NCP 2015 Exam Cycle Core Training Series Session 1 National Check Payments Certification Check Fundamentals and Check Processing Copyright© 2014 by the Electronic Check Clearing House Organization NOTICES This training course may provide an introduction to or summary of various aspects of check payments and the legal and rules framework for check image exchange. Responsibility for compliance with image exchange rules, and/or the legal, operational and regulatory requirements applicable to check image exchange, remains at all times with the financial institution participating in check image exchange and/or the individual or company using a check image exchange service. This presentation and the information contained herein is not intended as legal or compliance advice or recommendation to any person or company. This document could include technical inaccuracies or typographical errors and individual users are responsible for verifying any information found in this presentation and related “live” webinar or webinar playback. Financial institutions should consult with their legal counsel regarding legal and operational requirements applicable to any check image exchange program they may offer or in which they participate. These program training materials may not be reproduced or published, in whole or in part, without the express permission of ECCHO. Copyright© 2014 by the Electronic Check Clearing House Organization (Certain contributed content subject to third party copyrights) National Check Payments Certification 2 NCP Exam Registration Reminder • Free study aids upon registration: – P.R.E.P. Guide: 300+ pages of information, training guide, sample exam – Question of the Day: Summary available now New daily question & detailed study answer delivered via email beginning January 2015 – NCP Roadmap – Direction on establishing study plan – JumpStart Reading Program – Links to all references • Exam Fees: $400 ECCHO member $500 non-ECCHO member – Not sure about membership? Check current status at: http://www.eccho.org/memberships o Enter name in search box on left National Check Payments Certification 3 Session Topics • Check Basics – Definitions – MICR line • Need for Rules – Paper vs. Image Exchange • Check Payments System Overview • Other Payment Systems National Check Payments Certification 4 Check Basics General Check Definitions • Section will cover common definitions related to the check including: – Bank (general definition) – – – – Depositary Bank Collecting Bank Paying Bank (also called “Drawee” in the UCC) Drawer Payee Amount Courtesy Amount Legal Amount MICR line Selected MICR line fields • Other definitions discussed in subsequent sessions related to specific topics • For additional definitions, see 2015 NCPC P.R.E.P. Guide section titled “Glossary of Terms and Common Acronyms” – Available upon registration to all 2015 NCP exam registrants National Check Payments Certification 6 Bank • Bank: Reg CC definition – Expedited Funds Availability (EFA) Act uses the term depository institution – Reg CC uses simpler term “bank” Definition includes ALL depository institutions as defined by both the: o FDIA – Federal Depositary Insurance Act o FCUA – Federal Credit Union Act – 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 Act National Check Payments Certification 7 Blank Check Example Basic Consumer Check National Check Payments Certification 8 Parts and Parties to the Check • Paying Bank: Bank by which check is payable, to which it is sent for payment or collection – Federal Reserve Bank (FRB) / Federal Home Loan Bank (FHLB) by which check is payable; or – Bank through which a check is payable, if check is not payable by a bank; or – State or unit of local government on which a check is drawn and to which it’s sent for payment or collection • Drawer: Person ordering payment; Person signing the check • Drawee: Bank / person ordered to pay the check • Depositary Bank: First bank to which check is transferred even though it may also be Paying Bank of payee (Reg CC definition) – Depositary Bank or Bank of First Deposit (BOFD) and Paying Bank may be the same bank for on-us items National Check Payments Certification 9 Parts and Parties to the Check • Correspondent Bank: May conduct business transactions, accept deposits and gather documents on behalf of other financial institutions (respondents) • Collecting Bank: Any bank handling a check for forward collection, except the Paying Bank • Amount – UCC 3-104 requires a fixed amount for the item to be a negotiable instrument – Amount should appear twice on the check to help inhibit check fraud – Both in numbers and words Courtesy amount (or convenience amount) – Amount in numbers Legal amount – Amount in words National Check Payments Certification 10 Processed Check – Front National Check Payments Certification 11 Processed Check – Back Depositary Bank E RE H ES R O D N E DO NOT WR ITE, S TA MP OR SIGN B ELOW THIS LINE Indorsers National Check Payments Certification 12 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 countries Consists of ten numeric characters and four symbols – MICR line at the bottom of physical check National Check Payments Certification 13 MICR Line of a Check • Six-inch check – Generally used for consumer checking accounts DRAWER NAME STREET ADDRESS CITY, STATE 12-5-09 Payee’s Name One hundred twenty-three and 45/100 123.45 Drawer’s Signature Account Number and Serial Number 10 DIGITS – External Processing ABA Routing Number Code Field - 9 digits, no spaces Optional - bounded by transit symbols 1 digit National Check Payments Certification 14 MICR Line • Key Fields – Six-inch check – Amount 10 digit field – On-Us Drawer’s account number Check serial number – Routing Number ABA assigned routing number for Paying Bank – EPC – External processing code Optional, single-digit field o Provides information for handling or routing of check/check data to financial institutions and other processors National Check Payments Certification 15 MICR Line of a Check • Large check (longer than six inches) – Generally used for business checking accounts Payee’s Name One hundred twenty-three and 12-5-09 45/100 123.45 Drawer’s Signature Aux On Us Field: Can optionally include serial number or other transaction or product