By Patti Murphy
ProScribes Inc.
The Federal Reserve wants to move check payments into the 21st century. A batch of amendments to Regulation CC (rules governing check collection and funds availability) handed down in May 2017 include changes that would place electronically created checks on an equal regulatory footing with paper checks. And that could spur ongoing initiatives to promote completely digital checks, sometimes called e-checks. The amendments, which take effect in July 2018, also address requirements for "expeditiously" returning checks and dealing with duplicate deposits that arise when checks enter the clearing system by way of remote deposit capture.
The amendments should be well received by financial institutions and their customers, as the issues addressed have been difficult to navigate under a regulatory regime that speaks primarily to paper-based check clearing.
Reg CC implements federal laws enacted in the late 1980s (the Expedited Funds Availability Act) and the early 2000s (the Check 21 Act), when processes like check truncation and image check exchange were considered cutting edge. Yet today better than 99.99 percent of checks that clear through the Federal Reserve Banks are electronic images, according to a document detailing the adopted amendments. And electronic images clear far faster than paper.
As it was originally written, Reg CC requires a financial institution that determines it will not pay a check to return that check to the financial institution that originally accepted the item for deposit – and to do so expeditiously. It defines expeditious as two to four business days, depending on whether the paying bank is local and other factors. Under current regulations, when checks being returned are for amounts of $2,500 or more, the returning institution also must provide a notice of nonpayment to the presenting bank within two business days.
One amendment set forth last month establishes a hard-and-fast rule that a check return (whether paper or electronic) must arrive at the institution that first accepted the item by no later than the second business day following presentment. The Fed also raised the threshold for required notices of nonpayment from $2,500 to $5,000.
Remote deposit capture (RDC) has been a big hit with consumers and businesses. Consumers primarily are attracted to the convenience of making deposits using desktop scanners and/or smartphones rather than visiting branches or ATMs. Businesses, too, like the convenience of RDC, but are also drawn to the operational efficiencies and cost savings that arise from migrating labor- and time-intensive paper collection protocols to digital methods. Despite the popular consensus, some experts assert that RDC creates new risks for financial institutions, such as the risk a check deposited using RDC might be deposited multiple times, either accidentally or as part of a fraud scheme. The system has not been awash with duplicate checks – RemoteDepositCapture.com, for example, reported a duplicate loss rate of 0.031 percent (about 3 out of every 10,000 RDC items) among banks and credit unions offering RDC in 2016.
This compares to an overall return item rate of 0.4 percent, or 40 out of every 10,000 checks processed through the Fed's clearing network. Nonetheless, concerns continue to be raised about the risks and legal liabilities that arise when checks deposited using RDC are deposited again using RDC or some other means. So the Fed has added a new provision to Reg CC that addresses these situations.
The new provision indemnifies a bank or credit union that receives a deposit of an original paper check that is subsequently returned unpaid because it already had been accepted as an RDC item and paid. The indemnity, however, does not apply if the check contains a restrictive indorsement, such as "for mobile deposit."
The proliferation of RDC and related technologies has created significant interest among banks and businesses in extending the digitization of checks from simply depositing and clearing checks as images to payment initiation. To that end, several companies have developed offerings that support check payments that are fully electronic, from online (or mobile) initiation through clearing and settlement.
These initiatives, however, require workarounds because Reg CC provisions regarding check presentment, returns and warranties don't apply to electronic images or information. Deluxe Corp., for example, is sending e-checks to "hundreds of thousands of payees," Chris Clausen, Executive Director, North American Payments and Transactional Services at Deluxe, told me in a recent interview. To ensure the items are covered by Reg CC protections, however, Deluxe actually prints out paper items, then effectively recaptures the images to create RDC files. (Clausen noted it as a rapid-fire process.)
Financial institutions, meanwhile, typically use formal agreements with correspondents and check exchange partners to spell out warranties and other terms for forward and return collection processes related to fully electronic checks.
Workarounds such as these shouldn't be necessary once the new Reg CC amendments take hold. They establish a formal definition of what the Fed calls "electronically-created items." ECIs are check-like items that never exist in paper form, the Fed stated.
The amendments make clear that warranties described in Reg CC as applying to paper checks now also apply to ECIs and electronically returned checks. Language also has been added to the regulation indemnifying financial institutions receiving ECIs from any losses, claims or damages arising from the fact that an item did not originate as a paper check. And new indemnities have been added that address losses from ECIs not authorized by accountholders, as well as losses from duplicate ECIs.The regulatory changes have been languishing at the Fed since 2014, which led me to speculate the amendments had been tabled indefinitely. Now with the amendments set to take effect in just over a year, I'm optimistic that e-checks (ECIs) are poised for takeoff.
When I spoke with Clausen, he said Deluxe was on track to handle $5.3 billion in e-check transactions this year. And Deluxe isn't the only company that can support end-to-end electronic checks. Bank of America has teamed with technology startup Viewpost to support online initiation of check payments. Viewpost generates paper checks from digital instructions then images and submits the checks as RDC files.
There are other initiatives, too, like Checkbook Inc., which has an email-based electronic check product that can be offered to consumers or businesses. Now that the Fed has adjusted its regulatory framework to recognize fully electronic checks, e-check adoption can be expected to accelerate. 
Patti Murphy is Senior Editor of The Green Sheet and President of ProScribes Inc. She is also the founder of InsideMicrofinance.com. Email her at patti@greensheet.com.
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