also not returned to their members. Financial
institutions opposed this extension because it would significantly raise financial
institutions’ cost of handling disputed checks and drafts. They argued that the
protection was unnecessary and pointed to credit unions that have not returned
checks since 1980 with almost no complaints or problems. The protection was not
extended beyond the substitute check in the Check 21 Act.
Second, the Consumers Union argued that 10 days is too long for consumers to
not have access to the disputed funds due to the use of the substitute check. It
preferred the expedited recredit provisions in the Fed’s original proposal that the
disputed amount of the payment would be credited to the consumer’s account by the
close of the next bank business day after receiving the claim. The purpose of the
provision is to reduce consumer inconvenience due to the use of the substitute check.
However, the Check 21 Act provides for a recredit after 10 business days, which the
banking industry argues is appropriate. In practice some banking analysts believe
that most banks will recredit the accounts before the 10th business day.
Third, CU would have liked to raise the expedited recredit amount from $2,500
to $5,000. In H.R. 1474, disputed substitute checks for up to $2,500 would be
automatically recredited by the next business day while the dispute is being resolved.
CU sought to have the expedited recredit limit raised to $5,000 because the size of
the amounts of these transactions is expected to increase over time. In addition, CU
sought to shorten the number of days required to complete the overall recrediting
process to less than 20 days. Financial institutions, on the other hand, prefer the
longer time to clear up disputed checks in order to make sure that corrections are
made accurately. These suggested changes, however, could significantly raise the
cost to financial institutions to the point where it is no longer cost-efficient to adopt
check truncation. In P.L. 108-100 the expedited recredit amount stayed at $2,500.
9(...continued)
Supported by Consumer Federation of America, U.S. Public Interest Research Group and
the National Consumer Law Center, [http://financialservices.house.gov/hearings.asp?
formmode=detail&hearing=204].
10See [http://www.consumersunion.org/finance/checkwc102.htm].

CRS-8
A counter to the CU’s argument for protection against processing errors is that
in cases where check truncations have been used for years, processing errors are
practically nonexistent and when they occur, they are quickly resolved. Asked by
Senate Banking Committee Chairman Richard Shelby how many complaints she has
received from credit union members about electronically produced copies of checks,
the President and Chief Executive Office of the NIH Federal Credit Union, said that
over a period of 14 years, she had received none. In response to a question from
Senator John Sununu, the Vice Chairman of the Federal Reserve System said that in
his seven years on the Fed board, he has never heard of a case in which checks were
double-debited.11
The Already Declining Use of Checks
The overall number of checks being written has been declining partly because
the Fed is already truncating three million checks a day for its member banks12 and
additional checks are being truncated by private banking associations as well.
However, the majority of banks use the traditional paper check clearing process. The
Federal Reserve, with the largest single check clearing operation, closed 13 of its 45
check-clearing centers in 200313 and announced plans to shut down nine more in
2005 and 2006. The Fed estimates that 2004’s check processing will fall 9% from
2003’s and a further 13% to 15% in 2005.14 As a consequence of the expected
decline in the use of checks, the Fed has increased its fees for processing check by
almost 8% to cover the increased cost per check cleared.15 The decline in the number
of checks being processed is not due to the just implemented Check 21. But it is due
to the growing popularity of alternative payment methods, including debit
transactions and online payments. In addition, because of the rapid consolidation
taking place in the banking industry more checks are being cleared inside the mega-
banks as internal settlements. Of these alternatives the most significant is the growth
in automated clearinghouse (ACH) transactions. ACHs are electronic payment
systems that are run by the Fed and private banking organizations. They are mainly
large volume electronic payment systems that enable corporations and consumers to
make electronic payments. Payroll, recurring bill payments, and Social Security
benefits are examples of typical ACH payments. Normally, ACHs send or receive
11Richard Cowden, Consumer Groups Prefer Paper Checks, BNA Daily Report For
Executives, No. 65, Friday Apr. 1 4, 2003, p. A-15. [http://pubs.bna.com/nwsstnd/ip/BNA/
BAR.NSF/2002090b92a4a3bc85256743006da1ea/2f92eebadf7bc66985256cff000fca1b?
OpenDocument].
12 Patricia A. Murphy, “Check remains King Even in Face of truncation,” Check 21 from
Paper to Imaging: A supplement to American Banker, Nov. 2003, p. 9.
13 Bert Ely and Kimberly Hover, “Check 21 Spells the end of the Fed Check Processing”
American Banker Online, May 21, 2004, p. 2.
14 Steve Bills, “ACH, Not Check 21, Cited in Fed’s Check Decline,” American Banker
Online, Oct. 14, 2004, p.13.
15 Will Wade and Danian Platta, “New Fed Fees May Hasten the Inevitable,” American
Banker Online, Nov. 5, 2004, p.1., [http://www.americanbanker.com/article.html?id=
20041104482GTL4O&from=washregu].

