Check Fundamentals and Check Processing 2016 On‐Demand
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Copyright© 2016 by the Electronic Check Clearing House Organization
National Check Payments Certification
Program Series
Training On‐Demand
Session #1
Check Fundamentals and
Check Processing
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NOTICESThis training course may provide an introduction to or summary of various aspects of checkpayments and the legal and rules framework for check image exchange. Responsibility forcompliance with image exchange rules, and/or the legal, operational and regulatoryrequirements applicable to check image exchange, remains at all times with the financialinstitution participating in check image exchange and/or the individual or company using acheck image exchange service.
This presentation and the information contained herein is not intended as legal orcompliance advice or recommendation to any person or company. This document couldinclude technical inaccuracies or typographical errors and individual users are responsiblefor verifying any information found in this presentation and related “live” webinar orwebinar playback.
Financial institutions should consult with their legal counsel regarding legal and operationalrequirements applicable to any check image exchange program they may offer or in whichthey participate.
These materials may not be reproduced or published, in whole or in part, without the express permission of ECCHO.
(Certain contributed content subject to third party copyrights)
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Planning to Register? Free ECCHO / NCP study aids upon registration!
JumpStart Reading Programo Links to all program resources
NCP Roadmapo Direction on establishing a personalized study plan
P.R.E.P. Guideo Training guide, glossary of terms, sample exam
Question of the Day & Summary o New daily question & detailed answer to
prior day’s question with weekly summary
Exam Fees: $400 ECCHO member$500 non‐ECCHO member
Not sure about membership?o Check current status at: www.eccho.org/memberships
― Enter financial institution name in search box on left
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Suggestions for Further Study 1.
“Use of Check Images By Customers of Financial Institutions” (July 14, 2006) www.eccho.org/check_image/
“The Role of Private Sector Rules and Federal Reserve System Rules in Check Image Exchanges” (February 12, 2008 - CheckImage Collaborative) www.eccho.org/check_image/
“ANSI X9.100-160-1-2009 - Magnetic Ink Printing (MICR) Part 1: Placement and Location” (June 26, 2009) www.x9.org
Uniform Commercial Code (UCC) Article 3 - Negotiable Instruments; Article 4 - Bank Deposits And Collections www.law.cornell.edu/ucc/
Regulation CC (12 CFR Part 229—Availability of Funds and Collection of Checks http://ecfr.gpoaccess.gov/
Review Questions 2.
The following questions are a review of key points covered in this section to be used to further aid in the study of these topics. See “Section Four – Exhibits”; Exhibit 10 for the Answer Key.
Describe the check routing number in fractional form and define each part? – The aux on-us field on a check is typically used for what purpose? – What do Article 3 and Article 4 of the Uniform Commercial Code (UCC) –
cover? What does Federal Reserve Regulation CC implement? –
NCP P.R.E.P. Guide
Register for exam with ECCHO to access the Guide
4
300+ pages with suggestions for further study 35‐question multiple choice exam Quizzes at the end of each section with Answer Key
(example follows):
Check Fundamentals and Check Processing 2016 On‐Demand
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Session Topics Check Basics
Need for Rules
Check Payments System Overview
Other Payment Systems
Note: To prepare for the NCP Exam, it is recommended you review the entire training series Includes 11 sessions plus at least 1 recommended review session
o For a complete training program listing, visit ECCHO’s website at: www.eccho.org/ncpc_training
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Check Basics
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General Check Definitions Section will cover common definitions related to the check
including: Amount Bank (general definition)
o Collecting Banko Depositary Banko Paying Bank (also called “Drawee” in the UCC)
Drawer Payee MICR line
o Selected MICR line fields
Other definitions discussed in subsequent sessions related to specific topics
For additional definitions, see the current NCP P.R.E.P. Guide section titled “Glossary of Terms and Common Acronyms”
P.R.E.P. Guide is included in the NCP exam registration
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Blank Check Example
Consumer Check
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Processed Check Example
Consumer Check
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Parts and Parties to the Check Regulation CC Definitions (§229.2)
Bank: Includes ALL depository institutions as defined by:
o FDIA – Federal Depositary Insurance Acto FCUA – Federal Credit Union Acto Includes:
