[Senate Hearing 108-397]
[From the U.S. Government Publishing Office]
S. Hrg. 108-397
THE FEDERAL RESERVE BOARD'S PROPOSAL
ON CHECK TRUNCATION
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
ON
LEGISLATION TO INCREASE THE EFFICIENCY OF CHECK COLLECTION AND TO
ELIMINATE UNNECESSARY STEPS THAT WILL HELP IMPROVE OUR FINANCIAL SYSTEM
__________
APRIL 3, 2003
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island JON S. CORZINE, New Jersey
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Peggy R. Kuhn, Senior Financial Economist
Patience Singleton, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
THURSDAY, APRIL 3, 2003
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Bennett.............................................. 2
Senator Johnson.............................................. 3
Senator Bunning.............................................. 4
Senator Miller............................................... 4
Senator Hagel................................................ 5
Senator Chafee............................................... 5
Senator Sununu............................................... 15
Senator Allard............................................... 16
Prepared statement....................................... 41
Senator Sarbanes............................................. 30
Senator Carper............................................... 34
Senator Dole................................................. 41
Senator Schumer.............................................. 41
WITNESSES
Roger W. Ferguson, Jr., Vice Chairman, Board of Governors of the
Federal Reserve System......................................... 5
Prepared statement........................................... 42
Response to written questions of:
Senator Sarbanes......................................... 58
Senator Reed............................................. 65
Senator Schumer.......................................... 65
Lindsay A. Alexander, President & CEO, National Institutes of
Health Federal Credit Union; on behalf of the Credit Union
National Association........................................... 17
Prepared statement........................................... 46
Response to written questions of:
Senator Shelby........................................... 66
Senator Reed............................................. 67
Janell Mayo Duncan, Legislative and Regulatory Counsel, Consumers
Union.......................................................... 19
Prepared statement........................................... 48
Response to written question of Senator Reed................. 68
Danne L. Buchanan, Executive Vice President, Zions
Bancorporation; on behalf of the American Bankers Association,
America's Community Bankers, Consumer Bankers Association,
Financial Services Roundtable, and Independent Community
Bankers of America............................................. 21
Prepared statement........................................... 52
Response to written questions of:
Senator Sarbanes......................................... 69
Senator Reed............................................. 74
Senator Schumer.......................................... 75
Senator Bennett.......................................... 77
(iii)
THE FEDERAL RESERVE BOARD'S PROPOSAL
ON CHECK TRUNCATION
----------
THURSDAY, APRIL 3, 2003
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m. in room SD-538 of the
Dirksen Senate Office Building, Senator Richard C. Shelby
(Chairman of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The Committee will come to order.
We have some pending nominations and if we get a quorum,
Governor Ferguson, we will probably interrupt the proceedings
and move to the nominations and then go back to where we are,
so if you will be patient with us. We appreciate that you are
here today.
This morning the Committee meets to consider the Federal
Reserve Board's proposal on check truncation. We are very
pleased to have as our first witness Vice Chairman Roger W.
Ferguson of the Federal Reserve System, who will discuss their
proposal and its benefits in some detail.
For our second panel today, we will welcome three
witnesses: Ms. Lindsay Alexander, President and Chief Executive
Officer of the NIH Federal Credit Union, representing the
Credit Union National Association; Ms. Janell Mayo Duncan,
Legislative and Regulatory Counsel from Consumers Union; and
Mr. Danne L. Buchanan, Executive Vice President from the Zions
Bancorporation, testifying on behalf of several banking trade
associations.
Long before credit cards and debit cards came along, the
paper check served as a convenient and a safe means for
consumers to make purchases and pay bills. Despite the growing
popularity of these newer payment instruments, checks remain a
significant part of the American payment system. The Federal
Reserve System estimates that over 40 billion checks are
written annually, accounting for $39.3 trillion in payments.
I doubt that many of us have given any great thought to
what happens when we write a check to a merchant or put one in
the mail to pay a bill. Today's hearing provides us an
opportunity to highlight how the existing check clearing
process works and how little that process has changed to fully
incorporate advances in technology. I truly believe that most
Americans would be surprised at how dependent our system
remains on the physical transportation of paper checks.
Under current law, banks must physically present and return
original checks to receive payment unless the bank has an
agreement with another bank to do so by electronic means. Some
banks have such agreements and have been able to take advantage
of electronic processing using advanced imaging technology.
However, since there are over 15,000 banks, thrifts, and credit
unions, negotiating such agreements with each individual
institution would be impossible. As a result, we continue to
have billions of checks, literally tons of checks, either
trucked or flown across the country every night. Given the
availability of inexpensive electronic transmissions media,
this enormous dependence on ground and air transportation
systems makes very little sense. Truncation could be used to
make the process less expensive over the long-term.
The Fed's proposal would end the requirement to move paper
by allowing banks to transfer electronic images of checks
rather than the originals. In cases where a hard copy of a
check was needed, a legally equivalent substitute could be
downloaded from the electronic image and delivered to the bank.
The end result is considerable savings in time and money
through the elimination of an
outdated law. We can learn from the experience of the credit
union
industry, which has used the truncation process for many years.
We will hear more about that later this morning.
I look forward to hearing the testimony of the witnesses
today. Governor Ferguson, we are pleased to have you with us
this morning. Modernizing the check clearing process would
provide benefits to consumers and financial institutions and I
believe to our economy as a whole. I intend to work with my
colleagues on both sides of the aisle to develop legislation
that accomplishes this task.
Senator Bennett, do you have a statement?
COMMENTS OF SENATOR ROBERT F. BENNETT
Senator Bennett. Yes, thank you, Mr. Chairman. I very much
appreciate your holding this hearing. I will get into it more
when we get into the second panel, but I have seen this process
at work. I have seen the software. I have seen the product. And
once you have seen it actually happen, you wonder, why in the
world would anybody want to continue the present system?
We should remind ourselves that on September 11, the entire
airline system was shut down for security purposes. It was the
prudent thing to do. It was the essential thing to do. We did
not know where the attacks were coming from, and the only way
that we could find out was to get all of the airplanes out of
the sky and then any that were still flying, we knew were under
control by someone other than by the FAA.
That was the homeland security requirement. No one
questioned it at the time and no one would question it if it
were to be required again. But it completely brought to a halt
all transfer of funds in the United States because there was no
physical transfer of checks outside of individual communities.
And the economic cost of that physical transfer was highlighted
in that situation.
So in the new world in which we live, where terrorists can
interrupt economic activity with physical acts, we should have
an electronic work-around that can resolve that and keep the
economy going smoothly in the face of such an attack. And that
is why, in addition to all of the economic reasons, this makes
sense, there are security reasons why it makes sense as well.
I thank you again for holding the hearing.
Chairman Shelby. Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Chairman Shelby, for holding
today's hearing on check truncation. While we may not spend a
lot of time thinking about how our checks get processed, it is
clear that electronic presentment of checks is an important
step forward in modernizing our Nation's payment system.
In the days, as Senator Bennett has noted, following
September 11, when planes across the country remain grounded,
banks were forced to take drastic steps to ensure the shipment
of checks from bank to bank. Check payments across the country
were delayed, which opened up possibilities for processing
errors and fraud.
Electronic payments, on the other hand, continued to be
processed in a safe and timely fashion during that crisis. But
even absent a crisis, processing challenges confront banks in
my State of South Dakota every winter. Deep snowfalls and vast
distances between small town banks and processing centers add
significant costs to physical transportation of checks. These
costs trickle down to consumers and everyone ends up paying the
price of our outdated system.
Last year, I introduced a Check Truncation Act, together
with my colleagues, Senator Carper and Senator Miller. Our bill
would improve America's check payment system by allowing banks
to exchange checks electronically. Current law requires banks
to physically present and return original checks, a tedious,
antiquated, and expensive process. Our bill would also reduce
infrastructure costs for banks, allowing for more flexibility
and great cost savings for the consumer.
Our bill would not, however, prevent banks from returning
checks to consumers who still like getting their physical
checks
returned. Banks would continue to have the discretion to
provide
returned check services. The only difference would be that some
of those checks might be legal substitutes rather than the
original payment instrument, and this is an example of that
legal substitute [indicating].
The Federal Reserve Board has spent a greater deal of time
analyzing the potential benefits of check truncation. I want to
commend Mr. Ferguson and the Fed for their exhaustive efforts
in this area. They have put together a comprehensive working
group that included a diversity of viewpoints, ranging from
members of the industry to consumer representatives. Our bill
closely mirrors their proposal. Some of the Fed's
recommendations have evolved over time and I would urge the
Committee to pay attention to some of these changes as we
proceed with any legislation.
I also wanted to note that Senator Bennett, who is now
Chairman of our Financial Institutions Subcommittee, has spent
a great deal of time on this issue and our staff has been
working closely together with his on check truncation.
I look forward to working with Senator Bennett on this and
a number of issues that affect America's financial institutions
and Mr. Chairman, I am pleased that you are working so quickly
to focus the Committee's attention on the potential for check
truncation to increase the stability and efficiency of our
financial system.
It is the right time to give electronic versions of checks
the same legal validity as paper checks, so America's financial
institutions can provide customers with faster check clearing
and better access to liquid funds in both good times and times
of crisis.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. I want to thank
you for holding this hearing, and I would like to thank all of
our witnesses for appearing today.
I am very familiar with check truncation. My bank in
Kentucky has been truncating checks for a number of years.
There have been no problems, and I think it has added a good
service I receive by being able to have my checks cleared
faster. At my bank, we have seen none of the problems that at
least one of our witnesses will speak to today. Of course, not
every bank is as well run as the bank I have in Kentucky.
[Laughter.]
I certainly understand the concerns of opponents of the
Federal Reserve proposal. They are valid. But I believe that
they are being addressed. Nobody wants consumers to be charged
twice for a check-cashing service. We have to do what we can in
this legislation to make sure that it does not happen. We also
must make sure that criminals are not able to get their hands
on the original or truncated checks and do everything we can to
prevent fraud. I think the banks understand this. If one of
their customers is a victim of a double charge or fraud. It is
very likely that the consumer will vote with their feet and
probably take their family and friends with them. In this
highly competitive financial service environment, not very many
banks can afford that.
I would especially like to welcome Governor Ferguson today.
I am probably one of the Fed's strongest critics when I think
they have done something outside of their mandate, and I make
no apologies for that. But if I am going to criticize the Fed
when I believe they are wrongfully exceeding their mandate, it
is only fair that I compliment them when I think they are doing
a job well done. I believe the Fed should be commended for
moving this issue forward and trying to promote the use of
technology to clear checks faster. Clearing checks faster is
pro-consumer.
Once again, Mr. Chairman, I thank you for holding this
hearing and I look forward to hearing from our witnesses.
Chairman Shelby. Thank you.
Senator Miller.
COMMENTS OF SENATOR ZELL MILLLER
Senator Miller. Thank you, Mr. Chairman, for holding
today's hearing, and I thank all of the witnesses for being
here.
I have no opening statement.
Chairman Shelby. Senator Hagel.
COMMENTS OF SENATOR CHUCK HAGEL
Senator Hagel. No, I do not have an opening statement, Mr.
Chairman. Thank you.
Chairman Shelby. Senator Chafee.
COMMENTS OF SENATOR LINCOLN CHAFEE
Senator Chafee. I have no opening statement. Thank you.
Chairman Shelby. Thank you.
Governor Ferguson, you proceed as you wish.
STATEMENT OF ROGER W. FERGUSON, JR.
VICE CHAIRMAN, BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
Governor Ferguson. Thank you very much, Mr. Chairman. I
would also like to thank the Committee for inviting me to
discuss the proposed Check Truncation Act and for holding
hearings on this very important legislative initiative.
The proposal that the Board forwarded to Congress in
December 2001, is designed to remove the legal barriers to the
use of new technology in check processing. It accomplishes this
essentially by allowing banks to replace one piece of paper
during the check collection or return process, the original
check, with another piece of paper that contains exactly the
same payment information, a substitute check. This simple
change holds the promise of a more efficient check collection
system.
Today, consumers, businesses, and the Government write
about 40 billion checks annually. And over the years, banks,
thrifts, and credit unions, which going forward I will refer to
collectively as banks, have applied a variety of electronic
technologies to automate check processing, which involves
handling and sorting checks so that they can be physically
shipped to their destinations.
A typical check is processed several times before it is
eventually paid. First, it is processed by the bank in which it
is deposited. Then it may be shipped for processing to one or
more intermediaries. And finally, it is shipped for processing
and payment to the bank on which it is drawn.
While most checks are currently processed in this fashion,
some checks are removed from the collection process and the
payment information on the checks is captured and delivered
electronically to the banks on which they are drawn. This
process, which is commonly referred to as check truncation, as
Senator Bunning has
indicated, reduces the number of times that each check must be
physically processed and shipped. As a result, check truncation
is generally more efficient, more cost-effective, and less
prone to processing errors.
The check system's legal framework, however, has not kept
pace with technological advances and is now constraining the
efforts of many banks to use new electronic technologies, such
as digital check imaging, to improve check processing
efficiency and to provide improved services to customers.
Today, check truncation can only occur by agreement of the
banks involved because existing law requires the original paper
checks to be physically presented or returned in the absence of
an agreement to the contrary. Given the thousands of banks in
the United States, it is not feasible for any one bank to
obtain check truncation agreements from all other banks, or
even a large proportion of them. Therefore, legal changes are
needed to foster the use of new electronic technologies to
improve check processing and to reduce the need for physical
transportation in the check collection process.
The proposed legislation facilitates check truncation early
in the check collection or return process, without mandating
that banks accept checks in electronic form. The proposed
legislation accomplishes this by creating a new negotiable
instrument called a ``substitute check,'' and this, as you have
already seen, is an example of a substitute check. That is a
check that banks could use in place of an original check.
Under the proposed legislation, banks would be able to
truncate original checks, process check information
electronically, and deliver substitute checks to other banks
and bank customers that want to continue receiving paper
checks. As a result, banks could handle much of their check
processing electronically without needing to obtain legal
agreements from thousands of other banks to truncate checks.
A substitute check would be the legal equivalent of the
original check, and could be used by both banks and their
customers just as if it were the original check. It would look
like a regular check, as you have seen, would carry an image of
the original check on the front and the back, as you can tell,
and could be processed on existing check processing equipment.
Under the proposed legislation, a bank could still demand
to receive paper checks, although it would be likely to receive
a mix of both original checks and substitute checks. Because
substitute checks could be processed just like original checks,
the bank would not need to invest in any new technology or
otherwise change its current check processing operations.
Further, bank customers that receive cancelled checks with
their monthly statements would continue to receive cancelled
checks. Only some would be the original checks and some would
be substitute checks. Bank customers would be able to use the
substitute checks in exactly the same way that they would use
the originals.
While allowing banks to replace one piece of paper with
another might seem like a small change, eliminating the need to
deliver original checks would allow banks to speed up a process
of technological transformation in check clearing that is
already under way. By adopting a market-based approach that
permits each bank to decide when and how to use substitute
checks, the proposed legislation should result in the use of
technology to provide a more efficient and flexible check
collection system.
The proposed legislation would also help address the risks
to the check collection system from its extensive reliance on
air transportation that was highlighted immediately after the
September 11 tragedy. One effect of air transportation being
grounded was that the flow of checks slowed dramatically.
During the week of the
attacks, the Federal Reserve Bank's daily check float ballooned
to over $47 billion, which is more than one hundred times its
normal level.
Had the proposed legislation been in effect at that time,
and had the banks been using a more robust electronic
infrastructure for check collection, banks would have been able
to collect many more checks by transmitting electronic check
information across the country and presenting the substitute
checks to paying banks that desired them.
The proposed legislation might also enable banks to provide
new and improved services to their customers. For example,
banks might allow some corporate customers to transmit their
deposits electronically.
Further, if banks begin to transmit check images from the
point of deposit to their operation centers for processing,
they might be able to establish branches or ATM's in more
remote locations and provide later deposit cut-off hours for
their customers. Later deposit cut-off times could result in
some checks being credited one day earlier and interest
accruing one day earlier for some checks deposited in interest-
bearing accounts.
Because the proposed legislation will likely encourage
greater investments in image technology, banks might also be
able to expand their customers' access to enhanced account
information and check images through the Internet. In addition,
banks might be able to resolve customer inquiries more easily
and quickly than today by accessing check images.
Further, as the banks reduce their operating costs, the
savings will be passed on through a combination of lower fees
to their customers and higher returns to their shareholders.
After all, the banking industry, as Senator Bunning has already
noted, is quite competitive. And banks have indicated that they
expect cost savings to be substantial.
While there is a fairly broad consensus on the desirability
of the underlying concepts of the proposed legislation to
permit the use of substitute checks, the issue of customer
protections has been the subject of much debate. Since we
forwarded the proposed legislation to Congress in late 2001,
the Board has had an opportunity to further reflect on the
views that have been expressed by both consumer advocates and
the banking industry.
The Board originally included the expedited recredit
provisions in an attempt to balance the interests of consumers
and banks. Given that existing check law already protects
customers from check processing problems, and there does not
appear to be a pattern of problems suggesting these protections
are inadequate, the Board has now concluded that these
provisions are not necessary for the successful implementation
of the proposed legislation.
Congress, however, may arrive at a different conclusion as
it considers the need for customer protections, and I would
like to briefly discuss why we believe the expedited recredit
provisions are not necessary.
The Board's proposed legislation extended the protections
of the existing check law, including the Uniform Commercial
Code, or UCC, and the Federal Reserve Board's Regulation CC, to
substitute checks as though they were original checks.
Long-established check law protects bank customers if
checks are improperly charged to their accounts. If a bank
charges a customer's account for a check that is not properly
payable, the bank could be liable to its customer not only for
the amount of the unauthorized charge, but also for interest on
that amount and consequential damages for the wrongful dishonor
of any subsequently presented checks.
While it is true that the UCC does not provide a specific
time frame within which a bank must act, the UCC's provisions
give the bank a significant financial incentive to resolve
problems on a timely basis.
Specifically, the longer a bank takes to research and
resolve a customer's claim, the longer the bank is exposed to
the liability for consequential damages arising from the
wrongful dishonor of subsequently presented checks.
These existing protections appear to have worked well for
many decades.
In addition to the protections provided in current check
law, the proposed legislation requires banks to provide new
warranties for substitute checks and to indemnify customers for
losses resulting from the receipt of a substitute check instead
of the original check. Specifically, banks must warrant that
substitute checks that they handle are legally equivalent to
the original checks and that the check will not be paid more
than once from a customer's account.
Banks must also indemnify customers for losses they incur
due to the receipt of substitute checks rather than the
original checks. And taken together, these warranties and the
indemnity provisions provide customers with, I think,
additional protections against losses related to the use of
substitute checks.
The use of substitute checks is not expected to result in
problems different from those that are routinely addressed in
today's environment. And existing law already encourages the
prompt redress of consumer complaints.
Therefore, the Board believes that the significant
compliance burdens imposed by the expedited recredit provisions
on banks that receive substitute checks would outweigh the
small incremental benefits that the provisions would provide to
consumers.
Nonetheless, Congress may conclude that the expedited
recredit provisions for consumers should be included in the
legislation. In that case, we believe any expedited recredit
provisions should be consistent with the proposed legislation's
basic purposes and should not go beyond the provisions proposed
by the Board. In the unlikely event that additional consumer
protections are needed for substitute checks, the proposed
legislation grants the Board the authority to adopt such
protections by regulation.
In conclusion, although an increasing number of payments
are being made electronically, it is clear that checks will
continue to play an important role in the Nation's payment
systems for the foreseeable future.
The Board believes that over the long run, the concepts
embodied in the Check Truncation Act will spur the use of new
technologies to improve the efficiency and the flexibility of
the Nation's check collection system, and provide better
services to bank customers.
The proposed legislation accomplishes this by simply
permitting banks to replace one piece of paper, the original
check, with another piece of paper, the substitute check, and
both of which contain the same payment information. Because the
proposed legislation should result in substantial cost savings,
it would also be desirable to begin obtaining these savings as
quickly as possible.
We look forward to working with the Committee as it further
considers this legislation. I thank you gentlemen for your time
and I would be happy to answer your questions.
Thank you.
Chairman Shelby. Governor Ferguson, I believe this is a
copy of a check that the Fed has given us.
Governor Ferguson. Yes. This is what a substitute check
would look like. As you can see, it is very much the same size
as a regular check and it includes notification.
Chairman Shelby. It is very clear, the imaging on it.
Governor Ferguson. Yes, it is quite clear. The technology
for imaging is good.
Chairman Shelby. I think most of the Members have seen that
up here. I do not know about the press.
The use of imaging technology is an additional cost to
banks and may be a larger consideration for smaller community
banks. Is there any reason, Governor Ferguson, to believe that
up-front costs could impede the small banks from moving toward
more electronic processing?
Governor Ferguson. No, I have no reason to believe that the
up-front costs will impede the small banks from moving. The
cost of the imaging equipment has come down quite dramatically.
And there also are a number of service providers that are
willing to provide that kind of service to small banks. So, I
think there is no competitive disadvantage that could emerge
from this legislation.
Chairman Shelby. Wouldn't electronic processing be
particularly attractive to banks which are more remotely
located and are thus, sensitive to transportation disruptions
or paper checks?
Governor Ferguson. Absolutely. It would be both beneficial
to the banks and as Senator Johnson has indicated, potentially
beneficial to those customers, as well as time speeds up.
Chairman Shelby. Rural areas?
Governor Ferguson. Rural areas, mountainous areas, areas
with bad weather that impedes transportation. There are a
number of parts of the country where this is clearly a net
plus.
Chairman Shelby. The Fed is required, as I understand it,
to monitor funds available under the Expedited Funds
Availability Act. Greater use of electronic images will likely
mean that checks will clear through the system faster, as you
have indicated. Assuming that truncation legislation is passed,
would it be appropriate to phase in truncation prior to making
decisions regarding expedited funds availability? In other
words, how long a trial period of observation would be
appropriate here?
Governor Ferguson. Well, I think, as I have tried to
suggest, that since there are some savings and benefits here,
it is appropriate to move expeditiously, as you intend, and to
make sure that the effective date is as near to passage as you
think reasonable.
I do not see a reason to phase in truncation per se. I do
think it is appropriate to let truncation and this Act develop
over some time and give us plenty of opportunity to see what
does, in fact, happen with respect to presentment times and
when that funds availability becomes sooner.
We will be monitoring that extremely closely and will be
prepared to act under the Expedited Funds Availability Act as
soon as the facts do become clear.
So, I think that there would be nothing that we would do
that would slow down the benefits at all. We would be quite
aware of the question that you just raised and our need under
the Act to track very closely when funds become available to
make sure that the regulations reflect reality.
Chairman Shelby. You went into this earlier, the truncation
at the point of sale.
Some merchants have implemented programs to truncate checks
at the point of sale in stores already. In some of these cases,
the consumer actually gets to keep a copy of the cancelled
check. This type of system also has some appeal as it permits
customers to continue to use checks that they are familiar with
while also eliminating transportation of paper checks. Has the
Fed been involved in these types of initiatives?
Governor Ferguson. We have been watching them and
monitoring them closely. We spend a great deal of time--I
personally, and the staff even more so--talking to the
institutions that have been doing this, including some of the
larger retailers.
Many of the benefits that you observed have come forward.
And what we have seen, particularly in grocery stores and
others that have a heavy dependence on cash and checks, is that
for many of them, this has been a real plus. It has been
important, obviously, to explain to customers that they will
get their check back and what that implies. But there seem to
be no major problems that have emerged as we have watched this
closely.
Chairman Shelby. As I understand it, these transactions are
handled through an automated clearinghouse and are not governed
by check law. Can you confirm that?
Governor Ferguson. That is true. In those cases, the check
is being used as the initiating document for electronic funds
transfer and it is not governed by the usual check law.
Chairman Shelby. What about the customer acceptance of
that?
Governor Ferguson. There appears to be no problem with
customer acceptance. Many customers already are familiar with
electronic deposits, electronic debits, et cetera, and they
understand in many cases what is happening. The only thing that
needs to be explained is that they will be getting their check
back and that it is just being used in some cases to start an
electronic funds transfer.
Chairman Shelby. As we move toward greater use of
electronic images, there will have to be some type of standard
format or data requirements for the substitute checks. Could
you elaborate as to what set of standards there would be and
how detailed those standards are likely to be?
Governor Ferguson. There is a private-sector group called
ANSI, I believe, that is already working with respect to the
question of standards. The standards would have to do with
things such as the placement and size of the image on the
substitute check. There would also have to be standards in the
image archives themselves to make them work together, to make
them more interconnected.
But the good news is that there is already progress
underway there and that there are many standards that the
private sector is developing that are responding to the
questions that I have just identified, such as what the
contrast should be, for example.
Chairman Shelby. Governor, the privacy of electronic
checks, that has been raised. What protections govern how
financial institutions and other processors use these images
and the information on them?
