Electronic Banking: The Check Truncation Issue

CRS Report for Congress
Electronic Banking:
The Check Truncation Issue
Upda ted Novembe r 8 , 2003
Specialist in Economic Po licy
Go ve rnment and Finance Division

Congressional Research Service ˜ The Library of Congress

Electronic B anking: The Check Truncation Issue
The clearing process for checks is more expensive than other methods of
paym ent w hi ch are cl eared el ect roni cal l y, s uch as credi t cards and Int ernet b anki ng.
The m ai n reason i s t h at check cl eari n g requi res b anks t o physi cal l y present and ret u rn
checks unl ess t hey obt ai n l egal agreem ent s t o cl ear el ect roni cal l y. T he C h eck
Clearing for the 21 st Century Act of 2003 (P.L. 108-100) eliminates the requirement
to physically return the origi nal check s t o t h e payi ng bank. Before the b ill by the
same title became l aw, o n April 3, 2003, the S enate h eld its first h earing o n t he Fed’s
Check Truncation Act (CTA) p roposal th at was s ent t o b anking committees of both
Hou s e s in December 2001. On J une 5, 2003, the House p assed H.R. 1474 and
referred i t t o t he Senate Committee on B an k i ng, Housing and Urban Affairs. On
J une 18, 2003, at a m arkup, the S enate Banking Committee approved its Check
Truncation Act of 2003 (S. 1334) and o n J une 27, 2003, the full S enate p a ssed S .
1334 and i ncorporated it in H.R. 1474. On October 1 , 2003, House and S e n a te
conferees reported H.R. 1474 (Conferen ce Report H.Rept. 108-291). On October 28,

2003, President Bush s igned t he Check Clearing for the 2 1 st Century Act (P.L. 108-

100) into law, which i s now also known as C heck 21 Act.

Estimates of cost s avings from m oving to el ect ronic check cl earing vary widel y
because estimates o f t he cost of using a check and t he number o f checks written each
year remain in dispute. Consequently, estimates o f cost s avings range from $1.4
billion annually for t runcat i o n a lone to $68 billion for replacing checks with
el ect roni c p aym ent s. In t est i m ony at t h e h earing o f S enate and House b anking
committees in the 108th Congress, the Fed’s CTA i n t he Senate and H.R. 1474 in the
House were s upported b y t he Federal R eserve Bo ard, which t estified t hat i t would
like t o remove some of the co n s umer protection p rovisions that were in its 2001
proposal because they were unnecessary. The Fed argued that the regulatory costs
thes e provisions would place on banks would outweigh t he consumer benefits. S till,
the b ill is supported b y America’s C ommunity Bankers, t he America n Bankers
Association, the C onsumer Bankers Asso ciation, and t he Fi nancial S ervices
Th e opposition t o t he Check 21 Act came from t he Consumers Union, supported
in its testimony by the C onsumer Federation of America, the U.S. P ublic Interest
Res e a rch Group, and t he National C onsumer Law C enter. The C onsumers Union
argued that the Act would m ake i t impossible for an estimated 45.8 million U.S.
households who are currentl y ge tting their paper checks back to continue to do so.
These consumers would b e l ess p rotec t ed from fraud under t he Act t han under t he
ex isting check clearing p rocess when t he re are d isputes about check paym ents. T he
Consumers Union’s s uggeste d c h a n ges i n t he proposed legi slation would
significantly increas e consumer protection. At the s am e time, t hese changes would
increase financial institutions’ costs of vol untarily adopting check truncation. Other
wi t n esses argued t hat t hose b anks wi t h decades of usi n g t runcat ed checks h ave not
ex peri enced m a n y d i s p u t ed check paym ent s , and when t h ey di d t hey w ere qui ckl y
This report will be updated as l egislative and financial d evelopments warrant.

In troduction ......................................................1
Legislation .......................................................1
ThePaperCheck ClearingProcesses ...................................3
ElectronicCheck Presentationand Truncation ...........................5
TruncationbyanIntermediary ........................................7
Costs ............................................................8
Benefits .........................................................8
The C heck C l eari n g for t h e 2 1 st Century Act (H.R. 1474, P.L. 108-100) .......9
Consumer Groups’ R eaction t o H.R. 1474 .............................10
PossibleObjections to UniversalCheck Truncation ......................12
Figure1. ThePaperCheck ClearingProcess ............................4
Figure2. CheckTruncationattheBankofFirstDeposit ...................6
Figure3. CheckTruncationbyanIntermediary ..........................7
Table 1. Estimated P er Check Paym ent C osts and Benefits of Check Truncation
OverthePaperCheck Process ....................................8