― Insured commercial bank;― Insured credit union;― Mutual savings bank;― Savings and loan association; or― Agency or a branch of a foreign bank as defined in the International
Banking Acto Note: Expedited Funds Availability (EFA) Act uses the term
“depository institution” Collecting Bank: Any bank handling a check for forward collection, except the Paying Bank
o Federal Reserve is collecting bank for items sent through the Fed; See Regulation J –§210.4 for more information
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Parts and Parties to the Check Regulation CC Definitions (§229.2)
(continued) Depositary Bank: First bank to which check is transferred even though it may also be Paying Bank of payee (Reg CC definition)
o Depositary Bank or Bank of First Deposit (BOFD) and Paying Bank may be the same bank for on‐us items
Paying Bank: Bank by which check is payable, to which it is sent for payment or collection
o Federal Reserve Bank (FRB) / Federal Home Loan Bank (FHLB) by which check is payable; or
o Bank through which a check is payable, if check is not payable by a bank; or
o State or unit of local government on which a check is drawn and to which it’s sent for payment or collection
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Parts and Parties to the Check UCC Definitions (Sections 3‐103, 3‐104, 4‐104, 4‐105)
Amount: Part of definition of a negotiable instrumento Negotiable Instrument:
― Means an unconditional order to pay a fixed amount of money
o Should appear twice on the check:― Courtesy amount: Amount written in numbers
May also be referred to as convenience amount― Legal amount: Amount written in words
Bank: Includes a savings bank, savings and loan association, credit union, or trust company
Drawer: Person who signs, or is identified in a draft, as the person ordering payment
Drawee: Bank or person ordered in a draft to make payment
Item: An order to pay money that is handled by a bank for collection or payment
o Does not include a payment order governed by Article 4A (Wire Transfer)
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Parts and Parties to the Check UCC Definitions (continued) Depositary bank: First bank to take an item even though it is also the payor bank
Payor bank: Bank that is the drawee of a drafto Bank ordered in a draft to make payment
Intermediary bank: Bank to which item is transferred in course of collectiono Except the depositary or payor bank
Collecting bank: Bank handling an item for collection, except the payor banko Federal Reserve Banks are collecting banks
Presenting bank: Bank presenting an item, except a payor bank.
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Parts and Parties to the Check Correspondent Bank: Financial institution
that provides services on behalf of another financial institution Can conduct business transactions, accept deposits and gather documents on behalf of other financial institutions they serve under the correspondent agreement (respondents)o Example: Banker’s bank (correspondent) and their members (respondents)
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Processed Check – Front
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Processed Check – Back
Indorsers Depositary Bank
DO
NO
T W
RIT
E, S
TA
MP
OR
SIG
N B
EL
OW
TH
IS L
INE
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What is MICR?Magnetic Ink Character Recognition (MICR) 1956
Descriptive information comprised of numbers and symbols
Magnetic ink printed characters that can be recognized at high speed by automated processing equipment
E‐13B Font – Used in magnetic ink printing in USA, Canada and several other countrieso Consists of ten numeric characters and four symbols
MICR line at the bottom of physical check
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123.45One hundred twenty-three and 45/100
– External Processing Code FieldOptional
Account Number and
Serial Number
12-5-09
Payee’s Name
Drawer’s Signature
ABA Routing Number‐ 9 digits, no spaces‐ bounded by transit symbols
DRAWER NAMESTREET ADDRESS
CITY, STATE
MICR Line of a Check Six‐inch check Generally used for consumer checking accounts
10 DIGITS
1 digit
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MICR Line Key Fields – Six‐inch check
Amount: 10 digit field On‐Us
o Drawer’s account numbero Check serial number
Routing Numbero ABA assigned routing number for Paying Bank
EPC – External processing codeo Optional, single‐digit field
― Provides information for handling or routing of the check or check data to financial institutions and other processors
o New EPC code value added (effective 2015) for the remotely created check (RCC)identifier― EPC value = ‘6’
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MICR Line of a Check Large check (longer than six inches) Generally used for business checking accounts
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MICR Line Key Fields – Business‐sized check Same fields as smaller six‐inch check
Includes Aux On‐Us (optional field)o To the left of the Routing Field on the MICR line
Used for:o Consecutive check serial numbers; or
o Account control information; or
o Product codes/information
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Routing Number Used for all financial institutions in the U.S.
