Technology
CONVERTING PAPER CHECKS
TO ELECTRONIC PAYMENTS
WHAT YOU NEED TO KNOW

by Alan Koenigsberg and Amy Smith

   Over the last several years, consumers have embraced the use of electronic payments. Yet, a significant portion of the public has steadfastly refused to part with their checkbooks. According to Federal Reserve research, consumers made 26.1 billion payments electronically and 21.6 billion payments with checks in 2001. While the trend towards electronic payments continues, retailers, merchants and billing companies seek more cost-efficient and reliable methods for processing checks.
   Check conversion, also known as the Accounts ReceivableCheck (ARC), came into existence in March 2002. Theprocess allows billers to read the data from a check and convert it to an electronic payment through the Automated Clearing House (ACH). According to NACHA The Electronic Payments Association:

  • 60 million check conversion payments were made in the third quarter of 2003.
  • That represents an 87 percent increase from the previous quarter and a dramatic 718% increase over the same period last year.
The Rationale Behind Check Conversion

   The Federal Reserve supports moving the U.S. economy from a payments system based on checks to one based on electronic payments.
   The move toward electronic payments is driven by several key factors. The U.S. economy depends on the ability of consumers and businesses to reliably make and receive payments routinely, safely and efficiently. Credit card, debit card and ACH payments have grown rapidly in popularity. A recently released Dove Consulting Group study reveals that credit and debit cards account for 52 percent of transactions at the point-of-sale, while cash and checks combined account for 47 percent. Despite these gains at the register, most people still prefer to pay bills sent by mail with checks. (Source: American Banker, 12/16/03; Dove Consulting Study 2003-04.)
   The Federal Reserve has devoted considerable resources toward guaranteeing the safety of the system and exploring ways to increase efficiency through the implementation of electronic payments.

Safer, Faster, Cheaper

   No other industrialized nation relies on checks as much as the U.S., but as a result of check conversion, both billers and consumers may now reap the benefits of electronic payments. The check conversion process yields fewer bad checks, earlier fraud detection, fewer errors, enhanced privacy and reduced costs.
   Fraud costs billions of dollars each year and is a constant concern for billing companies and banks. In the latest American Bankers Association Deposit Account Fraud Survey Report, check fraud loses for financial institutions reached an estimated $698 million in 2001, and attempted check fraud soared to $4.3 billion, doubling for the second time in four years.

Electronic payments are safer than checks.

   With check conversion, billing companies often receive payment within a day, reducing check float, which cuts down on the occurrence of check fraud. Also, the automated clearing of electronic payments greatly reduces the incidence of errors by eliminating the need to have checks pass through many hands as they are processed.
   Consumers enjoy added financial privacy with electronic payments as transactions pass electronically from one financial institution to another using encryption, electronic data scrambling, message authentication codes and other security procedures to protect their information.
   Electronic payments are less costly than checks. In the Fed's annual report, the costs associated with transaction processing for ACH payments are rapidly decreasing, as compared to checks. The report shows that the Fed's cost to process a check remained at 4.5 cents per item in 2002, while its cost to process an ACH payment is 1.3 cents per item. This saves the U.S. economy close to $1.62 per ACH transaction. ACH use in 2000 alone saved consumers, businesses, and the government an estimated $8.4 billion.
   Billing companies enjoy additional savings as the number of return items is reduced.

The Nuts And Bolts Of Check Conversion

   For consumers, check conversion (ARC) is a behind-the-scenes process, which has no negative impact on payments.
   For billing companies, the conversion process offers reduced fraud, shorter settlement time and lower costs.
   After a customer makes a payment by check, it is either processed directly by the billing company or sent to a lockbox processing center. The check is used as a source document to retrieve information necessary to create an ACH transaction in lieu of processing the paper check. Information is taken from the magnetic ink character recognition (MICR) on the check. The MICR line contains the routing number of the payor bank, the number of the check and the account number of the customer. Then the amount of the check is captured using a variety of automated tech- nology methods. The billing company subsequently compiles a file of multiple ACH transactions for delivery to its bank, and then for settlement.
   Once the customer's account is electronically debited, the transaction is listed on his account statement, including the date of payment, name of the biller, check serial number and amount of payment. Because the check conversion process reduces the billing company's settlement time from the typical four or five days down to two, collection float is expedited.

Educating Consumers

   As the adoption rate for ARC continues to grow rapidly, more consumers are experiencing electronic transactions for the first time. Billing companies and financial institutions are increasingly faced with customer inquiries about the nature of these payments.
   To better educate companies that bill consumers as well as financial institutions, regulatory agencies and legislative bodies the Check Conversion Education Coalition (c2ec) was created in August 2003. The c2ec, which is composed of financial institutions, government agencies, ACH operators, and non-profits, is reaching out to interested parties to help them teach consumers about how the check conversion process impacts the payment of their bills.
   The following are some commonly asked questions about the check conversion process that billing companies are likely to receive from consumers, and the answers they can provide:

  • What happens to the paper check? During the check conversion process, thepaper check is copied, stored and destroyed. These steps ensure that the check cannot be used for any other purpose. The billing company keeps a copy of the check for two years.
  • Can billing companies take extra money from a consumer's account using check conversion? No.
  • Can billing companies see how much money a consumer has in their account? No. The only account information available to the company during the check conversion process is what is on the paper check.
  • Where does a converted check show up on a consumer's account statement? The check may appear in the same space as ATM withdrawals, debit card payments, and other electronic payments, or included in the check listing.
  • Can consumers get copies of their checks? Consumers can obtain a copy of the check from the company to which they sent the check, but all of the relevant information will be on their account statement. The account statement is an accepted form of proof of payment.
  • Can consumers put a stop payment on their checks? Yes. As with a paper check, consumers can place a stop payment before the payment is posted to their account.
  • Is the payment deducted from a consumer's account faster when a paper check is converted? The payment may clear faster when a company has converted the paper check to an electronic transaction.
  • Is check conversion safe? Yes. Electronic payments have proven to be safer than using paper checks. Consumers gain financial privacy with electronic payments thepayment information is transferred through computers over a private network protected by encryption, message authentication codes and other security procedures.
The Electronic Evolution

   The rapid migration from paper to electronic payments is being driven by theincreasing expense of paper check processing, as compared to the significant benefits gained through check conversion. Electronic payments have created greater efficiency, improved savings to business, reduced errors, enhanced privacy and increased protections for consumers. According to Dove Consulting's ARC Consumer Research report, conducted in August 2003, check conversion will account for 55% of all remittance processing in the U.S. by 2007. While the economics of check conversion are clearly compelling for billing companies, the greatest challenge will be in educating consumers. Through a concerted effort by the billing and banking industries, consumers will learn that they can continue to use their checkbooks while being afforded the added safety, convenience and confidentiality of electronic payments.