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FED ER AL RESERVE BANK OF DALLAS
D ALLAS. TEX AS

75222

C irc u la r No. 75-104
July 22, 1975

A PERSPECTIVE ON RETURNED CHECKS

TO ALL BANKS IN THE
ELEVENTH FEDERAL RESERVE D IS T R IC T:
The volume of unpaid items has been increasing at a substantial
rate over the past few y e a rs , p a r tic u la rly in the Eleventh Federal Reserve
D is tric t. As a result of this noticeable increase in re tu rn items and the
attention brought to the problem by recent Bank Adm inistration Institute
studies, the Federal R eserve Bank of Dallas conducted a s u rve y of its own
to determ ine the characteristics of the re tu rn item volume processed at the
Dal las Office.
The results of the s u rve y a re discussed in the attached report,
"A Perspective on Returned C h ecks." T h e document points out the areas
w here efforts of the banking community should be concentrated to reduce
the re tu rn item volume and suggests possible ways to achieve this red u c­
tion. We hope the report w ill stimulate some initiatives in the banking com­
m unity which might ultim ately lead to reductions in the trend of re tu rn item
g r o w th .

Sincerely yours,
T . W . P la n t
F i r s t V ic e P r e s i d e n t

Enclosure

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

Federal Reserve Bank of Dallas-^
A
Perspective
on

RETURNED CHECKS

A Perspective on

RfTUnniCB CHECKS
The Federal Reserve Bank of Dallas experiences a disproportionately large number of
returned checks (return items, unpaid items) in comparison with other offices of the Federal
Reserve System. Furthermore, there has been no improvement in the trend of return items at
the Dallas office of the Eleventh Federal Reserve District, although there has been some im­
provement nationally.
In both 1973 and 1974, for example, the Federal Reserve Bank of Dallas had the third
largest volume of return items processed among all Federal Reserve offices, including branches.
In 1974, the Dallas office received 13.58 return items per 1,000 checks processed, while the
entire Federal Reserve System received an average of 9.17 and the 174 banks surveyed by the
Bank Administration Institute in 1973 received an average of 10.84. The proportion of return
items to checks processed at the Federal Reserve Bank of Dallas was greater than all but one of
the other Federal Reserve head offices and was eighth highest among all Federal Reserve offices,
including branches.
The Bank Administration Institute has been studying the check collection system, includ­
ing the return item problem, for several years and published a research report "The Impact of
Exception Items on the Check Collection System" in 1974. The BAI classifies as exception
items all MICR rejects, returned checks, and cash letter adjustments.
The BAI found that in 1973, return items accounted for 2/3

of 1
percent

of all checks

processed; however, return item processing accounted for about 11 percent of total expendi­
tures for check processing. In comparison, at the Dallas Head Office, return items accounted
for 1.3 percent of all checks processed in 1974 and return item processingaccounted for 5.3
percent of the total expenditures for check processing.