Governor Ferguson. Well, the check activity would be
governed by the usual rules that cover privacy and financial
privacy, and you are obviously well aware of what those rules
are. There is nothing here that would in any sense change that
one way or the other.
I would also hasten to add that there is nothing in the
ability to use images that creates new incentives for banks to
change or violate privacy of their customers. So the
preexisting privacy laws would obviously continue to apply for
the substitute checks in images, as well as the existing
approaches to paper checks.
Chairman Shelby. Senator Bennett.
Senator Bennett. Governor Ferguson, are you familiar with
the 1996 study published by the Michigan Federal Reserve Bank's
quarterly review?
Governor Ferguson. I think I am, yes. You may have to
remind me of some of the details. But go ahead.
Senator Bennett. In that study, they said that the social
cost of clearing a check is currently $3, and it would be $1.25
for an electronic transfer. Do those numbers sound about right
to you?
Governor Ferguson. Those numbers sound about right, but let
me be cautious.
It has always been hard for us to get a very good fix on
the social cost. I have seen numbers that size. I have seen
numbers somewhat smaller, to be fair. I have seen numbers on
the scale of $20 billion, for example. But there is a
significant cost in the check clearing process. And as I have
said, I believe, and based on talking to bankers, that there
would be significant cost savings.
I would encourage you, Senator, to talk to the second panel
where there are some bankers to talk about their experience and
what the cost savings may look like. It has been very hard for
us to really get the kind of Fed quality numbers on cost
savings, but I am quite convinced that there would be
significant cost savings that would occur.
Senator Bennett. I picked on that one because it is
connected to the Fed. It is the Minneapolis Federal Reserve
Bank.
Governor Ferguson. Right. I realize that. And as I said,
that study is certainly a valid one. We have had many other
studies as well and the numbers do change somewhat.
The reason I suggest that you talk to the banks in
particular is that the Act deals with permission to do
something. Part of the question of how much cost savings comes
depends on how fully the banks use it. That is the linkage
there.
Senator Bennett. My own assumption--my own experience, I
should say--says that as it becomes more widespread, the cost
savings would become even greater.
Governor Ferguson. I agree.
Senator Bennett. So, you do not know the assumptions that
are built into this as to what level of use it has. But simply
doing the math, that is $73 billion a year, if you take the 42
billion checks.
Governor Ferguson. There are significant savings,
potentially significant savings. The question of how much of
those savings we capture and how quickly depends on business
decisions and how quickly banks continue to go down this path.
Senator Bennett. Now can you address or do you know of any
studies that address the issue of the increased profits to the
banks that come as a result of the reduced float time?
Governor Ferguson. I have not seen any studies that address
that specifically. I would again encourage you to talk to some
of the bankers that are on your second panel.
But one of the things that one has to recognize is, as I
have indicated as an economist, and others here know, the
banking industry is extremely competitive. And one of the
things that I have seen in a number of advances in payment
systems, including creation of ATM's and other things, is that
because of the competitive nature of the industry, the cost
savings that occur to banks are quickly transmitted in terms of
better products and services for customers, because, indeed,
customers get a number of mailings as you know with respect to
bank services almost on a daily basis.
It is also the case that we have found many of these
advances with respect to payment systems, if they have led to
greater profitability, have obviously then been returned to
bank shareholders.
So, I am not in any sense concerned about how our financial
system works from a competitive standpoint, and insofar as
there are cost savings. I think they will accrue to consumers
in one form or another over time because we have a very
competitive banking system. And that has been borne out with
almost every advance with respect to payment systems, that,
ultimately, the banks make the investments and the consumers
reap the rewards in one form or the other--lower costs, better
services.
Senator Bennett. That is the point I was hoping the
question would make, and I thank you for that explanation
because it is very clear that if we can bring the costs of
doing business down in the economy wherever, the net result is
more economic efficiency. More economic efficiency means lower
prices, and it ultimately means better economic activity.
One of the challenges that we have in the Congress right
now is that we are in a sluggish economy and we are trying to
find ways to make it revive. And if we could do something that
puts $73 billion a year, plus whatever additional economic
advantage would come from the improvement of the float, into
the economy, at least during the budget debate, we would say
that was a good day's work, if we could find $73 billion of
stimulus one way or the other.
[Laughter.]
The only other comment I would make, echoing what Senator
Johnson has said, is there are plenty of rural people in Utah.
And to do something that would improve services to the
customers who live in those rural towns is something that
clearly we need to do.
However, we should be careful not to get carried away with
concerns that apply theoretically that cause us to deny
benefits that are there in reality for a lot of people who do
not happen to live in big cities.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Johnson.
Senator Johnson. I will waive questioning, Mr. Chairman.
Thank you.
Chairman Shelby. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
I don't know whether you read Ms. Duncan's testimony or
not.
Governor Ferguson. I am aware of some of it. I have been
told some of it.
Senator Bunning. Would you like to respond or comment on
some of her concerns? Particularly the recommendations that she
has made on the final page.
Governor Ferguson. I do not have the recommendations per
se.
Senator Bunning. Because all consumers are equally
susceptible to harm from processing errors, the recredit
loophole in the proposed ETA should be closed----
Chairman Shelby. Senator Bunning, could you suspend? We
have a quorum now where we can move----
Senator Bunning. Absolutely.
[Laughter.]
Chairman Shelby. Thank you. We will now move into Executive
Session and deal with some nominations.
We have: Alfred Plamman, to be a Member of the National
Consumer Cooperative Bank; Thomas Waters Grant, Noe Hinojosa,
and William Robert Timken, all of whom were nominated to be
Directors of the Securities Investor Protection Corporation.
All of these nominees appeared before this Committee at a
hearing held on March 25. So, I would ask now, is there any
comment or debate on the nominations?
[No response.]
Hearing no objection, it is so ordered.
All in favor of the nominations, say aye.
[A chorus of ayes.]
Chairman Shelby. Those opposed, no?
[No response.]
Chairman Shelby. The ayes appear to have it. And the four
nominations will be favorably reported to the Full Senate.
Thank you, Senator Bunning.
Senator Bunning. Thank you.
Chairman Shelby. Senator Bunning is recognized again.
Senator Bunning. Mr. Ferguson, would you like to comment?
Governor Ferguson. Yes, I would like to comment on them. I
would also observe that, having been a nominee before this
Committee, I am pleased to see the Committee move so
expeditiously with nominations.
[Laughter.]
To a more serious point, because I take it very seriously,
the concerns that have been raised in this testimony,
particularly the recommendations, are ones that, frankly, I do
not share. And it is not from any lack of concern about
consumers whatsoever on my part. It is rather based on analysis
of the current situation and what the likely new situation
would be under the Check Truncation Act.
The current situation is one in which we have a number of
laws that emerged out of common law because people have been
drawing drafts on banks for hundreds of years. It has been
codified in the UCC and also in some Federal Reserve
regulations, in which the banks, if they do, inadvertently do a
double debit, have the legal responsibility to fix that problem
so that the consumers are not at risk there and there are a
number of incentives that are built in to encourage the banks,
incent the banks, to fix any of those problems early on.
I would also observe, as others have, that we have a system
that has 40 billion checks or so every year. And as we have
looked at our databases, we see very, very few problems across
all of the regulatory agencies that deal with consumer
complaints, that deal with the kinds of concerns that are
raised here in terms of double debits or a calculation error or
an error in simply transmitting the correct information. So, we
have a system that works very well.
All we are doing here under this proposal is creating a new
form of paper in lieu of the old form of paper. But the same
protections would be there and we have proposed some new
protections in terms of a warranty and an indemnity.
Now to the specifics. That is the background, of a system
that works well, common law that is codified that has worked
well, plus some new protections here to really give the right
kind of teeth to this legislation.
Now to go to these two comments.
First, on the question of processing errors and the right
of recredit to be expanded, I have said to you, while we would
have no objection if you wanted to put in a right to recredit,
we do not think it is necessary. We do believe that if you
choose to put in, the right to recredit, it should not be
expanded beyond the case in which consumers get back a
substitute check. The reason is that if we expand it more
broadly than that, you are going to find that we have two
different types of legal regimes that could potentially, as you
were indicating, come into conflict with each other.
We would be building a system in which we are trying to
protect against potential risks that I think are really fairly
remote. And so, if one were to have a recredit, I would
encourage it to be a fairly narrow and focused recredit because
otherwise, you are opening up a case in which consumers do not
know which rights they really have and you are creating, I
think, more confusion than you are clarity.
With respect to the second point here regarding the
comparative negligence standard as an inappropriate way to
resolve harm suffered by consumers due to processing errors,
again, we have very, very few processing errors as far as we
can tell. But this question of comparative negligence already
exists in many of the common law standards for tort and
particularly as embodied in a variety of different ways,
sometimes using the words, comparative negligence, sometimes
not, in the UCC. And it has withstood the test of time.
I would argue that comparative negligence is a standard
that is well understood in common law, well understood in
business tort, well understood in check law, and I think that
is appropriately maintained by the Check Truncation Act as we
have proposed it.
So in both cases, while I am always sympathetic to consumer
interests as part of what I am asked to do, I think that these
two recommendations really do not find a useful place in the
kind of proposal that is being put forward here, and they are
indeed presuming a greater degree of risk than we think is
likely to occur, and are creating, if you will, a set of check
law that is in some sense, in the case of recredit, not a
necessary addition to a check law that we have had for many
years that works very well and that would not be undercut--in
fact, would be reinforced--by what we have in the proposed Act.
Therefore, I am not supportive of these two
recommendations.
Senator Bunning. Thank you very much.
Chairman Shelby. Senator Miller.
Senator Miller. I guess following up a little bit more on
that, Governor Ferguson, you do not have a great concern, then,
of the possibility of the customer getting debited twice, once
for the original check and once for the substitute check?
Governor Ferguson. No, I do not because there are a number
of incentives already built in that stop that from happening.
We have, as I said, 40 billion checks a year that are
written now and we have very little evidence of this as a major
problem whatsoever. And partially, I think it has to do with
the incentives that Senator Bunning talked about in the
competitive environment.
Banks have created a number of systems to minimize the risk
of a double debit, and I do not think that creating an
opportunity to use more electronics is going to increase that
risk or change those incentives.
Senator Miller. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Sununu.
COMMENTS OF SENATOR JOHN E. SUNUNU
Senator Sununu. Thank you, Mr. Chairman.
Governor Ferguson, could you be more specific? Very little
evidence, 40 billion checks. For what percentage does the
double debit problem exist?
Governor Ferguson. We have gone back and looked at the
databases of all the consumer complaints that we have had. I
believe that we have absolutely none where I have heard
anything of a double debit.
[Pause.]
And the staffers are shaking their heads in agreement.
There may be the rare case out there, but it has not emerged
through the complaint process.
Senator, I am not going to be facetious at all. I get a
large number of letters with a variety of complaints about
things that banks do. I have gone back and looked at my files
and the things that I have responded to. And over the 7 years
that I have been on the Board, the 6-plus years that I have
been on the Board, I haven't received one complaint of this
nature.
So, I would have thought since there is something at stake
here, that either the formal complaint process or others would
suggest an issue here.
Senator Sununu. And other than the interpretation based on
correspondence or complaints that you are receiving through
formal channels, there is no statistical database of the 40
billion checks and what kind of problems----
Governor Ferguson. No. We have a statistical database for
all complaints. There is not a statistical database of what
happens to the 40 billion checks.
Senator Sununu. Okay.
Governor Ferguson. But since we are responsible for
consumer complaints in part, we have looked across all the
FFIEC agencies and we see nothing there.
Senator Sununu. No evidence that consumers are reluctant to
call you and complain?
[Laughter.]
Governor Ferguson. I am not encouraging more of that.
[Laughter.]
But, no, there is no evidence of reluctance of their part
to let me know if things are not going well.
Senator Sununu. You say that you do not recommend or
advocate necessarily for a credit provision. Correct?
Governor Ferguson. That is correct.
Senator Sununu. Why not? And I apologize, it may have been
at least touched on in your testimony, which I missed. But
could you elaborate on the reason that recredit, you do not see
it as being necessary?
Governor Ferguson. We do not see it as being necessary
because current check law gives the right set of incentives to
fix any problems that might emerge. Banks have effective
problem-solving resolution processes already for these kinds of
problems insofar as they emerge. And we have proposed in this
Act an additional warranty and an indemnity that gives even a
little more strength there.
We do not see that there is a hole in current existing law
that needs to be filled because of this new proposed approach
to dealing with paper checks. And so, it is just simply an
analysis based on reflection, the passage of time, and a better
understanding.
Senator Sununu. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Allard.
COMMENTS OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman. I have a couple of
questions concerning the point of sale of the merchandise.
Will it be possible at some point to eliminate the paper
check at the point of sale or purchase instead of at the point
of first deposit, further reducing the paper requirements?
Governor Ferguson. It is quite possible that other
institutions may decide that they want to truncate the checks
and pass that
information on electronically and use that to start an EFT, an
electronic funds transfer.
Some of that already does occur. And obviously, we have a
large number of nonpaper-driven retail payments through the
form of debit cards and credit cards already.
So, indeed, we are getting assistance and becoming
gradually more electronic and less paper-based. But when you
start with a system that has 40 billion checks, we still have a
very large critical mass of checks. Even though they are not
increasing, other things are, and we will I think over time see
fewer checks being written. But, still, when you are counting
things in the billions, it is important to deal with that
problem as well.
Senator Allard. Well, when a consumer gets used to a
certain format, they tend to like to stick with it,
particularly as they get older. They do not like to change.
Governor Ferguson. Right.
Senator Allard. My understanding is the retailers generally
support your effort on check truncation. There has been some
that have expressed concerns with the logistics of the warranty
provisions in the draft legislation from the standpoint that a
retailer would like to process a check electronically from the
point of sale.
If the warranty to process a check electronically with
legal protections came from individual banks, a clerk would
have to examine each check to determine whether it was written
on the bank providing the retailer with a warranty. Do you see
the need for revisions or expansions in that area?
Governor Ferguson. No, I do not. I think it is not as
onerous a problem as perhaps some believe--we thought through
this balance issue and are pretty comfortable with where we
came out in the proposed legislation. I do not see any reason
for changes there.
Senator Allard. Thank you, Mr. Chairman. I ask unanimous
consent that my opening remarks be made a part of the record.
Chairman Shelby. Without objection, your statement will be
made part of the record.
Governor Ferguson, we appreciate your appearance here
today. We might have some other questions for the record and we
will
expedite them to you.
Governor Ferguson. Sure.
Chairman Shelby. Our second panel will consist of: Ms.
Lindsay Alexander. She is President and Chief Executive Officer
of the NIH Federal Credit Union in Rockville, Maryland. She
will be representing the Credit Union National Association. Ms.
Janell Mayo Duncan, Legislative and Regulatory Counsel,
Consumers Union. And Mr. Danne Buchanan, Executive Vice
President, Zions Bancorporation, on behalf of the American
Bankers Association, the
Financial Services Roundtable, America's Community Bankers,
Independent Community Bankers of America, and the Consumer
Bankers Association.
We welcome all of you here today. Your written statements
will be made part of the record in their entirety and if you
would sum up the points of what you want to touch on, it would
be appreciated and it would give us some time to ask questions.
Ms. Alexander, we will start with you.
STATEMENT OF LINDSAY A. ALEXANDER
PRESIDENT & CHIEF EXECUTIVE OFFICER
NATIONAL INSTITUTES OF HEALTH FEDERAL CREDIT UNION
ON BEHALF OF THE
CREDIT UNION NATIONAL ASSOCIATION
Ms. Alexander. Chairman Shelby and Members of the
Committee, thank you for the opportunity to provide comments on
how check truncation has been working at credit unions for the
past three decades. I am Lindsay Alexander, President and CEO
of the National Institutes of Health Federal Credit Union in
Rockville, Maryland. I am testifying before you today on behalf
of the Credit Union National Association, CUNA.
I would like to provide you with information regarding how
check truncation works at credit unions and insight into our
views on proposals to facilitate check truncation.
Most credit unions that offer checking accounts truncate.
Sixty-four percent of credit unions offer checking accounts,
and of those credit unions, 91 percent truncate share drafts or
checks.
Credit unions tends to truncate checks at the last step in
the check collection process by not distributing share drafts
to their credit union members by not giving the checks back.
Credit unions do not usually truncate the checks drawn on
other financial institutions that their members deposit or use
to make loan payments at the credit union.
Credit unions have found that check truncation, under
existing check law, allows credit unions to serve their members
very well. The experience of credit unions is that our members
rarely request or need originals from truncated share drafts or
checks.
We found in an informal survey in 2001, that of 1.1 billion
checks, only about 480,000 requests, or 0.04 percent, were made
for the original check. In almost all cases, a good quality,
clear image of the check satisfied the member's needs.
I would like to now describe the experience of my credit
union.
Like most credit unions, we do not return checks to members
and never have. We image all the checks that we receive, both
the checks drawn on our members' accounts and the deposited
checks from other institutions. This imaging service reduces
the time it takes to retrieve checks from approximately 2 to 3
days to almost instantaneous.
In my 14 years at NIH Federal Credit Union, we have never
had a member that has complained about not getting an original
check. In those cases where the member does request a copy, the
most common reasons are because the member needs it for proof
of payment or for an audit. At my credit union, about 90
percent of those that request a copy need it as proof of
payment and about 10 percent request it for audits such as IRS
audits. In a very few, isolated cases, members need it for a
court case or some other reason.
The Federal Reserve initially presented to Congress a
proposal allowing financial institutions to voluntarily decide
to present an item totally electronically without the need for
previously adopted agreements. The Federal Reserve proposal
would have allowed existing truncation programs, such as those
in credit unions, to
co-exist, without imposing new requirements from the proposal
on existing credit union programs.
We strongly support that provision in the Federal Reserve
proposal. And we strongly oppose any expansion of the scope of
the Act that would impose requirements on check truncation
programs that already exist and do not use a substitute check.
Expanding the scope of this Act is unnecessary and would
interfere with credit union check truncation programs that
already seem to be working very well.
We support changes that have been made to the Federal
Reserve proposal that appear in the Check Clearing for the 21st
Century Act, that was recently introduced by Representatives
Hart and Ford in the House. These changes would allow the
financial institutions to truncate all types of checks.
Moreover, the House bill
allows an indemnifying financial institution to produce a copy
to
resolve a consumer's complaint or claim when a copy is
sufficient for that purpose.
The experience of credit unions is that at nearly all times
a copy is indeed sufficient, so there should not be a
requirement to reproduce anything more than a good quality
copy.
We are also supportive of consumer protections in the House
bill that mirror those of existing laws and give credit unions
more time to investigate complaints. The recredit procedure in
Section 6 gives the member's credit unions 10 business days to
investigate the claim before being required to recredit the
member and 45 calendar days in certain unique circumstances.
The credit union's ability to investigate a consumer's
claim prior to being required to recredit the consumer's
account is essential for the credit union to avoid fraud losses
from the new expedited recredit procedure.
In conclusion, most credit unions truncate their share
drafts or checks and have done so for decades. We remain
supportive of the current attempts to voluntarily facilitate
check truncation and we look forward to working with the
Committee, the Federal Reserve, and consumers in further
strengthening this proposal.
I thank you for this opportunity to comment and I would be
happy to answer any questions.
Chairman Shelby. Ms. Duncan.
STATEMENT OF JANELL MAYO DUNCAN
LEGISLATIVE AND REGULATORY COUNSEL
CONSUMERS UNION
Ms. Duncan. Good morning, Chairman Shelby and Members of
the Committee. Thank you for providing me the opportunity to
come before you today. I am Janell Mayo Duncan, Legislative and
Regulatory Counsel at Consumers Union. And my testimony today
on the proposed CTA is supported by the Consumer Federation of
America, the U.S. Public Interest Research Group, and the
National Consumer Law Center.
We believe that in its current form the proposed CTA would
be bad for consumers for three important reasons. First, the
proposed legislation would eliminate the ability of an
estimated 45 million consumers to receive their original
cancelled paper checks each month. Second, the recredit
provisions in the proposed CTA would not protect all consumers
whose check information is processed electronically. Third, if
enacted into law, the proposed comparative negligence
provisions would give banks an unfair ability to deter, delay,
or reduce claims for damages resulting from processes errors by
alleging that a consumer was somehow at fault.
Although we recognize the value of the advances in
technology, and we recognize what they could provide to
consumers, we are concerned that the proposed CTA would take a
system that works relatively well and change it in a way that
imposes new risks on consumers.
Those risks include: The inability to get original checks
back in order to prove payment or forgery. Potential improper
account debits resulting from the double processing of a single
check. Errors in reading the amount of, or account number on, a
check.
This proposal contains a loophole. Recredit is limited to
consumers who receive substitute checks back from their banks.
However, issuance of substitute checks is at the discretion of
each back.
Although Section 6 of the proposed legislation requires a
bank to put $2,500 in disputed funds back into a consumer's
account if the matter is not settled in one business day, it
would allow consumers to seek recredit of disputed funds only
if they receive a substitute check from their banks.
Banks could prevent consumers from having the right to
recredit simply by not issuing them a substitute check. We
believe that the recredit provision should be mandatory and
extend to all consumers, regardless of whether or not he or she
receives a substitute check.
Consumers unable to seek recredit would not be similarly
and adequately protected. They would have to seek redress under
the UCC provisions and State law that do not require a bank to
redeposit disputed funds in consumer accounts and would require
a consumer to sue his or her bank over disputes. This is too
expensive and time-consuming for consumers for most amounts
likely to be in dispute.
Although the proposed CTA has added warranty and indemnity
provisions, they also require a lawsuit to enforce. Because all
consumers are equally susceptible to harm from processing
errors, the recredit loophole in the CTA should be closed and
the right expanded to apply in every case.
The recredit provision is critical. Until a recent
reversal, the
importance of the recredit provision has been recognized by the
Federal Reserve Board. The initial summary documents that were
included in the transmittal letter sent in December 2001, by
Chairman Greenspan to then-Banking Committee Chairman Sarbanes
with the proposed CTA stated: ``The expedited recredit
procedure is intended to mitigate the effects on consumers of
any potential problems associated with the receipt of
substitute checks.'' It also states: ``These expedited recredit
provisions of the proposed Act are limited to consumers who are
generally not in a position to negotiate with their banks the
terms of their deposit accounts that affect the consumer's
rights and liabilities, such as how payments are processed and
charged to their accounts.''
We, therefore, would strongly oppose any CTA without
recredit for consumers.
The proposed CTA contains comparative negligence provisions
that would allow banks to reduce the amount of damages a
consumer can recovery by asserting the consumer was somehow at
fault. It is unlikely that a consumer could contribute to
improper check processing, but this provision could unfairly
allow a bank to deter or delay a consumer's claim by asserting
that a consumer was partly responsible. The comparative
negligence standard is inappropriate to resolve harm suffered
by consumers and should be
removed from the proposed CTA.
I thank the Chairman and the Members of the Committee and I
look forward to any questions that you may have.
Chairman Shelby. Mr. Buchanan.
STATEMENT OF DANNE L. BUCHANAN
EXECUTIVE VICE PRESIDENT
ZIONS BANCORPORATION
ON BEHALF OF THE
AMERICAN BANKERS ASSOCIATION
AMERICA'S COMMUNITY BANKERS
CONSUMER BANKERS ASSOCIATION
FINANCIAL SERVICES ROUNDTABLE AND THE
INDEPENDENT COMMUNITY BANKERS OF AMERICA
Mr. Buchanan. Good morning. My name is Danne Buchanan. I am
the Executive Vice President of E-Business Solutions at Zions
Bancorporation in Salt Lake City, Utah.
I am here today representing the six major banking and
financial services trade associations--the American Bankers
Association, the America's Community Bankers, the Consumer
Bankers Association, the Electronic Funds Transfer Association,
the Financial Services Roundtable, and the Independent
Community Bankers of America. I am pleased to present the
associations views on the concept of check truncation as
envisioned by the Federal Reserve Board's proposal.
The associations believe that legislation to sanction
substitute checks will facilitate electronic check processing
that will produce significant cost savings, efficiencies, and
new consumer conveniences, to the great benefit of both the
consumers and the financial institutions.
On behalf of the associations, I would like to extend our
appreciation to Senator Shelby for holding this hearing. We
also commend the staffs of the Senate Banking Committee and the
Board, who have worked tirelessly to address the concerns of
the banking industry, consumer groups, and others in moving
this important concept forward.
Check processing is a very expensive and labor-intensive
process that requires checks to be handled, sorted, and
physically transported to the paying bank. Because of current
law, paper checks generally must physically move from the bank
of first deposit to the paying bank. The primary impediment to
elimination of this route is the fact that customers have the
right to receive back their original paper checks. The only
exceptions when checks do not have to be returned are unusual
cases where the very largest banks with the largest check
volumes have reached private agreements. Such arrangements and
check truncation are out of reach for small institutions,
rendering the technology largely unusable for them.
