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Check Truncation – Definition

Check Truncation Definition

Check truncation as used in American English refers to a system of clearing check that involves the removal or elimination of physical paper cheque processing and replacing it with electronic means, through which checks are deposited in the bank and then processed for payments. In other words, it is a check processing system where the verification system of checks is done using digital copies instead of tangible paper copies.

A Little More on What is Check Truncation

Generally, check truncation processing is much faster and more efficient compared to that of a paper check. This is because it removes the complicated physical transfer of paper checks from one place to the other, hence reducing the period spent on settling payments. 

Note that banks use check truncation to create what is called, substitute checks. A substitute check is a document considered by law to be valid and, therefore, equal to the original check. This is because the information on the substitute check is the same as that on the original checks. This document is officially used to carry out financial transactions.

Most banks usually do away with the original check once they have made a substitute check. However, when sending an account statement, the bank may consider sending you a substitute check in case of check cancelation.

Also, where verification of payment is involved, you can ask from your bank a copy of the substitute check. Note that in some banks, there is a fee you are required to pay for them to issue you with this document.

Why Check Truncation was Created

The original process of clearing checks involved taking the check to the bank of the drawee. As the usage of checks increased, the paperwork became more and more cumbersome for banks to handle. Banks had to arrange a meeting so that they could meet and exchange checks as well as make payments in cash.

On the other hand, customers had to deposit checks in person to their own banks. The bank would then forward the check to the drawee’s bank. This process also involved crediting and depositing of cash from respective accounts. In case a check is canceled, then the bank would physically return the check to the original bank.

Note that this manual check processing would take a number of days because the clearing cycle involved transporting checks to and from various places, until the last verification is done and payment is done. This required a lot of time and large manpower to get the job done.

However, because of this tedious and cumbersome processing cycle, some countries decided to create what is called, “Check 21 Act,” a law that allowed banks to implement truncation. The banks would scan the original check to make a digital copy which then would be used by banks to do transactions.

When the electronic process is all done and everything is in order, the original check is then destroyed and the digital copy would be used in the banking system to process payments. Truncation was mostly embraced by the banks that received large volumes of checks that required clearing.

Benefits of Check Truncation

  • It reduces the time spent on processing paper checks. Note that paper check involves a verification process which is complicated and tedious hence consuming much time. Check truncation, therefore, speeds up the process of check clearing more.
  • Secondly, check truncation is cost-efficient as it saves banks from incurring costs involved with transporting paper checks from one place to the other. It is worth noting that with check truncation, you only need to scan and then the scanned copies are emailed to respective parties at once for verification.
  • It gets rid of the tedious process of moving check papers from one place to the other. Instead, the process is easily done electronically with much ease.
  • Lastly, by using check truncation, it is easier to check the possibility of fraud.

Check Truncation Law

For truncation to take place, countries needed to enact a law that would permit banks to implement truncation. The United States enacted the Check 21 in 2004, which gave banks the authority to implement check truncation. The banks were able to convert the original paper check into an electronic copy which was then presented to the respective bank for clearing. The Check 21 Act that was enacted validated and accepted the use of a “substitute check,” which was created by banks instead of the original paper check.

In addition, the law was necessary to ensure that the digital copy was a real and accurate copy of the original for the purpose of protecting consumers from cases of fraud. Since the paper check would no longer be given back, the law was necessary so that the process of dishonored checks could be addressed accordingly.

Check Truncation Operations and Clearing 

When working with check truncation, it requires taking into consideration things such as creating an electronic check and also security-related images. The process of check clearing is then adjusted for the purpose of accommodating the electronic check. As part of the process, check truncation system is usually applied.  The process involves two things:

Outward Clearing

This part of the process clearing is done at the branch level and the following activities takes place:

  • Depositing  and scanning of checks
  • Account entry and amount of entry
  • Document verification
  • Balancing and banding
  • Submitting the check to a service branch

Inward Clearing

The inward clearing is done at the service branch. At this level, the following activities are carried out:

  • There is the processing of checks being received from the branch level.
  • There are account and amount entry
  • There is document verification
  • There is balancing and bundling of checks
  • There is submitting the checks to the clearing house after verification

Note that the checks that do not pass validation as a result of them having some errors (discrepancies) are canceled and returned to the original bank for corrections.

References for Check Truncation




Academic Research for Check Truncation

The Place of EFT and Check Truncation in Corporate Payment Systems, Leary Jr, F., & High, P. H. (1980). Del. J. Corp. L., 5, 1. There is much more written on e-fund transfers (EFT), checking system and credit card until now. The objective of this paper is to evaluate the potential effect of EFT on the banking system and the corporate treasurer. It closely evaluates a corporate check truncation voluntary system. Several writers and researchers highlight the latest advancements in through-the-wall electronic COTs (Consumer Operated Terminals) as revolutionary and new ones and free-standing terminals. From the viewpoint of the bank officer and the corporate treasurer, the new consumer terminals are a little addition to the e-fund transfer system which exists for several years. Even, at the bank of 1st deposit, check truncation is not a big change.