Electronic Banking:
The C heck Truncation Issue
The United S tates b anking system pro cesses approx imately 42.5 billion checks
annually, but only a fraction of these checks is processed electronically by check
truncation. Check truncation o ccurs when the check is stopped b efore i t reaches the
payi ng bank and t he check cl eari n g p rocess i s com pl et ed el ect roni cal l y. (The t erm
bank is used to include commercial b anks, savings insti t u tions, and credit unions.)
The Federal Reserve Board (the Fed) has p roposed legi slation t hat would authoriz e
the creation o f “substitute checks,” an elect ronically produced instrument, t hat woul d
al l o w b anks t o t runcat e t he ori gi n al check cl eari n g p rocess and com p l et e t h e p rocess
electronically with the s ubstitute check. The customers would receive the s ubstitute
check, which would b e t he legal equivalent of the o rigi nal check.
If al l checks w e r e r e p l aced by el ect roni c t ransact i ons, t he ex act cost savi ngs
would s till be unknown, because estimates o f t he c o s t o f using a check and t he
number o f checks written each year remain in dispute. Consequently, estimates of
cost savings range from $1.4 billion annually for t runcation alone to $68 billion for
repl aci ng checks wi t h el ect roni c p aym ent s. A s i gni fi cant p art o f t he savi ngs com es
from eliminating t he handling, sorting, and physically transporting of checks t o t he
payi ng bank. To cl ear checks el ect roni cally, b an ks must negotiate processing
agreem ent s t h at m ake i t unnecessary t o physi cal l y present t he paper check. S i n ce t h e
benefits are n o t uniformly dispersed among the p articipants, b anks have found it
diffic u l t t o obtain t hese agreements, t hus constraining the widespread adoption o f
el ect roni c check cl eari n g.
On October 28, 2003, President Bush signed the Check Clearing for the 21st
Century Act into law (P.L. 108-100). The act is also known as C heck 21 Act. Theth
legi slation behind i t goes back to the t he 107 Congress. In December 2001, the
Federal R eserve Board d raft ed t h e C heck Truncat i o n A ct (C TA) and sent i t t o bot h
the House Financi al Services Committee and the S enat e C ommittee on Banking,
Housing and Urban Affairs t o b e i ntroduced in Congress. On October 2 , 2002, the
C h eck Truncation Act of 2002 (S. 3034) was i ntroduced by Senators Tim J ohnson
and Thomas R. Carper. P rior to that time, o n S eptember 25, 2002, the S ubcommittee
o n Fi nancial Institutions and C onsumer Credit of the House Financi al Serv i ces
Committee hel d a hearing on t he C heck Clearing for the 21 st Century Act (H.R.
5414), i ntroduced on September 1 9 b y R epresentatives Mike Ferguson and Harold
E. Fo rd J r. The bills, H.R. 5414, and S . 3034 and t he Fed’s p roposed bill, are almost
identical . They would eliminat e t he requirement to physically return the origi nal

checks t o t he payi ng bank and t herefore make it easier for more banks to voluntarily
adopt electronic check clearin g i nstead of continuing to use t he paper check clearing
process. The m ain d ifference b etween the Fed’s proposal and H.R. 5414 was t hat
the Fed’s proposal had greater consumer protection against unauthorized debits.1
Aft er t he heari n g h el d o n S ept em b er 25, 200 2, no further action was taken i n t he

107th Congress.