At our bank, over the last 2 years, we have been truncating
original items for payments and creating substitute checks. We
have accomplished this with two-party agreements between Zion's
Bank and its customers. I am pleased to let you know that this
process works. We have had few customer inquiries and have
successfully dealt with every issue or question posed by a
paying bank.
Keep in mind that many customers today do not receive their
checks back with their statements. Informal industry
assessments indicate that more than 30 percent of all checks
drawn by bank customers, and nearly all checks drawn by credit
union customers are not returned to the check writer.
It is important to note that these are sufficient for
consumers. For example, images are routinely used and accepted
as proof of payment for tax records. Original items are rarely
requested or needed. This fact is critical because many of the
objections raised by consumer advocates about the broader check
imaging envisioned under the Board's proposal exists today, but
in fact present few, if any, problems.
Electronic check processing has the potential to streamline
the collection of checks, reducing processing costs, and
minimize the
effect of unexpected disruptions to air and ground
transportation systems. No longer would a bank in California
have to ship a check drawn on a New York bank across the
country.
Improving the check clearing process may also allow banks
to develop new banking services. For example, image-capable
ATM's that can forward deposits electronically will allow banks
to deploy more ATM's in remote locations as the cost and
frequency of physically retrieving deposits and servicing ATM's
could be reduced. Consumers may be able to use these ATM's to
cash payroll checks at their place of employment, which may be
particularly attractive for those without bank accounts.
The proposal would also serve to promote check imaging
technology by adding another positive weight to the business
case for adopting check imaging generally.
For example, a more recent application of check imaging
allows their customers to view check images online. Customers
who do not bank online also benefit from imaging because
customer service representatives can quickly bring up for view
images to verify transactions for the customer. This requires a
fraction of the time typically required to research microfilm
or physical archives and transmit copies.
Finally, the proposal could provide real benefits to rural
community banks and their customers. This proposal would allow
rural community banks to transmit electronic images of checks
that can be used for clearing and settlement with their
existing systems, regardless of weather, transportation
constraints, or distances to processing centers.
The associations support the concepts outlined in the
Board's proposal. However, we strongly believe that the
provisions related to expedited recrediting for consumers are
unnecessary and will not only facilitate, but also, indeed,
encourage fraud. We believe that existing check law provides
appropriate and adequate protection to consumers with respect
to substitute checks.
The banking industry and consumers have an established
history with truncated checks and imaged documents. Indeed,
millions of consumers have been receiving either images or a
notation in their statement for years, without complaint that
disputes are not addressed satisfactorily. The current check
law works in a truncated and image environment. There is simply
no evidence to justify deviation from existing check law.
Consumer representatives complain that consumers need
protections above and beyond what is provided today because
they will be at a disadvantage if they receive substitute
checks rather than originals. However, the situations they cite
have existed for many years in the truncated environment
without adverse consequence to consumers. For example, consumer
groups express concern that it will be up to the consumer to
persuade a landlord or another person to accept a substitute
check as proof of payment.
Again, today, by the time consumers request a check, it is
likely to have already been destroyed in a truncated
environment, as was mentioned earlier by the credit unions.
Moreover, under the proposal, substitute checks will bear the
legend, ``This is a legal copy of your check. You can use it
the same way you would the original check.'' We believe that
this will convince landlords and others of the legal
equivalence of the check.
In addition, consumer groups also demand that the expedited
recrediting provisions of the proposal extend to all truncated
checks, including those provided today. They argue that
consumers will be confused because the rules for dispute
resolution for those who receive images voluntarily, as they do
today, will be different from those who insist on substitute
checks. The need for consistency argues for retaining current
check law. Since existing check law has a long, proven record
of success in the truncated environment, if a single consistent
rule is adopted, it should be based on proven check law, not a
new law that, arguably, will promote fraud.
The trade associations support the general principle
outlined in the Board's proposal to facilitate innovation in
the check collection system. We believe, however, that existing
law and regulations are both effective in protecting consumers
and minimizing the banking industry's exposure to fraud.
We hope that Members will also take this opportunity to
improve the efficiency of the U.S. payments system by quick
passage of this proposal.
Thank you.
Chairman Shelby. Ms. Alexander, you have indicated that
most customers who do request copies need them as proof of
payment.
Ms. Alexander. That is correct.
Chairman Shelby. Have your customers ever run into any
problems using the copies for this purpose?
Ms. Alexander. No, Mr. Chairman, not that I am aware of.
Although I do not get the volume of complaints that Mr.
Ferguson does, I get a lot of complaints that reach me. I have
never had a complaint from a member that they could not get an
original. Courts accept good images. The IRS accepts good
images. We have never had a problem with that.
Chairman Shelby. You have answered my question. The next
one was the IRS audits and other reasons.
Ms. Alexander. Yes, they do.
Chairman Shelby. They accept the images?
Ms. Alexander. Yes, they do.
Chairman Shelby. Mr. Buchanan, today, among other things,
we have discussed how some banks, which have agreements with
other banks, already use electronic transmissions to clear
checks. What happens to the original checks in these cases?
Mr. Buchanan. In the current environment, the physical
documents still follow in these environments. But then the
checks, if the checks are not returned to the consumer, they
are truncated and destroyed after a period of time.
Chairman Shelby. What can you tell us about consumers'
desires to get copies of these checks? You alluded to it
earlier.
Mr. Buchanan. Well, within our own bank, we still receive
requests for copies of checks, some that the consumer may have
even lost, for record of payment. We think that the banking
industry has always responded efficiently to those requests and
rarely receive problems around those issues.
Chairman Shelby. Are you aware of any problems associated
with consumers having to use copies of the checks rather than
the original checks?
Mr. Buchanan. No, sir. I am unaware of any problems with
that.
Chairman Shelby. Ms. Alexander, how many customer
complaints does your credit union receive regarding their
checks? Just your judgment.
Ms. Alexander. Regarding copies or just checks in general?
Chairman Shelby. Yes.
Ms. Alexander. I have not seen one in 14 years. I have not
had a specific----
Chairman Shelby. In 14 years?
Ms. Alexander. Yes. Not a specific complaint about
receiving a check copy.
Chairman Shelby. So, you do not have any complaints at all
about them that you know of ?
Ms. Alexander. I may, that have not reached me. I think
that earlier on, when we did not image, it took longer to get a
copy of a check and I did have some complaints about that. Now
it is immediate.
Chairman Shelby. Do you have any other complaints about
checks other than just trying to get a copy?
Ms. Alexander. I would say that, on the whole, the
complaints about our checking-account services are very low.
Chairman Shelby. Okay.
Ms. Alexander. We have very good services.
Chairman Shelby. Does the use of imaging enable you to
resolve just basic complaints more quickly than a paper-based
system?
Ms. Alexander. Absolutely.
Chairman Shelby. It is quicker, is it not?
Ms. Alexander. Absolutely. Very quick.
Chairman Shelby. Ms. Duncan, you have testified that the
right of recredit should be expanded to apply in every case
where the original check is not returned to the customer. This
would affect even those customers who have already agreed with
their bank to not receive paper checks back. What information,
what data can you provide us here at the Committee regarding
consumer complaints involving their checks?
For the record. In other words, I will ask it again. What
information can you provide to the Banking Committee here
regarding consumer complaints involving their checks?
Ms. Duncan. Well, I think quite a bit of your focus already
has been on image quality. And certainly, consumers do not have
problems when they receive checks, as long as the image quality
is good. If they need proof of payment, if the image quality is
good, oftentimes----
Chairman Shelby. Have you seen this, that the Fed gave us
just awhile ago [indicating] ?
Ms. Duncan. I have not yet seen that.
Chairman Shelby. I do not know what the other image is.
This is real clear, and I guess it depends on----
Ms. Duncan. What we are concerned about is those case where
a check image is not clear. Actually, I have a copy of a letter
here that I was cc:ed on, that was sent to the Chairman and to
Senator Sarbanes yesterday. It is from a lawyer in San
Francisco who represents low-income clients who experienced a
great deal of harm and stress based on the fact that the best
copy they could get of a mortgage payment they claimed to have
made was a microfiche and was unreadable.
Basically, just in summary, they paid their mortgage. Their
bank destroyed the original check, as was the practice. They
told the mortgage company that they had paid it, got a copy of
the microfiche, presented it to the mortgage company. The
mortgage company said that this was not acceptable because it
was not legible. Then the mortgage company turned the case over
to a collection company and foreclosure proceedings were
initiated.
We are concerned that this may be the tip of the iceberg.
This is just a microfiche copy and the way that it is done now.
The system that we are talking about would have images
converted in and out of electronic form. So, yes, that is one
of our concerns.
Chairman Shelby. I would agree with you that the imaging
should be legible. You should be able to read it. But there has
been tremendous breakthroughs in imagery technology. The
digitization of images would replace what you are talking
about, the microfiche, and would be much better, I believe.
I am just looking at what the Fed gave us up here.
Ms. Duncan. We welcome improvements in technology.
Chairman Shelby. You are right in this regard. The
technology, the imaging has to be clear.
Ms. Duncan. Yes.
Chairman Shelby. You have to be able to read it. Otherwise,
I do not guess you can have proof of anything.
Ms. Duncan. Right.
Chairman Shelby. But if you have some other information
regarding, other than this one instance, furnish it to the
Committee. Will you do that?
Ms. Duncan. We will furnish any additional information that
we receive.
Chairman Shelby. Do you know how common these complaints
are? I guess that is what----
Ms. Duncan. Our main concern here is there is a consumer
protection provision within the proposed legislation, and it
anticipates certain events.
We just think that if you were going to anticipate
consumers having a double processing--and it is more likely
when you have an electronic image and a substitute check going
through the system, it is more likely than you would have today
with just a paper check going through the system. We would just
like to see it applied to all.
Chairman Shelby. But you cannot hold back technology.
Ms. Duncan. And that is not what we are suggesting.
Chairman Shelby. I know. Okay.
Ms. Duncan. We are just suggesting that consumers receive
adequate protection.
Chairman Shelby. Sure.
Ms. Duncan. Somewhat similar to the Regulation E that
governs debit card transactions and electronic transactions
today.
Chairman Shelby. Sure.
Mr. Buchanan, are you aware of consumers having difficulty
getting access to their checks, digital images of checks?
Mr. Buchanan. No. In fact, if I could comment about the
earlier message around microfilm.
I think that what we are talking about here is looking at
an old medium and we can actually improve upon that. I think
things like microfilm and microfiche potentially have more
problems than what the imagining technology is.
Chairman Shelby. But these are dated technologies.
Mr. Buchanan. Exactly. We think that this is a dramatic
improvement and that the quality of those images in terms of
storage and retrieval would be far better. We are unaware of
any issues or problems around that.
Chairman Shelby. How do we get the banks to get up to the
digital world on imaging? That is important, too, for
uniformity.
Mr. Buchanan. Well, I think that there are a couple of
beneficial things with this Act.
One is that if a bank chooses not to have to adopt image
technology, the process still works with a substitute check. I
would say, though, that the way our system works, those who do
not adopt would be forced to through the competitive
environment because people will clear checks against those
banks quicker, which we think the marketplace will force
adoption.
Chairman Shelby. Ms. Alexander, your written testimony
indicates that your credit union currently receives checks back
from the Federal Reserve Bank, but that you are undergoing a
process to convert to an all-electronic system. What made you
decide to make that conversion? What will that conversion cost
your institution? And do you expect to save money over the long
run?
Ms. Alexander. We are constantly looking for ways to
expedite the process and to also reduce our costs. I do not
have an actual figure on what it will cost us. We know that
doing transactions electronically is less expensive than
actually handling the paper.
Chairman Shelby. But do you know how much less expensive?
Can you furnish that to the Committee?
Ms. Alexander. I can furnish that later, yes.
Chairman Shelby. Just give us a benchmark.
Ms. Alexander. I could. I am sorry I do not have those
figures with me.
Chairman Shelby. Okay.
Ms. Alexander. We know it will be less expensive and we are
looking for ways to not have to handle the paper checks.
Right now, we do actually, once we receive the checks back
from the Fed, we have to process them through our equipment. We
are trying not to do that and looking to the Fed for ways to
facilitate not doing that. And we know that it will be faster
and it will also be less expensive for us in terms of staff.
Chairman Shelby. Mr. Buchanan, one last question. How many
smaller or community banks pursue the alternative of savings
from the electronic process? And what are the potential savings
from moving away from the paper system?
Mr. Buchanan. We think that the savings are substantial,
and let me give you some examples within our banking system in
Utah.
As Senator Bennett mentioned, we have many rural
communities. Many of those communities we cut off at 1:00 in
the afternoon to be able to make deliveries to get them to our
item processing centers to clear checks.
Chairman Shelby. And you wouldn't have to do that.
Mr. Buchanan. We wouldn't have to do that any longer. We
would be able to provide our customers longer time frames to be
able to conduct their banking, make their deposits, make their
payments, and at the same time improve the process dramatically
by not having to physically transport these items around the
Nation and deal with them on a manual basis. So, we think the
savings will be substantial.
Chairman Shelby. Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman.
Ms. Duncan, I would get a hold of the lawyer and say,
microfiche technology is 30 to 40 years old. And I do not
anticipate any bank or credit union utilizing that under this
legislation. Any bank that would try to use microfiche to take
advantage of check truncation is living in the Dark Ages. It is
just incredible to me that anybody would even bring it up as a
possible way of handling this right now. I mean, I am sure the
incident occurred.
Ms. Duncan. It is old technology. And our concerns really
are making sure that consumers have adequate protections.
Speaking of actually things that have been around for a while,
the UCC was created quite a while ago. There are protections
that were created today with the types of issues that we are
concerned about in mind.
And as I mentioned, Regulation E has a 10-day right of
recredit, and it has an unlimited amount. It is unlimited in a
dollar amount. So, we would like to move forward. We would like
to look at things considering the technology of today. We would
like consumers to have protections, taking current technology
into account.
Senator Bennett. Let me just state a general thought that
has occurred to me.
Mr. Buchanan, of course, the hometown excitement is here.
You come from Utah, so, automatically, we are very proud of
you.
[Laughter.]
But I do not recall any time in the history of this
Committee that the ABA, the ACB, the CBA, the Roundtable, and
the ICBA--those alphabets do not mean anything to most of you--
but this is virtually every banking organization in the world,
have been satisfied by a single witness.
They always insist on coming in, each with a slightly
different take on things. I think this is the first time in the
history of this Committee that we have had that kind of
unanimity. And then to have the credit unions sitting at the
same table with the same view, maybe we should declare peace in
our time.
[Laughter.]
And to move forward on this. I think it is extraordinary
that we have had this kind of unity here.
So, we come back to you, Ms. Duncan. You have heard the
testimony here this morning from Governor Ferguson and then
from Ms. Alexander that says that there is virtually no double
charging going on and that this problem simply does not exist.
It would seem to me that the burden would fall upon your
organization to tell us, A, their figures are wrong and give us
surveys that demonstrate that there is a fairly high level of
problem here. Or B, how the adoption of the kind of technology
that Mr. Buchanan's bank is using would suddenly create
problems that aren't there.
Now is that an unfair question on my part? I want to be as
fair to you as I possibly can. But it seems to me, listening to
this, that the burden falls on you to say either, A, they are
wrong and there are a lot of problems, or, B, okay, there
aren't any problems, but there will be if we go in this
direction.
Ms. Duncan. Well, it is my understanding that the
organization that Ms. Alexander is here to represent also
supports the recredit provisions as they stand.
I think what we are talking about here is the fact that
this will be a new system. The way credit unions do what they
do today, a check is truncated at your bank. At the credit
union, you can walk right into your credit union and say, I
would like to see a copy of my check, the best copy you have.
What we are talking about here is, a consumer's original
check will be stopped somewhere back in the process where, with
a bank or an institution, the consumer may not have a
relationship with. And so the recredit provisions that we would
like to have to apply to everyone will just incentivize their
own bank to do whatever investigation is necessary to find out
what happened if there has been some error.
We are talking about just incentives. We are talking about
consumers and the real-life obstacles that they face.
Bureaucracy in a financial institution may well be one of them.
So this is what we are talking about. It is just an
incentive to balance this legislation so that consumers will
have more of an ease to resolve any disputes.
Senator Bennett. My only problem with what you are saying
is that the testimony we have heard says that those problems
now do not exist, that there are--Governor Ferguson said zero.
He did not say a small percentage. He said zero. And Ms.
Alexander said, at the beginning, she remembered a few
instances where the image wasn't good, which would recall
microfiche; but that in the last 14 years, it is zero.
Mr. Buchanan, as I understand the technology, a customer
could do exactly what Ms. Duncan just said, could walk into
your bank, even if the truncation occurred some place else, and
your bank would have electronically the ability to generate the
image and say to the customer, here is a substitute copy of
your check. Isn't that correct?
Mr. Buchanan. That is correct, Senator.
Senator Bennett. So it doesn't matter where in the system
the truncation occurs. The fact that the information is being
shared electronically means that the customer has more control
than they do now because if you depend entirely on the printed
check now, the chances of that printed check getting lost
somewhere in the system are much higher than the chances of the
electronic check getting lost.
We have had hearings in this Committee about identity
theft. And one of the main ways people get a hold of your
identity is by simply stealing your mail. And there is a check,
there is a credit card application, and so on, and they just go
out and steal mail without regard to what is in it, hoping as
they go through it that they will find a financial document
which they can then use.
This says, you cannot steal it. You can steal all the mail
you want, but the image of your check, wherever it got
truncated, is available at your bank.
It would seem to me that consumers would like that because
it would reduce the chances of fraud. It would increase their
opportunity to control their accounts, for the circumstances
you are appropriately concerned about, rather than going the
other direction.
I am having a hard time understanding why Consumers Union
is against this because everything that I see in the real world
says, this is going to make security of consumer information
substantially higher than it is today, and it is going to lower
costs, which can only benefit consumers in the long run as
well.
Now help me understand where I am off base here because I
am trying to do the right thing for the consumer.
Ms. Duncan. Right. Our concern is to ensure that consumers
are adequately protected, and we would like to have the
protections available to all consumers. That is our concern.
This will be a new system. And the system as it stands right
now poses different problems and has different risks and
benefits for consumers.
As I said earlier, you walk into your bank. You can get a
copy. In the truncated system, in this new system, the copy at
your bank may not be the best copy available. They might have
to trace back up through the system to find the best copy
available, which may be----
Senator Bennett. There is no evidence that that is the
case. Isn't that true, Mr. Buchanan, that the copy that you get
from the bank in many ways might be better because it hasn't
been handled and crinkled?
Mr. Buchanan. Again, I think I would go back and say in the
current environment, you would be relying on microfilm or
microfiche instead of an image document. In any case, an image
is going to be better than those alternatives.
Senator Bennett. Thank you.
My time is up. However, I really have a problem
understanding why there is a problem because, as I see it, the
consumer would have access at more places to the information.
The information would be protected from intrusion. It would be
protected from physical deterioration.
I have 6 kids and 17 grandkids and the checks can
disappear. My 2-year-old grandson can go through the house and
all kinds of things disappear.
[Laughter.]
And I have a sense of comfort knowing that it is preserved
electronically in the bank and that I can go there at any time
and get whatever I need.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Allard.
Senator Allard. I have a question for Mr. Buchanan.
Obviously, the proposal would involve new systems and
equipment. I have some bankers in my State of Colorado that
provide services in communities that are pretty small. They
operate more on the lower margin. Will this pose a burden for
small independent community banks? And how can we assure a
smooth transition?
Mr. Buchanan. Yes. Let me address that a couple of ways.
One of the great things about this bill is it does not
force banks to adopt imaging technology. As I have mentioned, I
think the marketplace will force that, for them to remain
competitive.
But let me go to your question about----
Senator Allard. Before you move on, I would like to pursue
that question a little further.
Mr. Buchanan. Sure.
Senator Allard. We may not have a mandate in the bill, but
where these gets centrally cleared, they may say, well, you
have to bring your system up to standards. We are not going to
take these unless they are electronically checked. So, we are
not going to accept it. Do you see what I am saying? In effect,
it becomes a mandate because somebody at the central clearing
point may refuse to accept it unless the individual banks adopt
that technology.
Mr. Buchanan. The item would look exactly as an original.
Senator Allard. Yes.
Mr. Buchanan. So there is no way to really force that
without stopping any original check from coming through the
system, which I think is unlikely.
But with that being said, let me move to your other
question about the cost for small banks.
One of the great things with technology right now is that
it is very affordable. We have scanning devices that we can
implement for branches that start at $700, moving to the low
couple of thousand dollars, and then on up. And so, there is no
evidence that we can see that only large banks can participate
in this. In fact, I would say that small banks have a
competitive advantage in being able to move quicker than a
large bank will be able to move. And cost will not be an issue
for them.
Senator Allard. Thank you, Mr. Chairman.
Chairman Shelby. Senator Sarbanes.
COMMENTS OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman.
Ms. Duncan, I am interested, first of all, in whether,
under the proposed legislation, consumers would lose
protections they now have under the UCC?
Ms. Duncan. The proposed legislation does not necessarily--
well, yes, it would. And the concern actually is--the proposed
legislation has a comparative negligence provision which is
actually broader than what the UCC is. It would establish--
somehow, if the consumer is at fault, that their damages could
be reduced.
Under the UCC, as it stands for checks, the comparative
negligence provisions really apply to areas that a consumer has
control over, such as paying attention and making sure that
there are not a series of fraudulent or forged signatures on
their checks. So it would expand comparative negligence in a
way that is not in current law.
Senator Sarbanes. So the proposal, as I understand it,
would in fact diminish consumer protections on the comparative
negligence issue. Is that correct?
Ms. Duncan. That is correct.
Senator Sarbanes. Does anyone at the panel disagree with
that?
Mr. Buchanan. I am not sure that I have a comment about
that, knowing it well enough to comment.
Senator Sarbanes. All right. Now, of course, it is not
necessarily the case that the existing protections for
consumers are adequate. So, I do not know that that is
necessarily the baseline that one should operate from. That
leads me to my next question. And that is the question of
expedited recredit for consumers. What is your view of the
provision in the legislation on that issue?
Ms. Duncan. We believe that the recredit provision is
inadequate because it does not apply to all consumers whose
check information is processed electronically. And we also
believe that consumers are not adequately protected. Those
consumers that do not have the ability to benefit from recredit
are not adequately protected because recredit is a simple
nonlitigation remedy, and consumers who are not protected would
be required to sue their banks, which would be a very big
burden on consumers for the amounts we are talking about.
Senator Sarbanes. Ms. Alexander, Mr. Buchanan, do you want
to comment on that issue?
Mr. Buchanan. Our belief, from an industry standpoint, is
that it is unnecessary. It does create fraud risk in that if
you have an immediate recredit provision, that what it does is
promotes the ability for fraudsters to take advantage of the
system. It also creates a regulatory burden for the banks that
we believe is unnecessary and is covered very well and handles
all the consumer issues with current UCC law.
Ms. Duncan. May I respond?
Senator Sarbanes. Certainly.
Ms. Duncan. Our concern is that the UCC--I am sorry. I lost
my train of thought.
Senator Sarbanes. Well, let me go to Ms. Alexander and see
if she wants to add anything to Mr. Buchanan's comments?
Ms. Alexander. Actually, I would echo Mr. Buchanan's
comments. We believe that the recredit provisions are
sufficient as they now stand.
In our own credit union, we have experienced a 256 percent
incident increase of check fraud in the last 5 years. Two days,
which was the original proposal, is simply not enough time to
be able to determine whether or not that check is legitimate.
We believe, as it stands now, is what we would support.
Ms. Duncan. I have regained my thought, if I may.
Senator Sarbanes. All right. I thought you might.
[Laughter.]
Ms. Duncan. Thank you. We believe that banks are adequately
protected, if not overly protected, in the legislation. Banks
are not required to recredit in instances where they believe
that fraud is an issue. They are not required to recredit in
areas where there is a new account, where there has been a
negative balance. And a bank is also able to reverse a recredit
where they believe that there is a problem.
So, we do think that that particular issue is well-
addressed in the legislation and it balances the consumer's
need for recredit. And to remove recredit would just be a
negative impact on consumers and that provision should apply to
all.
Senator Sarbanes. Now to what extent has the privacy
question been addressed in terms of this new technology? We are
seeing new technology being developed all the time. And every
time it happens, we seem to have another potential serious
incursion into people's privacy.
Of course, electronic documents have the advantage of being
easily transmitted. I understand some of the benefits of that.
But, presumably, this is going to result in the creation of a
large electronic database, which will have a lot of information
in it about the consumer and his check writing habits. That is
a valuable store of information. How is that privacy going to
be protected?
Mr. Buchanan.
Mr. Buchanan. I would say that the current process has all
of the information you are talking about anyway, and I am not
aware of problems around that. And I would also suggest that
the new process would eliminate manual steps and handling that,
in fact, would enhance privacy, not diminish it.