Our consideration of the problem has led to awareness that certain factors probably foster
the disproportionately large number of return items received at the Dallas office. One is the
generally higher degree of over-the-counter acceptability of checks in this part of the country
than in other areas. Another is the growing importance of "free" checking, which might be
encouraging a larger number of marginal checking accounts than would be likely if minimum
balance requirements were still strict.
Because of the higher than normal rate of returns and the attention drawn to the return
item problem by BAI studies, the Federal Reserve Bank of Dallas was prompted to develop its
own perspective. It is clear, however, that return item processing is a joint problem that must
be minimized through the efforts of the entire banking community.
THE O UTLOOK________________________________________________________________________
The Federal Reserve Bank of Dallas is currently processing approximately 5 million return
items annually. Ten years ago, the annual volume of return items was 2.5 million; thus, the
average annual growth rate has been approximately 7 percent. Over the same period, the cost of
processing return items at the Dallas office has increased at an average annual rate of 11 percent.
If the return item volume and processing cost continue to rise at their current rates, the average
annual processing cost will increase 50 percent by 1980.
Clearly, return item processing costs will be increasing even faster than they are now. If
action is not taken by the commercial banking community before 1980, the Head Office of the
Federal Reserve Bank of Dallas alone will be processing approximately 6.1 million return items
annually at a cost of over $310,000. Commercial banks can expect similar growth in volume
and in processing costs.
A national study by the Joint Committee on the Check Collection System found that in
1952, 2/3 of 1 percent of all items presented for payment were returned unpaid. This amounted
to approximately 50 million return items that year.
According to data submitted by banks participating in the BAI's exception item study,
the return item rate for 1973 was about the same as in 1952, even though the check volume
has increased threefold. The incidence of return items remained about the same, but the cost of
processing them increased more than eightfold, or over two times faster than the check volume.
As the return volume has increased, the banking industry has had to devote more and
more effort to processing these items. If the check volume and return item frequency continue
their present trends, according to the BAI study, there will be 42.5 billion checks by 1980 and
more than 283 million return items annually.
As check volume increases, continuing improvements in check-sorting computer hardware
and software enable the banking system to stay reasonably current in terms of processing sched­
ules and throughput. Simultaneously, however, problems created by the slower return-item pro­
cessing procedures are magnified. In the future, the automated check collection system may
begin "creating" return items at a rate that would make it difficult for manual systems to func­
tion without incurring prohibitive processing costs.
Currently, the Federal Reserve Bank of Dallas is using low-speed proof machines for
processing return items. A manual system is utilized since there is limited uniquely designed

2

automated equipment available that is economically feasible in the light of current volumes.
Equipment manufacturers have not directly addressed the return item problem—and it is not
expected that they will in the near term—for two reasons:
1. The return item volume is relatively low compared with
regular check volume.
2. The nature of sorting return items—by endorsement—is
not exactly adaptable to automated processing at high
speeds.
It is generally expected that there will be a reduction in the return item volume and pro­
cessing costs as the Nation converts more and more to electronic funds transfer systems (EFTS).
With the development of automated clearinghouses and point-of-sale systems, procedures for
processing unpaid items will probably change, as will the media used in processing them. How­
ever, the effects of EFTS on the return item volume will not be felt for at least 5 to 10 years
for two reasons:
1. EFTS will first concentrate on company payroll checks
and drafts, which account for a very small volume of re­
turn items. Most unpaid items are personal checks with
"not sufficient funds."
2. EFTS will first be implemented in large urban centers,
with later expansion to include the rural areas. Since
banks with net demand deposits under $12 million gen­
erate the largest volume of returns, electronic funds trans­
fer systems could not resolve the return item problem
until they are more universal.
It is obvious that the banking community can neither wait for EFTS to resolve the return
item problem nor rely on equipment manufacturers to develop an automated processing system.
These are long-term solutions. The banking community itself needs to take remedial action now
to slow the rate of increase in return item volume and processing costs.
H EA D OFFICE S TU D Y _________________________________________________________________
To gain further insight into the problem, return item cash letters deposited for credit with
the Federal Reserve Bank of Dallas were studied during a one-week period in September 1974.
Data were collected for each commercial bank in the Dallas Head Office Territory for one day
that week.
The study was made to determine why the items were returned unpaid by the banks and
to pinpoint their distinguishing characteristics. It is hoped that the findings of this study are of
help to commercial banks in developing a better perspective of the problem and determining
where their efforts might be concentrated to reduce the number of return items.
The accompanying tables summarize the data from the study according to bank size. Bank
size was determined on the basis of demand deposits of individuals, partnerships, and corpora­
tions at the end of 1973.
For the week the information was collected, Table 1 shows the number of banks in each
size category, the average number of cash items processed and cleared for the banks, the average
number of items returned, and the number of return items per 1,000 items processed. The lower
part of the table gives a breakdown of the reasons why items were returned.