In the 108th Con g ress , o n April 3, 2003, the S enate h eld its first h earing o n t he
Fed’s C heck Truncation Act proposal that was received i n Decem b er 2001. The
Federal R eserve Bo ard’s Vice C hairman R oger W . Ferguson J r test i f i e d t h a t t he
board would like C ongress to remove some consumer protection p rovisions that were
i n i t s 2 001 bill. “Upon further reflection, the Board has now concluded t hat t h e
si gn i fi cant com pl i ance burdens i m posed by t h ese p rovi si ons on ban k s t h at recei ve
[the el ect ronically produced] s ubstitute checks outwei gh t he smal l i ncremental2
benefits tha t t h e p r o visions would provide to the consumers.” The vice chairman
did not provide a new bill, but instead pointed out that “Nonethel ess, Congress may
conclude that the ex p edited recredit provi sions for consumers s hould b e i ncluded i n
the l egislation. In that case, . . . it should not go beyond the p rovisions proposed by3
the Board.”
On April 8, 2003, the S ubcommittee on Finan cial Institutions and C onsumer
Credit of House Financial Services Committee h eld a hearing o n H.R. 1474, thest
C h eck C l eari n g for t h e 2 1 Century Act of 2003. The bill was i ntroduced by
Representatives Melissa Hart and H arold E . F o r d J r. on March 27, 2003.
S ubst ant i v el y, t h e b i l l was not changed b et ween t h e t wo C ongresses. Vi ce chai rm an
Ferguson’s s tat e m e n t to the C ommittee was essentially the s am e as was the one
presented t o t he Senate Banking Committee. On May 21, 2003, the House Financial
Services Committee i n its consideration and markup session amended H.R. 1474 and
ordered i t t o b e reported b y voice vote. Th e amendment i s a cl arification amendment
made by Representative Artur Davis. It would allow a consumer to make a claim for
an ex pedited credit without possessing the s ubstitute check.
On J une 27, 2003, the full S enate p assed t he Check Truncation Act of 2003
(S. 1334) and i n c o r p o rated i t i n H.R. 1474. At a m arkup on J une 18, 2003, the
Senate Committee on Banking, Housing, and Urban Affairs approved S. 1334.
Earlier, on J une 5, 2003, the S enate Banking Committee received H.R. 1474, which
was p assed b y t he House o f R e p resent at i v es t h e s am e d ay and referred i t t o t he
Senate. The two bills are quite similar. The m aj or differences between the bills are
mainly in the a rea o f c o n s umer protection. The C TA is more generous in its

1 See Nicole Duran, “ Fed M akes Case for Check T r uncation,” The Ame rican Banker, Sept.


2 U.S. Congress, Senate Committee on Banki ng, Housing, and Urban Affairs, Federal
Reserve Board Proposal on Check T r uncation, hearing, 108th Cong., 1st Sess. Apr. 3, 2003,
unpublished, Statement of Roger W. Ferguson J r ., V i ce Chairman, Board of Gove rnors of
the Federal Reserve System,
[ ht t p: / / www.senat e .gov/ ~ banki ng/ 03_04hr g/ 040303/ f e r guson.pdf ] , p. 6, l a st vi si t e d Apr . 8,
3 Ibid.p.8.

consumer protection p rovisions. For ex ample, the C TA gi ves consumers 4 0 d ays
to file an ex pedited recredit claim, while H.R. 1474 would give only 3 0 d ays. In
addition, the S enate’s C T A w o uld s hift the burden o f documentation m ore o n t he
banks and l es s on consumers t han t he House’s bill.
On October 1 , 2003, House and S e n a t e conferees reported H.R. 1474(
C o nference Report H.Rept. 108-291). The Conference Agreement adopted t h e
House p ro v i s i o n of 30 days to file an ex pedited recredit claim p roviding that a
consumer who receives a substitute check does not have to have the check to make
a cl ai m f o r ex p edi t ed recredi t . On docum ent at i on, t h e C onference Agreem ent
adopted the S enate p rovisions placing most of the burden o n t he b a n k s , n o t the
consumers. A m aj or sticking point was only i ndirectly related t o t h e bills. It was
bet ween t h e Federal R eserve Board and t he Ai rNet S yst em In c., t he nat i on’s l argest
check transportation company, over t he Fed discl osure of i t s ch eck transportation
cost s. The C onference Agreem ent requi res t he F e d t o d i s cl ose i t s ex penses and
revenues for shipping commercial checks b etween processing facilities. The Fed
would have t o publish t he information i n its annual report for 10 years, but would not
have to disclose specif i c p r i ces. In addition, the act mandates a study on funds
availability incl uding the percentage of total checks cleared in which t he paper check
is not return to the paying bank. The Department of the Treas ury i s m andated t o do
annual s tudies on depository institutions serv ices efficiency and c ost reduction. The
Comptroller General of the United S tates at t he General Accounting Office (GAO)
is al so mandated t o study and evaluat e t h e i m p lementation and administration of
Check 21 Act and report t he finding to Congress.
The Paper Check Clearing P rocesses
Fi gure 1 i s a graphi cal represent at i o n o f t he ex i s t i n g p aper check process. It
begi ns w i t h a customer p aying a store u si ng a check; t hen t he store d eposits the
ch e c k i n i t s b ank, which m ay be different from t he customer’s bank. It is possible
that the customer and the s tore have accounts i n t he same bank, in wh i c h c ase t he
check would be s ettled as an “on-us” item. In the processing o f an on-us item, the
bank of first deposit would s imply debit t he customer’s account and credit t he store’s
account in the amount of the check. It i s estimated t hat 33% of the checks written i n
the United S tates are on-us items.4 Assuming t his check is not an on-us item, there
are a number of ways t hat banks may clear and s ettle checks among them selves by
the rules of interbank check settlement. The rules for interbank check settlement are
governed by arti c l e s 3 and 4 o f t he Uniform C ommercial C ode (U.C.C.) and b y
Federal R eserve regu lations J and CC.
After t he store deposits the customer’s check in its bank, the bank of first deposit can
return the check to the paying bank by m ailing t he check directly to the paying bank,

