Consultation outcome

Speeding up cheque payments: legislating for cheque imaging

Updated 27 October 2014

This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government

1. Introduction

Payment systems sit at the heart of the economy. They are the mechanisms that allow money to flow continually among and between households and businesses. The government is committed to ensuring that the UK’s payment systems are innovative, efficient and effective, and that they meet the needs of end users. Cheques continue to form a vital part of the British payments landscape. Nearly £840 billion of cheques were processed in 2012, accounting for ten percent of all payments made by individuals. While there is a decline in cheque volumes, over nine in ten businesses and other organisations continue to use them. Cheques are used by sole traders, other micro businesses and small businesses to make over a fifth of their outgoing payments. For many smaller charities and other voluntary organisations, cheques are the primary method of payment.

The government has already taken a number of steps to ensure that the banking industry provides individuals and businesses with a choice of payment methods that adequately serve their needs. In 2009 the Payments Council, the industry body responsible for setting payments strategy, announced a target date of 2018 for closure of the central cheque clearing system. Many stakeholders felt this decision would lead, in practice, to the abolition of cheques. This decision caused considerable anxiety for many people in the UK, particularly those who are elderly, housebound or rely on cheques to conduct their day to day business (such as many charities, clubs and small businesses).

Following pressure from the Treasury Select Committee (TSC) and the government, the Payments Council reversed its decision and the banks undertook to provide cheque services for as long as customers needed them. In its response to the TSC cheques report, the government also accepted the case for bringing the UK’s payment systems into formal regulation. In 2013, the government legislated to introduce a new Payment Systems Regulator to address imperfect competition and to challenge under-investment and a lack of innovation in the UK’s payment systems. The Regulator will be equipped with a full range of powers to promote competition and innovation in the payment systems market and to ensure that systems are operated in the interests of end users.

This consultation now proposes a further step, setting out the legislative measures that the government intends to take to support ongoing innovation in UK payments and to secure the future of cheques. Specifically, these legislative measures will allow UK banks and building societies to introduce cheque imaging, an innovation that cuts down cheque clearing times by sending a digital image of the cheque for clearing, rather than the paper cheque itself. Cheque imaging is already established in the USA, France and parts of Asia.

Cheque imaging will provide greater opportunities for banks and building societies to innovate and provide new services. For example, customers may be able to take a photograph of their cheque on their smartphone and pay it in electronically via their bank’s mobile banking app. Customers without smartphones will be able to deposit their cheques as usual at bank branches or cash machines, where a cheque can be scanned and the image transmitted electronically. Some banks and building societies may opt to continue transporting their paper cheques to their processing centre for the cheques to be scanned there, in order to leverage the imaging technology already in place at the site of the processors. Institutions that do this would still be able to meet a new standard timescale for clearing of two days.

1.1 Challenges facing the current system

Consumers and businesses rely on payment systems to move money around the economy quickly and efficiently. In both respects there is scope for the cheque system to move more into line with the standards of electronic inter-bank and debit and credit card schemes. Today, cheque clearing operates on a maximum “2-4-6” timescale. This means that a customer paying a cheque into their account starts to earn interest on the money no later than two days after depositing the cheque; no later than the fourth day, the customer is able to withdraw the money from the deposited cheque, but the cheque can still be dishonoured (“bounce”); only on the sixth day can the customer be certain that the money is theirs and that it will not be reclaimed from their account without their consent, unless they are a knowing party to fraud.

Under the current model, cheques are transported from bank branches to clearing centres where the essential details of the cheque (the amount, sort code, account number, and cheque serial number) are read and this data is exchanged electronically between banks. But because under current arrangements the paying bank takes responsibility for detecting cheque fraud, cheques need to be taken from the clearing centre of the collecting bank to an exchange centre, and then to the clearing centre of the paying bank. Here the paying bank can undertake an examination of the paper cheque to determine that it is genuine, has not been fraudulently altered and to establish that there are sufficient funds and that the cheque has been signed, dated and written correctly.