Senator Sarbanes. How in the current system do you create a
database which can be either sold or exploited for other
purposes which fully identifies the consumer's spending
practices?
Mr. Buchanan. Well, banks today currently are able to
retain images. And so many banks already retain those images,
as we have discussed. For instance, there is a company by the
name of U-Point that stores images for banks like Bank of
America, Chase, Zions, First Tennessee, and others. The data is
currently available. I am not aware of any consumer privacy
issues around that, or banks using that inappropriately.
Senator Sarbanes. So what do the banks do with this stored
information?
Mr. Buchanan. Primarily, it is used for a couple of things.
One is for customer service aspects. If a customer calls up
and says, I would like to see what this check was from 3 months
ago, it can be easily retrieved. Going back to the comment
about being able to go into a branch and request a copy of a
check, those images are retrieved from those types of devices.
Senator Sarbanes. And what other purposes?
Mr. Buchanan. The other purpose would be for Internet
usage. So if I am a consumer at home, I may want to be able to
look at my last 30 days' checks and retrieve those images
online.
Senator Sarbanes. Are the banks currently using these
checks to identify consumer spending patterns and then to use
that information either themselves or--to either sell or convey
it to others to be used for various marketing purposes?
Mr. Buchanan. I could not speak for all banks. I can tell
you that at our bank, we do not use it that way.
Senator Sarbanes. But you do not know if other banks do so?
Mr. Buchanan. No, sir, I do not.
Senator Sarbanes. Would it be easier to engage in that
activity if this material was being stored electronically?
Mr. Buchanan. I would suggest again that if a bank wanted
to do that, they could currently do it, and have had that
ability for quite some time.
Senator Sarbanes. But they would have to add another step.
Whereas, you are now going to substitute or introduce this
technology, so it will be done not for that purpose, but for
the purpose of the truncation, to gain the advantages that are
sought in this legislation, which we recognize.
Then, having done it for that purpose, they will have this
database then available for other purposes. They do not have to
go through the extra step. Isn't that correct?
Mr. Buchanan. Let me try and address it. I think there is--
--
Senator Sarbanes. Let me first just make sure I am correct.
Then they would not have to go through the extra step. Correct?
Mr. Buchanan. I think that there is confusion between
storage and clearing. And what this Act primarily relates to is
creating efficiencies in the clearing system not relating to
storage of data.
Banks currently store vast amounts of data that could be
used in that way. This Act really is related to making
efficiencies in our clearing system with the use of substitute
checks so that those physical items never need to flow through
to the paying banks.
So, I do not believe that it changes the dynamics from a
privacy standpoint, and I do not think that it even requires
additional steps from a privacy standpoint. This is really
related to clearing and not storage.
Senator Sarbanes. Would the industry support check
truncation if there was a very strong rule that check images
could not be used for any purpose other than check processing,
dispute resolution, and consumer requests?
Mr. Buchanan. I would like to address that with the
industry and not speak for them off the cuff. So, I would like
to get back to you on that question.
Senator Sarbanes. I take it that that means that giving a
simple yes to its limitation for those purposes, that would
create problems. You are not comfortable with that. Is that
correct?
Mr. Buchanan. I am not saying it would create problems. I
am just saying that if I were to speak for my institution, I
would answer one way. I do not know if I would feel comfortable
answering for the entire institution.
Senator Sarbanes. Presumably, for your institution, the
answer would be yes. Am I correct?
Mr. Buchanan. I think that from our institution's
standpoint, we would like to use the data in the same ways that
we currently do, which falls within----
Senator Sarbanes. Which goes beyond these objectives that I
discussed, that I mentioned?
Mr. Buchanan. No, no.
Senator Sarbanes. It stays within them?
Mr. Buchanan. It stays within them.
Senator Sarbanes. Okay. Thank you, Mr. Chairman.
Chairman Shelby. Senator Carper.
COMMENTS OF SENATOR THOMAS R. CARPER
Senator Carper. Good morning. Thanks for joining us this
morning. I apologize for missing your testimony, but I will
have a chance to read it later, and I actually will. I know
that some people find this subject boring, I am told; but I
really find it actually
pretty interesting.
When I was a pup of a Congressman back in the House of
Representatives serving with then-Congressman Shelby, I think
the first bill I ever introduced was legislation dealing with
the availability of funds. When we deposit checks into our
accounts, how quickly can we have access to those monies.
I have a question. Mr. Buchanan, I will start with you, but
I want to ask the others to respond as well.
I am pleased that today, people have quicker access,
quicker availability of funds when they deposit checks than
used to be the case, say 20 years ago. I want to make sure that
if this legislation were enacted, that we do not somehow set
the clock back and, if anything, that we could actually make
availability of funds maybe expedited even further for people
who deposit checks into their accounts. Can you tell me how
this legislation relates to the availability of funds and our
ability to make use of the funds when we have deposited a
check?
Mr. Buchanan. Yes, I can. I think if you go back to my
earlier example about rural communities within Utah and Nevada,
for instance, as I mentioned earlier, the way that the process
works is that a branch needs to be cut off at a certain time to
be able to make the physical transportation deadlines. That can
be, say, 1:00 in the afternoon for some of our branches.
With this technology, we believe, and we would implement
within our environments the ability for consumers to make
deposits up until the branch closure, which could be 8:00 at
night for some of our banking centers, which would then provide
them the ability to earn interest on those funds a day earlier,
to have their payments posted sooner and their deposits made
the same day, instead of being held over for the following
banking day.
Senator Carper. Let me say to Ms. Duncan and Ms. Alexander,
in considering this legislation, I am interested in how this
legislation is not just going to help financial institutions. I
think it is pretty clear how it would help or be advantageous
to the industry. But I am looking for ways that this
legislation could actually be of benefit to consumers. And this
would appear to me, at least at first blush, to be a plus for
consumers. Am I missing something there, or do you see it that
way, too, at least this aspect of it?
Ms. Duncan. The faster the availability of funds would
certainly be a potential benefit of the legislation. It
certainly is not included as a requirement for part of this
legislation. So, we would definitely want to make sure that if
this does become a possibility, that it becomes a reality.
Senator Carper. How might that happen?
Ms. Duncan. Well, there are two possibilities.
The banks would--it is within their purview whether to make
the funds available faster. We would want to see that happen.
In addition, if it becomes possible for funds to become
available faster, then the Fed can take a look at this. And we
want them to take a hard look at it if the legislation were to
become law, to see if there is an ability to make the funds
available faster and possibly change the regulations governing
funds' availability to make sure that consumers are benefiting
from this.
Senator Carper. Thank you.
Ms. Alexander, any comments?
Ms. Alexander. Well, I would agree certainly that the
funds' availability to consumers is certainly going to be a
benefit, a side benefit of this legislation and other
legislation that may follow.
We would be able to make funds available to our members
much more quickly. I also think in the longer term, that
overall expense of offering checking accounts may come down as
well. It is less expensive to offer electronic transactions
than over-the-counter teller transactions and other types of
transactions that require human beings.
Senator Carper. Can you quantify that at all in terms of
the order of magnitude?
Ms. Alexander. We offer online banking to our members and
they are able to transfer funds, create a check, access check
images, do any number of things in the online banking
environment.
It costs us approximately a little over $3 to serve a
member at a teller counter. It costs us about 45 cents for a
member to actually access his account and do a transaction with
online banking. So as a not-for-profit institution, credit
unions look for ways to reduce costs and ultimately return
those back to the members. We see this as being able to
ultimately offer something along those lines because we will be
able to restructure pricing.
Senator Carper. Let me just ask the others, are there other
examples in this legislative proposal that would also inure to
the benefit of consumers, or at least have the potential of
inuring to the benefit of consumers?
Mr. Buchanan. Yes, I could give a couple more.
Another example would be ATM usage, which I mentioned in my
testimony, where consumers would be able to make deposits in
ATM's, which have again the same type of cut-off time frames in
making a deposit. And we believe that those capabilities would
be far expanded again over the current availability for
consumers.
Another example would be where, again, rural commercial
customers that need to drive to the bank every day to make
their check deposits would no longer be required to do so. They
could actually truncate those checks at those commercial
enterprises and move the images through the clearing system.
Senator Carper. How would that work?
Mr. Buchanan. We actually have a system that Senator
Bennett has seen that provides for the scanning of the image
and the voiding and making the image, the actual original item,
nonnegotiable, and then moving the image through the clearing
system and providing significant benefits to commercial
customers.
Senator Carper. Ms. Alexander, as I understand it, the
credit unions have had for some time the ability to truncate
checks. What have you learned from that experience with your
industry that we should put to use in this instance?
Ms. Alexander. Well, credit unions truncate the checks at
the very end of the process. We do not return checks to members
as most banks do. In fact, when we were permitted in 1977 to
offer checking accounts, we weren't allowed to return them.
That has since changed.
But we have done a very good job of educating our members
that in most cases, they do not really need the paper checks
back. If they do, we are able to provide them a very clear and
legible copy.
In the early days, we actually did provide them back with
the original if they needed it. Now, we provide them an imaged
copy. My members, they do need to request copies once in a
while. It is not frequent. When they do, we can provide it
immediately, which is faster than we could have if we gave them
the paper check.
We feel that the service has actually improved. Our members
do not see the need to have the checks returned and we have not
been returning them. We never returned them. And we have been
offering checking accounts at my credit union since about 1978.
Chairman Shelby. Senator Bennett, any other questions?
Senator Bennett. Yes. But just a comment to Senator Carper.
I made reference to a study that was done by the
Minneapolis Federal Reserve Bank that indicated that this would
save $1.75 per transaction. I did the math and that is $73
billion a year. And given the conversations that we are having
around here, if you multiply that by ten, that is $730 billion,
which, by coincidence, just happens to be the size of the
President's proposed tax cut to stimulate the economy.
[Laughter.]
So if we could have the same kick on the economy by passing
this legislation that we could have by passing the President's
tax bill and not have to worry about the deficit, I think it is
a legitimate thing that we should do.
Senator Carper. I thought you were going to say, we
wouldn't need the President's tax cut.
Senator Bennett. No.
[Laughter.]
Close, but no cigar.
[Laughter.]
I want to come back to what I was doing in the previous
round, and I do not want to beat this to death, but Senator
Sarbanes' questions raised it once again: The issue of privacy.
Hearings before this Committee have indicated that identity
theft and concern about privacy comes from the present
situation, where there is access to a physical financial
institution, that people steal mail in order to get a financial
instrument.
And just to nail this down, is it not true, and my
understanding of it, is it not true that exposure to identity
theft from those who would move into the area of privacy would
be eliminated by the kind of system that Mr. Buchanan has
indicated. I have seen it operate. I have seen it work. My
understanding of it is that consumer privacy would go up very
substantially as a result of application of this system.
Now that is as soft a ball as I can give you, Mr. Buchanan,
but I think it is an important one for everybody to understand.
Could you expand on that?
Mr. Buchanan. Yes, I would agree. Again, I think that by
eliminating the need to move these items around in the system,
and being able to truncate checks, we would enhance privacy,
not diminish it. And so, I would echo your views.
Senator Bennett. Ms. Alexander.
Ms. Alexander. I would just like to comment. I would tend
to agree. In fact, at my credit union, it is much harder for my
staff to get an image of a check. It is a two-password system
on a separate server and much more secure than the paper checks
that are put in with the daily work and locked in a drawer. And
to me, it seems that the overall privacy issue is strengthened
by this kind of a system. It is just harder to get those images
than it is anything on paper.
Senator Bennett. Ms. Duncan, do you have a reaction to
that?
Ms. Duncan. I would just be concerned that we take a close
look at the storage of this information. To the extent that the
information might be aggregated, might be potentially mined for
information, that would be available for somebody who had a
nefarious
intent. The identify theft type----
Senator Bennett. In what way would it be available that it
is not available now?
Ms. Duncan. Actually, you make a good point. There is a lot
of electronically stored data as it stands right now. This
would just increase the amount and possibly increase the risk
for consumers.
Senator Bennett. I do not want to be argumentative, but I
do not understand how it would increase the available data. Let
me walk through what I have seen because maybe we are talking
past each other here.
A merchant in a Delaware town----
Senator Carper. Where we have no sales tax.
[Laughter.]
Senator Bennett. Yes. Okay.
[Laughter.]
A merchant in a Delaware town at the end of the day has a
series of checks. And under the present situation, he adds all
those checks up, makes a handwritten deposit slip, puts them in
a bag, and carries it to the bank and deposits it in an
overnight depository and it gets opened the next day.
Under this system, the merchant sits there, he has a little
black box. He runs the check through the black box and then he
locks the check up.
It is transmitted instantly and electronically to the bank,
which means it is in the merchant's account that night. It
doesn't get there the next morning. The availability of funds
is there. The bank then has that electronic information, which
then goes back to the various customers and is taken out of
their banks electronically and instantly.
How is that creating a database that can be mined for
nefarious purposes that is any different from the present
situation where the bank makes a microfiche or an electronic
whatever, or the credit union keeps track of it?
How is the transmission efficiency created by this system
creating a new database that doesn't exist, that is more
vulnerable than what we have now?
Ms. Duncan. If we are talking about the increased
opportunities for ID theft or underneath this proposed
legislation, then we would want to wait to have more
information on how the banks would intend to use this
information because increased storage, collection, and
dissemination of information does lend to ID theft. We would
just continue to pay close attention as this moves along to how
the data may be used for other purposes.
Senator Bennett. Ms. Alexander and Mr. Buchanan, just very
quickly, does the system increase the database that could be
used for ID theft?
Mr. Buchanan. No. Maybe just a final comment around this.
The data is already stored. I think what you described,
Senator, is very good in that the way the new process will work
is that it will eliminate a number of manual steps that I think
could create more problems around privacy and the vulnerability
of dealing with physical items moving through the various
points versus just moving it electronically, storing it as it
currently is stored--I do not think, and I think it is
important to understand that we are not talking about storing
anything differently than it is already being stored, and then
being able to clear these items. We see this system improving
significantly, not diminishing.
Senator Bennett. Ms. Alexander.
Ms. Alexander. I agree that the database exists now. If
someone wishes to use it for nefarious reasons, they could do
it this day. I do not see that this process exacerbates that.
It simply uses it much more efficiently and for the benefit of
the consumer.
Senator Bennett. If I understand your previous testimony,
actually, this system could make the current database more
secure. Is that--am I----
Ms. Alexander. That has been my experience, yes, it does.
Senator Bennett. I see.
Thank you very much, Mr. Chairman.
Chairman Shelby. Any other questions?
Senator Carper. Just one, if I could.
Margaret Simmons, my staff member here, was good enough to
share with me a copy of--this is a legal copy of your check.
You can use it the same way you would use the original check.
I am one of those people who actually balances his
checkbook. I still reconcile my checking account every month.
My kids--my boys are now 13 and 14. And as they get older,
they actually watch what I am doing and they say, what are you
doing? Why do you do that every month? I tell them, I just want
to make sure that I know how much money is in our checking
account. Well, don't you get those statements? And I say, yes,
but I sometimes make mistakes and I just like to check the math
and make sure that I know exactly what is in the account.
And I save, religiously save my checks, and I have them
like stacked up in our basement and they are in their boxes in
the right order and everything. My wife says, it is a disease.
I am not sure if it is or not.
[Laughter.]
But I have been into this for a long time. I think I am
beyond redemption. So, I face the prospect of not having my
checks coming in my statement every month. But if I actually
need a copy of my check, I guess I can get something like this.
And my question is, how quickly can I get it? Do you have to go
through a lot of hoops? Do you have to submit something in
writing? How does it work? Ms. Alexander, I guess you all have
been doing this for a while.
Ms. Alexander. We have. In fact, members can give us a call
on the telephone. They can walk into a branch. If they are an
online branching user, they can access it themselves and print
it out. It is absolutely instantaneous. It takes very little
effort to produce. It is right there. It is as good as that
copy you have.
Senator Carper. So online, I can get it right away?
Ms. Alexander. Yes.
Senator Carper. If I telephone, what are we talking about?
Ms. Alexander. Well, we will mail it to you, or you could
stop in and pick it up. I can fax it, but, of course, faxing
denigrates the printing a little bit. But there are a number of
ways that you can get that. We encourage our online banking
users to obtain their checks themselves, which they do, in
large numbers.
Senator Carper. The complaints from consumers that you hear
most about the kind of check truncation that you have at your
credit unions, what are the complaints that you hear?
Ms. Alexander. We really do not hear complaints now about
truncation. In the early days, members did complain. They
wanted their checks back. It did take a while to get a copy.
You had to go retrieve the physical check. You had to make a
copy of it or give them the original and keep a copy yourself
if they needed it for an audit or for a court case. But that
was 20-some years ago.
The credit union where I am at now and where I was
previously have offered checking accounts from the beginning.
And after the first couple of years, members accepted it, we
became better at retrieving copies for them, and we tried to do
our best to give them excellent service.
Now, they consider it to be a very normal part of their
checking account process. I have had no complaints about
truncation.
Senator Carper. Ms. Duncan, a closing word from you on
this?
Ms. Duncan. Our main concern is just to make sure that
consumers are well-protected. In this situation, what we are
talking about is taking a consumer's check and turning it
virtually into an electronic transmission of information.
There is a scheme out there, Regulation E, which gives
consumers protection, which is taking into account electronic
processing of information and potential errors that can occur.
And that regulation includes a 10-day write of recredit and an
unlimited amount. So that is the thing that we would like to
see on a broad application.
When we look at the CTA, we would like to take the current
recredit system and apply it broadly to protect consumers.
Senator Carper. One last one. Mr. Buchanan and Ms. Duncan
and Ms. Alexander, do you see some way to resolve some of the
differences that we have heard here today? You talk about
issues about which reasonable people can disagree. Is this an
issue that we can resolve if we give it our best?
Mr. Buchanan. Well, my impression is that anything can be
resolved. I think that change is difficult, although I would
say that our position is that we are not taking anything away.
In fact, going back to your example about wanting to retain
your checks, I think it is important to know that you would not
necessarily not get those checks back. You would receive a
substitute document instead of the original check.
But from a consumer's standpoint, they would still receive
the items. You would still be able to take comfort in storing
those for as long as you would like. We do not see take-aways
here. We see value-adds. And therefore, we believe it is
unnecessary to add any additional regulation around that.
Senator Carper. That wasn't my question.
Mr. Buchanan. I understand.
Senator Carper. Are these differences resolvable?
Mr. Buchanan. Excuse me?
Senator Carper. In your view, are the differences that you
have heard here today resolvable?
Mr. Buchanan. I believe they are.
Senator Carper. Ms. Duncan.
Ms. Duncan. I believe they are resolvable, yes.
Senator Carper. Ms. Alexander.
Ms. Alexander. I would believe so.
Senator Carper. Good. All right. Well, let's try to do
that.
Thank you.
Chairman Shelby. I want to thank all of you--Ms. Alexander,
Ms. Duncan, Mr. Buchanan--for your appearance here today. I
think it has been a good hearing.
The hearing is adjourned.
[Whereupon, at 12:10 p.m., the hearing was adjourned.]
[Prepared statements and response to written questions
supplied for the record follow:]
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
I want to thank Chairman Shelby for holding this hearing to discuss
legislation that will ultimately improve the check collection system
and eliminate unnecessary steps in the process. I look forward to the
discussion today and am hopeful that we can work together to develop
legislation that will contribute to the overall improvement of our
financial system.
The Federal Reserve Board first sent its proposed Check Truncation
Act to the Congress in December 2001, with the goal of increasing the
efficiency of the check collection system. Their proposal recognizes
the existing legal barriers preventing the possibilities new technology
could bring to enhance the current system, and improvements that would
save time, money, energy, and resources.
Thank you to all of our witnesses for agreeing to appear before the
Committee today to discuss an important procedure that could change the
way our banks, thrifts, and credit unions handle check processing, a
major component of the money-handling system. I look forward to your
testimony.
----------
PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
Thank you, Mr. Chairman, I would like to express my appreciation to
you and to Ranking Member Sarbanes for agreeing to hold this hearing on
the Federal Reserve's proposed Check Truncation Act. Checks have long
served a critical function in the U.S. payments system. In 2001,
consumers made approximately 41 billion payments by check. However,
most checks continue to process as they did 50 years ago, requiring
physical presentation of the check at the bank at which the account is
held.
This requirement necessitates the physical transportation of
millions of checks across the country on a daily basis. According to
the Federal Reserve, an estimated 37 million checks were transported
every day in 2001. In order to accomplish this tremendous task, the Fed
contracts with independent air freight services to fly these checks
around the country. After the tragic events of September 11, 2001
halted all air traffic, this critical function of our system of
payments ground to a halt and further compounded the crisis which
ensued after the attacks.
Because of this weakness in the payment system, and as an effort to
improve its efficiency, the Fed has presented Congress with a
legislative proposal to transform our check processing system from a
physical to an electronic system. These improvements to the system
would result in considerable savings throughout the financial system
and would also reduce check clearing time for consumers and businesses.
As with any such fundamental change to our system of payments,
however, some questions will need to be answered as we move ahead with
reform of the process. In particular, the anticipated changes in the
system may open the door to fraud
unless all necessary precautions are taken. It is my understanding that
this proposal would require the destruction of the physical check at
the bank the check is deposited. Currently, checks contain security
devices such as microprinting and
watermarks which would be lost in a digital image. I would be very
interested in gaining a better understanding of the new security
features which would replace the traditional ones.
I look forward to discussing this issue and others with our
distinguished panel of witnesses today. I want to thank you all for
taking the time out of your busy schedules to join us here today to
share your considerable knowledge on this issue.
Thank you.
----------
PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER
Thank you, Mr. Chairman. I want to commend both you and Senator
Sarbanes for putting together such a distinguished panel. I also want
to thank our panelists for taking the time to meet with us.
Several days ago, I had the pleasure of meeting with a small group
of community bankers from New York, and we discussed this check
truncation proposal. These
individuals represented community banks who, as we all know, have a
strong dependence on the support and patronage of the individuals and
businesses in their area. Efficiency is important, but doing the right
thing to maintain the customer relationship is critical.
These bankers support the Fed's proposal on check truncation. Many
have already moved to electronic statements in their operations. They
told me that not a single customer had objected to the modernization of
the banking processes.
I have long been an advocate of consumer protection in our banking
systems. To me, the consumers can be the real beneficiaries if we
decide to make this change. While there are no guarantees in this
proposed legislation, experience tells us that lower operating costs
enable businesses to offer lower costs or better services to their
customers. Things like broader deposit options, later deposit cut-off
hours, more timely access to account information, and faster deposit
clearance. If one bank doesn't do it, another will. That is the nature
of our market system. And in the end the consumer wins.
``The check is in the mail,'' is an old expression. Today, despite
the tremendous advances in data systems, networks, and technology, the
check is still in the mail. It is time we updated our banking processes
so that the check doesn't have to be in the mail for banks.
The Federal Reserve has provided a thoughtful proposal. There is
some work to be done to ensure that the interests of consumers and
bankers are safeguarded and balanced. And much progress has already
been made. But it is time we moved forward with this legislation.
Thank you, Mr. Chairman.
----------
PREPARED STATEMENT OF ROGER W. FERGUSON, JR.
Vice Chairman, Board of Governors of the Federal Reserve System
April 3, 2003
I would like to thank the Committee for inviting me to discuss the
proposed Check Truncation Act (CTA) that the Board sent to Congress for
its consideration in December 2001. The proposed CTA removes existing
legal barriers to the use of new technology in check processing and
holds the promise of a more efficient check collection system. The
Board commends the Committee for holding hearings on this very
important legislative initiative.
Technological Advances in Check Processing
Check processing is far more efficient than it once was. Less than
50 years ago, clerks hand-sorted millions of checks each day. In the
1960's, the banking industry began to use mechanical high-speed check
processing equipment to read and sort checks, which had been redesigned
for automated processing. Today, banks, thrifts, and credit unions,
which I will collectively refer to as banks, process about 40 billion
checks that consumers, businesses, and the Government write each year.
Typically, after a check has been deposited at a bank's branch or
ATM, the bank transports the check to a central operations center. The
check is then usually sent to one or more intermediaries--such as a
Federal Reserve Bank or a correspondent bank--or a clearinghouse for
collection before it is ultimately delivered for payment to the bank on
which it is drawn. At each step, the check must be physically processed
and then shipped to its destination by air or ground transportation.
Some of the checks, however, are removed from the collection or return
process, and the payment information on the checks is captured and
delivered electronically. This process, which is commonly referred to
as check truncation, reduces the number of times that the checks must
be physically processed and shipped. As a result, check truncation is
generally more efficient, more cost-effective, and less prone to
processing errors.