4 J oanna Stavins, “A Comparison of Social Costs a nd Be nefits of Paper Check Presentment
and ECP with T r uncation,” New England Economic Review, J uly/Aug. 1997, p. 33.

or by sending it through a thir d party intermediary (private clearinghouse, 5 a
correspondent bank,6 or the Federal Reserve S ys tem). W hichever of these m ethods
the s tore’s bank select s, in most cas es , t he check must be physically returned to the
payi ng ban k before it pays the check. This m eans t hat checks m ust b e physically
transported t o t he banks on which t hey w ere d rawn before they are s ettled.
C onsequent l y, t he paper check cl eari n g p rocess i s s ubj ect t o t ransport at i o n d el ays.
If the c u s t o m e r d oes not have sufficient funds in the account to cover t he
paym ent t o t he store, the check is sorted out in the b ank’s b ackroom operations, and
is returned directly to the depository bank or to the i ntermediary t hat ret urns it to the
depository bank (Figure 1 ). Usually the d epository bank returns t he bounced check
to the s tore, while chargi ng a fee for d epositing a check with insufficient funds in the
account. The store t hen t ries to collect f r o m t he customer. At t he same time, t he
payi ng bank charges t he check writer a fee for havin g i n s u fficient funds in the
Fi gu re 1. T h e Pap er Ch eck Cl eari n g Process
S o u rce: Federal R eserve of Bo ston.

5 A check clearinghouse i s an association of banks to facilitate daily exchange of checks.
Checks drawn on one bank are offset against c hecks drawn on another.
6 Correspondent banks are banks having a direct connection or friendly r elations with each

W hich Bank P ays for Collecting the Funds. Under t he Federal R eserve
rul es, a l arge port i o n o f t he cost s o f t he cl eari n g p rocess, t hose rel at ed t o col l ect i n g
funds, falls on the d epository bank — t he bank in which t he check w a s f i r s t
deposited. The s tore’s bank in the above ex ample h as to pay for any i n t e r m ediary
check cl eari n g charges and for t ransport i n g t he check t o t h e p ayi n g b ank. The l egal
requi rem ent i s t h at checks p resent ed for p aym ent m u st be pai d at face val u e, even
though t he depository bank incurs cost in collecting t he funds. It s hould b e noted that
the p aying b ank also i ncurs cost i n p aying t he checks t hat are presented. However,
if banks have an equal amount of collection and paym ent, these cos t s o n n et could
tend to equalize among banks over time.
Paper Check Clearing Is Inefficient. Economists have argu ed th a t t h e
cont i nued u se of checks h as m ade t h e s oci et y worse o ff, because i t wast es resources
such as transporting checks b y p lanes t hr oughout the United S tates for collection.
A check i n t h e p rocess o f col l ect i o n creat es i n effi ci ency, b ecause i t pays no i n t erest
(z ero i nt erest rat e). A s a resul t , t h e great er t h e d i fference b et ween t h e m arket rat e o f
i n t erest and t he implicit interest rate of zero, t he great er the i ncome t hat can b e
earned by using checks. This income is called t he float. The float is income earned
by the check writer bet ween the time a check is gi ven as payment and t he time it is
settled. The i nteres t i ncome earned from t he float t ransfers inco me from t he payee
to the p ayer. E ven t hough t he net b enefit of the float between the p ayer and t he payee
is zero (the payee’s l osses are the payer’s gains), economists believe that the float is
cost l y t o soci e t y. C h e ck u sers em pl oy real resources to ex ploit t he float for
themselves. For ex ample, the l onger t h e p lane takes t o t ransport t he check to the
payi ng bank the greater the i ncome t he payer earns from t he float. Of course, from
t h e v i ew o f t he check i ssuer, t he fl oat i s not an i n effi ci ency, but a b enefi t .
By o ne estimate (Wells), the cost t o all parties i nvolved i n a check p a ym en t
could average about $1.60 (in 1993 dollars ) m ore t han t he cost of a p ayment made
el ect roni cal l y. 7 According t o t he Federal R eserve in 2001, government, households,
and businesses wrote about 42.5 billion checks.8 If the W ells estimate is correct , t his
might indica t e a s aving o f $68 billion i f checks were replaced with electronic
paym ents. A different study (Stavins) estimated a net b enefit of $1.4 billion from
el ect roni c check cl eari n g. 9 It i s general l y accept ed t hat t here are pot ent i al s avi n gs t o
be obtained b y adopting electronic check clearing.
Electronic C heck Presentation and Truncation
The elect ronic check cl earing and settlement proces s i s called elect ronic check
pres entation (ECP). C heck truncation i s a subset of the broad er term ECP.
El ect roni c check present at i o n i s a check col l ect i o n p rocess w hereby a check i s

