From Paper to Digital: What Does This Mean to Your Financial Institution?

by John Burnett, BOL Guru

The current trend away from paper checks and toward electronic payments is likely to continue. What does this mean to your financial institution?

If you haven't already heard the cries for help from your operations staff, you'll soon do so. As our nationwide shift toward electronic payments and away from paper checks continues inexorably, many banks are already reporting needs in their "back rooms" for help handling the larger volumes of customer inquiries, error resolution cases and new and confusing rules.

Check volumes are shrinking. As noted in the companion article, the Federal Reserve reports a 4.7% decline in check volume in 2003 (from 2002), and four consecutive years of decreasing check counts. Fewer checks to process suggests lower overall costs, potential for reduced staffing, and other "good news" items for the bottom lines of banks.

Of course, the shrinking numbers of paper checks processed by financial institutions are the result of growth in alternative --- electronic --- payment methods. Whether this shift from paper to electronics is supply or demand driven isn't really important. Just know that it's happening, and it will require that dreaded word: Change!

What is the significance of these changes to financial institutions?

Customer education
Let's start with customer education. Has your financial institution done enough to prepare customers for what's already changed, let alone what's over the horizon?

We've seen scores of Bankers Threads posts bemoaning the fact that customers don't get basic training in how to manage a checking account. If that's true, how can we expect customers to understand how using debit cards affects their accounts?
Two of the most problematic new "products" for consumers are the check conversion twins - POP and ARC - conceived by NACHA. Why have they been problems? Because customers didn't understand them (and in many cases didn't have a choice in the application of the ARC in particular).
Do your customers comprehend - and while we're at it, does your staff know - how your bounce protection program relates to the ability to use ATM and POS transactions to overdraw accounts? Many bankers started by telling customers that POS and ATM transactions were checked against their balances. And then we added bounce protection and ATM overdraft capability in the name of customer service and convenience. So now that account balance doesn't really mean anything? Do customers have false expectations?

Disclosures

Even if we can't educate our customers, Regulation E requires that we provide disclosures about the types of electronic transfers a customer can make. When the regulation was first issued over twenty years ago, that was pretty much limited to ATM and ACH transactions. With the advent of POS in ATM networks and debit cards using the national card infrastructures, financial institutions quickly updated their disclosure language to include the new products and features. That was to be expected, since the bank holding the customer's account was almost always involved in the process.

But the advent of the ARC and POP transactions, and their ACH cousins the WEB and TEL transactions, was apparently different. Probably because banks were not involved in the development of these transactions (in some cases, banks were caught flat-footed by customer questions), the impulse to add these transactions to disclosure language has been missing at some banks. Yet these are most definitely transactions that are subject to Regulation E. Compliance officers should dust off a copy of their account disclosures to see if these transactions have been addressed.

While we're discussing these four NACHA products and Regulation E disclosures, we should also point out the potential for problems when following the current blessed language for stop-payment disclosures found in ?A-2(h) of Appendix A to the regulation. The new NACHA creations are all subject to NACHA-mandated stop payment rights; unless you add language to your Reg. E disclosures describing those rights (they are different from the description in the model language), your bank could be accused of using deceptive language.

Staffing

What about staffing in financial institutions? Shouldn't a drop in check volume suggest a potential for leaner employee rosters? It's likely that the switch to e-payments will create, rather than eliminate, jobs in banks' back rooms. In many institutions, staffing traditionally associated with checks will continue to be needed, because they support the account rather than the checks. Someone still has to process overdrafts and exceptions; stop payments still need attention. No one believes for a moment that checks are going to go away soon, and the minimal number of people will still be needed to support their processing.

What we can predict, however, is a demand for added staffing in call centers and in areas that handle error resolution. The former derives from the added complexity perceived by customers in changes to their payment habits; the latter from the sheer increase in e-payment volume, which results in increases in problems.

Other changes?

We can also predict, as the Fed has already done, that per check processing costs will continue to increase as volumes shrink. This is inevitable, since fewer checks will absorb established processing costs. Put most obviously, if it costs $20 to transport a bundle of checks from your bank to your check processor, that's a penny a check if the bundle has 2,000 items; it's $20 a check if there's only one. One can wonder how soon it will be before banks start passing along these higher item costs. And what the consumer's reaction will be. The only certainty is that higher paper handling costs will accelerate the eventual demise of presenting actual checks for payment.

The advent of Check 21 can only help to speed up that process as it enables the exchange of electronic images in lieu of paper checks.

Another sure bet in this transition of our payments system is the development of new and more sophisticated scams. In many ways, electronic fraud is harder to detect and combat than fraud by paper check. Banks will press for more robust processing systems designed to uncover anomalies that might mean fraud. The use of customer metrics such as fingerprints, iris scans, and voice recognition to authenticate transactions will become more commonplace as physical signatures fall into disuse.

Checklist for Action

Banks will be best able to survive and indeed profit from the migration of payments from paper to electronics if they are prepared for the changes we must endure. Here's the start of a checklist of actions banks should consider -

Review your Regulation E account disclosures to ensure you have language describing check conversion transactions (ARC and POP) and the other recent additions to the ACH one-time authorization mix (such as WEB and TEL transactions).
Consider adding language to those same disclosures to clarify that customers have stop-payment rights on that same list of new one-time ACH authorizations.
Review your marketing program to see if it includes information pieces about how the one-time ACH transactions work. Don't forget to include the fact that customers have a right to refuse to have their checks converted.
Find out who in your organization is keeping informed on ACH initiatives to add more electronic payment alternatives. Form a working partnership between that individual or department and your compliance staff.
Make certain your staff understands the ACH rules and their interrelationship with consumer protections under Regulation E.
Be sure your operations and customer contact staff understand the complexities of error resolution procedures under Regulation E and how they relate to debit card, ACH, and other electronic transactions.
Be certain that staffing is adequate to support increased volumes of e-payments, and that the check processing staff remains adequate in the face of declining volumes.
Keep current on regulatory and examination developments with regard to overdraft protection programs. Make sure your customers understand how these programs work in conjunction with electronic transactions.
Be prepared for increased per check processing costs to be the norm at the Fed and correspondent banks.
Be aware that banks are no longer involved in the development or processing of all payment transactions. This requires more vigilance than ever to ensure that new payment transaction types will be processed accurately and efficiently on behalf of our customers.
Stay current with developments in the fraud arena, particularly those involving e-payments. Accept the knowledge that sophisticated scams will have to be countered by increasingly sophisticated systems for detection and prevention.
Bankers should assure themselves their stop payment process for checks can detect ACH check conversions. Although the ARC and POP transactions are required to include the check number, many stop payment routines don?t review incoming ACH entries. If your processing system can?t check ACH files for stops on paper checks, use some form of ACH stop to call suspects to your attention. Then work with your system providers toward improvements that will include the ACH entries in stop checking.

First published on BankersOnline.com 6/15/04