What The Government’s Cheque Clearing Changes Mean For Banks
In November 2006, the Office of Fair Trading (OFT), a branch of the UK Government and APACS jointly announced changes to the UK Cheque Clearing System. Who will blink first, the OFT, the Clearers or the Agency Banks? To explain how we come to this conclusion we break this article into four parts:
- The nature of the changes to the Clearing System
- The impact on Clearing Banks directly
- The impact on the Agency Banks
The Changes to the Clearing System
The details of these changes can be found at the OFT and APACS web site in the related links side bar to this article. There is also a 300 page document on the OFT web site that explains their rationale for these changes and what options they considered.
The background is that the cheque is a pretty poor payment instrument by modern standards (it is easy to defraud, gives little certainty of when if ever the recipient will get funds and is expensive to handle and process). Because of these facts cheque usage has been declining and is forecast to continue declining. Hence, the banking industry is loathe to spend a lot of money on enhancing a “dying product”. Unfortunately, this is a very slow death and cheque users tend to be among the more vulnerable members of society (old people, poor people and small businesses).
Thus the thrust of the OFT’s recommendations is to not significantly change the cheque clearing process but rather to:
- establish clear minimum timescales for what happens when from the customer’s point of view for all UK banks;
- significantly reduce the time allowed for a bank to return a cheque (hence increasing certainty about when the cheque cannot be bounced).
The essence of these timescales is called the “2-4-6” rule.
- Two days after paying a cheque into a bank the customer should start earning interest on the money deposited. This is called Cleared for Interest.
- Four days after paying the cheque in, the customer should be able to withdraw the funds. This is called Cleared for Value.
- Six days after paying the cheque in, the customer can be certain the cheque will not be bounced. This is called Cleared for Fate.
Individual banks can (and some already do) offer better service levels than this but none can offer less than this from 01/01/2008. currently many banks offer less than the 2 and the 4 and all reserve the right to bounce a cheque long after 6, albeit not very often. Sometimes these, generally elongated, timescales are caused by geographic reasons (e.g. Scottish and Northern Irish Banks), sometimes because of the nature of the bank (e.g. building societies). Nonetheless all these banks will now have to conform to the 2-4-6 rule.(An exception has been made for Savings accounts which are subject to a 2-6-6 rule.)
The Impact on Clearing Banks Directly
There are 15 Cheque Clearing Banks in the UKThe members of the Cheque and Credit Clearing Company Limited are;
2. Alliance and Leicester
3. Bank of England
4. Bank of Scotland (HBOS)
7. The Co-operative Bank
9. Lloyds TSB
11. Royal Bank of Scotland
The members of the Belfast Bankers’ Clearing Committee are currently;
1. Bank of Ireland
2. First Trust Bank
3. Northern Bank Ltd
4. Ulster Bank Ltd. They are the core of the cheque clearing process and provide cheque clearing services to the 400+ other banks in the UK. For them there will be little impact of these measures. The reason why, the fact that the clearing banks already comply with the four days for fate rule, is illustrated in the diagram below.
The reason why a bank does not clear a cheque for value immediately is that it wants to know if the bank that is paying the cheque will bounce it or not. By waiting 4 days, a clearing bank will be pretty certain that a paying bank would have returned any bounced cheques by then. (See UK Cheque Clearing
for more detail on how this all works). Thus a minimum proposition of 4 days for value is easily attainable for Clearing Banks with no change; indeed most clearing banks already offer better than this. The 6 days for fate target will probably involve some business process changes (but little or no IT work). The reason why a Clearing Bank will be holding up a cheque longer than this today will probably be because of some form of manual investigation (either for Fraud, or inconsistency between control totals). These will just have to speed up and/or have cut-offs where the banks take a risk and book the difference to Profit or Loss.
