Interoperability, convergence, ‘co-opetition’: Moving towards the Check 21 vision

When the Check Clearing Act of the 21st Century (Check 21) was enacted, the financial-services industry, the Federal Reserve and Congress started the US payments system on a journey towards a visionary future: a payments architecture fully based on electronics.

As an industry, tremendous progress has been made in moving steadily towards that vision. At the same time, though, we must also acknowledge some important obstacles on the road to full implementation, which are imposing costs and inefficiencies on the system, on our institutions, and our customers and clients. And we must find a way to get past these obstacles together.

Bank of America and other financial institutions remain firmly committed to Check 21 and to its larger vision of a more efficient, more resilient paperless payment system. And we believe that we can accelerate our mutual progress by working together and focusing on three critical aspects: industry interoperability, payments convergence, and “co-opetition”.
There is little disagreement that Check 21 was an idea whose time had come. Even though many financial institutions had made investments in basic image capabilities such as image archiving and statements starting in the early 1990’s, very little progress had been made. Because of the significant volume of paper checks, the US lagged its more electronified international competitors in terms of efficiency. And hauling around tons of paper made our system too susceptible to disruption, whether by mundane but inevitable occurrences such as snowstorms, or, as we found to our horror on 9/11, to the unexpected impacts of disaster. We all agreed: we needed a system that was both more efficient and more resilient. Check 21 is the foundation of that system.

A new payments system

The industry responded with an enthusiasm unprecedented in the US financial services industry. In just two years since Check 21 was passed, Electronic Check Clearing House Organization data shows some 40 percent of the 17,000 US financial institutions can receive images. Together, we are exchanging via image about 25 percent of the 35 billion checks processed every year. Image exchange volume has increased 257 percent year-over-year.

Many financial-services organizations have embraced the new electronic environment, recognizing advantages for themselves and, especially, for their customers and clients. Numerous community banks and credit unions, which have been fully imaged and truncated for over a decade, as well as large organizations, including Bank of America, have already created internal efficiencies by collapsing some or all of their legacy paper exchange networks and automating typical ‘Day 2’ functions such as returns and exceptions.

We are all excited about the potential to innovate, with new products and services that improve our clients’ banking experiences: we’ve already seen remote deposit capture, image-based ATMs take off. The opportunities for continued innovation are tremendous. We anticipate a flood of creativity, taking us to a future in which people look back on the era of paper items and shake their heads in disbelief at its inefficiencies and risks.

Unfortunately, many in our industry have yet to storm the castle walls of paper-based networks. (60 percent still cannot receive images, and 75 percent of checks are still being hauled from place to place in planes, trains and automobiles.) These institutions are waiting on the sidelines until electronification reaches the ‘tipping point’, where the number of institutions and processing volumes justify the costs of joining the image revolution.

It will happen. Decisions to migrate to electronification will be driven by unit costs of paper-based processing, which are being driven upwards by inexorable market forces. Check volume in general is declining five to seven percent every year as consumers find alternative payment methods. The number of checks processed is declining an additional two to five percent per year as more checks are being driven to ACH (online bill payment, ARC and most recently Back Office Conversion). The Federal Reserve will be consolidating 45 sites to four by 2011, and raising their fees for processing paper checks. The larger banks are now ramping up volumes, including Controlled Disbursements Accounts. And, as mentioned, new image-based products are proliferating. Celent research shows that more than 4000 banks offering Remote Image Capture. Little wonder that in a recent industry survey by the CheckACH Coalition, 93 percent of institutions acknowledged they would be investing in image exchange within 36 months.

As each institution enters the image arena, the momentum grows. The actions of any one financial institution, regardless of size or volume, benefit not only itself but the greater industry. But while we wait for greater adoption, many banks are operating a dual paper-and-image check-processing infrastructure. And they must wait for the cost ‘bubble’ – the temporary, but visible, increased cost associated with running two processing environments – to pop, allowing them to reap the benefits of fully electronic payments processing.

Industry wide adoption

Bank of America strongly believes in the spirit of Check 21 and its vision of a fully electronic based payments architecture. We are proud to be an industry leader in adopting image technologies and processes

To drive that industry-wide adoption, we in the industry collectively need to focus on three major fronts: continued industry interoperability, payments convergence, and using ‘co-opetition’ to remove barriers to adoption. Let’s look at each of these in some detail.

