The UK Cheque clearing process is a fairly time consuming procedure and the following article will explain how cheques are cleared and why it is such a lengthy process. To help explain this the article has been broken down into several parts:
- Normal Cheque Clearing Process
- Returning of Bounced Cheques
The process and timescales for processing cheques is a legacy from the times when banks did not have computers. It is essentially determined by how long it takes to move pieces of paper around the country (in the old days by trains, nowadays by motorcycle couriers and vans).
The process is illustrated below based on the example of a person called Hero paying a cheque into their own bank (Clearing Bank A) on day T but drawn on another Clearing Bank B.
Normal Cheque Clearing Process
1. Out Clearing
Our hero pays in the cheque and credit slip in a branch of his bank, Clearing Bank A. This cheque with all the other cheques deposited at the branch is couriered to a regional centre. In these regional centres the out-clearing is carried out. It essentially consists of the following tasks:
- Electronically reading the amount of the cheque by using Image Character Recording (ICR) technology.
- Electronically reading the sort code account number and cheque number from the bottom of the cheque using Magnetic Ink Recognition (MICR) technology or ICR Technology. (This line of information at the bottom of the cheque is called the code line).
- Sorting the cheques into piles corresponding to each clearing bank (using the sort codes read to identify the clearing bank). Thus at the end of the process there should be a pile for Barclays, one for HSBC, one for Lloyds TSB and so on.
- From the electronically read amount information and the electronic code line information electronic files of cheque payment records are created for each clearing bank. These are called IBDE (Inter Bank Data Exchange) files.
- The paper credit corresponding to the cheque is also converted into an electronic accounting entry by similar ICR/OCR technology and is put into an electronic file of credits for uses in Clearing Bank A’s internal accounting.
2. Clearing Bank A Accounting
Clearing Bank A feeds the electronic credit record into its accounting systems (usually overnight). The bank will give customer access to the funds for interest and/or withdrawal purposes according to its own rules, credit policies and credit assessment of the person paying the money in. For an established customer with a good credit history they may give value and withdrawal for interest from the first day. For new account holders or customers they consider high risk they may give access to the funds for interest purposes from day T but not allow the customer to withdraw funds until four days later; when they are more certain the cheque will not bounce. In our case, Hero is credited with the value of the cheque in time for the morning of day T+1.
Clearing Bank A sends all its piles of cheques drawn on other banks in a van to the Central Exchange near Milton Keynes. There, the piles of cheques are given to vans from the other banks. They also give Clearing Bank A piles of cheques that have been paid in at their branches drawn on Clearing Bank A. We are now interested in Clearing Bank B’s van which has collected Hero’s cheque in a pile from Clearing Bank A at the Exchange Centre and this now returns to the In-Clearing Centre at Clearing Bank B.
In parallel with the physical exchange of cheques is an electronic exchange of files of payments in the form of IBDE files. These are transmitted over secure network connection from each clearing bank to another on a Bilateral basis.
Both the physical and electronic records have been exchanged by 11:00 am on the morning of Day T+1.
The physical cheques are received from the Exchange Centre at Clearing Bank B. These cheques are processed with three* aims in mind (Some banks make electronic image copies of the cheques here as well but this does not change the basic process.):
- First the code lines are read (for sort code, account number and cheque number). This is used to verify the records in the IBDE file of electronic payments.
- Second the cheques are sorted into sort code and account number order for potential retrieval in case of queries/returns.
- The cheques for Agency Banks are sorted into separate piles for onward deliveries to those banks. For more details of Agency Bank cheque Processing click here.
Once the file of incoming cheques has been verified against the IBDE file of incoming cheques the electronic file of payments is passed onto the accounting (usually overnight) of Clearing Bank B on the night of T+1.
The overnight accounting provisionally debits the account with what is called an AM entry; effectively earmarking the funds.
5. Pay/No Pay
Clearing Bank B now spends a considerable part of day T+2 deciding whether to pay or not the cheques that have been drawn on its customers’ accounts. These decisions are a mixture of computer based and human based decisions. They fall into two categories.
- Account Related – if the account has insufficient funds to cover the amount of the cheque the overnight accounting will highlight the account as being in excess. Credit assessment systems then kick in on the account and for many customers will decide whether to honour the cheque or bounce it (in all cases the bank will charge fees but some accounts may be deemed credit worthy by the computer and hence allowed to go overdrawn). For some classes of customer such as large corporates or high net worth individuals where the customer relationship is very important banking officers will make the decision to pay or not. Other account based reasons for returning the cheque might be that the account has been closed or the customer has deceased.
- Cheque Related – there are also a range of Fraud and Technical reasons why the cheque should be returned. Banks run a number of tests such as testing the cheques are on special bank issued paper or that the signature on the cheque is a good match with their record of the customer’s signature to ensure the cheque is bona fide. They also run “profiling” tests which use statistical techniques to highlight unusual payments (e.g. unusually large, unusually frequent, etc.) to seek out potential frauds. Customers can ask to have cheques stopped so the bank runs a comparison of cheques to be processed against lists of stopped cheques with a view to returning such items that match. They also test to ensure words and figures match and that the date on the cheque is okay. If they discover problems with any of this they can return the cheque unpaid.
In our hypothetical case, the person who paid Hero has insufficient funds on his account so the bank decides to return the cheque to Hero. If the account had had enough money the clearing cycle would have stopped here. The next steps are illustrated by dotted lines in the diagram below.
Returning of Bounced Cheques
6. Unpaids Out
Clearing Bank B, towards the end of T+2, having decided that the cheque paid to Hero is to be returned, has to physically locate it among the thousands of cheques processed. A sorting process takes place creating piles of unpaid cheques, one for each of the other clearing banks. These piles are then put in a van to go to Central Exchange to be returned to the other clearing banks.
Some banks do not use this “Centralised Unpaids Out” model but rather make the pay/no pay decisions in branches and sort out the cheques to be unpaid in the branches as well. In these cases the branch returning the cheques posts them to Clearing Bank A by first class mail.
7. Unpaids In
Whether the cheque is returned via the Central Exchange or via post it is handled as part of “Unpaids In” at Clearing Bank A on day T+3. Clearing Bank A reads the code line of the returned cheques and uses the sort code, account number and cheque numbers as a key to identify the account that received the credit for the cheque amount. Once identified, the account is debited on the night of T+3 for the amount of the cheque, thus reversing the credit posted a few days earlier.
The above paragraphs form a high level description of the cheque clearing process which is a small industry in its own right. Aspects that have not been covered are:
- The credit clearing process (e.g. where someone pays a credit slip for Clearing Bank B in at Bank A). This is similar to the cheque clearing process but there are no IBDE files.
- The variations for the Northern Irish Banks and the Scottish Banks (extra days are incurred through logistics and lack of IBDE files).
- The Research and Adjustments processes, these are processes based around control totals for batches of cheques tallying right across the system – if they don’t someone has to find the error, usually the misreading of a value off a cheque somewhere in the system and correcting the error (an “adjustment”).
- The interbank settlement process of the Bank of England and associated interbank reconciliations.
Most importantly this only describes the cheque clearing processing for the main clearing banks. There are 15 of theseThe 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. However, there are 400+ banks in the UK that can pay or receive cheques who participate as “Agency Banks”. These banks outsource their cheque clearing operations to one of the Clearing Banks. To read a description of the Agency Bank cheque clearing operation click here.