Nyu – Leonard N. Stern School of Business Operations in Financial Service – B60. 2315. 030

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Check 21

Figure 6

Check 21 has been publicized as a revolutionary methodology in the check processing system poised to benefit participants in terms of cost containment and operational efficiency. However, omitted was the fact that these statements are forward looking and benefits are not expected to be realized immediately. In contrast to the traditional check processing system described in the previous section, Check 21 introduces various processing variables that now have to be taken into consideration. Since substitute checks are not expected to replace the traditional physical check immediately (big-bang approach), institutions must decide how and when this new process should be integrated into their system in order to maximize all expected benefits and minimize or eliminate new disruptions.

Operational Details

As shown above, with Check 21 the number of options for each institution has increased thereby increasing the complexity of check processing. At this level, it is expected that those institutions that have converted to image-based processing will no longer be handling checks the traditional way. However, the use of substitute check processes is not necessarily enterprise-wide. Due to cost, logistics, and other practical causes, some branches, sub-branch entities, or even certain schedules of branch processes may handle checks by traditional physical paper processes.
Original checks are image scanned (both front and back) according with specific standards in order to produce an electronically equivalent substitute check. At this point, the original checks themselves can be removed from the check circulation process altogether (Check Truncation) and replaced by the substitute check. The need to physically transport paper checks – whether across town or across the country – is now virtually removed. Institutions can now process this electronic image or use it to create a paper reproduction at any point in the process.


Check 21 allows deposited checks to be processed through different channels than traditional check. This bifurcation creates a need for an institutional analysis to determine how and when branches and processes will and can be converted. Even those branches not suitable for processing checks by traditional processes could become candidates. Further, internal bank processes may route checks from branch to branch to Check21 processes


Checks entering into the Check21 process are tabulated similarly to those going through traditional processes. Banks will have processes to decide which checks are sent through the substitute process, which are sent through a truncated or ACH process, which go through traditional physical clearing, and which are given special processes such as personal delivery.


Many smaller banks, bank branches in geographically inefficient areas, or institutions with other conditions making investment in internal imaging may turn to third party service providers to scan checks for them. In such a case, the third party provider will have a clearinghouse service bundled with the imaging services, send checks through another clearinghouse, have a relationship with a correspondent bank for substitute check service through the Federal Reserve. Further, a third party imaging service may be used as a imaging service which returns the images to the depository bank to clear. Under Check 21 legislation, banks are not required to send checks through substitute check processes; however, banks under OCC/FDIC/Federal Reserve regulatory control are required to receive substitute checks, treating such images as the banks would treat paper checks. Third party service providers are particularly helpful in this area insofar as where substitute checks are operationally inefficient to use, third parties service providers will get banks up to the regulatory floor.

4 & 6

Once a bank internally converts physical paper checks into electronic substitute checks, it has a variety of options for the clearing process including through private clearinghouse. Generally, private clearinghouses do not keep bank balances for transacting counterparties like the federal reserve does. Rather, a clearinghouse will calculate the aggregate balance of instrument transactions running through it, confirm the transaction balances with the counterparties and facilitate a daily or other periodic transaction through other payment means such as Federal Reserve Aggregate Settlement Service.


Participating banks have a choice to allow the Federal Reserve to scan checks through their FedImage Services. This step allows the Federal Reserve to image checks hurrying the second side of the clearing transaction to benefit from the increased speed and efficiency of the substitute check process. However, the physical checks must be transported to the Federal Reserve to be imaged, leaving an inefficiency from the traditional physical model. Once the image is created by the local Federal Reserve, there are number of processes which it may go through. First, the substitute image may be transferred to the local Federal Reserve of the Payor Bank. If the local Federal Reserve Bank of the Depositor is the same as the Payor Bank, the Federal Reserve will send the check on for presentment to the Payor Bank. This presentment creates the same automatic paired ledger entries as presentment by traditional methods. However, presentment occurs immediately rather than waiting for the batching and transportation delay of the traditional method.


A depository bank may choose to implement its own internal check imaging system; it may to integrate imaging processes into its traditional framework; or may create a hybrid system based on economic efficiency. Once the physical check is read into a substitute check, it must be transmitted to a clearing system such as the Federal Reserve or a local clearinghouse. The Federal Reserve receives the image from the depositor bank and through the FedForward routes on the substitute check to the electronic recipient. On the other side of the transaction, the Federal Reserve uses the FedReceipt service to send the payor bank.


Private clearinghouse such as Endpoint Exchange may create receipt settlement contracts with payor banks to receive electronic images in the same manner as they would physical checks. The clearinghouse, in such a case, sends a substitute check directly to the payor bank bypassing the Federal Reserve altogether.

Productivity Analysis

From the Federal Reserve’s perspective, there are now various in-bound transactions that would require overlapping internal processing paradigms and resources. As shown in figure 6, the Federal Reserve now has to contend with different types of inbound requests from varying sources both paper and imaged based. As a result, a balance of resources and scheduling activities must be met as the volume of image based processing increases while the demand for the traditional method decreases.

Productivity Inputs

  • The number of physical checks to be processed in the conventional method

    • Need to consider the traditional product array and processing methods

  • The number of electronic checks (not substitute checks) to be processed in the conventional method

    • Need to consider the traditional product array and processing methods

  • The number of physical checks to be imaged processed

    • FedImage Capture4

    • FedImage Archive5

  • Imaged checks to be processed electronically

    • FedImage Archive

    • FedImage Retrieval6

    • FedImage Delivery7

  • Labor force specialized in image processing related to check handling and administrative duties

    • The number of hours spent training

    • The number of hours spent conducting each task.

