Business goes electronic: the advantages of check imaging

Businesses seek efficiency to make them more profitable. Automation of business processes supports the efficiency drive, leading to accessible data, the ability to track the status of activities and the ability to predict the time of completion. Applied to paper check processing, these attributes encourage electronification of payment instruments.

Although the number of checks written by consumers is declining, there is little change in the number of checks written and cleared for business-to-business (B2B) payments. Automated clearing house (ACH) solutions, which convert paper checks to ACH files, apply only to consumers’ checks. A National Automated Clearing House Association (NACHA) rule establishing business check parameters that exempt them from check conversion took effect in September 2006. Businesses resist having their checks converted to ACH for a number of reasons: to continue the advantages of float, to retain check-based fraud prevention services and to keep from complicating internal bank statement reconcilements, since ACH transactions appear in different portions of the statement from checks.

Initially, the US government and banking industry worked to replace initiation of payments by check with electronic mechanisms (e.g., automated clearing house). While the introduction of the Check Clearing for the 21st Century Act (Check 21), effective October 28, 2004, serves to enhance acceptance of check image exchange between financial institutions for check clearing, it really addresses the requirement to accept image replacement documents (IRDs) or ‘substitute checks’ as the equivalent of an original paper check. Check 21 removes barriers for banks that want to truncate the journey of checks, because all paying banks must accept a substitute document. The check processing industry is in a state of rapid transformation. As changes in the regulatory environment, supported by new technologies, take hold to remove paper checks from the clearance and settlement cycle, paper checks are still supported as a payment instrument.

Paper checks, though used less often, will not be supplanted as a major payment option in the United States. Therefore, methods of electronifying checks early in the presentment process are gaining momentum. Remote deposit capture is an important offering for all sizes of banks. Many capabilities – scanning checks at remote sites, capturing Magnetic Ink Character Recognition (MICR) information, and creating images of the front and back of the checks – are creating both cost control and revenue generation opportunities for banks and their business clients.

Differing sizes of businesses view check payments in varying ways. Large corporations are the demographic most likely to embrace electronic payments, followed by middle- market companies and finally small businesses. Most large corporations have the internal information technology staff and knowledge to support electronic payments. Further, these companies have more experience with trading partners that are able to accept electronic payments and negotiate mutually agreeable terms to offset any float losses. As a result, Aite Group projects that large businesses will reduce their use of paper checks from 70 percent of their total B2B payments in 2006 to 60 percent by 2010. Small businesses are more likely to resist initiating payments electronically because they lack the technical expertise and resources to support file-generation and interfacing to bank and trading partner systems, and their cash flow supported by float is critical. Small businesses will retain 90 percent of their B2B payments as paper checks in 2010, as compared to 95 percent in 2006. Middle-market companies, like their name, will fall in between large corporations and small businesses. By 2010, 80 percent of middle-market B2B payments will be made via paper check, as opposed to 85 percent in 2006 (see Figure 1).

Figure 1: Businesses continue to prefer check payments to other payment methods

Remote deposit capture
For businesses of all sizes, remote deposit capture (RDC) converts checks into electronic images at any location without having to transport them to their bank. This capability saves time and resources, while shortening the time to good funds availability. Small-business owners and partners value time almost as much as cash flow. No matter how close the local bank branch may be, capturing check images at the business’ office is more efficient, and gaining in popularity. Based on an April 2006 online survey of 278 small-business owners/partners, 41 percent prefer an online banking channel, as compared to the 36 percent that prefer to use a bank branch (see Figure 2). Anecdotal evidence shared with Aite Group indicates that both small and large financial institutions based on institutions’ willingness to provide RDC to small businesses have won relationships.

Figure 2: US Small businesses prefer the online channel to branches

Important attributes of larger companies that embrace RDC include those industries that operate with distributed offices or stores. Examples include retail chains, insurance companies with dispersed brokers and real estate companies with multiple offices. A preferred solution for such companies is to direct check payments to a centralized or bank-sponsored lockbox operation. RDC is a beneficial supplement to lockbox services, as checks are still presented or sent to local offices (known in the industry as ‘stranded checks’). Generally, these items represent about 2 percent of the deposit activity, but cause an inordinate amount of the pain for companies. Surprisingly, the dollar value of a single stranded check can be well into seven figures per check — meaningful funds for any company.

Ubiquity of check image processing
At present, nearly all financial institutions can accept ACH items, while the number of image-accepting financial institutions continues to grow from a relatively small base. However, this number will increase steadily over the next six years. The most accurate measure available is the number of ‘routing transit numbers’ or ‘transit routing numbers’ (variously designated by one of the following acronyms: R/Ts, T/Rs, RTNs or TRNs) that are image-enabled. Today, there are about 28,000 R/Ts in use, and considerably fewer financial institutions. The lack of a one-to-one correlation is due to the need for R/Ts to direct checks and other items for clearing and settlement. When financial institutions have branches across multiple states and/or Fed districts as many do, then they also have multiple R/Ts.

Currently, about 6,000 R/Ts are image-enabled. By 2008, Aite Group forecasts that 15,580 will be image-enabled, and that number will grow to slightly less than 26,000 by 2012. Given that some of the 28,000 R/Ts are used for specialty purposes that would never lend themselves to check image exchange, this projection means that by 2012, nearly all US financial institutions will have the capability to exchange check images (see Figure 3).

Figure 3: US Financial institutions are increasingly image-enabled

Check imaging has grown to include a wide variety of products that provide new workflows or electronic analogs of existing paper workflows. It has matured rapidly and is positioning itself as an extremely important migration path over the next five years by supporting both consumer and business check electronification. The focus is already on facilitating interconnectivity between and among the various image exchange models. Going forward, value-added services — such as intelligent routing, incorporating least cost routing, and remittance data capture, matching and reporting — will become the differentiators for financial institutions.

What is clear from the availability of these solutions is that over the next several years, almost all paper can be eliminated from the payment workflow without regard for the number of checks actually being written. Solutions are available for any bank to allow their customers to continue writing checks, while the bank gains from the advantages of electronic processing for clearance and settlement. These gains translate to cost and service advantages for banks’ commercial clients.