Each FI has a unique number Some have more than one
Two forms found on checks: MICR form
Fractional form
Both forms appear on most checks, although only MICR form is used in automated item processing
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Routing Number – MICR Form Called the ABA Routing Number
May be referred to as:o ABA Number, Routing Transit (RT), Routing Transit Number
(RTN) First two digits: Fed District location of Paying Bank and Type of Institution
3rd and 4th digits: Specific Fed bank or branch serving paying institution
5th through 8th digits: ABA number for paying bank 9th digit is RT number validation (Check digit)
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Routing Number – Fractional Form May be printed in one of two forms as shown here:
OR
Numerator Includes a city (1‐49) or state (50‐99) prefix followed by the ABA institution identifier
Denominator is the Federal Reserve Routing Symbol ABA and Federal Reserve numbers match corresponding numbers in MICR form without leading zeros
Additional letters or numbers may be printed if paying bank chooses
91‐03/122191‐031221
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Example: Fractional RT ABA routing number:
122100037
In MICR form, shown on thecheck’s MICRline:
91-03/1221
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Example – Fractional RT To convert ABA routing number
122100037 to fractional form: Drop check digit ‐ last number
in ABA routing number Pick‐up city or state prefix
o Assigned by ABA ABA institution identifier
o Drop leading zeroeso Separate with dash “ – “
Federal Reserve routing symbolo Separate with slash “/ ”
122100037
91
0003
1221
12210003
91‐
91‐03
91‐03/1221
91-03 / 1221
Generally pre‐printed on the check in upper right near the check serial number
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Need For Rules
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Clearing Paper ChecksUCC & Reg CC Provisions[Statutory and Regulatory]
BOFD
UCC, Reg CC & Payee’s Deposit Agreement
Paying BankDrawer
Payee (Merchant)
UCC, Reg CC & Check Writing Agreement
UCC & Reg CC & Correspondent Agreement
Paper Check
Paper Check
Paper Check
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Paper Check Law Applicable Laws and Regulations Impose warranties on financial institutions when transferring and presenting checks
Together with case law form boundaries for most aspects of check processing
Complemented by large body of court interpretations Provide guidance and understanding in check payment disputes
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Recognized Role of Rules UCC [4‐103(b)] Recognizes role of check clearinghouse rules and Federal Reserve Operating Circularso May set forth additional provisions for paper check collection by financial institutions
Reg CC [229.37] Recognizes role of check clearinghouse rules and Federal Reserve Operating Circularso May vary some provisions of laws and regulations
― However may not fail to act in good faith or exercise ordinary care
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Not Covered Under UCC or Reg CC
Key Considerations:– Are the images authorized payments?– When does legal presentment occur?– Can the images be dishonored?– Who is responsible for duplicates?– Who is responsible for data security?– What are the rights of the payee and drawer?
BOFD Paying Bank
Drawer
Payee (Merchant)
IMAGE
What Rules or Agreements Apply?
Remote Deposit
IMAGE IMAGE
What Rules or Agreements Apply?
What Rules or Agreements Apply?
Clearing Images
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UCC Updates UCC anticipated electronic check
truncation/ image exchange 1990 revision (§4‐110) permits electronic presentment of items pursuant to an agreement for electronic presentment
Agreement may be in the form of: o Check clearing house rules and/or
o Federal Reserve regulation or Operating Circular
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What Did Check 21 Do? Successfully encouraged and supported the
rapid image exchange evolution by removing a key barrier to check truncation No longer required to obtain agreements from all parties to the transaction
o Provides for replacement of paper check with substitute paper check
o Allows unilateral decisions to truncate checks
Does not mandate the receipt of electronic (image) transactions Only applies to the substitute check, but. . .
Encourages image exchange Use image technology to create substitute check
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Paper Check vs. Images Regulations vs. Rules UCC and Reg CC provide statutory and regulatory definitions for a paper check,
but. . .
No default definition of image in current check law
Where is the image of a check defined?
