The Finale of the “Float”?: Check 21 Legislation Allows Instant Check-Clearing

Posted on March 14, 2018 in Business Essentials

Under a federal law that took effect on October 28, 2004, banks will have more leeway to process checks electronically, which means shorter or even nonexistent “float” times — the grace period between the time the check is written and when the money is debited from the account.

The Check Clearing for the 21st Century Act, known as the “Check 21 Act,” provides for a new way for funds to be transferred between accounts. Rather than ship original checks around the country, the Check 21 Act enables banks to create paper “substitutes” for the original checks through digital images of the checks. The funds are then electronically transferred between institutions, and the original checks are shredded.

The motivation for the Check 21 Act stemmed from the disruption in the payment system after the September 11, 2001 terrorist attacks. As airplanes were grounded, checks could not be flown to their banks of origin.

Technically, the Check 21 Act creates a new negotiable instrument called a “substitute check,” which permits a bank to take an image of a check that is presented for deposit and process it electronically. There is no need to transport the check to the bank against which it was written; that bank can print a substitute itself and send it to its customer.

Small businesses can benefit from the new law as, once they deposit a customer’s checks, those funds will be available far faster than before. Other changes have already begun to creep into effect: for example, bank customers will receive fewer of the original checks in their bank statements and more paper substitutes, which will be printed when checks are handled the new way. Many already receive statements with images of their checks or lists of them.

However, the Check 21 Act does carry some potential drawbacks, of which small businesses should be aware:

  1. The end of the “float”. By shortening the time that funds are cleared on checks, the law effectively closes the “float”: that window of financial leverage that small businesses had between the time they wrote a check and the time they could expect it to be cashed. Now that the funds will be deposited instantaneously, small businesses must rethink how they manage their finances and only write checks for which they know funds are actually available.
  2. Disputed checks. There will be a shorter window to place a stop order on a disputed check.
  3. Greater likelihood of bounced checks. Although checks may be cashed faster, the law does not change the length of time that banks can hold checks deposited by their customers. This means that there may be a greater possibility that checks will bounce.  
  4. Bigger benefits for banks. Small business owners will not necessarily see the savings that the efficiencies in the system may bring about. Rather, banks may reap the benefit of the bounced check fees.
  5. Increased potential for criminal activity. Some consumer groups have expressed concerned that there will be more room for fraud, like counterfeiting and identity theft, when banks start routinely converting original documents to images, which can be harder to read. In addition, check images, which include a copy of the bar code, will be easier to replicate. The absence of the original document may frustrate efforts to use fingerprints and other standard methods to catch criminals.

Regardless of the Check 21 Act, small businesses should not write checks on their accounts unless there are sufficient funds in the account to cover them. Now, small businesses need to treat every one of their checks as if that is the one that will clear instantaneously.

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