Image-Only Settlement Passes a Critical Test
American Banker, Wednesday, September 1, 2004
By Jennifer A. Kingson and Daniel Wolfe

Following are excerpts taken from the September 1, 2004 edition of American Banker. The article highlights an industry milestone in image exchange, with two of the nation's largest bank settling checks exclusively with digital images.

The banking industry has been through a lot in its quest to move check settlement from paper to electronics - debates about technology, merger-related delays, confusion over operational and legal issues, and doubts about whether the whole thing would work.

But at long last, in what bank technology executives call a milestone, two of the largest banking companies began settling a small number of checks exclusively with digital images this past weekend. And they plan to continue doing so, in ever-increasing volumes.

Other large banks are expected to soon join the two pioneers: KeyCorp and J.P. Morgan Chase & Co.'s Bank One Corp.

"We think it was a huge event," said Susan Long, the senior vice president at The Clearing House Payments Co. who was promoted Aug. 1 to lead its image exchange initiative, which involves a major roster of the largest banks. "Everything went well, as planned. It is the first time in the industry that an exchange has happened end to end, bank to bank, so that's very significant."

The imaging effort has been goaded by the passage of the Check Clearing for the 21st Century Act, which will take effect two months from now. The technical effect of the law will be to give banks the right to present replacement checks - known as IRDs, or image replacement documents - rather than the original items. But the gist of it is being taken as a broad imprimatur to develop image-related products and services and tie them to other payments technology.

"This past weekend was the first interchange of a real transaction, a live transaction," said Earl Jennings, a senior vice president for check processing at JPMorgan Chase, who has been involved in the project on Bank One's side. Before the purchase, JPMorgan Chase had not been preparing to be a part of the image exchange network The Clearing House has set up through its Small Value Payments Co./Electronic Clearing Services division.

The first transactions originated from a JPMorgan Chase facility in Phoenix and a Key facility in Albany, N.Y.; the files traveled electronically between the institutions through a network operated by SVPCo. They were checked for image quality and readability, and the receiving bank sent an electronic receipt through the SVPCo network.

Had the transactions been processed the traditional way, the checks would not have been shipped until Monday. They would have spent six hours in flight, plus time on the ground, and likely would not have cleared until Tuesday, at the earliest.

Over all, fewer than 100 transactions were processed electronically Friday to Monday, with no failures. "They were the real deal," Mr. Jennings said.

Mr. Jennings said that even though the initial volumes were small, the banks will increase the volume of their image-based settlements. "It's a continual step along a process to ramp up image exchange."

Don McLaughlin, a senior vice president and division manager of item processing at Key, said, "We're kicking the tires and making sure everything works as it's supposed to."

Now that the technology has proven itself in the real world, "increasing the volume is a prime objective," so Key will add more accounts to the network, he said. "It won't take very long to begin adding new accounts."

"We're very excited, and I guess I'd even go so far as to say we're proud of this milestone," Mr. McLaughlin said. "This is brand-new stuff, and we're the first on the block."

Leonard J. Heckwolf, the chairman of Nacha, the electronic payments association, and the senior vice president of automated clearing house and retail lockbox products at JPMorgan Chase, said the successful implementation points to a broader trend: What had been perceived as a cacophony of payments technology is starting to look more harmonious.

Image exchange and accounts receivable conversion were once viewed as competing systems, but they are now seen as convergent, he said.

"The next wave of products will start to link the paper and electronics in a way that's seamless to the customer," he predicted. "I think it's all synching up reasonably well. I think all of the concerns of a year ago or so that these products would kind of trip over each other - I think they've begun to complement each other."

Large banks have made their intentions clear in image exchange, and "the big open question is how much volume, how fast," Mr. Heckwolf said.

It has taken some time to get the infrastructure ready for the image-based future and the improvements will be ongoing, but things seem to be proceeding smoothly, he said. "I'm just not running into a lot of customer opposition around any of this. I think the industry has done it pretty well."

Darrell Royal, the executive vice president of payment solutions for Carreker Corp. of Dallas, which designed the software that generated Key's images, said that even though the two banks will continue to exchange images in low volumes, "we do not see structural barriers to a significant ramp-up in volume."

He agreed that some caution was necessary in moving the image-based settlement process from concept to reality, but "any significant operational concern or quality concern has been addressed."

Steve Ledford, the president of Global Concepts Inc., a payments industry consulting firm that has been advising SVPCo, predicts that the Oct. 28 effective date for Check 21 will act as a shotgun of sorts, accelerating what has so far been a gradual but steady effort to build infrastructure.

"I think we'll see a much broader and perhaps faster ramp-up to production volumes than some folks have been anticipating," he said. Whether or not they are involved in SVPCo, he said, financial institutions "are looking at image exchange and, quite frankly, don't have a whole lot of patience to go through a long, slow ramp-up." Also, as paper check volumes continue their rapid descent, "the faster you implement, the faster you get your payback."

Edward L. Neumann, the managing director of consulting services at Javelin Strategy and Research and a longtime payments industry observer, called the KeyCorp/JPMorgan Chase exchange both symbolic and "an important development for the industry." The message, he said, is that it is only a matter of time before such exchanges become commonplace.

Robert Hunt, a senior analyst at TowerGroup Inc., the Needham, Mass., unit of MasterCard International, said this past weekend's exchanges were "the toe in the water for image-based exchange."

A small volume was necessary for the first run in case of a failure, since it is easier to correct a hundred errors than it is to correct several hundred thousand, Mr. Hunt said.