Ware, Viveca Y., Independent Banker
What community bankers need to know about check image exchanges
Just as it was intended, Check 21 has spurred financial institutions of all sizes and charters to begin thinking about the next generation of check processing. Many community banks are already chomping at the bit to implement end-to-end check image exchange, and interest is only expected to surge when Check 21 takes effect Oct. 28, 2004.
According to the ICBA/lnFinet 2003 Technology survey, 53 percent of the respondents used check imaging, and another 39 percent were planning to evaluate the application within the next 12 to 18 months.
In addition to establishing the necessary connectivity for end-to-end check image exchange, banks must also take steps to understand the legal implications and how to address the associated risk.
Letter of the Law
Traditional paper check exchanges are governed by a plethora of laws and rules that have evolved over hundreds of years. These laws and rules include the Uniform Commercial Code, Expedited Funds Availability Act (Regulation CC), Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers Through Fedwire (Regulation J), Federal Reserve Operating Circular No. 3 - Collection of Cash Items and Returned Checks, clearing house rules, and case law.
The newest and probably mostwidely publicized check law, Check 21, covers substitute check exchanges but not image exchanges. How can this be when substitute checks are created from electronic check images? Quite simply, the Congress, supported by the industry, felt it was best to leave electronic check images outside the scope of Check 2 1 . ICBA and other industry advocates were concerned that covering electronic check images under Check 21 could result in the Congress establishing a mandate for electronic check clearing.
Image Exchange Risks
Despite the advantages that many believe end-to-end image clearing offers, banks must have a clear understanding of the legal implications before jumping onto the image bandwagon.
Just as image exchange is not addressed in Check 21, banks cannot rely on any of the traditional laws and regulations for legal support. Without federal or state statutes, regulations or case law to guide the courts in adjudicating disputes, the amount of risk associated with check image exchanges is indeterminate. In traditional check exchanges, there are some scenarios that include the risk of consequential damages, so it is reasonable to assume that some image exchange scenarios might include similar risks.
In the absence of law, the amount of risk assumed, and by whom, may be very different for image exchanges than under conventional check exchanges. There is no judicial guidance for determination of liability and award amounts. Without a clear basis for dispute resolution, the cost to resolve matters through the courts tends to be very expensive with unpredictable results.
The risk associated with check image exchanges can be mitigated through agreements among the various parties with an interest in the check. General agreement options include bilateral agreements, multilateral agreements and clearinghouse rules.
The best approach to agreements is to have all the parties covered under the same agreement. However, that's a daunting, if not impossible, objective. The likelihood of achieving hundreds of millions of agreements (19,000 institutions with tens of millions of customers) that are the same is extremely remote, thus creating asymmetry of liability allocation and unnecessary risk.
The best option for agreements is clearinghouse rules. Clearinghouses have special status under the Uniform Commercial Code (UCC). They can make or modify certain as- pects of the UCC, and when transactions are exchanged be- tween two members of the same clearinghouse, all parties are bound by the clearinghouse's rules whether or not they have agreed. …