A critical component of success of any structural change is industry-wide interoperability. Common standards are not only desirable but vital. The results of failure can be seen in a sad example from another high-profile business: high-definition DVD. Consumer adoption of this technology would bring benefits to everyone involved – viewers, equipment manufacturers, content providers and retailers. But widespread adoption has stalled because there are two competing standards.

Standardization has been our ally from the outset. Image exchange has succeeded largely because established exchange networks such as SVPCO, Viewpointe, and the Federal Reserve have matured together and created sound networks using common standards from ANSI that allow images to be shared easily. More recently, new networks – like Fiserv’s Clearing Network and Lending Tools’ “On We” network – have been created to address demand for alternative clearing opportunities. And many Correspondent Banks are creating their own dynamic image-clearing products to expand their clients’ reach into the marketplace.

Because of interoperability, all of this activity has created capacity for explosive growth. Efforts to interoperate, to ‘make markets’, and extend the reach of image products and services are imperative to accelerating the industry’s transformation.
Second, because it seems self-evident that the paper-to-image transformation will be driven forward as institutions have more options available, we need to explore the convergence of imaging with ACH.

As an industry, we’ve aggressively pursued this opportunity.

About a year ago, the CheckACH Coalition, an alliance of check and ACH professionals, looked at the feasibility of integrating check image exchange with the ACH network. The group proposed that the check be imaged, the image stored in a common industry archive, and the payment data flowed to the paying bank via the ACH network. The working theory was such integration might accelerate the adoption of check electronification and remedy the ‘paper purgatory’ some organizations were experiencing due to varying degrees of adoption of check electronification.

Ultimately, the coalition concluded that the idea would be difficult to execute, largely because of legal issues related to the blending of Regulation CC and Regulation E. However, the effort was very beneficial to the industry as a whole. It put issues of image adoption and check truncation at the forefront of the minds of a large, diverse group, and highlighted the need for more collaboration to address the legal and rules obstacles to payments convergence.

Very recently, NACHA has introduced a pilot project for deposited check truncation (DCT), anticipated to be piloted by volunteer banks in the first quarter of 2008. DCT could enable banks to truncate low-value consumer checks deposited with financial institutions. The exercise is being designed to help determine what role the ACH Network could play in facilitating the clearing and settlement of these low-value paper items as another alternative to paper clearing. While similar legal issues encountered during the CheckACH effort exist and the results and outcomes of the pilot are difficult to predict, the opportunity to address barriers and explore additional clearing alternatives and their overall impact to collecting banks, paying banks and our customers is intriguing and is worth a full end-to-end-evaluation.

These broad, industry-wide efforts lead us to the third major front: We must use such ‘co-opetition’ – co-operation among competitors (within the proper frameworks permitted by the antitrust laws, of course) – to help all of us, especially newcomers, deal with the complexity of managing the transformation to imaging. Co-opetition provides two major benefits: First, it lets us learn from each other’s experiences by sharing best practices (and worst practices) and lessons learned. Second, co-opetition is critical to establishing and maintaining the vitally important common standards mentioned earlier.
Bank of America has already enjoyed the benefits of co-opetition in numerous instances – joining forces with competitor institutions in various entities and forums that have enabled growth and progress for forum members and the industry as a whole. For that reason, we strongly endorse the concept and encourage institutions to identify opportunities to realize those benefits as well.

Bank of America believes that the US payment system will ultimately reflect what we believe was the vision of Check 21’s founders: by working together, we will provide US consumers and businesses with the most innovative, dynamic, efficient and resilient system in the world.

Much of this progress, as noted earlier, will be the inevitable result of unit-cost pressures driven by market forces. But we cannot – and should not – rely on those pressures and forces to pull us towards our future. As an industry, we have a shared responsibility to push it forward, for the benefit of our customers, business clients, shareholders, and even our economy.
In particular, we need to continue with our focus on interoperability, convergence and co-opetition. By working together, we have already made significant progress in a very short period of time. But we must also be resolved to push the envelope to bring the ‘end game” to fruition.