The only other significant area of investment for Clearing Banks will be that related to the Northern Irish and Scottish banks. Here there will need to be some investment in logistics (e.g. planes) to move paper cheques, credit slips and returned cheques around the UK faster. Furthermore, in the case of Northern Irish Banks, they may need to invest in their Clearing systems to produce electronic IBDE files (See UK Cheque Clearing for an explanation of this term). Nonetheless, compared to Faster Payments and to a lesser extent SEPA, these OFT driven measures are small beer for a UK cheque clearer.
Impact on the Agency Bank
Agency Banks are banks that make and receive cheque payments in the name of their customers but don’t participate in the UK Clearing system directly. They use a Clearing Bank to do their cheque clearing for them, i.e. act as their Agent, hence the name Agency Banks. See Agency Bank Clearing for an explanation of how this works.
Because the Agency Banks use Clearing Banks to do their clearing for them there are more players in the end to end cheque clearing process and more steps involving the physical transportation of cheques. This inevitably leads to an overall longer timescale for the process. For instance consider the case of a returned cheque illustrated below.
Compare this with the previous diagram for a clearing bank returned payment. It is clear that this process takes considerably longer when Agency Banks are involved. This is partly because there are more actors involved in the end to end transaction and partly because the extra steps in the process involve the physical movement of cheques and credit slips between the actors, often by the Royal Mail.
What’s more, because of the physical handling of the cheques, there is quite a high error rate (cheques getting lost, mislaid, misread) leading to further delays. This is the essence of the challenge facing the banking industry from the OFT’s “2-4-6” requirements.
The 2 days for interest is the least difficult part of the challenge for an Agency Bank as most will get the information required to credit their customers on T+2 already.
The problem lies with the 4 and 6 parts of the challenge. Currently many small banks have business processes that do not get returned payments back in time for them to be confident about releasing the funds for withdrawal on T+4. Given the recent increase in cheque fraud they would not want to just give value earlier without a corresponding change to the business processes to give confidence earlier.
The kinds of changes that are required are not really ones involving computer systems (Although the problems could be solved by using electronic images of cheques to move information around, the industry does not relish the up front investment expense nor the security implications). They are far more prosaic involving the replacement of the GPO by couriers on motor bikes and in vans through the night, with Agency Banks working on faxed advices more than the actual cheque or credit slip.
The diagram above illustrates a possible way of getting Agency Bank Cheque Clearing Cycle into line with the government requirements. The key features are:
- Increased use of couriers (for example from the receiving bank to the clearer to ensure it goes into the in-clearing the next day, or from the paying bank to the clearer to return its unpaid cheques in time for Unpaids out on T+2)
- Stiffer cut off times in Agency Banks (for example at the receiving bank earlier in the banking day on T or at the paying bank giving itself until just before lunch time for making pay/no pay decisions on T+2)
- More reliance on the electronic information provided by the clearing banks (for example faxed or email advice of unpaids on T+3 to the receiving bank from its clearer) rather than the actual cheques or credit slips.
The particular combination of these changes an Agency Bank will use will vary from Agency Bank to Agency Bank dependent upon internal business processes and its own organisational structure (e.g. existance of a branch network or not). However, we at HBW do not believe that this will be a small set of changes for any Agency Bank.
We have seen that Agency Banks will have quite a lot of extra work to do and the first question is who is going to pay for it? If the Agency Banks go with the types of change mentioned above (more use of couriering, more faxes/emails) then the ongoing costs will increase and one can foresee some arguments between the Clearing Banks and the Agency Banks about who will pick up the tab.
The second question is one of do-ability in the timescales for Agency Banks. The diagram below illustrates their 2007 payments challenge.
Not all Agency Banks will face the same degree of pressure to implement all the payment systems changes. For example a UK building society may choose not to do anything for SEPA whereas the subsidiary of a foreign bank may regard this as the highest priority. The converse may be true for UK Faster Payments with the building society very keen to implement and the foreign subsidiary less so. The bottom line though, is that it is going to be a heck of a year for Payments Departments in Agency Banks.