Today, however, check truncation can only occur by agreement of the
banks involved because existing law requires that, in the absence of an
agreement, the original paper checks be presented or returned. Further,
given the thousands of banks in the United States, it is infeasible for
any one bank to obtain check truncation agreements from all other banks
or even a large proportion of them. As a result, the check system's
legal framework, which has not kept up with technological advances, has
constrained the efforts of many banks to use new electronic
technologies, such as digital check imaging, to improve check
processing efficiency and to provide improved services to customers.
Therefore, legal changes are needed to facilitate the use of
technologies that could improve check processing efficiency and lead to
substantial reductions in transportation and other check processing
costs. The proposed CTA makes such changes.
Proposed Check Truncation Act
The proposed Check Truncation Act solves a long-standing dilemma--
how to foster check truncation early in the check collection or return
process without mandating that banks accept checks in electronic form.
Currently, under typical check truncation arrangements, electronic
information about a truncated check, rather than the original paper
check, is presented to the bank on which the check is drawn. The
proposed legislation facilitates check truncation by creating a new
negotiable instrument called a ``substitute check,'' which would permit
banks to truncate the original checks, to process the check information
electronically, and to print and deliver substitute checks to banks and
bank customers that want to continue receiving paper checks.
A substitute check, which would be the legal equivalent of the
original check, would include all the information contained on the
original check--that is, an image of the front and back of the original
check, as well as the machine-readable numbers that appear on the
bottom of the check. Under this proposed legislation, while a bank
could no longer demand to receive the original check, it could still
demand to receive a paper check. Banks would likely receive a mix of
original checks and substitute checks. Because substitute checks could
be processed just like original checks, a bank would not need to invest
in any new technology or otherwise change its current check processing
operations.
Banks could use the new authority provided in this legislation in a
number of different ways. For example, a bank would no longer need to
send couriers every afternoon to each of its branches and ATM's to pick
up checks that customers have deposited. Instead, digital images of checks could be transmitted electronically from those locations to the bank's operations center, where substitute checks could be created and forwarded
for collection. Not only would this be quicker and more efficient, but it could also permit banks to establish branches or ATM's in remote locations more cost effectively and to provide their customers with later deposit
cut-off hours.
Moreover, the proposed legislation would give a bank the
flexibility to transmit checks electronically over long distances, and
create substitute checks at locations near their ultimate destination,
for example, near to the bank on which the checks are drawn,
substantially reducing the time and cost associated with physical
transportation. By enabling the banking industry to reduce its reliance
on physical transportation, the proposed legislation would also reduce
the risk that checks may be lost or delayed in transit. Today, bad
weather routinely delays check shipments and check shipments have been
destroyed in plane crashes. The banking industry's
extensive reliance on air transportation was underscored in the
aftermath of the September 11 tragedy, when air transportation came to
a standstill and the flow of checks slowed dramatically. During the
week of the attacks, the Federal Reserve Banks' daily check float,
which is normally a few hundred million dollars, ballooned to over $47
billion, or more than a hundred times its normal level. Had the
proposed legislation been in effect at that time and had banks been
using a robust electronic infrastructure for check collection, banks
would have been able to collect many more checks by transmitting
electronic check information across the country and presenting
substitute checks to paying banks.
Finally, many banks hope to use the authority provided by this
legislation to streamline the processing of checks that they must
return unpaid. Today, after a bank processes its incoming checks and
determines which checks to return, it has to reprocess all of the
incoming checks to pull out the less than 1 percent of checks that are
to be returned unpaid. Many banks have indicated to us that they would
find it more cost-effective to use their image systems to generate
substitute checks for return rather than having to reprocess all of
their physical checks.
Both individual and corporate bank customers would also benefit
from the proposed legislation. As I noted earlier, as banks restructure
their branch and ATM networks, they could offer customers broader
deposit options or extended deposit cut-off hours. Such changes could
result in some checks being credited one day earlier and interest
accruing one day earlier for some checks deposited in interest-bearing
accounts. In addition, banks might allow some corporate customers to
transmit their deposits electronically. Because the proposed
legislation will likely encourage greater investments in image
technology, banks might also be able offer their customers new and
improved services. For example, banks might be able to provide
customers with access to online images of deposits and payments before
the delivery of paper statements or provide printed copies of checks
deposited at ATM's on ATM receipts. The same investment in image
technology might also enable banks to provide better customer service
by using check images to resolve customer inquiries more easily and
quickly than today. Further, as banks reduce their operating costs, the
savings will be passed on through a combination of lower fees to their
customers and higher returns to their shareholders. Banks have
indicated that they expect cost savings to be substantial.
The proposed legislation is designed to provide banks with
additional flexibility in processing checks by requiring banks to
accept substitute checks in place of original checks. The proposed
legislation does not, however, require banks to accept checks in
electronic form nor does it require banks to use the new authority
granted by the proposed legislation to create substitute checks. This
market-based approach permits each bank to decide whether to make use
of this new authority based on its business judgment about the costs
and benefits of doing so.
We believe the market changes arising from these revisions to the
check law will result in substantial cost savings. Clearly, because
substitute checks can be processed in the same manner as original
checks, recipients of substitute checks should incur little or no
additional processing costs.\1\ It is difficult, however, to estimate
the overall cost savings. Different banks will take different
approaches toward using the new authority granted by the proposed
legislation. Each bank's use of the new
authority will depend on its technology infrastructure and strategy,
its physical
infrastructure, and its customer and business profiles. Thus, the
magnitude of the cost savings, which will depend on the rate at which
banks begin using the new authority, is difficult to determine.
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\1\ The extent to which banks that receive substitute checks incur
additional administrative and compliance costs will depend largely on
whether the legislation, as enacted, includes expedited recredit and
disclosure requirements and, if so, the form of these requirements.
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Customer Protection Provisions
While there is a fairly broad consensus on the desirability of the
underlying concepts of the proposed legislation to permit the use of
substitute checks, the issue of customer protections has been the
subject of much debate. We recognize that this issue is the most
challenging policy issue in the proposed law, and Congress will have a
number of alternative approaches to consider as it contemplates the
need for additional customer protections. We would not object to any
approach that does not go beyond the protections included in our
original proposal.
Modified Position On Customer Protections
The Board's proposed legislation extended the protections of
existing check law to substitute checks and included new warranty and
indemnity provisions that were designed to address losses resulting
from the receipt of a substitute check instead of the original check.
In addition, the proposed legislation included consumer and interbank
expedited recredit provisions. Since we forwarded the proposed
legislation to the Congress in late 2001, the Board has had an
opportunity to further reflect on the views that have been expressed by
both consumer advocates and the banking industry and has concluded that
the expedited recredit provisions originally suggested by the Board are
not necessary for the successful implementation of the proposed
legislation. I would like to discuss briefly why we believe that
expedited recredit provisions are not necessary.
Existing Customer Protections
Long-established check law protects bank customers if checks are
improperly charged to their accounts. The proposed legislation would
apply existing check law, including the Uniform Commercial Code (UCC)
and the Federal Reserve Board's Regulation CC, to substitute checks as
though they were the original checks, to the extent such law is not
inconsistent with the proposed legislation.
Specifically, a bank may only charge a check that is properly
payable to a customer's account.\2\ A check is properly payable if it
has been authorized by the bank's customer and complies with any
agreement between the customer and the bank. Thus, if a bank charges a
customer's account for a check that is not properly payable, such as
when a check has been forged, altered, or duplicated, the customer has
a claim against the bank for an unauthorized charge to the customer's
account. For example, if a bank pays a counterfeit check, the bank
could be liable to its customer for the amount of the unauthorized
charge, interest on that amount, and consequential damages for the
wrongful dishonor of any subsequently presented checks. This
potentially large liability provides a strong incentive for the bank to
resolve a claim for an unauthorized charge as expeditiously as
possible.
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\2\ U.C.C. Sec. 4 - 401(a).
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Over the years, no pattern of problems has emerged to suggest that
existing check law is inadequate in protecting bank customers against
unauthorized charges. As part of its analysis, Board staff has reviewed
the consumer complaint databases of the five agencies of the Federal
Financial Institution Examination Council and
had found no pattern of problems associated with the timely resolution
of check problems, including problems related to accounts where the
checks are not returned with the monthly statements.
Additional Customer Protections Under The Proposed Legislation
In addition to the protections provided in current check law, the
proposed legislation requires banks to provide new warranties for
substitute checks and to indemnify customers for losses resulting from
the receipt of a substitute check instead of the original check.
Specifically, banks must warrant that the substitute checks they
provide to their customers are legally equivalent to the original
checks and that a check will not be paid more than once from a
customer's account. Banks must also indemnify their customers for
losses they incur due to the receipt of substitute checks rather than
the original checks. Taken together, these warranty and indemnity
provisions provide customers with additional protections against losses
related to the use of substitute checks.
Are Expedited Recredit Provisions Needed?
The Board's original proposal to Congress also included expedited
recredit provisions for consumers. (A companion section of the proposal
included interbank expedited recredit rules.) The expedited recredit
provisions required a bank to recredit a consumer's account, within a
specified time frame, if a substitute check was not properly charged to
the consumer's account. Upon further reflection, the Board has now
concluded that the significant compliance burdens imposed by these
provisions on banks that receive substitute checks outweigh the small
incremental benefits that the provisions would provide to consumers.
These compliance burdens would run counter to one of the Board's
guiding principles when drafting the proposed legislation: Minimization
of the operational and the administrative costs that would be borne by
banks receiving substitute checks, because these banks would have no
choice but to accept the substitute checks.
Further, the Board believes the expedited recredit provisions are
unnecessary given the protections provided by existing check law and by
the proposed legislation's new warranties and indemnity, which provide
additional customer protections. As discussed above, existing check law
provides substantive protections against unauthorized charges to
customer accounts. Further, while it is true that the UCC does not
provide a specified time frame within which a bank must act, its
provisions give the bank a significant financial incentive to resolve
problems on a timely basis. Specifically, the longer a bank takes to
research and resolve a customer's claim, the longer the bank is exposed
to liability for consequential damages arising from the wrongful
dishonor of subsequently presented checks. These protections, in
existing check law, appear to have worked well for many decades.\3\
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\3\ In contrast, there was no established body of law governing the
rights and liability of consumers regarding unauthorized electronic
funds transfers when Congress was considering the Electronic Fund
Transfer Act in 1978. Therefore, Congress decided to address consumer
rights and liability in that Act.
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In summary, substitute checks are not expected to result in
problems different from those that are routinely addressed in today's
environment. Therefore, we believe that the costs associated with the
expedited recredit provisions will substantially outweigh the small
incremental benefit of these requirements to consumers. To address the
possibility that additional consumer protections may become necessary
in the future, the proposed legislation grants the Board authority to
adopt such protections by regulation, if needed. Nonetheless, Congress
may conclude that expedited recredit provisions for consumers should be
included in the legislation. In that case, we believe any expedited
recredit provisions should be consistent with the proposed
legislation's basic purposes and should not go beyond the provisions
proposed by the Board.
Conclusion
In conclusion, although an increasing number of payments are being
made electronically, it is clear that checks will continue to play an
important role in the Nation's payments system for the foreseeable
future. The Board believes that, over the long run, the concepts
embodied in the proposed Check Truncation Act will spur the use of new
technologies to improve the efficiency and reduce the cost of the
Nation's check collection system and provide better services to bank
customers. The proposed legislation accomplishes this by simply
permitting banks to replace one piece of paper, the original check,
with another piece of paper, the substitute check, both of which
contain the same payment information. Because the proposed legislation
should result in substantial cost savings, it would also be desirable
to begin obtaining these savings as quickly as possible.
We look forward to working with the Committee as it further
considers this legislation. Thank you for your time and I would be
happy to answer your questions.
----------
PREPARED STATEMENT OF LINDSAY A. ALEXANDER
President & CEO, National Institutes of Health Federal Credit Union
on behalf of the
Credit Union National Association
April 3, 2003
Chairman Shelby, Senator Sarbanes, and Members of the Committee,
thank you for the opportunity to provide comments on how check
truncation has been working at credit unions for the past three
decades. I am Lindsay Alexander, President and CEO of National
Institutes of Health Federal Credit Union in Rockville, Maryland. I am
testifying before you today on behalf of the Credit Union National
Association (CUNA), which represents more than 90 percent of the
Nation's 10,000 State and Federal credit unions. As you know, credit
unions are cooperative, nonprofit financial institutions organized to
provide individuals associated by a common bond with a place to save
and a source of loans at reasonable rates.
I would like to provide you with information regarding:
The frequency of check truncation at credit unions.
How check truncation works in the credit union movement.
The benefits to credit unions and consumers of check
truncation.
The Federal Reserve Board proposal and other proposals to
facilitate
check truncation.
The Frequency of Check Truncation at Credit Unions
Credit unions have had extensive experience with check truncation
for nearly three decades. When the National Credit Union Administration
(NCUA) authorized all credit unions to provide share draft accounts in
1977, NCUA initially required truncation.\1\ This followed a pilot
program underway since 1974. As a result, most credit unions that offer
checking accounts truncate. Sixty-four percent of credit unions offer
checking accounts, and of those credit unions 91 percent truncate share
drafts or checks.\2\ Among the credit unions that offer checking
accounts, 7.1 percent include images of all checks within the
statements that their members receive. Although only two-thirds of
credit unions truncate, nearly all credit union members have access to
checking accounts. In fact, 96.1 percent of credit unions members are
in credit unions that offer checks.
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\1\ Share draft accounts at credit unions are equivalent to
checking accounts at banks.
\2\ Share drafts are checks.
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How Check Truncation Works in the Credit Union Movement
Initially, the NCUA required all credit unions offering share draft
accounts to truncate and NCUA defined truncation as when the original
share draft was not returned to the credit union member. As a result,
in the past and now, credit unions tend to truncate checks at the last
step in the check collection process by not distributing share drafts
to their credit union members. Under this system, there are two
processes. In the first case, a credit union may receive the checks
that a member writes against his or her account at the credit union,
but the credit union does not pass those checks onto the member. In the
second case, a credit union may have their members' checks truncated by
a Federal Reserve Bank or a third-party processor, and the essential
share draft information is transmitted electronically to the credit
union for payment or dishonor. In this scenario, neither the credit
union nor the member receives the original paper check. For all credit
unions, each share draft or check is itemized on the statement that the
member receives.
Credit unions do not usually truncate all of the checks that they
process. For example, credit unions do not usually truncate the checks
drawn on other financial institutions that their members deposit or use
to make loan payments at the credit union.
The Benefits to Credit Unions and Consumers of Check Truncation
Credit unions have found that check truncation, under existing
check law, allows credit unions to serve credit unions members well.
Check truncation has allowed credit unions to provide members with
lower fees and still provide members with outstanding service. The
experience of credit unions is that our members rarely
request or need originals from truncated share drafts or checks. In
fact, some credit unions never provide originals because they destroy
the originals within 2-3 business days. In 2001, an informal survey of
corporate credit unions, credit unions that provide services for other
credit unions, confirmed this. In 2001, corporate credit unions
processed over 1.1 billion items in total check volume. Of those 1.1
billion checks, only about 480,000 requests were made for the original
check, representing .04 percent of all checks. In almost all cases, the
corporate credit union could make a good quality, clear image of the
check that satisfied the member's needs.
I would like to now describe the experience of my credit union,
which is a $350 million asset institution. We have 48,000 members with
26,800 checking accounts.
Like most credit unions, we truncate the share drafts drawn on our
members' accounts at the end of the check process. We do not return
checks to members and never have. Although we currently receive checks
back from our Federal Reserve Bank, we are undergoing a process to convert
to an all-electronic system. We still use the paper collection system for
checks drawn on other financial institutions that are deposited by our
members.
In addition, at National Institutes of Health Federal Credit Union
we image all checks that we receive (both checks drawn on our accounts
and deposited checks from other institutions). After we image checks
drawn on other institutions, we keep copies onsite for 30 days and
retain copies offsite for 7 years. Our credit union processed about 2
million of our own checks that were worth approximately $649 million
and 461,532 checks drawn on other financial institutions worth
approximately $340 million.
In my 14 years at National Institutes of Health Federal Credit
Union, we have never had a member that has complained about not getting
an original. Members do not request originals anymore. A copy of the
share draft seems to satisfy members' needs as long as the share draft
or the check is clear and legible. In those cases where the member does
request a copy, the most common reasons are because the member needs it
for proof of payment or for an audit. At my credit union, 90 percent
request a copy of the check as proof of payment and 10 percent request
it for Internal Revenue Service audits. Only a few members need it for
court cases or other reasons.
Truncation has helped us meet our members' needs and our members
are extremely complimentary of the services that we can provide along
with truncation. In mid-February, we implemented a new service to
complement our truncation program whereby members who are registered
with our online banking service can obtain a copy of a share draft or
check free by accessing the image through their online account. Since we introduced the service we have had an extraordinary response, with
several members a week spontaneously sending complimentary e-mails to
the credit union praising this service. This imaging service reduces the
time it takes to retrieve checks from 2-3 days to making it nearly instantaneous.
The Federal Reserve Board Proposal and other Proposals to
Facilitate Check Truncation
The Federal Reserve initially presented to Congress a proposal that
would have permitted depository institutions to convert original checks
into electronic items and send those electronic checks to other
depository institutions that agree to accept electronic checks. The
proposal did not mandate check truncation, however. For
instance, if a depository institution did not agree to accept
electronic checks, then the presenting financial institution would send
that institution a substitute, paper-machine-readable copy of the check
(a substitute check). During the collection and return process, checks
would be converted into electronic and paper versions as necessary.
This proposal represented a step forward by allowing financial
institutions to voluntarily decide to present an item totally
electronically without the need for previously adopted agreements.
The Federal Reserve proposal would have allowed existing truncation
programs, such as those at credit unions, to coexist, without imposing
new requirements from the proposal on existing credit union programs.
We strongly support that provision in the Federal Reserve proposal. And
we strongly oppose any expansion of the scope of the Act that would
impose requirements on check truncation programs that
already exist and do not use a substitute check. The Act is designed to
address situations where a customer is forced to accept a substitute
check and the special provisions for substitute checks in the Act
should only apply to situations where the credit union member or bank
customer actually receives a substitute check. In the case of credit
unions, members have already agreed not to accept the check, and our
experience suggests that our members are doing well with this approach.
Therefore, expanding the scope of this Act is unnecessary and would
interfere with credit union check truncation programs that already seem
to be working. We hope the Senate, like the Federal Reserve, limits the
scope of its bill.
We support changes that have been made to the Federal Reserve
proposal that appear in the Check Clearing for the 21st Century Act
that was recently introduced by Representative Hart and Representative
Ford in the House. These changes would allow financial institutions to
truncate all types of checks, including checks drawn on the Department
of the Treasury, without unique processing streams. Moreover, the
consumer provisions found in the Act appear to reflect the experience
that credit unions have had with check truncation. The Act allows an
indemnifying financial institution to produce a copy to resolve a
consumer's claim when a copy is sufficient for that purpose. The
experience of credit unions is that at nearly all times a copy is
sufficient, so being able to reproduce a good quality copy should be
sufficient. The change is especially important because frequently the
original will be destroyed within a few days and might not be available
anyway.
We are also supportive of consumer protections in the House bill
that mirror those of existing laws. Section 6 of the bill would provide
a consumer who receives a substitute check with certain recredit
rights. If the member suffered a loss because of the substitute check,
the member's credit union under certain circumstances would be required
to recredit the account of the member up to $2,500 by the end of the
tenth business day following receipt of the member's notice that a
substitute check was not properly charged to the account. The approach
appears reasonable. The recredit procedure in Section 6 gives the
member's credit union 10 business days to investigate the claim before
being required to recredit the member and 45 calendar days in certain
unique circumstances. The credit union's ability to investigate a
consumer's claim prior to being required to recredit the consumer's
account is essential for the credit union to avoid fraud losses from
the new expedited recredit procedure. Similarly, the Section 6
expedited recredit procedure does not require the credit union to
provide notice to the member before reversing a claim that is not
substantiated. Requiring a credit union to give notice before reversal
would have
undermined the credit union's ability to protect itself from fraud,
because it gives the person a chance to withdraw funds even when the
credit union has discovered that there is a fraud in progress.
We also support Section 7 in the House bill that provides ground
rules regarding when a financial institution that has suffered a loss
from a substitute check must be recredited by an indemnifying bank.
Under Section 7, a claimant financial institution has 120 days to make
a claim that it suffered a loss as a result of a substitute check.
After that, the indemnifying bank must respond by giving the
appropriate recredit, or a copy of the check showing that the claim is
unfounded, or information why the bank does not need to provide either
of those two responses. Placing a time limit on responses to claims
among financial institutions protects smaller institutions and ensures
that paying financial institutions do not disproportionately bear the
burden for substitute checks that may have been mishandled earlier in
the collection process by an indemnifying bank.
Conclusion
In conclusion, most credit unions throughout the country in
addition to National Institutes of Health Federal Credit Union truncate
their share drafts or checks, and have done so for decades. The
experience of these credit unions is that members like this service,
and in particular, seem to find imaging helpful. Members find that in
cases where they need a copy of the share draft a good copy is
sufficient. We remain supportive of the current attempts to voluntarily
facilitate check truncation. And we look forward to working with the
Committee, the Federal Reserve, and consumers in further strengthening
this proposal.
We thank the Committee for this opportunity to comment and I will
be glad to answer any questions.
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PREPARED STATEMENT OF JANELL MAYO DUNCAN
Legislative and Regulatory Counsel, Consumers Union
April 3, 2003
Good morning, Chairman Shelby, Senator Sarbanes, and Members of the
Committee. Thank you for providing me the opportunity to come before
you today. I am Janell Mayo Duncan, Legislative and Regulatory Counsel
for Consumers Union.\1\ Consumers Union is the nonprofit publisher of
Consumer Reports magazine. Our mission at Consumers Union is to test
products, inform the public, and protect the consumers. Today, I offer
this testimony on the proposed Check Truncation Act as part of our
consumer protection function. My testimony today is supported by the
Consumer Federation of America, U.S. Public Interest Research Group,
and the
National Consumer Law Center.\2\
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\1\ Consumers Union is a nonprofit membership organization
chartered in 1936 under the laws of the State of New York to provide
consumers with information, education, and counsel about goods,
services, health, and personal finance. Consumers Union's income is
solely derived from the sale of Consumer Reports, its other
publications, and from noncommercial contributions, grants, and fees.
In addition to reports on Consumers Union's own product testing,
Consumer Reports with approximately 4.5 million paid circulation,
regularly carries articles on health, product safety, marketplace
economics and legislative, judicial, and regulatory actions that affect
consumer welfare. Consumers Union's publications carry no advertising
and receive no commercial support.
\2\ Consumer Federation of America is a nonprofit association of
almost 300 pro-consumer organizations, founded in 1967 to advance the
consumer interest.
U.S. Public Interest Research Group (U.S. PIRG) serves as the
national lobbying office for State PIRG's, which are nonprofit,
nonpartisan public interest advocacy groups with 400,000 members in
States around the country.
The National Consumer Law Center is a nonprofit organization
specializing in consumer issues on behalf of low-income people. The
Center's experienced attorneys work with thousands of legal services,
Government and private attorneys, as well as community groups and
organizations, from all States who represent low-income and elderly
individuals on consumer issues.
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If the proposed Check Truncation Act (CTA) is enacted into law, it
would have a significant impact on an estimated 45 million consumers
who receive their original paper checks in the mail every month.\3\ The
proposed CTA would enable banks, thrifts, and credit unions
(collectively referred to in this testimony as banks) to convert
original paper checks written by consumers into electronic form so they
can be sent by banks to other banks that agree to accept them.
Consequently, original paper checks would be ``truncated,'' or stopped
by one of the first banks in the system to process a consumer's check.
Banks refusing or unable to accept electronic check information would
receive a paper ``substitute check.'' During the check return process
under the proposed CTA, a consumer's check could be transferred in and
out of electronic and paper substitute form. Thus, the consumer's bank
would receive either an electronic image or a ``substitute check,'' but
would not receive back the consumer's original paper check. Likewise,
the consumer could only get back a ``substitute check'' but not the
original.\4\
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\3\ At an August 2002 meeting, bank representatives stated that
approximately 60 percent of consumers east of the Mississippi River,
and 30 percent of consumers in the West receive their original checks
back. Since approximately 90 percent of the 105 million U.S. households
have a bank account, usually a checking account, this means that
approximately 45.8 million U.S. households get back their paper checks.
\4\ Today many bank and credit union customers do not receive their
checks back in the mail monthly; however, a credit union creates an
image of the customer's check at the end of the process, after the
check has made its way through the check clearing process. In contrast,
a ``substitute check'' is a reconstituted version of the consumer's
check. Because not all financial institutions will transmit the check
in electronic form, the substitute check may contain errors arising
during the transmission process. In addition, if the consumer needs the
original check due to a claim of improper amount, forgery, or
alteration (which may require handwriting evidence) the original check
will now be in the custody of someone other than the consumer's own
bank, and so it would take longer to find and retrieve.