  • Labor force specialized in image processing related to service and maintenance duties.

    • The number of hours spent training

    • The number of hours spent conducting each task.

Productivity Outputs
Productivity outputs to include all existing parameters as described in the traditional method in addition to:

  • Time related to image processing:

  • Time related to image processing:

    • Time to electronically store each substitute check (indexing, compression, encryption, etc.)

    • Time to retrieve electronically stored checks.

    • Time to reproduce a physical version of a substitute check.

    • Time taken to resolve electronic related issues.

Although electronic processing times are expected to be relatively insignificant compared to other physical related activities, it is nevertheless directly proportional to the number of checks implying that there are capacity and performance contentions that have to be taken into consideration.

Quality Metrics
Quality metrics to include all existing parameters as described in the traditional method in addition to:

  • Service Availability (Uptime)

    • All consumer-facing check related services.

    • All back-end check related services.

  • Overall processing integrity

    • Number of externally reported errors

    • Number of internally caught errors

  • System recovery times

    • Instigated by event outages or performance slowdowns.

  • Fault resolution times

    • Time taken to resolve internally generated errors.

    • Time taken to resolve externally generated errors.

A practical analysis would be to determine how the introduction of image related technologies and activities has impacted the overall performance of the Federal Reserve check processing facilities. In other words, at a specific moment in time, has the introduction of Check 21 related activities negatively impacted overall performance (as expressed in the quality metrics described above)? Such a mechanism would be useful in tracking the progress of the Check 21 initiative and help the Federal Reserve adjust according to any overall degradation. Unfortunately, a direct comparison approach in this manner would be like comparing apples to oranges and would not produce definitive results given the complexity of the situation.

Alternatively, one approach would be to perform a linear programming in order to determine the optimal method of allocating resources to the new Check 21 related activities. Each linear programming activity will seek to maximize each of the quality metrics described above given the constraints of the productivity inputs. In this way, the Federal Reserve can determine and allocate appropriately resources across various activities in order to maximize, and in some cases minimize, each of the quality metrics described above.

  • Maximize Service Availability

  • Maximize Overall processing integrity

  • Maximize System recovery times

  • Minimize Fault resolution times

An assumption can be made that the processing centers at the Federal Reserve operate in a functional layout given the fact that there is a need for large batch jobs and check processing equipment has a large foot-print that cannot be architected to operate in a “product” oriented approach – see figure 7. Given this assumption a linear programming analysis would take the form of the following:




Check sorting process – includes MICR reading and writing functions


Image scanner and archive process




Average cost per check - includes labor and operating costs associated with the sorting process during a specific time period.


Average cost per check - includes labor and operating costs associated with image scanning and archiving process during the same time period.


Average time for one check to complete its check sorting process


Average time for one check to complete its image and archiving process

With an objective function to minimize C1x1 + C2x2 subject to the number of hours in a given time-slot and depending on the number of assigned workers. In some part, this time capacity will be a factor of the level of worker skills and system up-time.

Figure 7

Data Envelopment Analysis
The transition of the Federal Reserve’s check clearing services from a physical paper check system to one based on electronic presentment is ideal for DEA analysis; the electronic check presentment process is distributed to many different components spread both geographically and functionally. However, the relevant input and output parameters describing efficiency in the system are fairly limited. The major drawback in using DEA for such a process is that many of the inputs are upfront fixed costs such as equipment purchase and staff training; thus, there will be skewing towards more experienced facilities than to newer ones as the upfront costs are less absorbed in new facilities than in old ones.
In a 2004 analysis, David Wheelock and Paul Wilson used the following input parameters for a DEA analysis of traditional check processing:
1. Personnel: Number of employee hours
2. Materials, Software, Equipment, and Support

Materials: GDP implicit price deflator (seasonally adjusted, 1996 = 100)

Software: Private nonresidential fixed investment deflator for software (seasonally adjusted, 1996 = 100)


For 1979-89: PPI for check-handling machines (June 1985 = 100)

For 1990-2003: PPI for the net output of office machinery manufacturing (not seasonally adjusted,

June 1985 = 100)

Support: GDP implicit price deflator (seasonally adjusted, 1996 = 100)
3. Transit

Shipping and Travel: Private nonresidential fixed investment deflator for aircraft (seasonally adjusted, 1996 = 100)

Communications and Data Communications Support: Private nonresidential fixed investment deflator for communications equipment (seasonally adjusted, 1996 = 100)
4. Facilities: Facilities expenses from January, 2004.8

Outputs for the analysis used were:

1. Items Processed

Number of forward items processed

2. Endpoints Serviced

Number of Endpoints served.

All of these previous variables are relevant to a DEA analysis of the Check 21 presentment improvements. However, number of endpoints served could be omitted. In traditional check processing, there is extra complexity, labor, and errors created by having many endpoints served per facility; however, under Check 21, the number of endpoints is largely irrelevant. Further, this may create a skew towards Federal Reserve processing facilities which service high density areas.
Electronic presentment allows a number of additions to input and output variables to factor the added efficiencies and costs of the computerized system:
Added Inputs


  • Fixed and Variable Check21 computer costs

  • Support personnel Costs including both dollar amounts as well as actual man-hours used.

Added Outputs

Quality Metrics

  • Number of errors per period

  • Average time per transaction

The DEA analysis will assess which components of the process are more efficient than others. Further, Federal Reserve Banks using different processes, resources, and management may meter their operations against others.

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