Partners, Volume 15, Number 1, 2005

Check 21: A Step On the Path to Electronic Banking

The Fed envisions a U.S. payments system that is more reliable, faster, and less expensive as check processing becomes primarily electronic, displacing today’s methods of processing paper checks. “Check 21” is helping to pave the way.

Check 21 takes effect
The Check Clearing for the 21st Century Act, known as Check 21, became effective October 28, 2004, concluding a year of intense preparation by everyone in the check business. Check 21 permits banks to create and exchange a new kind of paper document, the substitute check.

Through the new law, a properly created substitute check becomes the legal equivalent of an original check. In simple terms, a substitute check is a digital image of an original check reprinted using a specific format that can be processed the same way as the original on the backroom systems of banks.

The purpose of Check 21
Check 21 makes it possible for banks to collect checks by exchanging electronic images of checks instead of the original paper documents, if they choose to do so. The new law not only permits a bank to print and use a substitute check in place of the original, but it also requires other parties to accept a properly created substitute check as if it were an original.

Prior to Check 21, a bank could insist on receiving paper checks and thus force other banks to demand original paper checks from its depositors. Now that Check 21 has taken effect, a bank that takes in “electronic checks” by agreement will be able to present substitute checks, even to institutions that do not agree to accept “electronic checks.”

The Federal Reserve’s role in Check 21
For Federal Reserve Banks, the year between the enactment of Check 21 and its effective date was one of intense activity.

To inform the public, Reserve Banks distributed information, conducted seminars, and developed tools to help banks prepare for Check 21. Behind the scenes, hundreds of Fed employees across the System retooled virtually every aspect of our check processing operations with new hardware and software. They developed new procedures, conducted staff training, programmed and tested new systems, and rewrote our Operating Circular No. 3, “Collection of Cash Items and Returned Checks.”

On October 28, Reserve Banks declared “all systems go” and brought to market the new services enabled by Check 21. It was the beginning of a new era in payments.

A smooth transition
No one was sure exactly how the transition to Check 21 would play out.

The new law is a bridge between the old-fashioned paper check that we use to pay a merchant and the widespread adoption of electronic technologies to collect that check.

After all the publicity and hard work surrounding implementation of the new legislation, perhaps the most striking thing, now that several months have passed, is how smooth the transition has been.

Prior to the transition, approximately 60 percent of consumers already had accounts that didn’t return canceled checks. For them, the change has not been noticeable. Among the remaining 40 percent who are used to getting canceled checks, a number have begun to receive a mix of canceled checks and canceled substitute checks. Contrary to some predictions, there has been no firestorm thus far.

In actuality, most checks are being collected today the same way they were before Check 21 became effective. Reserve Banks estimate they will be producing approximately 2 million substitute checks per day by the second half of 2005. But this figure still represents only 5 or 6 percent of total check processing each day.

Although Check 21 makes it possible for banks to collect checks using electronic exchanges instead of traditional paper processing, the new law does not force them to make this switch.

Payment trends
Since the introduction of computers, people have been predicting that the U.S. would abandon paper payments and turn to electronic commerce. In October 1975, Changing Times magazine advised Americans to “get ready for cashless, checkless living.” In 1983, the Federal Reserve Bank of Atlanta predicted that the use of checks would plateau between 1987 and 1989 and then begin to decline.

Example of the front and back of a substitute check.

Though Americans are much fonder of cash and checks than the pundits understood, in the past few years, the long-anticipated shift from paper payments to electronics has finally begun. According to a Federal Reserve study in 2004, 36.7 billion checks were processed in 2003, down from 41.9 billion in 2000. Increasingly, consumers are paying for goods and services by credit card, debit card, and automated clearinghouse (or ACH) transactions.

Debit card transactions increased from 8.3 billion in 2000 to 15.6 billion in 2003. In addition, payments that start out as checks are being converted into electronics for collection. Check-to-ACH transactions, in which a consumer writes a check and the payee collects the payment electronically through an automated clearinghouse, were introduced before Check 21 and have been growing rapidly. In the second quarter of 2002, 5.3 million checks were sent to lockboxes and converted into ACH items. By the fourth quarter of 2004, this number grew to 266.2 million items.

Check-to-ACH conversion does not work for every kind of check, unlike Check 21, which applies to all kinds of checks.

The 36.7 billion checks that Americans wrote in 2003 make it clear that we are far from becoming a “checkless” society. As long as we cling to the deeply-rooted American habit of paying for many things by writing checks, Check 21 does important work. The new law is a bridge between the old-fashioned paper check that we use to pay a merchant and the widespread adoption of electronic technologies to collect that check.

Technology drives changes
A pleasant surprise in the new era of Check 21 has been the introduction of new services for depositors. Within the coming year, some banks will begin to roll out image-enabled ATMs. These ATMs will be able to provide the depositor with a receipt that includes a photocopy of each deposited item. This process will provide much more useful records than those most depositors receive today.

Banks are also beginning to introduce retail businesses to the ability to deposit checks at the business site by imaging them and then transmitting the images to the retailer’s bank.

Looking ahead
Federal Reserve Banks will use Check 21-enabled backroom processing to encourage more and more banks to shift to electronic-based check collection. Today, while we continue to operate our traditional paper-based check processing systems, Check 21 makes it possible for Reserve Banks to send and accept checks in electronic form to and from banks that have adopted the new technology, to transport the data electronically, and to print and present substitute checks.

Over time, as more banks adopt the technology to process checks electronically, they will deposit an increasing proportion of their checks in electronic form. Simultaneously, Reserve Banks will be able to present an increasing proportion of checks to paying banks electronically rather than printing substitute checks.

Despite the publicity that surrounded Check 21, the new law has not caused a revolution. Nonetheless, Check 21 represents a significant step in evolution toward electronically processed payments in the U.S.

For more information, please access the Consumer Guide on Check 21 and Substitute Checks at

This article was written by Richard Fraher, assistant general counsel at the Atlanta Fed.

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