These aspects of the cheque system add delay and expense, contributing to the time it takes for cheques to clear, and the high fixed costs faced by banks and building societies in running the various centres and transporting paper cheques between branches, processors and exchanges. The government wants to speed up cheque clearing times and welcomes the introduction of efficiencies to the process; innovation in the form of cheque imaging will help to deliver these efficiencies and will bring real customer benefits. The government is therefore proposing to legislate in order to facilitate cheque imaging.

2. Legislating for cheque imaging

The government believes that the introduction of cheque imaging will directly address the challenges currently facing the cheque system, and will enable innovation to deliver wider benefits to consumers, businesses and the banking industry. However, while it is important that the banking industry modernises to remove anachronisms in the system, the essential characteristics that define the cheque system for users – and which make it such a vital payment method for millions – must remain intact. Following this government’s intervention to ensure that cheques are here to stay, it is important that the banking industry continues to innovate in a way that adequately meets the needs of customers who rely on cheques to conduct their everyday business. Therefore, under a cheque imaging model, customers will be able to write paper cheques exactly as they do currently, and banks and building societies must continue to offer the option of depositing paper cheques at branches and cash machines, as happens now.

2.1 The case for cheque imaging

The key benefit that cheque imaging will enable is a faster cheque clearing cycle – reduced from six days to as few as two – meaning consumers and businesses, including small and micro businesses, will receive their funds more quickly. This will bring cheque clearing times into line with other modern payment systems, and in some instances will be faster than the electronic models, such as Bacs and the card schemes, which can take several days.

The introduction of image capture for cheques will also allow whole sections of the payment journey after deposit to be digitised, leading to sizeable cost savings for banks and building societies. This will bring the cost of cheque clearing more into line with that of electronic inter-bank and card payment systems. Cheque imaging represents an opportunity to secure the future of the cheque by making it a cost-effective, sustainable payment option that financial institutions can afford to provide. Furthermore, by reducing or removing the need for courier transportation between branches, processors and exchanges, cheque imaging will significantly reduce carbon emissions in the financial services sector.

For end users, cheque imaging offers the prospect of added consumer convenience and choice of ways to pay. It also will allow banks to adopt innovative technology, taking advantage of the widespread take-up of smartphone technology to add real value in retail banking propositions. While customers will continue to be able to deposit cheques at branches, cash machines, Post Offices or by post and will still benefit from a faster clearing cycle, financial institutions will also be able to offer the option of paying in cheques via smartphone, tablets or other devices. For customers in rural areas or with limited mobility, for example, this extra option could help overcome current barriers to financial inclusion. Additionally, banks may be able to offer later last times of deposit to customers if they no longer require couriers to collect paper cheques daily from branches.

As well as cutting down the general costs for banks and building societies to provide cheque services, cheque imaging will also reduce barriers to entry and encourage greater competition in the retail banking market, by putting challenger banks in a better position to compete even if they lack an established physical branch network. While the presence of a local branch is an important factor for many customers – and the government is clear that cheque imaging must add to, not reduce options for customers in how they transact – the need to acquire a physical branch network is a contributing factor to the current concentration of the retail banking market. The option of paying in cheques via smartphone will make it easier for challengers to compete with the large, incumbent financial institutions, and will offer those institutions with a limited physical presence the opportunity to expand their customer base beyond their traditional brick and mortar footprint.

Question 1	The current cheque system faces a number of challenges, and legislation to introduce cheque imaging will help resolve these and deliver a set of wider benefits, as set out above. Do you agree with this analysis?
	Specifically, we are interested in views and evidence on the following points:
	the costs (quantifiable or non-quantifiable) of the current system
	the benefits (quantifiable or non-quantifiable) of introducing cheque imaging
	the costs (quantifiable or non-quantifiable) of introducing cheque imaging
	the appetite (among both payment service providers and customers) for adopting smartphone technology for the paying in of cheques
	the experience of other countries in introducing cheque imaging

2.2 Proposed legislative measures

The existing legislation governing the cheque payment system contains a number of outdated provisions that are currently blocking the banking industry from moving to a cheque imaging model. The government intends to introduce a set of amendments to the legislation, to enable banks to adopt cheque imaging, and to clarify the new legal status of images of cheques and the liabilities of paying, collecting and beneficiary banks under the new system.