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We believe the proposed CTA would be a bad deal for consumers for
three main reasons. First, the proposed legislation would eliminate the
choice preferred by millions of consumers who receive their original
paper checks each month. Second, the provisions in the proposed CTA
meant to protect consumers from processing errors will not be available
to all consumers whose check information is processed electronically.
Third, if enacted into law, the proposed CTA would give banks an unfair
ability to deter, delay, or reduce consumers' claims for damages
resulting from processing errors by alleging that a consumer was
somehow at fault.
Potential Impact of Federal Reserve Board Proposal
We recognize the value that advances in technology can provide to
consumers in terms of enhanced banking and customer services. However,
our concern is not with the technology--but the resulting removal of
consumer choice. The proposed CTA would take a system that works
relatively well and change it in a way that imposes new risks and
inconveniences on consumers. Today, some consumers prefer online
banking, some receive no checks with their monthly statement, and some
receive checks back every month, like clockwork. The proposed CTA would
tell millions of consumers that they can no longer get their original
paper checks back with their statements to double-check what a bank has
done with their funds, to make sure a payee has not changed the amount,
or to prove payment where this is an issue. In addition to eliminating
this consumer option, the proposed legislation creates a system of
electronic transmission of checks that could expose consumers to new
risks including double processing of a single check, or errors in
reading the amount of or account number on a check--resulting in losses
to consumers.
It is virtually certain that the largest banks will save money from
the efficiencies achieved from increased electronic processing of
checks. In contrast, there is no guarantee that consumers will benefit
from mandatory check truncation. In return for changing their banking
practices and being subjected to potential errors related to electronic
processing, the consumer is offered vague and unenforceable promises
that they will be sufficiently protected, promises of increased
flexibilty to view account information, and promises that in the future
funds from checks they deposit into their account may be available
sooner. None of these promises are certainties under the proposed CTA.
Loophole in Legislation Relating to ``Recredit'' of Disputed Funds
If the proposed CTA were enacted into law, consumers would need
additional protections to address any errors or disputes that occur
when their check information is processed electronically. In an effort
to provide protections, Section 6 of the proposed legislation, among
other duties, would require a bank to put up to $2,500 in disputed
funds back into a consumer's account if the matter is not settled in
one business day--called ``recredit.'' \5\ However, the proposed
language would allow consumers to seek recredit of disputed funds only
if they receive a ``substitute check'' from their bank.
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\5\ We believe that this amount should not be limited to $2,500.
Recredit amounts are not limited for consumers who conduct electronic
transfers.
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This is a significant loophole because a bank could avoid giving
account-holders these rights simply by refusing return substitute
checks to them. If a bank does not give a substitute check to its
account-holder, the customer loses the right to recredit, and is left
with weaker UCC remedies found under State law. Consumers unable to
seek recredit would have to seek redress under State law--UCC Articles
3 and 4--which governs negotiable instruments, including checks. UCC
liability provisions are not comparable to recredit because, although
they provide rules for liability, they lack a nonlitigation remedy. In
addition, UCC provisions do not set a specific time period to resolve
disputes, and do not require a bank to redeposit disputed funds. If a
bank delays or declines to solve the problem, the only way for the
consumer to get his or her money back under the UCC is to sue, which is
too expensive and time consuming for most disputes relating to modest
amounts.
Although consumers would benefit from additional warranty and
indemnity provisions under the proposed CTA, in order to obtain damages
for losses due to an improperly paid check under either the UCC or the proposed CTA's warranty and indemnity provisions, a consumer would be
forced to sue his or her bank. And as discussed earlier, this is an
expensive and cost-prohibitive prospect for most amounts likely to be in dispute. We, therefore, believe that the recredit provision should be
extended to all consumers, regardless of whether or not he or she
receives a ``substitute check.''
Although Inadequate in Current Form--The Recredit Provision is
Critical to Ensure Consumer Protections
Currently, consumers engaging in other electronic funds transfers
(for example, using debit or ATM cards or allowing funds to be debited
directly from their accounts) are protected by Regulation E,\6\ which
includes a 10-day right of recredit, and has no dollar limit. Because
the proposed CTA would allow banks to turn consumer paper check
processing into electronic transmissions of check information, the
recredit section essentially gives consumers protections that are
similar to those governing other types of electronic funds transfers.
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\6\ 12 CFR Part 205.
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In the absence of any recredit provision in the CTA, banks would
lack an incentive to expedite their investigations of possible errors.
During the delay, consumers could be denied access to rightful and
necessary funds. The recredit provision properly places the burden of
delay on the bank rather than the consumer. As described above, in the
absence of recredit, for unresolved disputes, consumers would be
required to sue their banks in order to pursue claims for improperly
debited funds.
The importance of a recredit provision cannot be over-emphasized,
and has been recognized by its authors. In a letter dated December 17,
2001, Federal Reserve Board Chairman Alan Greenspan presented the
proposed CTA to then-Senate Banking Committee Chairman Sarbanes, along
with an overview of the proposed legislation, and a section-by-section
analysis. The ``Highlights'' section of the overview of the proposed
legislation states that: ``The expedited recredit procedure is intended
to mitigate the effects on consumers of any potential problems
associated with the receipt of substitute checks.'' In addition, the
section-by-section analysis of proposed CTA Section 6 states: ``These
expedited recredit provisions of the proposed Act are limited to
consumers, who are generally not in a position to negotiate with their
banks the terms of their deposit accounts that affect the consumers'
rights and liabilities, such as how payments are processed and charged to their accounts.''
As recognized by the Federal Reserve Board, recredit is an
essential consumer protection element of the proposed CTA. The
alternative--requiring consumers to seek redress by suing their bank
over a disputed check processing error--is an unacceptably unfair, time
consuming, and potentially expensive alternative. We would, therefore,
oppose any CTA legislation that allows banks to treat checks like an
electronic funds transfer, without giving consumers the right to
recredit--a legal protection they need and deserve.
Comparative Negligence Provisions
The proposed CTA contains provisions that would make it harder for
consumers to seek damages from banks for improperly paid checks.\7\
These comparative negligence standards in Sections 5(b) and 8(c) of the
proposed legislation would allow banks to reduce the amount of damages
a consumer can recover by asserting that the consumer was somehow at
fault (that is, comparatively negligent). Despite the creation of this
defense, it is highly unlikely that a consumer could contribute in any
way to the double processing of his or her checks, or to a processing
error. This provision would unfairly enable a bank to deter a
consumer's claim, or make any litigation longer and more expensive by
asserting that the consumer was somehow partly responsible for check
processing errors.
---------------------------------------------------------------------------
\7\ Under Section 8(b) of the CTA, a bank could raise a comparative
negligence defense with respect to every claim by a consumer that his
or her account had been improperly debited (that is, a ``warranty
claim''). See CTA Section 8(b). Similarly, the CTA also would allow
banks to raise a comparative negligence defense if a consumer seeks
indemnity for harm caused by the unavailability of the original check.
See CTA Section 5(c).
---------------------------------------------------------------------------
The proposed CTA's comparative negligence provisions are much
broader than those currently governing consumer check transactions
under the UCC. Although the UCC imposes a comparative negligence
standard, it does so only relating to fraud.\8\ The proposed CTA,
therefore, gives banks greater protections than exist under current law
by extending a bank's ability to claim a defense of comparative
negligence beyond situations where there has been a loss to the
consumer due to fraud or forgery. This expansion would make it harder
for consumers to collect judgments against banks responsible for
processing errors. We, therefore, believe that the comparative
negligence standards in Sections 5(b) and 8(c) of the proposed CTA are
inappropriate to resolve harms suffered by consumers due to processing
errors, and should be removed.
---------------------------------------------------------------------------
\8\ The first instance relates to fictitious payees or imposters
[3- 404(d)], the second involves where a consumer's negligence
contributes to a loss due to a forged signature or alteration [3-
406(c)]. Finally, under the UCC, an account-holder has a duty to be
diligent in reviewing his or her monthly statement, and report any item
paid that was improperly altered or contains an unauthorized signature.
If the consumer fails to examine his or her statement and discover and
report such indications of fraud, then he or she may lose the ability
to assert a claim against the bank for wrongful payment [4- 406].
---------------------------------------------------------------------------
Recommendations
We recommend the following changes to the proposed CTA to more
properly balance the benefit of increased check processing efficiencies
with necessary consumer protections:
Because all consumers are equally susceptible to harm from
processing errors, the recredit loophole in the proposed CTA should
be closed. The right of recredit should be expanded to apply in
every case where the original check is not returned to the consumer
and a check may have been improperly charged to the consumer's
account.
A comparative negligence standard is inappropriate to resolve
harms suffered by consumers due to processing errors. Banks should
not be able to use this standard to avoid liability, or to delay a
consumer's action for improperly paid checks that result from
processing errors. Therefore, as it relates to consumers, the
language relating to a comparative negligence standard should be
removed from the proposed CTA.
We also have other concerns about the proposal, but we believe that
these two elements are among the most important.
I thank the Chairman, Senator Sarbanes, and the Committee for the
opportunity to testify, and I look forward to any questions you may
have.
----------
PREPARED STATEMENT OF DANNE L. BUCHANAN
Executive Vice President, Zions Bancorporation
on behalf of the
American Bankers Association, America's Community Bankers
Consumer Bankers Association, Financial Services Roundtable
and Independent Community Bankers of America
April 3, 2003
Good morning. My name is Danne Buchanan. I am the Executive Vice
President of the E-Business Solutions Group at Zions Bancorporation,
Salt Lake City, Utah. I also serve as the CEO of NetDeposit, a
subsidiary of Zions Bancorporation that provides processing and
clearing technology which allows organizations to move to electronic
presentment of paper checks.
I am here today representing the five major banking and financial
services trade associations--the American Bankers Association,
America's Community Bankers, the Consumer Bankers Association, the
Financial Services Roundtable, and the Independent Community Bankers of
America (the associations). I am pleased to present the banking and
financial services trade associations views on the concept of check
truncation as envisioned in the Federal Reserve Board's (Board)
proposal (proposal).
Although the associations sometimes have divergent views on issues,
on this issue, we are unequivocally united in supporting efforts to
increase the efficiency of the Nation's payments system. We believe
that legislation to sanction ``substitute checks'' will facilitate
electronic check processing that will produce significant cost savings,
efficiencies, and new consumer conveniences, to the great benefit of
both consumers and financial institutions.
On behalf of the associations, I would like to extend our
appreciation to Senator Shelby for holding this hearing. We also
commend the staffs of the Senate Banking Committee and the Board who
have worked tirelessly to address the concerns of the banking industry,
consumer groups, and others in moving this concept forward.
Consumer Payment Alternatives and the Check Clearing Process
Consumers today have a variety of alternatives at their disposal to
make noncash retail payments. These include debit cards, credit cards,
automated clearinghouse (ACH) debit payments in addition to traditional
checks. According to the Board, American consumers make more than 70
million of these noncash retail payments each year. While electronic
payments represent an increasing number of these noncash payments,
paper checks remain the dominant form of noncash payment in the United
States today. Despite repeated predictions of their demise, checks play
a significant role in the U.S. payments system and will continue to do
so for years to come.
Check processing is an enormously expensive and labor-intensive
process that requires checks to be handled, sorted, and physically
transported to the paying bank. Because of current law, paper checks
generally must physically move, by train, plane, and automobile, from
the bank of first deposit to the paying bank. The primary impediment to
elimination of this paper check travel route and adoption of electronic
check processing is the fact that customers have the right to receive
their original paper checks back. Of course, checks today can be
truncated at the paying bank site because paying banks and their
customers can agree to the arrangement. However, the bank of first
deposit usually does not have a relationship with the paying bank's
customer and cannot know whether the check writer will insist on
receipt of the paper check. Therefore, checks generally cannot be
truncated at the point of deposit, necessitating the long trip to the
paying bank. The only exceptions are unusual cases where very largest
banks with large check volumes have reached private agreements.
At our bank we have, over the last 2 years, been truncating
original items for payments and creating Image Replacement Documents
that have been processed by every major financial institution in the
United States for thousands of customers. We have accomplished this
with two-party agreements between Zion's Bank and its customers even
though the customer's deposit account may be held with another
financial institution. I am pleased to let you know that the process
works. After we disclosed the process, we had few customer inquiries
and have successfully dealt with every issue or question posed by a
paying bank. We have also proven the value propositions by streamlining
our internal operations and reducing costs in float, clearing fees, and
transportation.
We also have a pilot program for our imaging product with a large
New York bank and one of its customers and their results are equally
positive. The benefits have gone beyond banking as we are finding our
commercial customers anxious to begin truncating their payments
utilizing this same technology. We have several in production now, with
a large number awaiting implementation. The benefits for these
customers are improved availability, integration to back office
systems, and elimination of the daily bank delivery, along with the
extension of operating time frames. We are currently processing
approximately a million dollars per day with this process and expect it
to ramp significantly in the coming months.
Keep in mind that many customers today do not receive their checks
back with their statements. Informal industry assessments indicate that
more than 30 percent of all checks drawn by bank customers, and nearly
all checks drawn by credit union customers, are not returned to the
check writer. Depending on the bank's check safekeeping strategy, many
consumers receive convenient images of cancelled checks or detailed
information about their check transactions on their monthly account
statement. Those who receive notations on their check statements may
obtain copies of checks upon request. In addition, some customers also
have the ability to review check images online.
It is important to note that the detailed check transaction
information and check images satisfy virtually all customer needs
today. For example, images are routinely used and accepted as proof of
payment, for tax records, etc. Original items are rarely requested or
needed. This fact is critical because many of the objections raised by
consumer advocates about the broader check imaging envisioned under the
Board's proposal exist today, but in fact present few, if any,
problems.
The removal, or truncation, of paper checks from clearing,
processing, and settlement activities is growing and will continue to
proceed regardless of whether legislation is enacted. However, passage
of legislation will facilitate electronic processing so it progresses
in a more orderly, efficient fashion, to the benefit of all
participants.
The Board's Proposal Will Improve the Efficiency of the Check System
Responding to the massive costs and inefficiencies associated with
check processing, the Board's Payments System Development Committee
over 3 years ago began actively seeking input from the banking
industry, consumer groups, check clearinghouses, processors, and others
in developing a proposed legal framework that would remove the barriers
to the wide scale use of electronic check processing. The Board's
diligent review of comments, resolution of issues, and creative
thinking produced its draft legislation. We applaud those efforts and
the ultimate product.
The Board's proposal would allow a collecting bank to remove, or
truncate, the original paper check from the check collection and return
process. Checks could then be processed as images that are transmitted
electronically. Any bank in the process, as well as the check writer
could demand that items be reconverted from electronic form into a
``substitute check,'' complete with back and front images and the
magnetic ink character recognition (MICR). The proposal would establish
that substitute checks are the legal equivalent of the original check.
The proposal provides that substitute checks must adhere to rigorous
standards that ensure the document accurately represents the original
check and can be processed in the same manner as the original check. As
noted earlier in my testimony, we have proven that the concept works in
the real world without adverse impact to banks or customers.
No longer would a California bank have to ship a check drawn on a
New York bank across the country for clearing, processing, and
settlement. Checks could be processed and transmitted electronically
without the original paper check. Moreover, the proposal does not
require the banking industry to adopt wholesale electronic check
clearing; rather it provides flexibility to adapt to electronic check
clearing over time without interfering with the existing paper check
process.
The banking and financial services trade associations believe that
removing the legal impediments to electronic check processing will
improve the efficiency of our Nation's payment system and provide
benefits to both consumers and depository institutions. Electronic
check processing has the potential to streamline the collection and
return of checks, reduce processing costs, and minimize the effect of
unexpected disruptions to air and ground transportation systems.
Reducing the dependency on the physical presentment of original items
will result in faster check collection, which will allow consumers
sooner access to their funds. Consumers will also have faster, more
convenient access to information about check transactions.
Improving the check clearing process may also allow banks to
develop new and more flexible banking services. For example, image-
capable ATM's that can forward deposits electronically will allow banks
to deploy more ATM's in remote locations as the cost and frequency of
physically retrieving deposits and servicing ATM's could be reduced.
Consumers may be able to use these ATM's to cash payroll checks at
their place of employment, which may be particularly attractive for
those without bank accounts. It will also be possible for banks to
offer extended deposit cut-off at remote locations since the need for
physical same-day pick up could be eliminated.
Check Truncation and Imaging Will Benefit Banks and Their Customers
In addition to the direct impact on costs, the proposal would serve
to promote check imaging technology by adding another positive weight
to the business case for adopting check imaging generally. This broader
adoption of check imaging will help provide benefits beyond those
attributable to the electronic processing facilitated by the proposal.
New applications, services, and benefits will emerge and existing ones
expand if check imaging is boosted by the electronic processing aspect
envisioned under the proposal.
For example, today many consumers receive compendious and
convenient image statements of checks rather than disorganized, loose
checks. In addition, a more recent application of check imaging allows customers to view check images online. This helps consumers to quickly
and to conveniently review transactions, identify potential errors, and
detect fraudulent transactions sooner. Customers who do
not bank online also benefit from imaging because customer service
representatives can quickly bring up for view images to verify
transactions for the customer. This requires a fraction of the time
typically required to research microfilm or to physical archives and
transmit copies. Identifying errors and potential fraud as soon as
possible also helps banks minimize customer inconvenience, control
potential losses, and gives law enforcement an advantage in tracking
down the perpetrators. Such current imaging applications will expand
with the additional application of check truncation.
Finally, the proposal could provide real benefits to rural
community banks and their customers. In remote areas, banks are
constantly challenged to meet the Federally mandated funds availability
deadlines due to adverse weather conditions and limited access to air
courier services. In some places, it can take hours via ground
transportation to reach a processing facility. Air couriers are often
not available. With the Board reducing check processing services and
closing facilities, such physical challenges and complications will
only increase. Banks in these situations struggle to process checks
before they must make funds available pursuant to the schedules
mandated under the Expedited Funds Availability Act. The proposal would
allow rural community banks to transmit electronic images of checks
that can be used for clearing and settlement with their existing
systems, regardless of weather, transportation constraints, or
distances to processing centers.
Existing Consumer Protections for Checks are Adequate
The associations support the concepts outlined in the Board's
proposal. The legislation removes the need to transport and present
original checks. However, we strongly believe that the provisions of
Section 6 of the proposal related to expedited recrediting for
consumers are unnecessary and will not only facilitate, but also indeed
encourage fraud. We believe that existing check law provides
appropriate and adequate protection to consumers with respect to
substitute checks as envisioned under the proposal.
The banking industry and consumers have an established history with
truncated checks and image documents. Indeed, millions of consumers
have been receiving either images or a notation in their statements for
years, without complaint that disputes are not addressed satisfactorily.
The current check law works in the truncated and image environment. There simply is no evidence to justify deviation from existing check law.
In fact, the Board's staff has indicated that an informal review of
the consumer complaints filed with all the banking regulatory agencies
reveal no significant consumer issues relating to existing check
protections. Banks report the same dearth of complaints on these
matters. Complicated new recredit procedures would only serve to
confuse customers, create compliance headaches for banks, and expose
banks to potential new sophisticated fraud schemes.
Under the Uniform Commercial Code, a bank is liable to its customer
if it charges its customer's account for a check that is not ``properly
payable.'' This includes checks that are not authorized by the
consumer, checks containing a fraudulent endorsement or signature, and
other erroneously posted checks. A bank that improperly debits a
customer's account is liable to the customer not only for the
amount of the improper debit, but also for the amount of any damages
that are caused by any checks that are returned due to insufficient
funds resulting from the improper debit. Additional protections and
funds availability schedules are provided under the Board's Regulation
CC. For example, under Regulation CC, returning banks warrant to the
bank customer to whom the check is being returned that they have
returned the check in accordance with the requirements of applicable
law, that they are authorized to return the check, and that the check
has not been materially altered. These laws ensure check related
disputes are handled appropriately. They work, whether the original
check, an image, or a statement notation is involved.
Proposed Expedited Recredit Provisions are Unnecessary and
Will Promote Fraud
The proposal establishes a complicated expedited recredit and
reversal of recredit structure for consumers and banks that will
promote fraud. Section 6 of the proposal provides that consumers may
make claims for expedited recrediting if they assert that the bank
charged the account for a substitute check that was not properly
charged and that production of the check is necessary to determine the
validity of the charge. The bank then must either produce the original
check and show that the account was properly charged or recredit the
consumer account for the amount of the check up to $2,500 no later than
the business day following the banking day of the claim. The remainder
must be available not later than 20 business days following the banking
day of the claim. Funds must be available the day after recrediting.
Banks may delay recrediting under certain circumstances: The account is
``new;'' the account has been repeatedly overdrawn; the bank has
reasonable cause to believe that the claim is fraudulent; and
emergencies.
Even with the exceptions, the expedited recrediting period is far
too short and will not only facilitate fraud, but also indeed encourage
it. To illustrate:
A fraudster sets up a bank account and writes a check drawn on
the account for $2,400 that is deposited into another account
belonging to the same individual at another institution.
After the original item is truncated and a substitute check
sent to the paying bank, the fraudster disputes the item, claiming
the original has been altered from $240 to $2,400 and that the
original is required to resolve the problem.
Because in most cases, it will not be possible to obtain the
original check within 2 days, the bank will be obliged to release
the funds. The fraudster walks away with $2,160 of the bank's
money.
Under the proposal, the paying bank must make funds available 2
days after the claim, risking that the funds will be withdrawn before--
and if--it can produce the original check. In addition, the bank risks
liability for wrongful dishonor of additional checks drawn on the
account.
As a practical matter, under the proposal, the bank has no time to
obtain the check or investigate before it must release $2,500 per
claim. (The Proposal does not limit the number of claims an individual
may make in a single day.) Multiply the claims by multiple checks and
multiple accounts and the sum can be significant reward for such little
effort and time.
This is attractive not only for ``true fraudsters,'' but also for
customers who may be tempted to abuse the law on an occasional basis.
Certainly, this is banks' experience and complaint under Regulation E
which governs electronic fund transfers
related to consumer accounts and generally permits a more generous 10
days to recredit the account. Banks complain that this current 10-day
recrediting requirement means that they must absorb losses due to
fraudulent claims that cannot be resolved within the 10-day time frame.
Accordingly, we strongly recommend retaining current check law.
Consumer Groups' Concerns are Unfounded Because Consumers'
Situation Will Be Unchanged
Consumer representatives complain that consumers need protections
above and beyond what is required today because they will be at a
disadvantage if they receive substitute checks rather than originals.
However, the situations they cite have
existed for years in the truncated environment without adverse
consequence to consumers. As noted earlier, millions of bank customers
receive check images with their statements. Generally, banks providing
the images destroy the checks within 30 to 60 days. In many cases, by
the time the consumer requests the check, it has already been destroyed
and only a copy is available. Thus, the environment under the proposal
will differ little from the environment of today.
Testimony presented by Gail Hillebrand on behalf of Consumer Union
and others on September 25, 2002, before the House Financial Services
Committee, asserted that the substitute check would not be able to
``show things that cannot be copied such as the pressure applied to the
pen by a forger.'' This is true today with the ubiquitous image
statements.
First, by the time consumers determine they want the original, it
has usually already been destroyed. Second, examining pen pressure,
which is expensive, would typically only arise in rare cases, that is,
high dollar checks. In such cases today, the check may not have been
destroyed. Similarly, if the proposal is adopted, the bank may choose
not to truncate large checks or retain the original if they are
truncated, given the risk of loss in the event the item is disputed.
Thus, in rare cases when pen pressure might be examined, the check
would probably be available for examination as it is today.
In addition, consumer groups expressed concern that: ``It will be
up to the consumer to persuade a landlord or another person to accept
the substitute check as proof of payment.'' Again, today, by the time
consumers determine that they want the check, it is likely to have
already been destroyed. Moreover, under the proposal, substitute checks
will bear the legend, ``This is a legal copy of your check. You can use
it the same way you would use the original check.'' We believe that
this will be sufficient to quickly convince the landlords and others of
the legal equivalence of the check.
Finally, consumer groups also demand that the expedited recrediting
provisions of the proposal extend to all truncated checks, including
those provided today with the customers' consent. They argue that
consumers will be confused because the rules for dispute resolution for
those who receive images voluntarily, as they do today, will be
different from those who insist on substitute checks. The need for
consistency argues for retaining current check law. Since existing
check law has a long, proven record of success in the truncated
environment, if a single consistent rule is adopted, it should be based
on current proven law, not a new law that arguably will promote fraud.
Conclusion
The banking and financial services trade associations support the
general principle outlined in the Board's proposal to facilitate
innovation in the check collection system without mandating receipt of
checks in electronic form. We believe, however, that the body of law
and regulations that has developed around existing check clearing
processes is both effective in protecting consumers and minimizing the
banking industry's exposure to fraud. The banking industry and consumer
experience with existing check safekeeping and truncation programs
demonstrate that existing law and regulations work. The worries of
consumer groups demanding additional consumer protections are
unfounded. The examples they raise exist today without complaints of
the harms or inconveniences they predict will accompany the
legislation.