3

Table 1 shows, for example, that the Federal Reserve Bank of Dallas processed an average
of 1,018 cash items drawn on each of the 93 banks having demand deposits of $5,010,000 to
$6,500,000. These banks returned an average of 19.19 items. They had 18.85 return items per
1,000 cash items processed. Of the 19.19 returns per bank, 14.55 were returned because of
insufficient funds, 1.88 because of improper endorsement, and 1.28 because the account was
closed; the remaining 1.48 items were returned for various other reasons.
Table 2 focuses on the average number of returns, for each bank-size category, broken
down according to the type of account and item amount. For example, for the 93 banks with
$5,010,000 to $6,500,000 in demand deposits, 16.14 of the 19.19 returns per bank were indi­
vidual, or personal, checks. In the lower part of the table, it is shown that 13.45 of the 19.19
checks were for $50 or less.
On the basis of these tables and the study, some general observations can be made:
1. The largest volume of unpaid items was returned by
banks with demand deposits of $6,510,000 or more.
2. The number of returns per 1,000 items processed was
significantly larger for banks with demand deposits of
$20 million or less than for larger banks.
3. Insufficient funds checks accounted for 79 percent of
the returns, and 82 percent of all returns were less than
$100. In comparison, the BAI found that insufficient
funds checks comprised 72 percent of the return items
volume and 65 percent of all returns were less than $100.
4. Most unpaid items were individual checks, with com­
pany checks and insurance drafts ranking second and
third.
5. Banks with less than $20 million in demand deposits pro­
cessed a disproportionate number of returns due to in­
sufficient funds in relation to their demand deposits.
6. Although banks with demand deposits over $100 million
processed the largest volume of returns for lack of en­
dorsement, banks with demand deposits under $3 million
processed a disproportionate volume in relation to their
demand deposits.
C O M M ER CIAL BANK S U R VE Y _________________________________________________________
Even before its September 1974 study, the Federal Reserve Bank of Dallas gained insight
into the return item problem directly from the banks. A circular letter was sent to all commer­
cial banks in the Eleventh Federal Reserve District on June 26, 1974, citing the high volume of
returns and requesting comments and suggestions as to possible solutions for the problem.
A number of bankers commented on a wide range of problem areas and provided some
ideas for reducing the return item volume. The problem areas mentioned most often, in order
of frequency, were:
1.
2.
3.
4.

"Free" checking.
Submarginal checking accounts.
Service charge on return items.
Counter checks.

4

4

T A B LE 1

Bank size (Demand deposits—IPC, m illions o f dollars)
$1
or
less

Number o f banks on which
cash items were d r a w n ..............................

35

$ 20.01
to
$100

68

66

59

9

1 ,6 1 0

1,7 5 9

1,9 2 8

4 ,1 1 9

1 9 ,3 3 0

$2.01
to
$3

$3.01
to
$4

$4.01
to
$5

$5.01
to
$ 6 .5 0

$6.51
to
$9

121

86

69

68

93

80

1,0 1 8

$9.01
to
$ 12

$10 0 .0 1
or
m ore

$ 12.01
to
$20

$1.01
to
$2

Average num ber at Federal Reserve Bank o f Dallas on sample day
Item s processed and cleared
f o r each b a n k ........................................................................... . .

339

627

668

856

1 ,0 2 6

9 .5 4

1 1.5 0

1 3.22

1 6.95

2 0 .5 5

1 9.1 9

3 1 .8 2

2 9 .3 9

3 3 .8 6

3 9 .3 6

8 2 .7 8

. .

.

.

2 8.1 4

1 8.34

1 9.79

1 9.80

2 0 .0 3

1 8.8 5

1 9.7 6

16.71

1 7.5 6

9 .5 6

4 .2 8

I n s u ff ic ie n t f u n d s ....................................

.

R e tu rn ite m s f o r each b a n k ..................... . .
R e tu rn s p er 1 ,0 0 0 ite m s processed . .
Reason f o r re tu rn
.

7.9 7

8 .5 9

9 .4 5

13.71

16.51

1 4.55

2 6 .9 4

2 4 .7 6

2 8 .3 6

3 0 .9 5

4 2 .1 2

............................................. . .

