Coaxing US Banking And Payments Into The 21st Century

Editor's note: Jake Howerton is a co-founder of Zipmark, an online payment solution enabling business to make or accept secure digital check payments.  In the last decade, financial institutions and industry regulators, driven by consumer demand and fintech innovators, have slowly changed the way transactions are being processed in the United States. The national standard for electronic transfers continues to be the ACH system – a legacy system with origins dating back to the 1960s. NACHA, the national rule-setting body for the network, was formed in 1974 when several regional associations merged. Processing on the ACH network continues to be chosen (there were more than 22 billion payments processed in 2013) by businesses over more costly mechanisms like traditional credit card processing or alternative payment networks like PayPal in markets other than consumer retail and e-commerce. In recent years, startups like Balanced Payments, Dwolla and PaySimple have brought the experience of using this system more in line with the expectations of modern businesses. These startups have created a market for themselves by exploiting the biggest gaps where banks have traditionally failed to execute like ease of onboarding, simplified APIs and tools on top of the network, and providing high-quality support for merchant processors. Simultaneously, innovation has been steadily marching forward around true digital checks – a product of the Check 21 Act, which was passed in 2003. As with many regulatory initiatives, the legislation came as a reaction to what was already transpiring within banks and businesses interacting with the Federal Reserve. In this case, the legislation officially recognized the digitization of checks, by making the digital scans or images of the items legally equivalent to the paper. This change enabled banks and the Federal Reserve to stop shipping trucks, airplanes and containers full of paper checks around the country. It also enabled (and in some cases mandated) banks to bring some of the benefits of this efficiency back to their depositors by offering faster processing and additional applications on top of this network. If you are a consumer in the United States you have started to use services made possible by this legislation if you have ever scanned a check for deposit using your mobile phone or done so at an ATM. The digitization of payment transactions and the development of related regulation has been and still is a fluid process. In the U.S., we have active competition amongst banks, and the governing institutions are hesitant to unilaterally enforce major transitional changes like they have in other countries around the world. However, regulations have continued to adjust over time as institutions, processors and businesses moved toward more modern practices. These regulations and concepts form the basis of a digital check. Due to its contractual nature, a check captures a great deal of information about the transaction, as well as the payer’s intent. Checks are seen by many as an anachronistic relic of the U.S. payment system, but a better way to think of them, once you realize that the paper is not the important part of the check, is as the root concept that underlies all bank transactions. A check is a standardized agreement created by the payer, instructing a financial institution to pay the recipient the specified amount from the specified account on demand. Throughout history this concept has had various names, but it has not changed significantly in the last 2,000 years or so, and we don't expect it to change any time soon. Unlike the Wire network, the ACH network, and the card networks, the rules of a check are understandable, simple, and enshrined in the laws of our country as part of the Universal Commercial Code. Transaction disputes are an eternal fixture of commerce. Transactions can be reversed in countless ways, for countless reasons. Most commonly, the payer is either acting in bad faith by trying to reverse a transaction that they knowingly authorized and benefitted from, or acting in good faith, and is a victim of legitimate fraud. The possibility of either circumstance makes it important that there are protections in place for both the merchant and the payer. Due to its contractual nature, a check captures a great deal of information about the transaction, as well as the payer’s intent. For a check transaction to be reversed, the payer must be able to prove that they did not authorize the check, and they must sign an affidavit to that effect. The high burden of proof also protects the payer from fraud, by virtue of the amount of information required. ACH transactions can be reversed up to 60-90 days after the transaction (and sometimes even beyond that period), and the burden of proof to dispute a transaction is much lower. Unlike ACH, businesses collecting digital checks can be confident that transactions won’t be reversed. Digital checks combine the protections of a check with the convenience of electronic payments, which was previously only available via ACH. In light of this, it is surprising that more businesses and consumers don't demand check transactions. With enough care, digital payment services can remove the last vestiges of risk from digital checks. Another unexpected benefit of digitizing checks is rapid delivery of funds. Although checks are often thought of as clunky and slow, without the paper they are deposited in real time, so businesses can access capital from payments as quickly as the next business day, and potentially the same day without waiting for major changes to the banking infrastructure. Although there have been attempts to accelerate ACH network timelines in the past, they’ve mostly been unsuccessful. Digital checks are the closest we have come to a "no-risk" form of digital payment. Transactions will always carry risk, but with enough care, digital payment services can remove the last vestiges of risk from digital checks, giving businesses even more certainty about their payouts and collections process. A wave of companies has started to form to service these ancillary needs around risk management and knowledge in transactions. Companies like Sift Science, Riskified, and Socure are building fraud-detection services mostly around card transactions right now. We have seen the emergence of services like Jumio for ID verification, and BlockScore for easier querying of identity data. Companies that focus on minimizing transaction risk, speeding up payments, lowering fees and expanding access to financial services are all tackling critical problems that plague the U.S. payment landscape. Over the next few years, expect to see a flood of companies entering this space to address these issues. These initial steps to modernize forms of payment, such as digitizing checks, have only served to reveal how much work it will take to bring U.S. payment infrastructure in line with our current technological capabilities. A 2013 Federal Reserve Study found that one in six checks was deposited as an image, rather than paper. This would have been impossible only nine years prior. On the other hand, that means five out of six checks were deposited as paper. Progress made in the next 10 years will determine whether we can fully modernize this critical part of our economy.
Jake Howerton

Jake Howerton is a Writer at Gigabuzz, focused on covering early-stage startups, especially those with a technology focus and great perks.

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