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Need for Rules There Are No Laws To Cover Exchange of
Check Images Exchanging images in the absence of agreements exposes financial institution to an indeterminately large amount of risko Potential for consequential damages
Check Image Exchange Need agreements for exchanges through:
o Federal Reserve or
o Private sector
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Check Rules, Regulations and Agreements
Uniform Commercial Code (UCC) Developed with efforts towards uniform laws for sales and other commercial transactions in all 50 states
Detailed Code Addressing Most Aspects of Commercial Lawo Set of standardized state laws that govern financial contracts
o Establishes general duty standards for parties to act in Good Faith and exercise Ordinary Care
Organized as Articleso Each deals with a different subject area
― Article 3 covers negotiable instruments― Article 4 cover bank deposits and funds transfers
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Check Rules, Regulations and Agreements
Code of Federal Regulations (CFR) Codification of the general and permanent rules published by the executive departments and agencies of the Federal Government
Title 12 ‐ Banks and Bankingo Part 229‐Availability of Funds and Collection of Checks
(Regulation CC)
Reg CC implements legislation relative to:o Funds availability (EFAA)o Substitute checks (Check 21 Act)
Awaiting updates to Reg CC at this time Following review of industry responses to two RFC proposals in 2011 and 2013
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Check Rules, Regulations and Agreements Federal Reserve Regulations
Regulation J ‐ Subpart A: Collection of Checks and Other Items by Federal Reserve Banks
o Purpose is to provide rules for collecting and returning items and settling balances via the Federal Reserve Banks
o Referenced by Fed OC3
Industry Image Rules FRB Operating Circulars
o OC 3: Collection of Cash Items and Returned Checkso OC 5: Electronic Access
Private sector clearing house rules (such as the ECCHO rules)
Rules and regulations will be discussed in detail in other sessions
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Image Exchange Rules Items defined as “checks” under Reg CC and
“items” under UCC eligible for image exchange Covered by Fed OC3 and private sector rules such as ECCHO’s rules
US savings bonds now transmitted via image exchange
Noncash items not eligible for exchange ECCHO Rules permit “imperfect image” to be exchanged
Foreign items currently not eligible Canadian items may be exchanged by agreement
o ECCHO Rules updated 2015 to facilitate image exchange of Canadian items within U.S. prior to delivery to Canadian financial institution
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Summary Warranties/Indemnities Come From Different Sources
Federal regulations State Laws Rules and agreements
To determine what rules apply, is the item: Original physical check, a substitute Check (IRD), or an
image
For images, determine the presentment/clearing channel Through the Fed – Reg J and OC3 apply Through a clearinghouse – clearinghouse rules (i.e. ECCHO) Direct bank to bank (Clearinghouse rules or agreements)
Generally, warranties start at first bank that deals with substitute check or image
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Check PaymentsSystem
Overview
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Check Collection Process
Corporate Payor
Clearing Banks /Correspondent
Paying Bank
FederalReserve
Bank of First Deposit(BOFD)
On‐UsItems
IndividualPayee
Merchant or
Corporate Payee
Individual Payoror
“Day in the Life of a Check” Forward Collection
Image
Image
Image Image
Image Image
Image
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Clearing Payments Various channels to move payments
through system to final collection May use clearing bank, correspondent or Fed to present to Paying Bank
Depositary Bank wants to collect funds quickly and at reasonable cost
Depositary Bank collects funds it has provisionally credited to its depositor’s account
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Clearing Payments Clearing – Exchange of payment
instruction data between financial institutions Moves checks from banks where they are deposited to banks where they are drawn
Clearing process includes: Data collected from multiple transactions
Sent to FI’s core processing system
Affects accounts of the FI’s customers
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What is Settlement? Settlement – Exchange of value between
financial institutions for payments As shown in previous example:
o “Clearing” involves exchange of payment instructions (data) between two financial institutions
Settlement: Exchange of fundso Separate event based upon agreement between the two exchanging parties
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Settlement – Federal Reserve Settlement typically occurs at the Federal
Reserve Bank
All banks designate accounts for settlement at the Federal Reserve Bank May have their own Fed account
May use the settlement account of a correspondento Some banks utilize both and designate which types of settlement occurs at each account
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FRB National Settlement Service Owned and operated by Federal Reserve
Banks
Service is offered to depository institutions that: Settle for participants in clearing houses Financial exchanges Other clearing and settlement groups
Settlement agents electronically submit settlement files to Federal Reserve Banks Files are processed on receipt Entries are automatically posted to depository institutions' Federal Reserve Bank accounts
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Designated Settlement Accounts
Federal Reserve
Bank A’s Fed Account
Bank Bs Correspondent Account at
Bank A
Wires, TT&L, Treasuries
Checks, Credit Cards, ACH
+/‐ $ +/‐ $
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Settlement – Clearing House
Each member financial institution presents payment instructions to clearing house Clearing house facilitates presentment to each paying bank for “clearing”
Settlement occurs as a separate event
Data Data
Clearing House
Data Data