.54

.9 5

1.65

1.14

1.22

1.88

1.75

1.56

1.50

2 .2 5

2 1.4 5

A c c o u n t c l o s e d .......................................... . .

.5 8

.8 3

.8 4

.76

.8 8

1.28

1.36

1.29

1.88

2 .2 0

3 .0 0

Payee m i s s i n g ............................................. . .

.11

.5 5

.62

.13

.19

.36

.2 6

.24

.31

.17

.5 6

.31

.21

.22

.42

.47

.41

.66

.68

.79

1.51

5.11

.12

.14

.17

.16

.25

.10

.35

.20

.78

4 .0 0

.07

.23

.26

.39

.26

.30

.24

.32

.2 7

1.44

E n d o rs e m e n t

Ol

....................................

.

.

Signature ......................................................

.

.

P a y m en t s topped

—

U nable t o locate a c c o u n t ..................... . .

.03

P o s td a te d ......................................................

.

.

—

.04

.02

.03

...

.01

.04

.01

.04

.07

.11

R efer t o m a k e r ..........................................

.

.

—

.04

.01

.01

...

.04

.01

.04

.12

.22

1.22

U n c o lle c te d f u n d s ....................................

.

.

—

.0 4

G u a ra n te e /v e rify a m o u n t .....................

.

.

-

.03

Balance held

.............................................

.

.

-

.02

...

Papers n o t a t t a c h e d .......................................................

.

.

-

.01

~

A c c o u n t g a r n is h e e d .......................................................

.

.

-

A u t h o r i t y c a n c e l e d .................................

.

.

—

M a ker deceased

.......................................

.

.

-

M a ker says r e t u r n ....................................

.

.

—

...

.03

.04

.6 8

.04

.15

.09

.20

.31

.2 3

.0 3

.0 3

.09

.11

.0 9

.02

.47

.3 3

.2 5

.01

.01

.11

.04

.0 3

.03

.44

—

—

—

_

.....................................................................................

S t o l e n ....................................................................................................

—

...

—

—

.01
—
.01

.

.

..

—

...

.01

Send as c o l l e c t i o n ............................................................
Stale date

—

—
...

.01
—

...

—

.02

.01

...

.02

.01
—

.44

.0 2

...

.67
...

—

.0 2

.02

.11

...

.0 2

.05

.3 3

.03

.02

.3 3

—

—

—

—

—

—

—

...

—

—

—

—

—

—

—

...

...

.89

TABLE 2
B a nk size (D em and d ep o sits—IPC, m illio n s o f d ollars)
$1
or
less
N u m b e r o f banks on w h ic h
cash ite m s were d r a w n ...............

............

$1.01
to
$2

$2.01
to
$3

$3.01
to
$4

$4.01
to
$5

$5.01
to
$ 6 .5 0

$6.51
to
$9

$9.01
to
$12

$ 12.01
to
$20

$ 20.01
to
$100

35

121

86

69

68

93

80

68

66

59

9

8 2 .7 8

$ 10 0 .0 1
or
m o re

Average n u m b e r a t Federal Reserve B a nk o f Dallas o n sample day
R e tu rn item s f o r each b a n k

....

............

9 .5 4

1 1.50

13.2 2

16.95

2 0 .5 5

1 9.19

3 1 .8 2

2 9 .3 9

3 3 .8 6

3 9 .3 6

Type o f account
In d iv id u a l c h e c k s ...........................

............

8 .0 2

1 0.20

11.4 8

1 4.32

16.72

16.14

2 6 .6 6

2 4 .5 3

2 7 .4 8

2 8 .0 8

3 6 .4 4

C o m p a n y c h e c k s ...........................

........................8 9

.9 4

1.19

1.66

2 .6 5

1.84

3 .0 5

2.4 7

3 .8 5

4 .9 5

2 5 .0 0
17.78

...........................

........................60

.3 0

.45

.7 7

.78

1.09

1.83

1.97

2 .2 6

5.04

Bank m o n e y o r d e r s .....................