Under the current UK legislation, a paying bank has the right to demand that it is presented with a physical cheque before deciding whether to honour the payment. This provision is currently blocking the introduction of cheque imaging by banks who want to innovate, because they are still obliged to deliver the original paper instrument to other banks, going through the traditional infrastructure of the processor and the exchange.

The government’s key proposal is to remove the right of the paying bank to demand delivery of the original paper cheque. The certified, digital image of the cheque will become equivalent to the original paper cheque, but only for the purpose of presentment. Cheques will still have to be written on paper chequebooks issued by banks and building societies (or, for business customers, printed in an agreed format); it will not be possible for a customer to “write” a cheque digitally, on their phone. This amendment to the legislation will enable banks and building societies to adopt image capturing solutions and gain the full benefits of cost-effectiveness and efficiency, without an obligation to hold onto paper cheques and physically deliver them up to the paying bank.

The government is not proposing to specify particular image capture solutions that the industry should adopt, or to determine where in the payment journey images must be captured: it proposes to amend the legislation to remove statutory provisions currently blocking innovation. The government expects there will be private commercial decisions for individual banks and building societies to consider, for instance, on potential customer offerings via smartphone; and likely cross-industry decisions about collaboration on a new central infrastructure for the exchange of cheque images.

The proposal is designed to be an enabling measure and will not compel any financial institutions to start capturing images against their wishes (at a minimum, banks and building societies can continue sending paper to their processor where there are already scanning facilities in place). However, once this measure to enable cheque imaging takes effect it will require that all relevant institutions have some means of accepting cheque images, as a paying bank will have no right to refuse a cheque image and demand delivery of the physical cheque instead. The interdependence of paying, collecting and beneficiary banks in the cheque payment network necessitates such a measure if any bank is to move forward. Implementation is discussed in further detail below, including the possibility of the government providing banks with the option of receiving digital images in a paper form via a substitute cheque such as an Image Replacement Document (IRD).

The government has made it clear that it expects banks and building societies to continue to provide the option for customers to deposit cheques in branches as usual, alongside any option for paying in cheques via smartphone. This will safeguard the needs of customers who prefer to, or are only able to, deposit cheques in branches. Therefore, the government also proposes legislating to require that banks and building societies, where they have physical branches, must accept customers depositing cheques in branch and cannot force them to use only smartphone channels.

Question 2

The current legislation preserves the practice of exchanging paper instruments, and does not accommodate the transmission of digital images. Do you agree that the legislation should be amended to remove the right of the paying bank to demand delivery of the original paper cheque, and require a certified, digital image of the cheque to be treated as equivalent to the original paper cheque for the purposes of presentment?

Question 3

Do you agree that the government should legislate to protect the choice of customers to deposit paper cheques in branch, even where there is the option of paying in via smartphone?

2.3 Implementation

The legislative proposals set out above will amend outdated provisions in the statute that currently prevent the banking industry from digitising parts of the cheque payment system. Once these legislative measures come into force, all financial institutions providing cheque services will in effect need to have facilities, or access to facilities, allowing them to accept cheque images.

There are two broad approaches to delivering cheque imaging, and the government considers that the legislation will need to be tailored to support whichever model is selected. The first approach is a version of the system rolled out in the USA – where the legislation permitted financial institutions to continue receiving cheques in paper form if they wished. Under the US approach, the legislation removed the right of the paying bank to request delivery of the original paper instrument, but enabled the collecting bank to present an Image Replacement Document (IRD). The IRD is a substitute paper cheque, which has been re-converted from a digital image back into paper form (in the US example, most of the reconversion occurred in a service provided by the Federal Reserve) for traditional clearing for those banks that prefer to continue operating on a paper basis end-to-end.

The advantage of this approach is that rollout of imaging could start whether or not all banks are ready to accept images in digital form, meaning those banks which are ready would be free to adopt innovative technology and offer new customer propositions at an earlier date, and innovation would not be held back by the pace of the slowest mover. In this scenario, the government would not mandate a cut-off date by which all institutions must migrate to the new system, but would instead let the market decide, allowing banks to consider the benefits of investing in imaging against the option of running on a slower, more expensive IRD basis instead.