7 Kirsten E. Wells, “Ar e Checks Overused?” Feder a l R e s erve Bank of Minneapolis
Quarterly Review, Fall 1996, p. 2.
8 S e e R e vi s e d R e t ail Payments Research Proj ect at webs i t e
[http://www.frbservices.org/ Retail/pdf/RetailPaymentsResearchProj ect.pdf], last vi sited
9 Stavins, p. 37.

cleared based o n i nformation contained i n an electronic file or dat a , i nstead of the
actual p aper check. At a minimum, the file contains the amount of the check and t he
account number. The p h ys i cal check may o r m ay not follow t he electronic file.
W h en the c h e c k i s t r u n cated, i t i s s topped b efore reaching t he payi ng bank (the
check writer’s bank, which i s t he bank holding the funds against which the check is
drawn). Thus, under ECP with truncation, the writer o f t he check does not get h is/her
cancel ed check back. Inst ead, t he t ransact i o n i s i ndi cat ed on t h e m ont hl y s t at em ent
(Figure 2 ). A check returned for i nsu fficient funds would b e retur n e d t o t h e
depository bank electronically from t he payi n g b ank. The b ank o f first deposit
would be able to return the bounced paper check to its depositing customer, or
merchant, t o s upport appropriate action against the p aying customer.
Fi gure 2. Check Truncation at the Bank of Fi rst Deposit
S o u rce: The Federal R eserve o f Bost on.

Truncation by a n I ntermediary
If banks coul d not reach agreem ent s am ong t h em sel v e s o n s h ari n g t he cost
savi ngs o f el ect roni c check cl eari n g, t h ey coul d u se an i n t erm edi ary t o do t h e check
truncations (Figure 3 ). The Federal Reserve currently truncates checks. In 2000, the
Fed t run c a t e d 20% of the checks i t p rocessed. The u se of an intermediary reduces
the cost s avings , s ince additional t rans p o r t a t i on, sorting and handling costs are
involved when compared t o t runcation at t he bank of first d eposit. Fo r t hese services,
t h e i nt erm edi ary charges fees t h at coul d b e directly or indirectly passed t hrough t o
the b anks and t heir customers. Under t runcat i o n b y an i nt erm edi ary, t h e b ackroom
oper ations of the first deposit bank would be b asically unchanged, and the p aying
bank’s clearing and settling activities would be reduced, but not eliminated. The
Federal R es erve’s sugges t e d l egislatio n would m ake i t possible t o u se electronic
check clearing without agreements.
Fi gu re 3. Ch eck T ru n cati o n b y a n I n termed i a ry
S o u rce: Federal R eserve of Bo ston

Table 1. Estimated Per C heck Payment C osts and B enefits o f
Check Truncation Over t he Paper C heck Process
In cents (¢) and percent o f costs (%) benefits (%)
Deposi t i ng Cust omers Payi ng Cust omers
Cost is Unchange d — 0.00¢(0%) Loss of canceled checks a nd the f loat —5.22¢ (78%)
Fi rst Deposi t i ng Bank Payi ng Bank
Infrastructure ( hardware, software, Additional operating c osts — 0.30¢
training, s torage, r esearch and additional (3.5%)
operational c osts) — 0.87¢ (15%)
One time development, data processing and t ransmi ssion costs 0.30¢ (3.5%)
Total Costs 6.69¢
Deposi t i ng Cust omers Payi ng Cust omers
No loss of the f loat — 1.60¢ (14%) No c hange i n benefits — 0.00¢ (0%)
Fi rst Deposi t ory Bank Payi ng Bank
Risk of fraud reduced, a nd lower Lower c ost on: sorting, handling, postage ,
transportation and operational costs — return item processing, fraud

1.04¢ (9%) identification — 7.12¢ (61%)