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Gross vs. Net Settlement Gross Settlement Exchange of value for a single payment
Net Settlement Exchange of value for multiple payments
“Net effect” of all payments is settled to each financial institution
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Gross Settlement For the value of a single payment; one
financial institution receives credit and other receives debit DFI sending wire receives a debit on FRB books; DFI receiving the wire receives the credit
Federal Reserve
Debit Bank A’s Account on Books of the Federal Reserve
Credit Bank B’s Account on Books of the Federal
Reserve–$ +$
Bank B’s Fed Account
Bank A’s Fed Account
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Net SettlementMultiple payments are grouped together Net effect settled to the designated accounts on books at Federal Reserve
Federal Reserve
Bank A’s Account
All debits/credits are combined for single bank; Net effect reflected on the designated settlement account at the Fed
Net settlement ‐ Exchange of funds between participating banks in a clearing network
+/‐ $
Bank B’s Account
Bank C’s Account
Bank D’s Account
+/‐ $ +/‐ $ +/‐ $
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Float Overview Float Time between the deposit of a check and final collection and funds availability to the customero Dollar value of cash balances created by the time lag in processing unpaid checks― Checks outstanding in the process of collection
o Conditional credits in a depositor's checking account until the checks are collected/paid
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Float Overview Float Banks receive checks for deposit and provisionally credit the account of the check depositor
Timing of clearing – Collection and settlement of funds from drawee – the Paying banko Where the check is drawn
Check clearing results in checks in process of collection appearing briefly in accounts of both Depositary Bank and Paying Bank
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Types of Float Bank Float – May be referred to as “incurred
float” Non‐earning asset created through delay in collection of deposited funds
Correlates to calendar days elapsing between:o Posting of customer ledger credit; and o Bank’s receipt of usable funds
Customer Float – May be referred to as “assigned or allocated float” Sum of dollars credited to a demand deposit account but not available for immediate withdrawal or earnings credit
Correlates to calendar days elapsing between:o Posting of customer ledger credit; and o Funds made available to customer
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Positive and Negative Float Negative float occurs when: Customer Float (assigned or allocated) is greater than Bank Float incurredo “Negative” position from customer’s point of viewo “Positive” for the bank
― Bank has use of funds prior to funds availability to the customer
Positive float occurs when: Bank Float incurred is greater than Customer Float (assigned or allocated)o “Positive” position from customer’s point of viewo “Negative” for the bank
― Customer funds available made available for use priorto the bank’s collection and final settlement
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Other Payment Systems
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Multiple Channels / Options Check Can Be Cleared via Multiple
Channels As a physical check
As an image
Convert image to substitute check (IRD)
As an ACH debit (if check is eligible for conversion)o ARC – Accounts Receivable entry
o POP – Point of Purchase entry
o BOC – Back Office Conversion entry
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Automated Clearing House (ACH) Funds transfer system governed by NACHA Rules
Provides for inter‐financial institution clearing of electronic entries for participating financial institutions
General terms: ACH transactions may be debits or credits Examples include:
o Direct Deposit of payroll, government and Social Security benefitso Mortgage, insurance or other bill payments
ACH Operators: Two central clearing facilitieso Federal Reserve and o The Clearing House
Originator– Individual, corporation or another entity that initiates either a deposit or payment transaction
ODFI: Originating Depository Financial Institution RDFI: Receiving Depository Financial Institution
ACH generally considered “batch and forward” payment system where:
o Day 1: Files are originatedo Day 2 or beyond: Files are settled
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Ineligible Items – ACH Following Checks Do Not Qualify for
Conversion to ACH Transactions: Checks containing aux on‐us field
Greater than $25,000
Third‐Party checks/share drafts/money orders
Demand drafts/3rd party drafts with no signature
HELOC checks
Money market checks
Financial institution obligationso Traveler’s checks, official checks, cashier’s checks
State/local government checks
Checks/money orders in a foreign currency
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ACH Process Example
ORIGINATOR
ODFIOriginating Depository Financial Institution
ACH OPERATORFederal Reserve
or The Clearing House
RDFIReceiving Depository Financial Institution
RECEIVER
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Other Payment Systems Debit Card – Generally uses the shared ATM
networks that offer payment services associated with a financial institution’s DDA systems
Credit Card –Issued by a company to allow the user to purchase goods and services from merchants who accept the card
Wire – Electronic payment service for transfer of funds Characteristics include:
o Large dollar transactionso Immediate availabilityo Irrevocable payments
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Recommended Resources CheckImage Central Website:
www.checkimagecentral.org White paper on “Need for rules”:http://www.checkimagecentral.org/pdf/RoleOfPrivateSecRulesAndFRSRules.pdf
ECCHO website: www.eccho.org
Federal Reserve website: www.frbservices.org
Uniform Commercial Code (UCC) www.law.cornell.edu/ucc
o Article 3 – Negotiable Instrumentso Article 4 – Bank Deposits and Collections
X9 Standards: www.x9.org
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Appendix AWhat is a Check?