The second means of delivering cheque imaging would see all banks become ready to accept digital cheque images. There is a strong case for the industry moving as one onto a single, central infrastructure giving every institution the capability to exchange digital cheque images. The government would expect this central platform to offer improved open access for smaller banks to “plug and play” directly, rather than depend on larger banks in order to access cheque clearing. Moreover, while the government wishes to encourage competitive differentiation in the retail banking market, payment networks require a certain level of uniformity and interoperability. Payment systems are characterised by strong network effects (each user gains added value from a payment system with the addition of further users, meaning all major banks need to be connected for the system as a whole to be effective) and common standards and agreed rules have an important role. There is also a risk of customer uncertainty if the legislation permits banks to operate on significantly different clearing timescales. Cheque imaging represents an opportunity for the industry to upgrade the current “2-4-6” standard to a new maximum timescale of “1-2-2”, offering greater certainty and clarity for cheque users.

This approach is also favourable from a settlement risk perspective. It is preferable for the industry to build in the ability to cap the, currently unlimited, exposures, and it will be significantly easier to introduce hard caps on net settlement positions if there is a common infrastructure. Such capping of exposures could be beneficial for lowering barriers, or the perception of barriers, to entry to the cheque clearing system. Ultimately, the concept of the IRD paper substitute also conflicts with the government’s objectives of rationalising and modernising the UK’s payment systems.

Question 4	The government believes there is a strong case for the industry moving as one onto a cheque imaging model with a central scheme infrastructure, but is willing to consider permitting banks to request paper substitute cheques as an alternative.
	Should the government legislate for a date by which all financial institutions must be ready to accept cheque images? If so, what is a reasonable period of time to allow the industry to prepare for cheque imaging?
	Or should the legislation provide the option for financial institutions to accept an Image Replacement Document (IRD) as an alternative?
	A new model of “1-2-2” has been put forward as a desirable and realistic target for the industry. Do you agree?

2.4 Other paper instruments

The government also proposes to extend the benefits of imaging to paper instruments other than cheques that are currently cleared using the same system. These other instruments are bankers’ drafts, postal orders, government payable orders, warrants, travellers’ cheques and bank giro credits. If these paper instruments are not brought onto the imaging model, then the old infrastructure will need to run in parallel, which will undermine the objective of cost savings for the industry from moving to a new, more efficient system. Some of these instruments are closely similar to cheques in appearance and function but subject to separate legislation, and there is a risk of customer error or uncertainty regarding clearing times for similar, but differently classified, paper instruments and whether these can be imaged or not.

Question 5

Do you agree that the proposed legislative changes should apply to all of these paper instruments, to allow them to be cleared in image form?

2.5 Security and fraud

It is essential that the payment system is stable and secure, as the system will only deliver genuine benefits for banks and customers if it is safe to use. In a number of respects, cheque imaging provides new opportunities to address security and fraud risks that currently affect cheque users. Because it enables money to move more quickly through the payment system, imaging helps eliminate certain types of cheque fraud that take advantage of the time lag between a cheque being written and money moving between accounts. Banks will also be able to harness digitised data to improve aggregation and monitoring for patterns of fraud, and share electronic risk data with each other. As currently happens in the event of unusual credit card activity, banks could alert a customer if suspicious cheque imaging behaviour is detected. By making it easier and quicker for customers to pay in cheques, imaging means cheques can be deposited sooner, reducing the risk that the paper cheque is lost or damaged while a customer is waiting for a convenient opportunity to pay it in. Converting the paper cheque into a digital image also reduces the risk that the cheque is misplaced or physically damaged during courier transit, mitigating the factor of human error in the current system that sees a proportion of cheques go missing every year.

