The History of the
Checking System

“Checking accounts are used every day by millions of people. However, many people today do not realize that while they are taking this financial instrument for granted, it was not always a part of banking.” (Woodards) Just as Chris Woodards stated, I was one of those individuals that were taking the checking system for granted, that was until I started to do this research. As I was reading information about the history of the banking system and the checking accounts and check, I really did not know that there was so much information to the history of checking. I just thought that it was something that everyone did or has done forever, not ever paying attention to it. I knew of it just being a part of everyday life, especially as I was growing up. For buyers, checks are a more convenient, secure, and verifiable payments instrument as long as they have the funds in their account to cover the check so it does not get a stamp of “Non-Sufficient Funds.” Before the break out of the Civil War, banknotes and bills of exchange were used extensively; they remained competitive with the deposit accounts. Once the war broke out, congress passed legislation that was known as the National Banking Act. These were the two acts that established the banking system in the United States as we know, and they were the National Banking Acts of 1863 (originally known as the National Currency Act) and the National Banking Act of 1864, this new act was in acted to take the banking system out of the hands of the state government. “These acts encouraged the development of the national currency backed by the bank holdings of the U.S. Treasury securities and established the Office of the Comptroller of currency as part of the United States.” (Wikipedia, the free encyclopedia) As the United States was still young, the banking system was also and it was being ran how each individual bank in each of the states wanted to run their bank. With these laws, it allowed for the federally charted banks called national banks to effectively restrict the issue of banknotes to such banks. During the war, the US Treasury was putting into circulation, unredeemable banknotes known as “greenbacks,” as a war finance measure to push out the private banknotes. The reason for this was to get the public to hopefully start to use checks as a way to make payments. There was another important development at this time to settle checks that were from the banks in the same city, this was the clearinghouse. The first actual clearinghouse in the United States was the New York Clearing House in 1853, which it was modeled after the London Clearing House. In these clearing houses, the banks would meet on a regular basis to swap checks and to settle the debt that was between them. By 1915, there were some 229 bank clearinghouses throughout the United States. (Roberds) As time went on, there was no single bank entity nationwide, so the clearing and settling of the checks took a long time to be settled. This was due to the banks that could not branch out of their home towns, and if they were able to, they had to deal with the different state to state variations of the payment laws. Within this clearinghouse system, there could be checks that change hands several times before it reaches the correspondent, which is the bank that is responsible to settle that amount on that check. With that all the banks that handled that check could charge a fee to the bank that the check was drawn on, these bank would charge between one-tenth and one-fourth of 1 percent of the check’s face value. Even though this fee was so small, it would add up with all the checks that would be handled by each bank. And by the time the check had gotten to the correspondent bank, the face value would not be what the check had written on it. The check, at this time was becoming very useful in making payments. A downside was cost. Irregular check clearing cycles and decentralized settlement required banks to hold high levels of reserves, and long check clearing times inconvenienced both the bank and the customer. (Roberds) By the year 1913, the United States had 48 states which had accepted that check as some sort of payment for services and goods. As this happened, the amount of check grew and it would sometimes be several weeks before the checks cleared the bank that they were drawn on. For example, the check might be paid on one coast and deposited on the other. “That year (1913) the Federal Reserve Act established 12 Federal Reserve Bank Districts and their branches as check clearing and collecting centers for banks that were members of the Federal Reserve System”. (htt) The National Conference of Commissioners on Uniform State Laws (NCCUSL), helped by drafting up a model that standardized the clearinghouse process, which was adopted by most state legislatures by 1916. In 1918, the Leased Wire System, was a system that was able to clear checks over telegraph wire, it became to be known as the Fed Wire, better known later as Fedwire. This system was a way for the banks to be able to settle check without having to ship the note back and forth. So the Great Depression had worked to enforce the Federal Reserve dominance in the check clearing system in two ways; first, it undermined the banks’ confidence in private clearing house arrangements and second, it caused a massive contraction in the banking industry. With this, the banking system saw over 10,000 banks close during the years 1929 to 1933, due to insolvency.
