Cheque truncation (check truncation in the United States) is the conversion of physical cheque into electronic form for transmission to the paying bank. Cheque truncation eliminates cumbersome physical presentation of the cheque and saves time and processing costs.
To settle a cheque it has to be presented to the drawee bank for payment. Originally this was done by taking the cheque in person to the drawee bank, however as cheque usage increased this became cumbersome and banks arranged between each other to meet each day at a central location to exchange cheques and settle the money. This became known as central clearing. Bank customers who received cheques could now deposit cheques at their own bank and their bank would arrange for the cheque to be returned to the drawee bank and any funds credited and debited from the appropriate accounts. If a cheque was dishonoured or bounced it would be physically returned to the original bank marked as such.
This process would take several days as physical cheques had to be transported to the central clearing location, from where they had to be transported to the payee bank. If the cheque bounced it would be transported back to the bank where the cheque was deposited. This is known as the clearing cycle.
Cheques had to be examined by hand at each stage and required a large amount of man power and handling.
In 1960 machine readable codes were added to the bottom of cheques in MICR format which allowed the clearing and sorting process to be automated. This helped to speedup the clearing process, however the law in most countries still required the physical cheques to be delivered back to the payee bank and so physical movement of the paper continued.
Starting in the mid 1990s some countries started to change their laws in relation to cheques to allow for truncation. Cheques would be imaged and digital representation of the cheque would be transmitted to the drawee bank at which point the original cheques could be destroyed. The MICR codes and cheque details are normally encoded as text in addition to the image. The bank where the cheque was deposited would typically do the truncation and this dramatically decreased the time it took to clear a cheque. In some cases large retailers that received large volumes of cheques were also able to carry out this truncation process.
Once the cheque has been turned into a digital document it can be processed through the banking system just like any other electronic payment.
Although technology needed to exist to be able to truncate a cheque, it was the laws related to cheques that were the main impediment to their introduction. New Zealand was one of the first countries to introduce truncation and imaging of cheques, when in 1995 they amended the cheque act 1960 to provide for the electronic presentment of cheques. A number of other countries followed over the next few years, but progress was mixed due to the decline in the use of cheques in favour of electronic payment systems. Some countries decided that the effort to implement truncation could not be justified for a declining payment method and instead phased out the use of cheques altogether.
In 2004, the Check 21 Act was implemented in the United States to authorize conversion of the original paper check into an electronic image for presentment through the clearing process. The law also enacted the recognition and acceptance of a "substitute check" created by a financial institution in lieu of the original paper check. Any bank that receives the original paper check can remove or "truncate" the paper check from the clearing process.
New laws needed to address ways to make sure that the digital image was a true and accurate copy of the original cheque as well as mechanism to make sure that the process could be audited to protect consumers.
It also needed to address the mechanism for dishonoured cheques as cheques could no longer be returned. A typical solution, as defined by Monetary Authority of Singapore for the Singapore cheque truncation system, was that a special 'Image Return Document' was created and sent back to bank that had truncated the cheque.
Operations and clearing
The security related to imaging and creating the electronic cheque needed to be defined and the clearing process adjusted to accommodate electronic cheques.
- ^ "CHEQUE TRUNCATION ABRIDGED REPORT - 2008". Irish Payment Services Organisation. 2008. http://www.ipso.ie/x/File/PublicationsAndReports/IPSOReport/cheque_truncation_abridged_report2008.pdf. Retrieved 1 August 2010.
- ^ "Bills of Exchange (Cheque Truncation) Regulations 2002". Monetary Authority of Singapore. September 17, 2002. http://www.mas.gov.sg/news_room/press_releases/2002/MAS_ISSUES_BILLS_OF_EXCHANGE__CHEQUE_TRUNCATION__REGULATIONS_2002.html. Retrieved August 1, 2010.
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