The industry will need to agree on robust image quality standards and make use of sophisticated software to mitigate the risk that poor quality or tampered-with images enter or pass through the system. In most cases fraud detection is already conducted on the basis of a digital image captured at the processor, with a very small proportion of paper cheques inspected manually on an exceptional basis. To prevent re-presentment of the same cheque when paying in by smartphone, the payment system will also need to recognise and reject a cheque if a user attempts to pay it in twice. The government also expects that banks and building societies, where paying via smartphone is offered, will issue guidance to customers on how long to keep a cheque for their records and advice to shred or dispose of the paper instrument in an agreed manner. There will also be decisions for the industry for the treatment of unpaid cheques, and how to adapt certain services to the new model. For example, some customers request that processed paper cheques are returned to them for their own records or their own fraud/validation cheques; this could well be achieved under the new model by sending the digital image back to the customer.

It is important that there are clear liabilities appropriate to the new model. Currently, it is typically the paying bank that pays for undetected fraud. Given that the bank which collects the cheque/cheque image (the “collecting bank”) introduces it into the system for clearing, the collecting bank is best placed to implement front-line measures to make the system secure, to detect security risks at the earliest stage and reduce fraud in the system. Therefore, the government proposes that liability for fraud or error could sit with the collecting bank, not the paying bank. The bank that receives a cheque over its counter is not always the beneficiary of the payment. Where there are agency arrangements between direct and indirect member banks, a “collecting” institution may undertake services, such as counter services, on behalf of a smaller bank (the “beneficiary” bank), providing them with indirect access to the system. In these cases, the liability could sit with the collecting institution, the beneficiary bank, or be shared between the collecting and beneficiary bank.

If the liability is not transferred from the paying bank to the collecting and/or beneficiary banks, then the government proposes legislating to create a requirement for the collecting and/or beneficiary banks to carry out “know your customer” checks, and an obligation to analyse the image for the identification of alterations, to satisfy themselves of the authenticity of the image.

Question 6	Do you agree that liability should be with the collecting bank, rather than the paying bank?
	For agency arrangements, should the liability be with the collecting bank, or the beneficiary bank, or shared between them? The government would particularly welcome comments from banks and building societies with agency relationships.
	Should the government impose specific due diligence obligations on the collecting and/or beneficiary bank, as well/instead of transferring the liability?

3. List of questions

Question 1	The current cheque system faces a number of challenges, and legislation to introduce cheque imaging will help resolve these and deliver a set of wider benefits, as set out above. Do you agree with this analysis?
	Specifically, we are interested in views and evidence on the following points:
	the costs (quantifiable or non-quantifiable) of the current system
	the benefits (quantifiable or non-quantifiable) of introducing cheque imaging
	the costs (quantifiable or non-quantifiable) of introducing cheque imaging
	the appetite (among both payment service providers and customers) for adopting smartphone technology for the paying in of cheques
	the experience of other countries in introducing cheque imaging
Question 2	The current legislation preserves the practice of exchanging paper instruments, and does not accommodate the transmission of digital images. Do you agree that the legislation should be amended to remove the right of the paying bank to demand delivery of the original paper cheque, and require a certified, digital image of the cheque to be treated as equivalent to the original paper cheque for the purposes of presentment?
Question 3	Do you agree that the government should legislate to protect the choice of customers to deposit paper cheques in branch, even where there is the option of paying in via smartphone?
Question 4	The government believes there is a strong case for the industry moving as one onto a cheque imaging model with a central scheme infrastructure, but is willing to consider permitting banks to request paper substitute cheques as an alternative.
	Should the government legislate for a date by which all financial institutions must be ready to accept cheque images? If so, what is a reasonable period of time to allow the industry to prepare for cheque imaging?
	Or should the legislation provide the option for financial institutions to accept an Image Replacement Document (IRD) as an alternative?
	A new model of “1-2-2” has been put forward as a desirable and realistic target for the industry. Do you agree?
Question 5	Do you agree that the proposed legislative changes should apply to all of these paper instruments, to allow them to be cleared in image form?
Question 6	Do you agree that liability should be with the collecting bank, rather than the paying bank?
	For agency arrangements, should the liability be with the collecting bank, or the beneficiary bank, or shared between them? The government would particularly welcome comments from banks and building societies with agency relationships.
	Should the government impose specific due diligence obligations on the collecting and/or beneficiary bank, as well/instead of transferring the liability?