code National Check Payments Certification 16 MICR Line • Key Fields – Business-sized check – Same fields as smaller six-inch check – Includes Aux On-Us (optional field) To the left of the Routing Field on the MICR line – Used on commercial checks for Consecutive serial numbers; or Account control information; or Product codes/information National Check Payments Certification 17 Routing Number • Used for all financial institutions in the U.S. • Each FI has a unique number – Some have more than one • Two forms are currently used: – MICR form – Fractional form • Both forms appear on most checks, although only MICR form is used in automated item processing National Check Payments Certification 18 Routing Number – MICR Form • Called the ABA Routing Number – May be referred to as: ABA Number Routing Transit (RT) Routing Transit Number (RTN) ABA Institution Identifier (4 digits) Check digit (1 digit) – – – – Federal Reserve Routing Symbol (4 digits) First two digits designate Fed District location of Paying Bank and Type of Institution 3rd and 4th digits represent specific Fed bank or branch serving paying institution 5th through 8th digits are ABA number for paying institution 9th digit is RT number validation (Check digit) National Check Payments Certification 19 Routing Number – Fractional Form 91-03 1221 Numerator includes a city (1-49) or state (50-99) prefix followed by the ABA institution identifier 91-03/1221 National Check Payments Certification 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 wants • May be printed in one of two forms as shown • 20 Example: Fractional RT • ABA routing number: 122100037 91-03/1221 • In MICR form, shown on check’s MICR line: National Check Payments Certification 21 Example – Fractional RT • To convert to fractional form • ABA routing number: 122100037 – Drop check digit - last number in ABA routing number – Pick-up city or state prefix Assigned by ABA – ABA institution identifier Drop leading zeroes Separate with dash “ – “ – Federal Reserve routing symbol Separate with slash “/ ” 122100037 12210003 91 9191-03 91-03/1221 0003 1221 91-03/1221 22 Need For Rules Clearing Paper Checks UCC & Reg CC Provisions [Statutory and Regulatory] UCC, Reg CC & Payee’s Deposit Agreement Payee (Merchant) UCC & Reg CC & Correspondent Agreement BOFD National Check Payments Certification Paper Check Paper Check Paper Check UCC, Reg CC & Check Writing Agreement Paying Bank Drawer 24 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 National Check Payments Certification 25 Recognized Role of Rules • UCC [4-103(b)] – Recognizes role of check clearinghouse rules and Federal Reserve Operating Circulars 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 Circulars May vary some provisions of laws and regulations o However may not fail to act in good faith or exercise ordinary care National Check Payments Certification 26 Clearing Images Not Covered Under UCC or Reg CC What Rules or Agreements Apply? What Rules or Agreements Apply? What Rules or Agreements Apply? Remote Deposit IMAGE IMAGE IMAGE Payee (Merchant) Key Considerations: – – – – – – Drawer BOFD Paying Bank 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? National Check Payments Certification 27 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: Check clearing house rules and/or Federal Reserve regulation or Operating Circular National Check Payments Certification 28 What Did Check 21 Do? • Designed to encourage check truncation by removing key barrier to truncation – No longer required to obtain agreements from all parties to the transaction Provides for replacement of paper check with substitute paper check Allows unilateral decisions to truncate checks • Does not mandate the receipt of electronic (image) transactions – Only applies to the substitute check • Encourages image exchange – Use image technology to create substitute check National Check Payments Certification 29 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? National Check Payments Certification 30 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 risk Potential for consequential damages • Check Image Exchange – Need agreements for exchanges through: Federal Reserve or Private sector National Check Payments Certification 31 Exchange Channels and Rules • 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 National Check Payments Certification 32 Check Rules and Regulations • Federal Reserve Regulations – Regulation J Subpart A: Collection of Checks and Other Items by Federal Reserve Banks • Image Rules – FRB Operating Circulars OC 3: Collection of Cash Items and Returned Checks 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 National Check Payments Certification 33 Check Rules and Regulations • 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 Law Set of standardized state laws that govern financial contracts Establishes general duty standards for parties to act in Good Faith and exercise Ordinary Care – Organized as Articles Each deals with a different subject area o Article 3 covers negotiable instruments o Article 4 cover bank deposits and funds transfers National Check Payments Certification 34 Check Rules and Regulations • 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 Banking Part 229-Availability of Funds and Collection of Checks (Regulation CC) – Reg CC implements legislation relative to: Funds availability (EFAA) Substitute checks (Check 21 Act) National Check Payments Certification 35 Eliminating Barriers to Image • Prior to Check 21 – Number of barriers made transition from paper checks to electronic check payments slow Difficult to accept and implement – To truncate paper check and replace with image, all parties with interest in check had to agree With thousands of FIs and millions of customers, task was impossibly large National Check Payments Certification 36 Image Exchange • Today – 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 for image exchange ECCHO-hosted subcommittee discussing topic o Canadian Payments Association (CPA) and Canadian banks participating Updates being discussed for ECCHO Rules o Goal: Facilitate image exchange of Canadian items within U.S. prior to delivery to Canadian financial institution National Check Payments Certification 37 Check Payments System