Fewer r eaders/sorter passes, no loss of the f loat on rej ects or weather emergencies,
and cost s aving on r eturn items — 1.90¢ (16%)
Tot a l Benef i t s — 11.66¢
Source: Figures t aken from Stavi ns’ Appendix B and percentage s a dded.
Under ECP process, the estimated distribution of costs and benefits between the
banks and t heir customers s eems t o b e t he reverse o f what i t i s under t he paper check
process. Under t he paper p rocess for ex ampl e, the paying customer get s t he float and
the canceled check, while under ECP, t he payi ng customer loses t he float and does
n o t get t he canceled check back. T hat m akes it difficult for b anks to adopt E C P
without an ex plicit agreement about how they w i l l share t he benefits. On n et,
accordi n g t o S t avi ns’ s t udy, represent ed i n t abl e 1 , t he payi ng bank’s cust o m ers

would s uffer t he greatest cost from m oving to the ECP process with the l oss o f
cancel ed checks and the float . At t he same time, t he payi ng bank recei v e s t h e
greatest b enefit. That benefit would b e l ar ge enough t o compensate its customers for
their l osses i f i t s o chose and still leave i t b et t e r o f f after adopting t he check
truncation process.
For t he depositing bank customers, t heir costs are unchanged and t hey benefit
from not losing the float . The depository bank’s costs and benefits are estimated t o
be cl oser to break-even, but the net benefit i s also positive. The higher i nfrastruct ure,
storage, and operating costs are estimated t o be slightly less than the benefit from
reduced risk of fraud, and return check handling.
Despite the net benefit of check truncation, only a small number o f b anks have
b een u s i n g i t . This could be ex plained by table 1. It estimates t hat t otal costs of
6.69¢ per t ransaction are ex ceeded by total b enefits of 11.66¢. This clearly suggests
that there are net b enefits of 4.97¢ per p ayment in using check truncation i nstead of
the paper check process. However, the distribution among participants in the check
truncation proces s i s not as simple. The payi ng bank’s customers incur 78% of the
cost s and recei ve no benefi t from changi n g from t he paper check cl eari n g p rocess t o
check truncation. On the other hand, the depository bank’s customers gain more than

14% of t h e b enefi t . For t he banks, t h e payi ng bank recei ves 61% of t h e b enefi t s ,

while the d epository bank receives about 9% of the ben efit. The i ntermediary b enefits
from t h e check t runcat i o n at t he fi rst b ank o f d eposi t si nce t he t runcat i o n p rocess
would eliminat e its handling of t he paper checks. As a res ult, the i ntermediary
accounts for 16% of the b enefits.
There m ay be a concern t hat, to the ex t ent t hat c h e c k t runcation s hortens the
time for a check to cl ear, i t m ay disadvantage t hose l es s wealthy i ndividuals who live
paycheck to paycheck and count on the float in payi ng rent and o ther b ills. While
such people would l i k e l y adjust t o t he new s ys tem, it may not be thei r preference.
To the ex t ent t hat t runcation reduces the availability of the float , fewer checks m ay
The Check Clearing for the 2 1 st Century Act
(H.R. 1474, P.L. 108-100)
The m ain d ifference b etween H.R. 1474 and t he Fed’s C heck Truncation Act
proposal is that H.R. 1474 has l ess consumer protection t han t he Fed’s p roposal. This
legi slation would facilitate wider voluntary u se o f truncated checks, without
interfering with the check cl earing proces s of i nstitutions that do not currently have
truncation agreements. The Act would enable t his b y creating a new t yp e o f p aper
do cu m e n t , a “s ubstitute check,” that would be t he legal equivalent of the origi nal
check. The substitute check would:
! contain an image of the front and b ack of the o rigi nal check;
! conform t o t he industry s tandards for substitute checks;
! contai n t he m a gn etic-ink charact er recognition (MICR) line t hat
would permit the s ubstitute check to be processed on check-sorting
equipment; and,