Digital check forgery attacks on client check truncation systems, Gjomemo, R., Malik, H., Sumb, N., Venkatakrishnan, V. N., & Ansari, R. (2014, March). In International conference on financial cryptography and data security (pp. 3-20). Springer, Berlin, Heidelberg. This article proposes a Digital Check Forgery (DCF) attack on CPS (Check Processing Systems) applied in online banking which induces in check fraud. There are many factors that facilitate this attack: digital images use to conduct check transactions, image processing advances, using client-side untrusted software and devices and deposit modalities. The authors observe that these attacks offer chances of committing fraud successfully than traditional Check forgery attacks. The authors provide an example of these attacks and state that there are many leading banks vulnerable to DCF. Finally, they investigate whether these digital attacks affect the systems of client check truncation.

A comparison of social costs and benefits of paper check presentment and ECP with truncation, Stavins, J. (1997). New England Economic Review, 27-44. Every year, the banks collect almost sixty billion checks in the US. With the growth of e-payment methods shares in these years, for example, the debit and credit cards and the automated clearing house, the volume of the check has, in absolute numbers, increased more during the past twenty years as compared to all combined e-payment methods. Checks are still a popular method of performing transactions due to their convenience. This paper compares the advantages and social cost of e-check presentment with the replacement of paper check processing. Many obstacles, including network externalities, transition costs and uneven savings distribution may stop the private market from being truncated universally in the future

Work in progress: The Fed’s” default check truncation rule”, Bielski, L. (2000). American Bankers Association. ABA Banking Journal, 92(11), 62. This paper describes the rule of default check truncation passed by the Federal government. The author compares the checking process with the paper flow which involves more processing. The storage and transportation costs will eliminate from the NPS (National Payment System). In the near future, the system will look like the present debit card approach which will serve the corporations and the consumers both. There are ideas of capturing images and check-information at the sale point or the 1st deposit point, whether a bank branch or the lockbox turning the check into a form of disposable debit card.

The move toward a cashless society: a closer look at payment instrument economics, Garcia-Swartz, D. D., Hahn, R. W., & Layne-Farrar, A. (2006). Review of network economics, 5(2). Since when the 1st general-purpose charge card introduced in the 1950s, there has been a prediction of a cashless society by pundits. After 50 years, we finally may reach near that vision. This paper empirically examines the first time the shift to a cashless society with the help of a cost-benefit structure. The authors closely look at the economics of payment instrument. The findings are that when we consider all main parties to a transaction and add the benefits, checks and cash become more expensive as compared to several earlier researchers’ suggestions. Generally, the move to a cashless society seems to be advantageous.

Uniformity, Regulation, and the Federalization of State Law: Some Lessons from the Payment System, Rubin, E. L. (1988). Ohio St. LJ, 49, 1251. In the American legal system, one of the most important trends in the last century is the federal government role. All governmental power and their absolute power has definitely increased. However, the federal government has developed rapidly. It has performed several functions, the state law regulated earlier so that its control range, comparable to state governments, remains higher than the previous century. The progress of federal law at the cost of the states can be called as the Federalization of running legal system. Finally, the author discusses some lessons learned from the payment system.

A Call for International Legal Standards for Emerging Retail Electronic Payment Systems, Hughes, S. J. (1996). Ann. Rev. Banking L., 15, 197. This paper presents the fundamental participants’ protection for emerging payment systems. It seeks to adopt an international standard due to multiple cross-border transactions and new payment procedures. The basic purpose of this study is to discuss the norms of payment systems in the banking, e-commerce and legal communities. The author makes a comparison of the legal and fundamental framework of the emerging payment methods and recent payment systems. Then, he examines many prospects of emerging systems which require standards and presents standards on the basis of models from available payment systems. For new retail e-payment systems, the offered legal standards regulate available e-payment methods, e.g. e-funds transfers and wholesale wire transfers.

Can the Fed be a payment system innovator?, Lacker, J., & Weinberg, J. (1998).  The payment system is a part of the communications industry where Federal Reserve Banks provide services of communication in their activities of check collection. In history, the state intervention in other communication industries presents a lesson for the Fed in trying for payment system innovation. When the intervention places barriers to competition for promoting worldwide access to services, it weakens the market participants’ incentives for the adoption of new technologies. On the other hand, overcoming barriers to competition boosts efficient innovation but it may need some retreat from the objective of global access.

The Revision of UCC Articles Three and Four: A Process Which Excluded Consumer Protection Requires Federal Action, Budnitz, M. E. (1991). M Mercer L. Rev., 43, 827. This paper reviews the UCC (Uniform Commercial Code) article number 3 and 4 passed officially in 1990 and states that it shows a great failure in the process. It severely requires a re-evaluation of the payment system Law since it has an impact on all consumers. Rather the NCC (National Conference of Commissioners) on Uniform State Laws and ALI (American Law Institute), which are the revision sponsors, opted out to exclude the whole problem of protection to consumers. The question arises about the latest progress in the provision of government incentives to the ones who have no bank account whether the approach of uniform state laws is viable for future legislative activity regarding the law of payment systems which has an effect on consumers.

Electronic banking in Bangladesh, Shamsuddoha, M. (2008). This paper examines the performance of banking and financial institutions and their advancements over time in Bangladesh. The banking industry of Bangladesh has become more mature now as compared to the previous one. Its impression is good in many activities, one of which is the electronic banking system. Some multinationals and private commercial banks on the local level have launched modern banking services, nowadays. In the banking sector, e-banking is one of the latest and most demanded technologies. This study throws light on the current status of e-banking in the financial services sector in Bangladesh.

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