We urge Members of the Committee to consider changes to the Board's
proposal that will preserve existing law with respect to substitute
checks. We hope Members will also take this opportunity to improve the
efficiency of the U.S. payments system by quick passage of the
proposal, which has the broad support of the banking industry and the
Federal Reserve Board.
Represented Organizations
American Bankers Association
The American Bankers Association brings together all categories of
banking institutions, including mutually-chartered savings banks and
savings associations, to best represent the interests of the rapidly
changing industry. Its membership--which includes community, regional,
and money center banks and holding companies, as well as savings
associations, trust companies, and savings banks--makes ABA the largest
banking trade association in the country.
Consumer Bankers Association
The Consumer Bankers Association is the recognized voice on retail
banking issues in the Nation's capital. Member institutions are the
leaders in consumer finance (auto, home equity, and education),
electronic retail delivery systems, bank sales of investment products,
small business services, and community development. CBA was founded in
1919 and provides leadership and representation on retail banking
issues such as privacy, fair lending, and consumer protection
legislation/regulation. CBA members include 85 percent of the Nation's
largest 50 bank holding companies and hold two-thirds of the industry's
total assets.
America's Community Bankers
America's Community Bankers represents the Nation's community banks
of all charter types and sizes. ACB members, whose aggregate assets
exceed $1 trillion, pursue progressive, entrepreneurial and service-
oriented strategies in providing
financial services to benefit their customers and communities.
The Financial Services Roundtable
The mission of the Financial Services Roundtable is to unify the
leadership of large integrated financial services companies in pursuit
of three primary objectives: To be the premier forum in which leaders
of the U.S. financial services industry determine and influence the
most critical public policy issues that shape a vibrant, competitive
marketplace and a growing national economy; to promote the interests of
member companies in Federal legislative, regulatory, and judicial
forums; and to effectively communicate the benefits of competitive and
integrated financial services to the American public.
Independent Community Bankers of America
ICBA, ``The Nation's Leading Voice for Community Banks,''
represents nearly 5,000 institutions at more than 17,000 locations
nationwide. Community banks are independently owned and operated and
are characterized by attention to customer service, lower fees, and
small business agricultural and consumer lending. ICBA's members hold
more than $526 billion in insured deposits, $643 billion in assets and
more than $405 billion in loans for consumers, small businesses, and
farms. They employ more than 231,000 citizens in the communities they
serve.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM ROGER W.
FERGUSON, JR.
1. In your written testimony you stated that, ``Check
truncation is generally more efficient, more cost effective,
and less prone to processing errors.'' Based in part on this
assessment, you concluded that, ``The proposed legislation
should result in substantial cost savings.'' In defining how
these benefits would be distributed, you stated that, ``As
banks reduce their operating costs, the savings will be passed
on through a combination of lower fees to their customers and
higher returns to their shareholders. Banks have indicated that
they expect cost savings to be substantial.'' Based on these
statements, I have two related questions.
Q.1.a. What is the Fed's estimate of the size of these savings
for banks?
A.1.a. While we believe that the proposed legislation will
result in substantial cost savings, the magnitude of those
savings is difficult to estimate. The magnitude of the savings
will depend on the rate at which banks begin using the proposed
legislation's new authority. Each of the bank's approach toward
using the new authority will depend on its technology
infrastructure, physical infrastructure, business strategy, and
customer profile. On the other hand, banks receiving substitute
checks will be able to process substitute checks in the same
manner as original checks, thereby incurring little or no
additional processing costs. Banks that receive substitute
checks, however, will incur additional administrative and
compliance costs that will depend largely on whether the
proposed legislation, as enacted, includes expedited recredit
and disclosure requirements and, if so, the form of those
requirements. Therefore, while banks have indicated that they
expect cost savings to be
substantial, the actual magnitude of the cost savings is
difficult to
determine.
Q.1.b. What portion of these substantial savings do you expect
to go to customers as opposed to shareholders?
A.1.b. We are not able to forecast the relative amount of the
cost savings that might accrue to banks' customers and
shareholders under the proposed CTA. Banks implement changes
for a variety of reasons. Banks might implement changes to
improve profitability or to increase market share by attracting
and retaining customers through improved services or fee
reductions. Historically, both banks and their customers have
benefited from banks' investment in technology. We expect that
the proposed CTA will benefit both banks' customers and
shareholders.
2. It is my understanding that the CTA reduces the amount of
damages that a consumer can recover under an indemnity loss
claim, breach of warranty, or failure of the bank to meet any
requirement of the CTA, in proportion to the amount of
negligence or bad faith attributable to the customer. In your
April 3 testimony, you stated that, ``The question of
comparative negligence
already exists in any of the common law standards for tort and
. . . in the UCC. And it has withstood the test of time.''
Consumer groups agree. However, they allege that the
comparative negligence standards in subsection 5(c) and 8(b) of
the CTA are much broader than the Uniform Commercial Code (UCC)
standards governing consumer check transactions and will make
it more difficult for consumers to recover damages from banks.
Q.2.a. Are consumer protections under the CTA weaker than under
the UCC as the consumer groups allege?
A.2.a. The CTA consumer protection provisions are generally
consistent with, and would not weaken, consumers' rights under
the UCC. The comparative negligence standard is included to
ensure that the doctrine of comparative negligence adheres to
the newly created rights under the warranties and indemnity
that would apply to substitute checks. The comparative
negligence language is also intended to negate any concern that
the CTA preempts well-established State check law protections.
Consumer protections under the CTA are additional protections
over and above current UCC provisions. The CTA warranties and
indemnity, as well as the comparative negligence provisions,
would overlay existing check law and apply in cases where
substitute checks are used.
Comparative negligence is a common law concept under which
courts apportion tort liability according to how much the
actions of each party contributed toward the loss. This concept
has been incorporated into check law through the UCC, as well
as the Board's Regulation CC (See 12 CFR Sec. 229.38(c)). The
UCC contains several provisions that allocate liability based
on fault. For example, the UCC sets out a comparative
negligence standard in cases of imposters and fictitious payees
(Section 3- 404(d)) and alterations and forged signatures
(Section 3- 406). These cases often, but need not always,
involve fraud. Other UCC provisions reduce a person's ability
to recover losses based on that person's negligent actions and
generally do not involve fraud. For example, Section 4 - 406(d)
reduces a consumer's ability to recover for unauthorized items
if the consumer does not make a timely examination of his or
her statement. Also, under Section 3- 407(c), a consumer could
be held liable for a check that was completed in an
unauthorized manner if the check was signed yet incomplete when
it left the consumer's hands.
The CTA comparative negligence provision would operate in a
manner similar to these UCC provisions: When a party to a check
(which could be a consumer, a nonconsumer, or a bank) acts
negligently or in bad faith, that party's ability to recover
under the CTA warranties or indemnity will be proportionally
reduced.
Q.2.b. Please explain why there are comparative negligence
provisions in the CTA when current law governing check
processing remedies already provides a comparative negligence
standard?
A.2.b. Although State law already encompasses a concept of
comparative negligence in the provisions of the UCC and as a
common law principle, a new Federal law that did not explicitly
incorporate such a concept may be deemed to preempt the State
law. Therefore, the proposed CTA includes a comparative
negligence provision to make it clear that the new liabilities
created by the CTA warranties and indemnity could be reduced
where the complaining party acts negligently or in bad faith.
Q.2.c. What types of actions are anticipated that would make a
consumer somehow at fault for a bank's processing error? Does
the Board believe that a consumer could contribute in any way
to the double processing of a check or to a processing error
such that the amount they recover is reduced?
A.2.c. There are relatively few processing errors today, given
the 40 billion checks written annually, and it is highly
unlikely that the CTA would change that very positive
experience for those who use checks for their payment needs. It
is possible, although unlikely, that a consumer's actions would
result in a bank processing error. A bank processing error
could take many forms, including misencoding and the creation
of illegible or duplicate substitute checks. Misencoding of
checks seldom occurs today and there are encoding warranties in
the UCC and the Board's Regulation CC that address this issue.
Consumer actions rarely contribute to such errors. Similarly,
we believe it would be a rare circumstance when a consumer's
actions contributed to the creation of an illegible or
duplicate substitute check. For example, a consumer may have
taken some action with respect to the original check with the
intent that the substitute check created from that original
check would be illegible. A bank that can prove such consumer
intent may be partially or fully absolved from liability.
Generally, a bank that is liable for damages because it has
created an illegible or duplicate substitute check would not be
able to assert a comparative negligence defense against a
consumer absent unusual circumstances, such as those described
above. It is our expectation that the comparative negligence
provisions will apply in most cases to disputes between banks.
Q.2.d. Consumer groups allege that under the UCC, a bank may
only raise a comparative negligence defense with respect to
fraud or forgery. Is this correct?
A.2.d. As indicated in more detail under the first question,
there are instances under the UCC where a consumer's ability to
recover losses or to avoid liability is limited due to the
consumer's own
negligence or bad faith (see UCC 3- 407(c) and 4 - 406(d)).
Fraud or forgery is not necessarily involved.
Q.2.e. Is it true that under the current law a bank could not
defend against processing errors on the grounds of comparative
negligence?
A.2.e. The legal defenses available to a bank depend on the
nature of the processing error and whether the consumer's
actions contributed to that error. As indicated above, we
believe that a consumer's actions rarely contribute to errors
such as misencoding. However, in the event that a consumer
intended to defraud a bank and took actions intended to result
in misencoding or misdirection of a check, it appears that the
bank could recover against that consumer under the UCC and
common law. We note, however, that the case law involving
misencoded checks generally is between banks and does not
involve consumers.
3. In your written summary testimony you note that check
imaging under the CTA could ``provide their customers with
later deposit cut-off hours. Such changes could result in some
checks being credited one day earlier and interest accruing one
day earlier for some checks deposited in interest-bearing
accounts.'' Based on this statement, I have three questions.
Q.3.a. It is my understanding that while the adoption of CTA
will likely allow banks to benefit from faster check clearing,
the CTA does not make changes in the Expedited Funds
Availability Act (EFAA) that would ensure that banks make
customers' funds available to them more quickly. Is this true?
A.3.a. The EFAA already requires that the Federal Reserve Board
shorten the maximum permissible hold periods that banks may
place on a category of checks if improvements in the check
collection and return system enable banks to learn of the
nonpayment of most of those checks more quickly (see EFAA
Section 603(d)(1)). The Board will monitor improvements to the
check system and reduce permissible holds as warranted. Because
the Board complies with current law and will continue to do so,
there is no need to either repeat existing mandates or create
new ones. It is important to note that most institutions
already make funds available to their customers more promptly
than required by law. In a 1996 report to Congress on Funds
Availability Schedules and Check Fraud at Depository
Institutions, the Federal Reserve Board reported that over 70
percent of banks provide customers faster funds availability to
customers than required by Regulation CC.
Q.3.b. In the absence of a change in the EFAA and its
regulations, how can we be certain that consumers will be able
to access their funds more quickly?
A.3.b. The EFAA already requires that the Federal Reserve Board
shorten the maximum hold that banks may place on a category of
checks if improvements in the check collection and return
system enable banks to learn of the nonpayment of most of those
checks more quickly. If the proposed CTA results in such
improvements, the Board will shorten maximum permissible holds
as required by the EFAA.
In addition to the general improvements that might result
in the shortening of the maximum permissible hold schedules,
the proposed CTA might result in some consumers being able to
access their funds more quickly through the possible extension
of deposit cut-off hours at some banks. Every bank has a cut-
off hour after which check deposits are considered made on the
next banking day. Banks could use the proposed CTA to transmit
check deposits to central processing centers for collection
faster than the deposits could be physically shipped to the
centers. Banks could use this additional time to extend deposit
cut-off hours, which could result in some consumer checks being
credited one day earlier and consumers potentially obtaining
access to funds on those deposits one day earlier.
Further, as was noted above, a large percentage of banks
already provide customers with faster funds availability than
required under regulation. This suggests that market forces
provide banks with incentives to improve funds availability
where possible. It seems likely that if technology and business
processes change such that banks are able to collect checks
more quickly than they do today, market forces may well lead
banks to provide customers access to their funds more quickly.
Q.3.c. What steps will the Board take under EFAA to ensure that
consumers receive most of the benefit from faster check
clearing under the CTA?
A.3.c. As required by the EFAA, the Board plans to monitor
improvements to the check system and reduce the maximum
permissible hold schedules as warranted.
Q.4. A recent American Banker article on check truncation
reported that Mr. John Hodas, Chief Financial Officer for
Florida Gulf Bank, which uses check imaging, is concerned about
the quality of these images. The story states that: ``Mr. Hodas
said the images are sometimes too faint to read, especially
when checks are written in light-colored ink.'' Does the Fed
proposal include any standards for the quality of an electronic
or substitute check? Why or why not?
A.4. The proposed CTA requires that a substitute check conform
to generally applicable industry standards. There are two
American National Standards specifications that would be used
in a future CTA environment. The first is ANS X9.90--
Specifications for Image Replacement Documents. This standard
outlines the design or layout of a substitute check and
incorporates other existing standards, including standards that
deal with paper dimensions and quality, MICR line location and
printing, check background design, and check endorsements. The
second is ANS X9.37--Specifications for Electronic Exchange of
Check and Image Data. This standard has been revised to support
the inclusion of images and electronic endorsement records,
which is critical to the implementation of the proposed CTA.
These two standards have already been released as Draft
Standards for Trial Use (DSTU's).
The proposed CTA also requires that a substitute check
include an image of the front and back of the original check.
Further, to be the legal equivalent of the original check, the
proposed CTA requires that a substitute check accurately
represent all the information on the front and back of the
original check at the time the original check was truncated. If
the writing on a check is clear on the original but not on the
substitute, then the substitute check would not be legally
equivalent to the original check and the reconverting bank
would be in breach of its legal equivalence warranty.
Q.5. It is my understanding that under the Fed proposal banks
will still be able to return substitute checks to customers if
both the bank and the consumer agree to that service. To do
such would require that at some point the image of the check be
translated into a substitute check and that that substitute
check either be sent to or printed at the customer's bank.
David Walker, Executive Director of the Electronic Check
Clearing House Organization (ECCHO) is quoted in a recent
American Banker article as estimating the cost of creating and
processing substitute checks in the range of 2 to 2.5 cents
apiece, versus about 1 cent for regular checks. As a result of
this higher cost the article concludes that, ``The industry's
hope, of course, is that substitute checks will not be a
concern for long.'' Mr. Ferguson, should one be concerned that
the potential high costs involved in creating and handling
substitute checks will make it increasingly less likely that
banks will even offer customers the ability to receive
substitute checks?
A.5. Under the proposed CTA, banks would have to weigh the
costs associated with creating substitute checks against the
savings from being able to handle more of the check collection
process electronically. Mr. Walker's statement simply suggests
that using the substitute checks may not be the most cost-
effective approach for processing all checks. A collecting bank
will collect checks using the most cost-effective approach for
each type and category of check. Therefore, some checks may be
collected as original checks, some as substitute checks, and
some electronically under electronic exchange agreements.
Regardless of how checks are collected, banks will have the
ability to provide their customers with accounts that return
cancelled checks with bank statements. Assuming there is demand
for accounts that return cancelled checks to customers,
competition in the banking industry should drive banks to offer
such accounts. Further, some States have laws that require
banks to offer accounts that return cancelled checks to
customers.
Q.6. It is my understanding that banks are required by law to
maintain a copy of all checks for 7 years. As I have been
informed, the majority of these copies are kept using
nonelectronic means (generally microfiche), while some smaller
percentage is stored electronically. If check truncation were
implemented under this proposal would you expect this to change
such that the vast majority of checks would be stored
electronically?
A.6. Microfiche or microfilm technology is a relatively old
technology. As the cost of digital imaging technology declines,
banks are increasingly using this technology to maintain copies
of checks that they handle. The proposed CTA would likely
accelerate this trend because there would be more business
applications for the technology, thereby making investments in
the technology more
attractive.
7. One general advantage of electronic documents is that they
are easily transmitted and that large numbers of documents can
be sorted according to a wide variety of information. Thus, it
is possible, perhaps likely, that this legislation could lead
to the creation of a large, electronic database containing the
information of many consumers' check writing habits.
Q.7.a. Is it your opinion that the CTA would create new and
expanded opportunities for banks to mine personal consumer
information for commercial purposes?
A.7.a. A check is typically imaged several times in today's
environment. The check is imaged by the bank at which it is
deposited, it may be imaged by any intermediary handling the
check, and it is imaged by the paying bank. Therefore, there
are already significant databases containing check images.
Check images, however, are simply pictures of checks. To mine
information, extra steps are required to extract information
from check images and to enter that information into a
database. Given the 40 billion checks that are written each
year, mining information from check images would likely be
relatively expensive and labor intensive.
Q.7.b. Is there any provision in the proposed Act that would
limit a bank's ability to search its database of electronic
check information and use it to create and to share a detailed
profile of the customer's buying and spending habits?
A.7.b. There are no provisions in the proposed CTA that address
the privacy of financial information. The Congress has already
addressed the protection, disclosure, and use of consumer
financial information in Title 5 of the Gramm-Leach-Bliley Act.
There are many ways by which banks obtain financial information
about their customers other than through checks that they handle. If
Congress wishes to expand the privacy provisions of the Gramm-
Leach-Bliley Act, it would be more effective to consider such
expansions in separate, broadly applicable, legislation rather
than in a narrowly targeted bill such as the CTA.
Q.8. The Board's section-by-section analysis of the CTA,
accompanying Chairman Greenspan's transmittal letter to the
Committee on December 17, 2001, includes the following
sentences:
``The Federal Reserve Board believes that a next day
recredit limit of $2,500 is a reasonable compromise
between banks and consumer interests'' and ``the
expedited recredit procedure is intended to mitigate
the effects on consumers of any potential problems
associated with the receipt of substitute checks.''
You failed to endorse this provision in your April 3
testimony. Instead, your written testimony notes that, ``Upon
further reflection, the Board has now concluded that the
significant compliance burdens imposed by these provisions on
banks that receive substitute checks outweigh the small
incremental benefits that the provisions would provide
consumers.'' There may be some practical problems with the
expedited recredit provision contained in the Board's CTA
proposal, but I am most interested in understanding what has
changed since December 17, 2001? What are some of the new
compliance burdens? Was the Board staff unaware of the Uniform
Commercial Code's protections when the proposal was sent to
Congress? If so, why was the provision included?
A.8. The Board submitted a draft of the CTA to the Congress in
December 2001, with the understanding that it would serve as a
starting point for discussions among the Congress, banks,
consumer groups, and other interested parties. The Board
expected that further revisions could and would likely take
place as the interested parties, including the Board itself,
continued to consider the pros and cons of various provisions
of the legislation. In particular, the Board expected further
debate on the expedited recredit provisions, which had been the
subject of spirited discussions between banks and consumer
groups well before December 2001.
Two of the Board's guiding principles in developing the CTA
were that: (1) the burdens associated with the proposed law did
not outweigh the associated benefits for either banks in the
aggregate or their customers in the aggregate; and (2) banks
that choose to convert a check to, or receive a check in,
electronic form should internalize, to the extent practicable,
the costs and risks related to the creation of the substitute
check, because they receive most of the associated benefits.
The Board believed at that time (and continues to believe) that
the risks of any serious consumer problems under the proposed
CTA would be low and was well aware in December 2001, that the
UCC provided strong check-related protections to consumers.
Nevertheless, our discussions with the banking industry and
consumer groups on this issue focused largely on how to craft
expedited recredit provisions rather than on the need for such
provisions.
Since that time, however, the Board has had further
opportunity to carefully consider the arguments on both sides
of this debate. The Board has also had the opportunity to
consider the results of ongoing experiments in the marketplace
involving substitute checks, which have raised virtually no
consumer problems. In addition, as the draft CTA has evolved,
additional burdens in the form of notice requirements have been
placed on banks that are passive recipients of substitute
checks. After further reflection, the Board now believes that
the compliance burdens imposed by the expedited recredit
provisions on banks that receive substitute checks would
outweigh the small incremental benefits that the provisions
would provide to consumers. Therefore, the Board does not
believe that the expedited recredit provisions are necessary to
successfully implement the CTA. Nevertheless, if Congress
concludes that expedited recredit provisions for consumers
should be included in the legislation, we believe that any
expedited recredit provisions should be consistent with the
proposed legislation's basic purposes and should not go beyond
the provisions proposed by the Board.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM ROGER W.
FERGUSON, JR.
Q.1. Under the Fed proposal, if a hacker interferes with a
check's electronic transmission (for example, the creation of
electronic counterfeit checks), who would ostensibly bear the
sole liability for lost assets? Does the indemnity provision of
this proposal cover incidences of electronic fraud?
A.1. Under existing law, a bank can only charge a customer's
account for transactions authorized by the customer. In the
example you cite, the bank's customer has not authorized the
fraudulent transaction and is not responsible for the loss. The
customer, of course, has a duty to examine his or her bank
statement and must notify the bank of any unauthorized charges.
Where the ultimate liability falls depends on the facts of the
particular case. Generally, banks that have agreed to exchange
checks electronically would include in their agreement
provisions governing the responsibility for data integrity at
various points in the check collection process.
The proposed CTA's indemnity provision only covers
situations in which the receipt of a substitute check results
in a loss to a bank customer or other party to the check. As I
noted, existing law protects bank customers from electronic
fraud.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM ROGER W.
FERGUSON, JR.
Q.1.a. Please comment on the implications of this proposal on
the security of checks. My understanding is that today checks,
like the U.S. dollar, are actually quite sophisticated pieces
of paper ``technology'' with various safeguards against fraud
``wired'' into the check. Will the Fed proposal preserve that
high degree of security?
A.1.a. Today, some checks incorporate a variety of physical
security features including microprinting, chemical
sensitivity, security fibers, watermarks, high-resolution
border text, and latent images. Many of these security features
are lost when checks are imaged. A number of vendors, however,
have developed a variety of image-survivable security features
to address check security issues in an image environment. These
features include two-dimensional bar coding, seal encoding, and
digital watermarking. Banks could use these new features to
protect against fraud. Also, we expect that, as the use of
substitute checks becomes more prevalent, other new security
features will be developed to help prevent fraud.
Q.1.b. Who will be responsible for authenticating a check?
A.1.b. Ultimately, the bank paying a check is responsible for
``authenticating'' a check that is written by its customer. The
paying bank has knowledge of the drawer's signature and
generally has knowledge of check stock type, check serial
number range, and so forth. This knowledge is useful in
identifying many fraudulent checks. We also expect that over
time the security features in checks would evolve to
accommodate the technological developments in check processing.
Q.1.c. And if the physical check does not end up back at the
bank that is on the hook for the funds--and presumably most
motivated to do a thorough security verification--how will you
ensure a high level of attention to security?
A.1.c. Today, most security verification is done at the paying
bank. This process will likely continue, albeit through the use
of new security features. Banks at which checks are deposited will
have access to the original checks and will be able to perform the
same verification they do today.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM LINDSAY A.
ALEXANDER
Q.1. What is the difference in cost for clearing a check
electronically versus paper?
A.1. Based on the volume of checks cleared at NIHFCU (a total
of 2.5 million checks are cleared annually), our costs for
clearing checks electronically versus paper are $6,250 compared
to $37,500. The following figures showing the cost of each
service are from the Federal Reserve's website, at
www.frbservices.org. ACH origination--.25 cents per item
($0.0025). ACH receipt--.25 cents per item ($0.0025). Check
Truncation @ Fed--1.5 cents per item ($0.0150). Even without
our labor and fixed costs factored in, it costs one-sixth as
much to move transactions electronically.
Q.2. Your testimony states NIHFCU will be undergoing a
conversion to an entirely electronic system. What are the costs
associated with such a conversion?
A.2. The exact figures to convert to an entirely electronic
system are not available. However, we expect the costs to be
minimal, since NIHFCU already truncates its checks and offers
imaging and online services to its members. The fees associated
with such a conversion would mostly stem from internal
conversions needed as a credit union to use the new
technologies, in addition to a one-time fee from the Federal
Reserve.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM LINDSAY A.
ALEXANDER
Q.1. Under the Fed proposal, if a hacker interferes with a
check's electronic transmission (for example, the creation of
electronic counterfeit checks), who would ostensibly bear the
sole liability for lost assets? Does the indemnity provision of
this proposal cover incidences of electronic fraud?
A.1. Under the Federal Reserve proposal, the liability for the
lost assets would not be covered by the proposal itself.
According to the section-by-section analysis of the Check
Truncation Act, the indemnity section provides an indemnity for
a loss incurred by the recipient of a substitute, if the loss
is due to the receipt of the substitute check, rather than the
original check. Moreover, under this section, if the loss would
have occurred even if the original check had been transferred
or presented instead of the substitute check, the party
incurring the loss would not have an indemnity claim, because
that party is no worse off as a result of having received the
substitute check. In this case, the loss is not caused by the
receipt of the substitute check. In fact, in your case, there
is no mention of the substitute check. The consumer would be
able to recover under the Uniform Commercial Code Article 4.