Between 1939 and 1952, there were 47 million checking accounts, which were almost doubled from the 27 million and with 8 billion checks written annually, which was up from 3.5 billion. The average check passed through 2.3 banks and required 2.3 business days in the process of being presented and collected. Therefore, on an average business day, there were 69 million checks in process throughout the payments system. (htt) When this was happening, it was slowing down the process of clearing the checks and pulling the money from the accounts that needed to be paying on those checks. And with this, the paper checks were being handled and sorted manually by reading the routing number in fraction form printed in the upper right hand area of the check. With this being done manually, it was threating to bring the banking system to its knees with costs and man power. In1954 the Bank Commission of American Bankers Association, had put together a technical committee to study the problem of how the checks are handled and came up with a recommended way to fix this. It took the committee two years, when they published a document known as 138, Magnetic Ink Characteristic Recognition (MICR): The common Machine Language for Check Handling. So in 1956, the banking association had designated the MICR as a standard for the checking system and by 1962, 97 percent of the banks were using this, but many banks were still sorting checks manually. “MICR did not become the full industry standard until 1967, when all checks routed through the Federal Reserve were required to contain the MICR-coded identification of the bank on which they were drawn.” (Quinn) In 1972, the Fed had started another change in the clearing process, which had dropped the clearing time of a check to a half day to 1.9 days, through a thing called Remote Check Presentment Centers (RCPC’s). These were located in areas without a Federal Reserve Bank or branch. During this time, the checks that were written quadrupled to 32.7 billion from the 8 billion, this is more than a 5 percent average rate increase. This is when the term check was also known as a “payment other than by cash.” Check Floating, which is the lag time that a check goes through between when the check is deposited to the payee’s bank and the time the check is paid by the paying bank, became a common occurrence during the late 1970’s. The floating process generated two significant costs. “The first cost derived from the activities of banks, corporations, and individuals playing “the float game,” that is, engaging in costly practices such as remote disbursement and expedited collection in an attempt to capture float benefits, including the benefits of the Federal Reserve float. The second cost arose from distortions in the choice of payment method since check float can generate a private benefit to the writer of a check even if there is no corresponding social benefit.” (Quinn) In 1980, the Monetary Control Act was set to rectify this problem by requiring the Federal Reserve to change the interest rate for the float. The Federal Reserve had to rationalize the provisions that they used and to start to charge to for the services so that they could recover the costs for the services that they provided. Also in 1980, there was a relaxation on the restrictive bank branching laws which led to a wave of bank mergers. This period revealed another problem, and that was the check payment law, where the procedure of dealing with checks that needed to be returned for insufficient funds. The check had to be returned the same path that it took to get paid, which delayed in the payment for the goods. Banks were reluctant to make funds available when checks are presented to them due to them being exposed to the risk of nonpayment. These delays frustrated depositors, which led to the 1987 passage of the Expedited Funds Availability Act (EFAA). The number of checks being used as a payment had peaked to a number of 49.5 billion in 1995. But as this was happening, checks had already started to lose significant market shares to other forms of payment such as the credit card, debit card and to the automated clearing house payments. And by 2003, the check was outnumbered by electronic competitors for the first time ever and by 2006, the checks’ market share had fallen to 33 percent of noncash payments. Because of the decline in the use of checks, the Feds have had to close many of their RCPC’s and many of the Federal Reserve Banks are not processing the checks either. As the check use continues to fall, there have been two significant policy initiatives have been sought after to further rationalize the checking system. These policies are the Check Conversion and the Check Clearing for the 21st Century Act, which is known as “Check 21.” Check conversion where certain categories of checks are converted to automated clearinghouse transactions. These are done at retail checkout stands, where the check is scanned for the MICR information and then handed back to the customer. Once they are scanned, this is considered an electronic payment and the check does not enter the traditional collection system. The funds are usually cleared out of the payer’s account right away. The Check 21 was passed into law shortly after the September 11, 2001 terrorist attacks, which had disrupted the air transport of checks to paying banks. This is also known as the substitute check, which is a certified copy of an electronic image of the check. The checking system has seen a rough start in the early years of its existence here in the US, but as time went on, it was there have been many changes which have helped it to maintain its existence. But as the technology has changed, so has the checking system. And now that there are credit and debit cards, people are using less and less paper checks.

Bibliography

Quinn, Stephen and Roberds, William. "Federal Reserve Bank of Atlanta Economic Review." 2008.
Roberds, Willam and Quinn, Stephen. Economic Review. 4 November 2008. 15 April 2014 <https://www.frbatlanta.org/filelegacydocs/er08no4_QuinnRoberds.pdf>.
Wikipedia, the free encyclopedia. n.d. 14 April 2014 <http://en.wikipedia.org/wiki/National_Banking_Act>.
Woodards, Chris. http://ezinearticles.com. 12 December 2010. 14 April 2014 <http://ezinearticles.com/?A-Brief_History_of_Checking_Accounts&id=5652340>.