! bear a l egend t hat i ndi cat es t h at i t i s t h e l e g al equi val ent of t h e
Using t his s ubstitute check, a bank would be able t o t runcat e a check from a bank
with which i t has no el ect ronic ex change agreement by sending a substitute check
i n st ead of t h e o ri gi nal check. As a resul t , check t runcat i o n woul d rem ai n vol unt ary.
Banks that now use paper checks would be able t o proces s either the s ubstitute check
or t h e o rigi nal checks without any m odifi cation i n t heir check clearing p rocess o r
t h ei r b ack-offi ce operat i ons. T he cost of ch eck processing would b e unchanged for
banks already u si n g c h eck truncation and banks that chose not to adopt check
Much of the draft legi slation s pells out in detail the l egal similarity between the
original check and t he substitute check under t he un i f o r m c o m m ercial code. For
ex am pl e, i t woul d creat e a w arrant y s t ruct u re t o prot ect agai nst l osses associ at ed wi t h
the s ubstitute check. The proposal woul d a l s o c r eate an i ndemnity structure t o
a d d r ess l osses resulting from receiving a s ubstitute check, rather t han t he origina l .
In addition, the d raft l e gi slation would p rovide an ex pedited recredit procedure.
Recredit is the act of gi ving credit to an account even though t he documentation t o
do so is being questioned. In short, the recrediting procedure allows customers’
accounts t o b e cred i t e d as s oon as possible whether or not there are problems
associated with the receipt of the s ubstitute checks i nstead of the o rigi nal.
The ex p edited recrediting s ections of the Fed’s proposal and t he Check Clearing
for t he 21st Century Act are different. The Fed’s proposal would give customers
involved i n a transaction where a s ubs titute check was u sed a one day right to a
recredi t i f t h e y c l a i m a check was i m p roperl y p ai d. That m eans t hat cust o m er’s
account could b e recredited t he amount of the improper p ayment by the close of the
nex t business d ay. In contrast, t he Check Clearing for the 2 1 st Century Act provides
for a recredit 10 d a ys a f t e r a claim o f an improper p ayment. Under both v ersions,
consumers u sing banks that have sign ed truncation agreements would n o t ge t t his
recrediting right. Only customers of banking institutions that have not voluntarily
agreed to check truncation would h ave t his right. Furthermore, under t h e Fed’s
proposal, t he time the consumer has t o request a recredit o f d i s p u t ed funds was 6 0
days . Under t he Check Clearing Act (P.L. 108-100), i t would b e 4 0 d ays.
Consumer Groups’ R eaction to H .R. 1474
At bo t h the S enat e Banking Committee and the House Financi al Services
Committee hearings on April 3, and 8, 2003, the s trongest opposition t o H.R. 1474
came from t he Consumers Union. The v iews in its testimony were supported b y t he
Consumer Federation o f America, the U.S . P ublic In terest Research Group, and t he
National C onsu m er Law C enter. The C onsum ers U ni on argu ed t h at t h e A ct woul d
make it impossible for an estimated 45.8 million U.S. households who are currently
getting t heir paper checks back to continue to do so. It s tates t hat t hese consumers
would b e l ess p rotected from fraud under t he Act t han under t he ex isting check
clearing p rocess when t here are d isputes a bout errors in the check paym ent p rocess.
Specifically, t he Consumers Union argu e t hat t here is a l oophole i n S ection 6 o f t he
CTA t hat consumers could only s ee a recred it if they receive substitute checks from

t h e i r b ank. Banks could avoid giving consumers t he recredit just by refu s i n g t o
return the s ubstitute check to consumers.
At these h earings the C onsumers Union made two recommendations to protect
the consumers under t he proposed Check Truncation Act.
! Because al l consum ers are equal l y suscept i b l e t o h arm from
processing errors, t he recredit loophole i n t he proposed CTA s hould
be closed. The righ t o f recredit should b e e x p a nded t o apply i n
every case w here t h e o ri gi nal check i s not ret u rned t o t h e consum er
and a check m ay h ave b een i m p roperl y charged t o t h e consum er’s
! A comparative negligence standard is inappropriate to resolve harm
suffered b y consumers due to processing errors. Banks should not
be able to use t his standard to avoid liability, o r t o del ay a
consumer’s action for improperly p a i d checks t hat result from
processi ng errors. T herefore, as i t rel at es t o consum ers, t h e l angu age
relating t o comparative n egligence standard should b e removed from
the C TA. 10
At t h e h eari n g h el d i n t he 107 th Congress on H.R. 5414, the C onsumers Union
suggests c h a n g e s in the p roposed legi slation t hat would s ignificantly increase
consum er prot ect i o n w hen checks are cl eared el ect roni cal l y. T hese changes focus
mainly on the recrediting procedure.11 Fi rst, the Union would like t o ex t end t he
recredi t provi si ons i n t h e Act t o al l checks where the o rigi nal checks are not returned
to the consumer and t here is a claim of improper payment or a warranty claim. This
amendment woul d e x p a n d t h e i n d e m n i f i c a tion coverage beyond the s ubstitute checks
in the p roposed H.R. 1474. It could ex t end coverage to more than 20% of all b ank
checks t hat are current l y not ret u r n ed t o cust om ers and m o re t h an 80% of credi t
unions’ drafts t hat are al so not returned to thei r m em bers. Financi al institutions are
ex pected to oppose t his ex t ension because it would s ignific a n t l y raise financial
institutions’ cost of handling disputed checks and drafts.
Second, the C onsumers Union argu es that 10 days is too l ong for consumers t o
not have access t o t he disputed funds d u e t o the u se of the s ubstitute check. It
prefers t he ex pedited recredit provisions in the Fed’s proposal. That i s b y t he close
of business t he nex t day, the d isputed amount of the p aymen t ( u p t o $ 2,500.00)
would b e credited t o t he con s u m e r ’ s account. The purpose o f t he provision is to
reduce consumer inconvenience due to the u se of the s u b s titute check. However,