What financial institution bears sole liability for this
loss under Article 4 of the Uniform Commercial Code would
depend on how the electronic check was altered to commit the
fraud. For instance, if the electronic counterfeit alters the
check writer's signature to obtain the payment then the paying
bank would cover the loss pursuant to Uniform Commercial Code
4-208(3). On the other hand, if the payee's endorsement is
altered, then the presenting financial institution would be in
breach of its warranty and the presenting bank would bear
liability for the claim under Uniform Commercial Code 4-
208(a)(1). Under different scenarios, different parties would
be liable.
The indemnity provision would not cover incidences of
electronic fraud. As described above, the scope of this Act and
the indemnities and warranties are limited to substitute
checks. For instance, the indemnity only begins when a
financial institution converts an electronic check into a
substitute check. From that point forward, the indemnity runs
with the substitute check or any subsequent electronic version
of the check. However, the loss must be suffered because of
receipt of the substitute check instead of the original check.
In order for that requirement to be fulfilled there would have
to be a loss caused by receiving the substitute check when it
was not good enough (for example, for forgeries where the
original was necessary to make a determination) or for having
two substitute checks presented or other similar circumstances.
Q.2. If we move forward with this legislation, what assurances
can you give consumers that they will see lower costs or better
services in their banking experiences: I believe consumers will
benefit from this change, but perhaps you can outline some
specifics for us?
A.2. Consumers would see lower costs and better services
because the technology allows us to provide both. NIHFCU
already truncates its checks and also offers imaging and online
services to its members. By combining truncation with imaging,
NIHFCU offers members greater access to their checks online.
Members have used these enhanced services to access their
checks much more frequently than was possible before imaging.
Also as stated in the answers above, at any point in the
process check truncation is much cheaper to NIHFCU than full
manual processing of checks. Thus, since NIHFCU as a credit
union is a member-owned institution these savings will be
passed along to its members.
Q.3. In a dispute over check fraud, how will your policies
change--if they change at all--in investigating fraud and
making the consumer whole in the event of fraud?
A.3. NIHFCU does not believe that there would be increased
fraud from electronic transactions. As a result, NIHFCU does
not plan to change its policies regarding check fraud if check
truncation legislation passes because its current policies and
procedures to handle fraudulent items are more than sufficient
to handle the fraud that may arise. If a member alleges that
they have been the victim of check fraud, NIHFCU investigates
the allegation and within time frames prescribed by applicable
laws, NIHFCU makes consumers whole in cases of fraud.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM JANELL
MAYO DUNCAN
Q.1. Under the Fed proposal, if a hacker interferes with a
check's electronic transmission (for example, the creation of
electronic counterfeit checks), who would ostensibly bear the
sole liability for lost assets? Does the indemnity provision of
this proposal cover incidences of electronic fraud?
A.1. The Federal Reserve proposal doesn't appear to assign
liability for losses due to unauthorized access or fraudulent
alteration of a check during electronic transmission. In
addition, the proposal does not create any new protections for
electronically transmitted checks. Under the Fed proposal, the
check must be transformed into a substitute check to trigger
any additional protections, such as indemnity.
The indemnity provision of the Fed proposal does not
clearly
address the issue of a fraudulently created substitute check.
The indemnity provision relates to damages resulting from the
creation of a substitute check, instead of the original check.
However, it is not clear that the indemnity provision would
assign liability to a bank, thrift, or credit union
(hereinafter collectively referred to as banks) where a
substitute check is fraudulently created or altered by a
hacker.
Even if the indemnity section applies to fraudulently
altered or created checks, it would require a lawsuit to
enforce, which would be very time consuming and potentially
expensive for a consumer to pursue. Additionally, the indemnity
section of the Fed proposal contains a comparative negligence
section that would not assign ``sole liability,'' and instead
would require a fact intensive exploration of comparative fault
between the bank and the consumer.
Presumably, common law negligence principles also would
apply to a bank that negligently failed to safeguard consumer
check information, leading to a loss. However, if a court were
to look to the Uniform Commercial Code (UCC) to define
negligence, a bank may be able to avoid responsibility if it
maintained a low standard of care, but acted in compliance with
industry standards. Under UCC 3-103(a)(7), ``ordinary care'' is
defined only as ``observance of reasonable commercial
standards, prevailing in the area in which the person is
located. . . .'' In addition, UCC 4-103(c) further provides
that, ``Action or nonaction consistent with . . . a general
banking usage not disapproved by this Article, is prima facie
the exercise of ordinary care.'' See also UCC 4 -103, Comment
4. This standard of ordinary care raises the concern that if no
other banks have taken sufficient security measures, it will
provide prima facie evidence that a bank that has had its
electronic check processing system breached is not negligent.
This concern is heightened by the fact that the Fed proposal
fails to create any new obligations on banks electronically
transmitting consumer check information to safeguard the
information from security breaches.
Finally, under existing law, Section 4 - 401(a) of the UCC,
a bank may only charge against a customer's account, ``An item
that is properly payable from the account even though the
charge creates an overdraft.'' The Section continues, ``An item
is properly payable if it is authorized by the customer and is
in accordance with any agreement between the customer and the
bank.'' Under this Section of the UCC a bank may be liable for
improperly paying a fraudulently created, or improperly altered
consumer check because it is not a ``properly payable'' item.
However, seeking a remedy places a tremendous burden on the
consumer because in order to recover losses under the UCC, he
or she must litigate the claim.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM DANNE L.
BUCHANAN
1. As the representative of the American Bankers Association,
the Financial Services Roundtable, America's Community Bankers,
Independent Community Bankers of America, and the Consumer
Bankers Association, please answer the following questions.
Q.1.a. Are banks, subsidiaries, or affiliates of banks or other
entities that process bank checks, currently using information
from checks, such as payee or amount, to identify consumer
spending patterns? If so, do firms use this information
themselves or do they share it with or sell it to other firms
or financial institutions?
A.1.a. Banks have always had the ability to extract information
from paper checks or check images to detect potential fraud and
to analyze customer spending habits and there are some
depository institutions which extract information on an ad hoc,
sporadic basis for internal purposes or for sharing with
affiliates. However, this practice of extracting information
from checks is not prevalent. First, extracting information
from images is relatively difficult, time-consuming, and labor
intensive for both paper checks and check images. We are aware
that products may emerge that may extract information more
efficiently that rely on character recognition, but to our
knowledge, such techniques are currently unreliable. Second,
public sensitivities inhibit use and sharing of such
information. Finally, the privacy provisions of the Gramm-
Leach-Bliley Act significantly restrict how such information
can be shared outside of the bank.
Q.1.b. Would the industry support check truncation legislation
if it contained a provision that check images, or any data
contained on the check, could not be used for any purpose other
than check processing, dispute resolution, or responding to
customer requests?
A.1.b. Any privacy issues related to the use of check
information should be addressed in the broader context of
financial information privacy and should not be included as
part of any check truncation legislation. The check truncation
process as envisioned by the Federal Reserve Board's proposal
will have no impact one way or the other on the type of check
information collected by banks, how that check information is
or is not used for purposes outside of check processing,
dispute resolution, or responding to customer requests.
2. As you know, on March 26, the American Banker reported that
Viewpointe Archive Services shut down the JP Morgan and Bank of
America image exchange pilot at the end of February.
Viewpointe's Chairman and CEO, John Lettko, noted that the
pilot was discontinued because the banks had reached, ``A point
of diminishing returns.'' According to Mr. Lettko, the banks
concluded that, to get further economic value from the
exchanges, they needed to install more image capability in
their back-office processing shops. The article further noted
that only a small number of banks can process images ``from the
front end of the office to the back.''
Q.2.a. As we explore legislation facilitating widespread check
imaging, what lessons can be learned from the Viewpointe
experience with image exchange?
A.2.a. To respond to the Committee's question regarding
Viewpointe and check image exchanges, I consulted with Grant
Cole, Senior Vice President at Bank of America, who has more
direct information on the Viewpointe project. The response
below is based in part on information obtained from Bank of
America.
In November 2001, JP Morgan Chase and Bank of America
embarked on a research and development project to test
assumptions about check image exchange using a shared central
archive. Both banks are owners of Viewpointe Archive Services.
The banks set out to develop processes, rules, agreements, and
logistics related to the exchange of check images in a shared
archive to facilitate the collection and settlement of checks
that traditionally had been exchanged between the banks in
paper form. The Federal Reserve was invited to participate in
the design of the process, but not to exchange checks in this
phase of the project. The Electronic Check Clearing House
Organization (ECCHO) was asked to join the project as well, in
the capacity of rules rationalization.
Through this exchange project, the banks developed the
design for exchanging images of checks within a central
archive, the indices required, privacy requirements, and access
capabilities. This design was then tested by exchanging through
the Viewpointe archive a small sample of check images from each
bank. During this test, the paper checks were still exchanged
by the banks. The banks still needed the paper checks because
they have not completely extended image technology to all
aspects of the banks' check operations and so were needed to
perform exceptions processing such as return item processing.
It is anticipated that prior to a full rollout image exchange
between two or more banks, the participating banks would extend
the necessary technology throughout the check processing
systems at such banks.
The project to test image exchange through Viewpointe was a
complete success as the banks involved in the test were able to
prove an operational design that fulfilled all the objectives.
The article that was published in the American Banker
regarding the check image exchange through Viewpointe is
misleading, as the comments out of context left the wrong
impression. The quote by Mr. Lettko of ``diminishing returns''
is accurate, but only because the objective of testing the
image exchange process was met, and as long as the original
paper checks have to follow the exchanged check images, there
would not be much of an additive economic
benefit. Also, the banks recognized during the test that there
is a need for more automation to handle images efficiently in
``the back office'' which will be accomplished prior to the
full implementation of check image exchange.
The comment in the American Banker article about a ``small
number of banks being able to process images from the front end
of the process to the back'' is also misleading. There are
check image projects underway today in almost all large banks,
and many smaller financial institutions are generally ahead of
large banks in deploying image technology. The 2002 ICBA and
InFinet Resources Community Bank survey results indicate that
community banks' use of check imaging technology outpaces that
of larger banks by a margin of 2 to 1, with 47 percent of the
respondents currently using the technology and another 41
percent planning to evaluate the technology within the next
12 -18 months. This corresponds to 88 percent of the
respondents currently using or planning to evaluate imaging
technology. Many small institutions have responded that they
are waiting for check truncation legislation
before investing in imaging. While not all banks are today
implementing front-to-back exchange of images, the image
programs established by these banks are the first and necessary
step toward the day when banks can exchange images with any
other bank in the Nation.
We believe the Boards proposed check truncation legislation
will provide the impetus for the expansion of image exchange
programs.
Lessons to be learned from the Viewpointe experience are
that the image exchange using a common shared archive can be
accomplished efficiently and securely. It also illuminated that
in order for the real benefits of image exchange to be realized
for the Nation's payment system, check images must be exchanged
without the need for the original paper checks to be
transported. For the reasons discussed above, we believe that
the substitute check process contemplated in the Board's
proposal will provide the impetus
required for the furtherance of the business case for check
image
exchange.
Q.2.b. As the President of NetDeposit, a company that provides
processing and clearing technology that facilitates the
electronic presentment of paper checks, what are some of the
problems you have experienced with imaging?
A.2.b. We have experienced very few problems with the
technology or customer complaints. One reason is that paying
banks are not required to have image capability since they are
provided substitute checks. Some banks and merchants have
expressed concerns about the lack of clarity with regard to the
legal validity of substitute checks. The Board's proposal would
provide that clarity by stating substitute checks are the legal
equivalent of the original.
Q.2.c. Do the check images (substitute checks) contain
securities features? If not, what are some of the obstacles
currently preventing banks from imaging security features onto
substitute checks?
A.2.c. New image-survivable security features have been
developed, and are under development, that should provide all
check issuers with superior security features for checks that
are imaged or converted to substitute checks. For example, we
are aware of one technology company that offers a security
feature for checks that are image-survivable, but also machine-
readable, allowing for automatic processing. These image-based
security features/processes are superior to the paper-based
security features currently in use because check issuers can
verify the security procedures carried on each image on an
automated basis, rather than upon physical inspection of the
paper check.
Industry standards groups are also working on standards and
other operational issues for check image systems and substitute
checks. The standard defines a structure to properly identify
security features. The standard enables the incorporation of
standardized and proprietary security features into the
original check by providing a trigger and identification
structure. The standards do not specify requirements for the
type of security features.
At the time the check is issued or printed a one- or two-
dimensional bar code is printed on the check with information
about the check. For example, the dollar amount or check number
could be encoded. One of the benefits of this encoding process
is that the image of the check with the encoding can be
authenticated anywhere in the check collection process. The
validating encoded information is carried on both the paper
check, the image of the paper check, and a subsequent printed
copy of the check image (such as a substitute check).
See example below with a one-dimensional bar code.
Q.3. In your written testimony, you note that, ``Reducing the
dependency on the physical presentment of original items will
result in faster check collection, which will allow consumers
sooner access to their funds.'' Moreover, the Federal Reserve
has noted that due to check imaging under the CTA banks could,
``Provide their customers with later deposit cut-off hours.''
It is my understanding that while the adoption of CTA will
likely allow banks to benefit from faster check clearing, the
CTA does not make changes in the Expedited Funds Availability
Act (EFAA) that would ensure that banks make customers' funds
available to them more quickly. In the absence of a change in
the EFAA, how can we be certain that consumers will be able to
access their funds more quickly? Would the industry support a
change in the EFAA requiring that funds become available to
customers more quickly?
A.3. No change is necessary as the Expedited Funds Availability
Act already anticipates a reduction in the funds availability
schedules in the event checks are processed and returned more
quickly. Specifically, under Section 603(d) of that Act, the
Board must, by regulation, ``Reduce the time periods . . . to
as short a time as possible and equal to the period of time
achievable under the improved check clearing system for a
receiving depository institution to reasonably expect to learn
of the nonpayment of most items for each category of checks.''
Q.4. Is it my understanding that banks are required by law to
maintain a copy of all checks for 7 years. I have been informed
that the majority of these copies are kept using nonelectronic
means (generally microfiche), while some smaller percentage is
stored electronically. If check truncation were implemented
under this proposal, would you expect this to change such that
the vast majority of checks would be stored electronically?
A.4. Over time, we would expect that most checks would be
stored electronically regardless of whether the proposal is
enacted.
5. A general advantage of electronic documents is that they are
easily transmitted and many documents can be sorted according
to a wide variety of criteria. Thus, it is possible, perhaps
likely, that this legislation could lead to the creation of a
large, electronic database containing the information of many
consumers' check writing habits. In your written testimony, you
stated that you are CEO of NetDeposit, ``A subsidiary of Zions
Bancorporation that provides processing and clearing technology
which allows organizations to move to electronic presentment of
paper checks.'' The American Banker has reported that, ``Zions
is selling the system [NetDeposit] to other institutions and
has one money-center bank testing it.'' As CEO of NetDeposit,
please answer the following questions.
Q.5.a. Does NetDeposit currently, or plan in the future, to
handle electronic check processing for multiple banks?
A.5.a. NetDeposit will handle electronic check processing for
multiple banks.
Q.5.b. What information is, or could be, kept electronically
from an imaged check as it goes through the NetDeposit system?
A.5.b. The only information held by the NetDeposit system will
be images that are stored for several days to ensure that if
items are not received or lost, we can recreate the cash
letter. At the end of 5 days, these images are backed up to
tape for record retention only and stored offsite for 7 years.
Q.5.c. What restrictions regarding privacy exist for imaged
checks?
A.5.c. The Gramm-Leach-Bliley Act (GLB Act) imposes significant
restrictions on the sharing and use of information from paper
checks or check images. Banks also could only use or disclose
customer information from checks in compliance with their
privacy policies adopted pursuant to the GLB Act. In addition,
the GLB Act requires the banking agencies to establish
appropriate standards for financial institutions relating to
administrative, technical, and physical safeguards to protect:
(1) the security and confidentiality of customer information,
(2) against unauthorized access, and (3) against anticipated
threats or hazards.
Q.5.d. Does the legislation proposed by the Federal Reserve
provide any additional privacy protections?
A.5.d. No. The Federal Reserve Board proposal does not include
additional privacy provisions. For the reasons stated above, we
believe additional privacy legal provisions are not needed for
check truncation programs. As a practical matter, customer
privacy will be enhanced by the proposal as access to checks
and their information will be far more restricted when
controlled in an electronic check collection process. For
instance, the current paper check route offers opportunity to
acquire information more easily than if the check image were
transmitted electronically. Today, paper checks sit in
airports, etc. awaiting transport and delivery. They must also
be physically handled along the various stops where the
information can be compromised. Electronic delivery eliminates
these physical stops and the opportunity to acquire the checks
and information.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM DANNE L.
BUCHANAN
Q.1. Under the Fed proposal, if a hacker interferes with a
check's electronic transmission (for example, the creation of
electronic counterfeit checks), who would ostensibly bear the
sole liability for lost assets? Does the indemnity provision of
this proposal cover incidences of electronic fraud?
A.1. Both the Federal Reserve proposal and the Uniform
Commercial Code protect consumers from liability for any check,
electronic or not, that is charged against their account and is
not properly payable. Thus, under no circumstances would the
consumer be liable in this case. Depending on how and where the
hacker intercepted the information and how the hacker used it,
one of the banks in the check process would bear the loss,
based on warranties of the Uniform Commercial Code, the Federal
Reserve proposal, and interbank agreements. If a hacker used
the account numbers in the electronic check image database to
create an electronic funds transfer from the customer's
account, the consumer would be protected from liability under
the Electronic Fund Transfer Act and its implementing
regulation, Regulation E. That law protects consumers from
liability for unauthorized electronic fund transfers.
In addition, hacking would seem unlikely in this case. As
currently envisioned and configured, banks use only secure data
lines to transmit the check image data to the database, and the
databases themselves are protected with data encryption and
other
security techniques.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM DANNE L.
BUCHANAN
Q.1. A question for the bankers on the panel: If we move
forward with this legislation, what assurances can you give
consumers that they will see lower costs or better services in
their banking experiences? I believe the consumers will benefit
from this change, but perhaps you can outline some specifics
for us.
A.1. Generally, the potential benefits of the proposal derive
from the expected cost savings and quicker access to funds and
account information associated with the elimination of the need
for paper checks to physically travel from the bank of first
deposit, through various check processing participants, to
reach the paying bank. Consumers benefit from the potential
cost savings in the form of lower costs and better services. In
a market as competitive as the banking industry, competitive
pressures will compel depository institutions to pass on to
consumers savings from a more efficient check collection
system. In addition to the potential costs savings, consumers
will benefit from better service:
Reducing the dependency on the physical presentment of
original items will result in faster check collection,
which will allow consumers sooner access to their funds.
Consumers will also have faster, more convenient
access to information about check transactions.
Improving the check clearing process may also allow
banks to
develop new and more flexible banking services. For
example, image-capable ATM's that can forward deposits
electronically will allow banks to deploy more ATM's in
remote locations as the cost and frequency of physically
retrieving deposits and servicing ATM's could be reduced.
Consumers may be able to use these ATM's to cash their
payroll checks at their place of employments, which may be
particularly attractive for those without bank
accounts.
In addition to the direct impact on costs, the proposal
would serve to promote check imaging technology by adding
another positive weight to the business case for adopting check
imaging generally. This broader adoption of check imaging will
help provide benefits beyond those attributable to the
electronic processing facilitated by the proposal. New
applications, services, and benefits will emerge and existing
ones expand if check imaging is boosted by the electronic
processing envisioned under the proposal.
For example, today many consumers receive compendious and
convenient image statements of checks rather than disorganized,
loose checks. In addition, a more recent application of check
imaging allows customers to view check images online. This
helps consumers to quickly and conveniently review
transactions, identify potential errors, and detect fraudulent
transactions sooner. In addition to the timely receipt of
information, the customer might also be able to print a copy of
the check or send a copy of the check to a party questioning
payment.
Customers who do not bank online also benefit from imaging
because customer service representatives can quickly bring up
for view images to verify transactions for the customer. This
requires a fraction of the time typically required to research
microfilm or physical archives and transmit copies. Identifying
the errors and potential fraud as soon as possible helps banks
minimize customer inconvenience and control potential losses,
and gives law enforcement an advantage in tracking down
perpetrators. Such current imaging applications will expand
with the additional applications contemplated in the Board's
proposal.
Q.2. A question for the bankers on the panel: In a dispute over
check fraud, how will your policies change--if they change at
all--in investigating fraud and making the consumer whole in
the event of fraud?
A.2. Generally, bank policies will remain unchanged with regard
to investigating fraud and making the consumer whole.
Today, depository institutions investigate and resolve
claims as soon as possible because of the potential liability
under the Uniform Commercial Code (UCC) for consequential
damages for failure to properly pay items. The proposal
preserves these UCC rights.
In addition, though the industry believes it unnecessary
and dangerous from a fraud perspective, the proposal adds new
``expedited recrediting'' provisions that basically guarantee
consumers that funds for unauthorized substitute check
transactions will be available on the second day after the
depository institution is notified of a claim. We believe that
this provision is unnecessary as existing check law provides
appropriate and adequate protection to consumers with respect
to substitute checks as envisioned under the proposal.
The banking industry and consumers have an established
history with truncated checks and image documents. Indeed,
millions of consumers have been receiving either images or a
notation in their statements for years, without complaint that
disputes are not
addressed satisfactorily. The current check law works in the
truncated and image environment. There simply is no evidence to
justify deviation from existing check law.
In fact, Board staff has indicated that an informal review
of the consumer complaints filed with all the banking
regulatory agencies reveal no significant consumer issues
relating to the existing check protections. Banks report the
same dearth of complaints on these matters. Complicated new
recredit procedures would only serve to confuse customers,
create compliance headaches for banks, and expose banks to
potential new sophisticated fraud schemes.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BENNETT FROM DANNE L.
BUCHANAN
Q.1. What is the effect of the provisions of Sections 5 and 8
in the Federal Reserve's proposed Check Truncation Act that
provide a comparative negligence standard for indemnification
and other claims under the Act? Would this comparative
negligence standard alter the current customer protections
under check law?
A.1. The comparative negligence provision of Sections 5 and 8
of the Federal Reserve proposal provides that the potential
liability of a bank to another person under the proposal's
indemnity relating to a substitute check or for other failures
to comply with the proposal is limited to the extent that the
resulting losses are caused in part by the negligence of the
person making the claim. As an initial matter, it should be
pointed out that the person making the claim against a bank
could be a consumer, a business customer, or even another bank.
The comparative negligence provision would apply the same way
in all cases.
This comparative negligence provision was included in the
proposal to provide a similar defense to full liability that is
available under common law in most States, as well as under the
Federal Reserve's Regulation CC and the State law Uniform
Commercial Code (UCC) provisions that currently regulate check
operations. This comparative negligence standard does not
change check law liabilities as they work today, but rather makes
the application of the new warranties provided under the proposal
similar to the liability structure established under the UCC, and
Regulation CC for checks today.
Under the Federal Reserve Board Regulation CC, the damages
a person is entitled to as a result of a failure to comply with
that Regulation are diminished in proportion to the amount of
the negligence or bad faith attributable to that person. (See
Regulation CC, Section 229.38(c).)
The UCC similarly includes the concept of comparative
negligence. For example, Section 4 - 406 of the UCC requires
that a customer must exercise reasonable promptness to examine
a statement of checks to determine if any unauthorized checks
have been paid. If the customer fails to comply with this duty,
the customer may be precluded from recovering the amount of the
unauthorized checks. Furthermore, if the customer can establish
that the bank's negligence contributed to the customer's loss
under this UCC section, the loss is allocated between the bank
and the customer on the basis of the relative comparative
negligence of the parties.
This comparative negligence approach in the proposal (as
well as the UCC and Regulation CC) reflects the policy of
fundamental fairness--if both parties acted wrongly and each
contributed to the loss, they should share the loss
accordingly.
The comparative negligence provision of Sections 5 and 8 of
the proposal only applies in the event of a claim made under
the Section 5 indemnity or for a failure to comply with the
Act. The comparative negligence provisions of the proposal do
not alter or preempt any other State or Federal law rights or
claims the customer may already have under existing law
relating to a check payments.
Finally, as a related matter, whenever one is discussing
claims between a bank and its customer, it should be
highlighted that the vast majority of customer complaints or
disputes regarding a check transaction are resolved by the bank
to the customer's satisfaction through the normal customer
service process. Very few disputes between customers and banks
actually go to arbitration or litigation. Accordingly, while
this comparative negligence standard is very
important for a large dollar dispute that results in
litigation, in the typical consumer allegation of error in a
check transaction, this comparative negligence standard would
likely not be relevant or applied.