Check Collection Process “Day in the Life of a Check” Forward Collection On-Us Items Individual Payor or Image Image Image Individual Payee Clearing Banks /Correspondent Image Image Corporate Payor Merchant or Corporate Payee National Check Payments Certification Bank of First Deposit (BOFD) Image Image Federal Reserve Paying Bank 39 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 National Check Payments Certification 40 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 FIs core processing system – Affects accounts of the FI’s customers National Check Payments Certification 41 What is Settlement? • Settlement – Exchange of value between financial institutions for payments – As shown in previous example: “Clearing” involved exchange of payment instructions (data) between two financial institutions – Settlement: Exchange of funds Separate event based upon agreement between the two exchanging parties National Check Payments Certification 42 Settlement – Federal Reserve • Settlement typically occurs at the Federal Reserve Bank • All banks designate accounts for settlement at the Federal Reserve Bank – May have own Fed account – May use that of a correspondent Some banks utilize both and designate which types of settlement occurs at each account National Check Payments Certification 43 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 National Check Payments Certification 44 Designated Settlement Accounts Checks, Credit Cards, ACH +/- $ Bank A’s Fed Account National Check Payments Certification Federal Reserve Wires, TT&L, Treasuries +/- $ Bank Bs Correspondent Account at Bank A 45 Settlement – Clearing House Data Data Data Data 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 National Check Payments Certification 46 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 National Check Payments Certification 47 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 Debit Bank A’s Account on Books of the Federal Reserve -$ Credit Bank B’s Account on Books of the Federal Reserve +$ Federal Reserve Bank A’s Fed Account National Check Payments Certification Bank B’s Fed Account 48 Net Settlement • Multiple payments are grouped together – Net effect settled to the designated account on books at Federal Reserve All debits / credits are combined for single bank; Net effect reflected on designated settlement account at the Fed +/- $ Bank A’s Account National Check Payments Certification Federal Reserve +/- $ +/- $ +/- $ Bank B’s Account Bank C’s Account Bank D’s Account Net settlement: Settle between participating banks in a clearing network 49 Float Overview • Float – Time between the deposit of a check and final collection and funds availability to the customer Dollar value of cash balances created by the time lag in processing unpaid checks o Checks outstanding in the process of collection Conditional credits in a depositor's checking account until the checks are collected/paid National Check Payments Certification 50 Float Overview • Float – Banks receive checks for deposit and provisionally credit the account of the check depositor – Timing of clearing (collection / settlement of funds from bank upon which check is drawn) Check clearing results in checks in the process of collection appearing briefly in the accounts of both Depositary Bank and Paying Bank National Check Payments Certification 51 Types of Float • Bank Float (Incurred float) – Non-earning asset created through delay in the collection of deposited funds – Correlates to calendar days elapsing between posting of customer ledger credit and bank receipt of usable funds • Customer Float (Allocated float) – Sum of dollars credited to a demand deposit account but not available for immediate withdrawal/earnings credit – Correlates to calendar days elapsing between posting of customer ledger credit and funds made available to customer National Check Payments Certification 52 Positive and Negative Float • Negative float occurs when: – Customer Float billed is greater than Bank Float incurred • Positive float occurs when – Bank Float incurred is greater than Customer Float billed National Check Payments Certification 53 Other Payment Systems 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) ARC – Accounts Receivable entry POP – Point of Purchase entry BOC – Back Office Conversion entry National Check Payments Certification 55 Automated Clearing House (ACH) • Funds transfer system governed by NACHA Rules – Provides for inter-financial institution clearing of electronic entries for participating financial institutions – Generally considered “batch and forward” next day payment system where: Day 1: Files originated / Day 2: Files settled RECEIVER RDFI Receiving DFI National Check Payments Certification ODFI Originating DFI ORIGINATOR ACH OPERATORS 56 Ineligible Items – ACH • Following 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 – FI Obligations Traveler’s checks, official checks, cashier’s checks – State/local Gov’t checks – Checks/money orders in a foreign currency National Check Payments Certification 57 Other Payment Systems • Debit Card – Generally use 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: Large dollar transactions Immediate availability Irrevocable payments National Check Payments Certification 58 Questions National Check Payments Certification 59 Recommended Resources • Uniform Commercial Code (UCC) – Article 3 – Negotiable Instruments – Article 4 – Bank Deposits and Collections • 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 National Check Payments Certification 60 Recommended Resources • ECCHO website: www.eccho.org • Federal Reserve website: www.frbservices.org • Uniform Commercial Code (UCC): www.law.cornell.edu/ucc – Article 3 – Negotiable Instruments – Article 4 – Bank Deposits and Collections National Check Payments Certification 61 Ellen Heffner, NCP Director and Education Manager [email protected] 214-273-3211 Check Fundamentals and Check Processing Thank You! Electronic Check Clearing House Organization 3710 Rawlins Street; Suite 1075 Dallas, Texas 75219 NOTICE This NCPC Program document contains copyrighted materials of its publisher. These program training materials may not be reproduced or published, in whole or in part, without the express permission of ECCHO.