10 U.S. Congress, House Committee on Financial Servi c e s , C heck Cl earing f or the 21th
Century Act of 2003, hearing, 108 th Cong., 1st Sess. Apr. 8, 2003, unpublished, Statement
of J anell Mayo Duncan, Legislative and Regulatory Counsel, Consumers Unio n , also
Supported by Consumer Federation of Ame rica, U.S. Public Interest Research Group and
the National Consumer Law Center,
[http://financialservices.house.gov/hearings.asp?formmode=detail&hearing=204], l ast
vi sited Apr. 8, 20003
11 See [ ht t p: / / www.consumer suni on.or g/ f i nance/ checkwc102.ht m] , l ast vi s i t e d Aug. 24,


H.R. 1474 provides for a recredit after 1 0 business d ays, which t he banking industry
argu es is appropriate.
Third, Consumers Union would like t o raise the ex p edited recredit amount from
$2,500 to $5,000. In H.R. 1474 and t he Fed’s p roposal, checks for less than $2,500
w o u l d b e recredi t ed b y t he nex t busi n ess d ay, i f t he check i s bei n g d i s pu t e d .
Consumers Union would like t h e ex pedited recredit limit raised to $5,000 because
the s ize o f t he amounts o f t hese t r an sactions is ex pected to increase over time. In
addition, the Union would like t o s horten t he number o f d ays required t o complete
the overall recrediting process to less than 20 days. Financial i nstitutions, on the
other hand, prefer the l onger time to cl ear up disputed checks i n order to make sure
t h at correct i ons are m ade accurat el y. In s hort , t h e C onsum ers Uni on’s changes
would p rotect consumers from t he loss of the fraud protection p rovided b y t he righ t
to have the origi nal check returned to them . This right is now protected by statute and
regu lations. These suggested changes, however, could s ignificantly raise t he cost to
financial i nstitutions to the point where i t i s n o l onger profitable t o adopt check
truncation. In P.L. 108-100 the ex p edited recredit amount stayed at $2,500.
A counter to the C onsumers Union’s argument for protection against processing
error s i s t h e fact t h at i n cases where ch eck t runcat i ons have been used for years
processing errors are p ractically nonex istent and when they occur t hey ar e q u i c k ly
resolved. Asked by Senate Banking Committee C hairman R ichard Shel by (R-Ala.)
how many complaints she h as received from credit union members about
el ect roni cal l y produced copi es of checks, Al ex ander, P resi d ent and C h i ef E x ecut i v e
Office of the NIH Federal C redit Union, said that over a period of 14 years, she h ad
received none. In response t o a question from S en a t o r J ohn S ununu (R-N.H.)
Ferguson, Vi ce C h ai rm an of t h e Federal R eserve S ys t em , sai d t h at i n hi s s even years
on the Fed board, h e h as never h eard o f a case i n w h i ch checks w ere double-
Possible Objections to Universal Check Truncation
Under t he CTA, the adoption o f check t r u n cation o r electronic check
p r es en t ation would s till be primarily voluntary, even though i t could s ignificantly
reduce t he cost of usi n g checks. Many banks are not m aki ng agreem ent s , b ecause
while there might be substantial s ocial benefits if most or al l checks were t runcat ed,
t h ey and t hei r cust om ers m ay never b e abl e t o achi eve su f f i c i e n t b enefi t s over t he
present p aper check system to justify ex p ending the resources to adopt check
truncation. A m ajor obstacle t o universal a doption i s t he uneven distribution of costs
and benefits am ong the participants in the process. M a ny observers believe this
obstacle i s unlikely t o b e overcome without a l egally mandated cost d istribution, as
is currently provided for in the p aper check process. The p roposed Check Truncation
Act w o u l d m a k e l egal any d istribution agreement (or non-agreement) the b anks
approve among themselves.

12 Richard Cowden, Consumer Groups Prefer Paper Checks, BNA Daily Repo r t F o r
Executives No. 65. Friday April 4, 2003 Page A-15.
[http://pubs.bna.com/nwsst nd/ip/BNA/BAR.NSF/2002090b92a4a3bc85256743006da1ea
/2f92eebadf7bc66985256cff000fca1b?OpenDo cument], last vi sited Apr. 9, 2003.