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Payments Teaser Is this paper check a check?
Yes – a paper check is a “check” This example has all the elements of a check
o Date
o Signature of drawero Payee name
o Amount – both in words and numbers
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Is This Large Check a Check? Hint: Assume this check has a MICR line
Could be considered a “negotiable instrument” under the UCC definition Has same elements as our last example:
o Date, signature of drawer, payee name, amount and a MICR line
But it is not a check based on regulations Under Reg CC a “check” must be able to be processed by automated check processing equipment
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Is This A Check? If this is a check, what type of check is this?
Substitute check or IRD (image replacement document) Yes, assuming this is a properly prepared substitute check, it is considered a check under check law
o Considered a legal equivalent of the original check
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Is This A Check? Hint: This “cloud” illustrates an image of a check.
Is this a check?
No default definition for this ‐ Not defined by current regulations This is only a check by agreement between the exchanging parties No law or other regulation makes the image of the check a “check”
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Is This A Check? This is a MICR line from a check Is this a check?
The MICR line is not a check. By agreement exchange partners may agree to accept only this information to
clear an item (to make the item processable) but. . .
It would not be defined as a check
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Is This A Check? Hint: It is being sent directly from a mobile
device?
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Mobile RDC Example An image on the phone (prior slide) is not
a check by default. However, If by agreement an exchange partner accepts this information to clear the item, it may be accepted for exchange
Example: Customer has the original check and is under a Remote Deposit Capture agreemento Image exchange process via the mobile device would be similar to any other image channel for exchange
o But this is still done only by agreement
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Is This A Check? Hint: This is created and sent from an online bill
pay/accounting software?
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Online Software Example Currently , a check must begin as a physical
item ‐ a “tangible writing” according to the Uniform Commercial Code
See the check illustrated on the prior slide If electronically created and transmitted from an online software system, but not printed first and then imaged, it is not considered a “check” under current check law
May be considered an “electronic payment order” or an EPO, but not a check
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Negotiable Instrument & Check Two Concepts – Two Definitions
Negotiable instrument and check defined in UCC Check considered a “demand draft”
Check also defined in Reg CC To be considered a check (not a noncash item)
o Item must qualify for handling by automated check processing equipment
In prior examples – the large “donation” check would be considered a negotiable instrument but... Even with all elements of negotiable instrument:
o Would not qualify for automated processingo Would not meet definition of a check under Reg CC
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Summary Negotiable Instrument
Defined in UCC 3‐104 as a “draft” Written order signed by the drawer
o Unconditional order to pay:― a fixed sum of money― on demand or at a definite time― to a named payee or to bearer
Check – Negotiable Demand Draft Defined in Reg CC 229.2(k) as drawn on:
o or payable through or at a bank; o the Federal Reserve Banko Federal Home Loan Bank;o US Treasury;o a state or unit of local government;
Does not include a noncash item
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Additional Information For additional details regarding terms
defined in these materials, please see: UCC Articles 3 & 4
Regulation CC – Availability of Funds and Collection of Checks
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Thank You!
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Dallas, Texas 75219
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Direct: 214‐273‐3218
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