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payments from payment centers.16 The wider use of ACH payments is the single
most important reason for the decline in paper check processing.17
Banks’ Adaption to Check 21
The Check 21 Act is not likely to significantly accelerate the decline in number
of checks being processed in the near future. While more checks will be processed
electronically under Check 21, the original checks will just be replaced by the
substitute check after Check 21 is implemented. The major banks such as Citibank,
Bank of America, and Wells Fargo are likely to increase their use of the substitute
check at first. Because of the initial cost of devices used in producing the substitute
checks or IRDs, experts expect that most smaller banks will not already have the
installed technology to generate substitute checks, and the cost of acquiring the
technology will stop them from participating in the Check 21 process. In 2003, an
IRD cost about 5-10 cents an item, making the substitute check more costly to clear
then than a paper check right now.18 Some of the nation’s largest banks are said to
be budgeting $100 million to 200 million for truncation hardware and software.19 For
the typical smaller community bank the price tag runs between $250,000 and
$400,000, according to several experts. In contrast, according to an Independent
Community Bankers of America survey last year, most community banks (46%) had
budgeted less than $50,000 for 2004 technology spending.20 Even though the cost
of producing substitute checks is expected to decline rapidly, initial up front cost of
clearing checks is expected to increase under Check 21.
Another reason for the higher cost initially is that banks are now using multiple
presentment formats — paper, electronic, and IRD. The Fed and private check
clearinghouses provide clearing services in all three formats. For banks receiving the
substitute checks, back office paperwork operations, including the sorting, and
handling is not eliminated. Even with Check 21, banks will still need their back
office operations, and they may have to make additional investments in these back
office operations to accommodate efficient management the substitute checks along
with the original checks. Some bankers believe that they should wait until straight
through processing (STP) becomes more popular. STP is an entirely electronic
clearing environment that would combine checks into the same stream as debit and
credit cards, ATM and point of sales clearing.
16 For more details, see CRS Report RL31476, Electronic Payments and the U.S. Payments
System, by (name redacted) and Pauline H. Smale.
17 Steve Bills, “ACH, Not Check 21, Cited in Fed’s Check Decline,” American Banker
Online, Oct. 14, 2004, p.13.
18 Michael P. Voelker, “Getting Ready for Check 21” Check 21 from Paper to Imaging: A
Supplement to American Banker, Nov. 2003, p. 17.
19Patricia A Murphy, “Time Banks Need to Get Ready for Check Truncation,” Check 21
from Paper to Imaging: A Supplement to American Banker, May 2004, p. 28.
20 Ibid.

CRS-10
Conclusion
The Check 21 Act establishes an electronic check clearing mechanism in which
banks may voluntarily generate image replacement documents in place of checks.
However, in terms of using and being responsible for the physical substitute checks,
banks are mandated to participate in the new mechanism. Whether a bank employs
electronic check clearing depends on how well it fits with the bank’s business
strategy. Bankers faced with expensive technology adoption costs would not be
likely to adopt check truncation if their customers place a high value on the float and
on receiving their canceled checks. Large banks with millions of checking accounts
supported this legislation and are expected to be the greatest beneficiary of this law.
Smaller banks would have to increase their technology spending far beyond what
they do now with the expectation of capturing fewer benefits or savings than the
larger banks. However, even some of these large banks, which are heavily invested
in other forms of payment, such as Internet banking, and credit and debit cards that
have electronic clearing processes, may view Check 21 as unwelcome competition.
They may oppose initiating use of a substitute check themselves, and as the act is
implemented many of these large banks may refuse to go beyond meeting their legal
responsibilities in the new process. The new system may also confuse consumers
who receive few or no visible benefits from it.
In sum, Check 21 places the check clearing process in a kind of a way station
between paper check clearing and fully electronic processing. The latter is more
efficient but is of concern to many consumers. Electronic clearing is also most
welcomed by banks and recipients of funds, because it is faster and actually less
prone to error. Over the years, the payment system has improved by adding MICR
encoding to speed up the old system, and debit cards and online bill paying with other
forms of payment. These additions have gained enough popularity to completely
replace paper checks for some customers. Check 21 is yet another way to shift out
of paper checks into electronic clearing. Many banks may not participate fully
because Check 21 to them is too temporary to make the required investment now.

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