The check is dead! Long live the check! A Check 21 update.

The Check Clearing for the 21st Century Act (Check 21), signed into law in 2003 and effective one year later, was intended to foster innovation in the payments system and enhance its efficiency. Although conceived before September 11, 2001, Check 21 attained new urgency after the terrorist attacks led to the grounding of commercial air travel for several days. During that time, many checks could not be cleared because clearing required that the checks be returned to the paying banks--and timely delivery between regions relied on air transportation. Grounded checks peaked at a value of over $45 billion, highlighting the risks associated with a national payment system dependent on air transportation.

Check 21 was designed to encourage the use of electronic check clearing but not mandate it. Before Check 21, paying banks were permitted by law to insist that they receive the original paper check ("presentment") before they transferred funds. Check 21 authorizes a new paper negotiable instrument called a "substitute check," which contains a printed image of the front and back of an original paper check and is suitable for automated processing. The substitute check is the legal equivalent of the original and must be accepted by any bank that demands presentment of a paper check for payment. By permitting the creation of substitute checks, Check 21 removed a key legal impediment to the replacement, during the collection process, of paper checks with electronic information ("check truncation").

At first blush, all this may sound odd: If electronic check clearing methods improve efficiency and robustness, why did it take an act of Congress to promote them? From an economic perspective, Check 21 fosters innovation by solving a major coordination problem. In the United States there are thousands of depository institutions that, in the absence of Check 21, would have had to agree simultaneously to implement a change to electronic check clearing. But not every bank has the same incentive to adopt such a change. Some banks, for example, stood to lose interest on float if the use of electronic clearing methods sped up check processing. Other banks might not have been willing to make changes to their processing operations without the assurance that many other banks would do likewise. The option to use a substitute check permits banks to unilaterally replace the original paper check with an electronic image and process that information electronically for at least a portion of the clearing process, creating substitute checks only for banks that require paper. This allows banks that want to convert to electronic clearing to do so without enlisting the cooperation of others. …

To read the full text of this article and others like it, subscribe today!