Inside the Check 21 Act

By Tom Schmidt

For banks and their customers, October 28, 2004 is a red-letter date: that's when the Check Clearing for the 21st Century Act (or Check 21) goes into effect. The act authorizes the creation of an IRD, or image replacement document. An IRD is a substitute check that has been imaged from the original paper version presented to the clearing bank. More importantly, the IRD has the same legal status for proof of payment as an original check. The new law raises issues of trust for banks, as well as opportunities for fraud mitigation and customer education.

Eliminating the 'float'
By eliminating the need to physically ship paper checks, Check 21 is widely expected to speed up check clearing, and many banks are looking forward to gains in operational efficiency. IRDs allow banks to electronically submit a request for payment through a collecting bank -- one with which they have an existing relationship -- which will then send an IRD by local mail to collect payment. Paper and mail remain involved, but banks can now look to local transportation costs, and shorter turnaround times to payment.

Reducing fraud
Because Check 21 allows for faster processing of checks via electronic transmission, the chance of fraud can be significantly reduced. That's because the shorter the time a check is outstanding, the shorter the time fraud can go undetected. Also, the digital nature of the new process improves the chances of detecting fraud. Under the new law, banks are now likely to learn of a bad check within one day, rather than two to four days as they do now.

Of course, banks must always be extremely vigilant about potential new opportunities for attack. Mitigating the latest online fraud techniques requires a combination of measures, including security assessment, real-time monitoring, consumer education, and increased protection. Banks must ensure that they're able to detect fraudulent substitute checks, images and data, and to safeguard the security of check images, data, and the routing of them.

In a recent report ("Check 21 Offers Opportunities and Challenges for Banks," August, 2004), researcher Gartner Inc. advises banks take the following steps to improve fraud reduction in check processing:

• Use archived electronic check images and data and compare to incoming check images. This historical data will offer more proactive fraud detection.
  
  
• Use established rules, including anti-money-laundering rules, to flag potential check fraud or money laundering. This approach will require the integration of front-office teller applications with back-office image archive systems.
  
  
• Use historical data and images to conduct bank-wide fraud analysis in identity-theft detection efforts.

With annual losses due to bad checks estimated to run as high as $25 billion, any reduction in fraud could amount to significant savings for banks.

Getting the word out to the staff
Banks need to be particularly diligent in monitoring the entire image process for substitute checks, as this is still fairly new to bank employees. It is also essential to train customer service representatives about the way IRDs work, as this group will be on the front lines explaining such matters to customers. An informed, educated staff can play a pivotal role in building customer trust and confidence. As for information security, staffers should be thoroughly familiar with procedures to mitigate the risk of fraud associated with electronic check processing.

A sea-state change
It is no exaggeration to say that the Check 21 Act represents a sea-state change for the banking industry. Indeed, Gartner believes that this change to the presentment and clearing process will cause banks to decrease the cost of image-based check clearing and bring check processing closer to real time. But with these opportunities come challenges. Banks must be keenly aware of the potential for new types of online fraud, especially now that paper-based security features such as watermarks stand to be eliminated. Now is also the time for banks to be proactive in identifying and responding to new fraud techniques, and in educating their customers and employees about the many ramifications of the Check 21 Act.

Tom Schmidt writes frequently about information security topics. He has more than 15 years' experience as a writer and editor in high-tech publishing.