........................03

.0 5

.07

.03

.01

.04

.06

.37

.04

1.05

.89

P a yroll c h e c k s .................................

.......
.......
.......

.01

.03

.17

.38

.0 3

.16

.04

.2 3

.14

1.56

Insurance d ra fts

Cashiers' c h e c k s ...........................
T ravelers' c h e c k s ...........................

—
—

. ..

. ..

. ..

—

...

...

...

. ..

...

. ..

. ..

. ..

...

.01

.0 5

.06

.01

. ..

.10

.11
1.00

Ite m a m o u n t
$ 5 0 o r le s s ............

7 .2 7

8 .6 4

9.6 9

12.10

13.53

1 3.45

22.71

2 0 .9 0

2 3.2 7

24.7 0

4 3 .2 2

$ 50 .01 t o $ 1 0 0 . .

.9 5

1.32

1.78

2.2 0

2.8 5

2 .6 2

3 .8 5

3 .6 2

4 .3 9

5 .7 0

12.45

$ 1 0 0 .0 1 t o $ 3 0 0 .

.86

1.10

1.25

1.83

2.81

2 .0 3

3 .4 5

3 .2 9

4.11

5 .6 2

1 7.78

$ 3 0 0 .0 1 o r m o re .

.4 6

.44

.50

.82

1.36

1.09

1.81

1.58

2 .0 9

3 .3 4

9 .3 3

Free checking, or service-charge-free checking accounts, was the most often mentioned
cause of insufficient funds checks. The respondents believed that free checking accounts attract
the small depositor that maintains an active account with a low average balance. If free-checking
service is a primary factor in generating insufficient funds checks, a change to a realistic service
charge policy could have a significant impact on the return item problem since at least 70 per­
cent of all returns are NSF items.
The return item service charge was a subject about which the bankers had diverse opin­
ions. Some thought that a stiff service charge for each return item would help reduce the num­
ber of returns. Others seemed to think that, because of the amount of income derived from
return item service charges, some banks do little to discourage the customer that writes insuffi­
cient funds checks. Some of these respondents believed that banks following this practice may
not realize that substantial expense is incurred by the other banks in the return item chain. In
this connection, one of the bankers said:
I personally believe that this [return item volume] will con­
tinue to be a mounting problem until such time that bank­
ers stop relying on the return check charge as a major source
of their income. Many of the banks now in t h e ______ .area
charge $5.00 for a return check and by advertising the "no
service charge checking" they attract the accounts that are
more likely to write insufficient checks and more than make
it up on these charges.
Many of the bankers thought that a more thorough investigation of individuals should be
made before opening new accounts. The consensus of the respondents was that more credit
investigations and follow-ups on previous banking connections should be required to help hold
submarginal checking accounts to a minimum.
The use of counter checks, according to the bankers citing this problem area, only invites
the writing of bad checks. Personalized checks provide better identification, and they signify
that the check writer has a bank account.
CONCLUSION__________________________________________________________________________
Generally, then, it is evident that the volume of return items could be reduced, or at
least controlled, by making some policy changes. Changes recommended by the BAI in its 1974
exception item study were:
1. Increase the fees charged to customers for return items.
2. Promote the use of overdraft services.
3. Prohibit the return of insufficient funds checks and "re­
fer to maker" items in certain classifications.
The BAI believes that the return item volume could be reduced substantially if such policy
changes were made by the banking community.
Taking another approach to the problem, there are at least two types of systems in opera­
tion that could also minimize the number of return items. One is being used in Minnesota and
Wisconsin. The system works this way: A central service group requires participating banks to
report all accounts that are closed as a result of bad account experience. The service maintains
a fast-access file of these accounts and can provide information to an inquiring bank in about

7

10 seconds. The system is used primarily to check on applicants for new accounts. The bank
thereby avoids the cost of opening, servicing, and then closing the account of a customer that is
likely to write bad checks.
Since this system's inception in the Minneapolis-St. Paul area in 1971, the rate of badcheck clearings has steadily declined. Many of the local grocery and discount store chains have
reported that in spite of increased sales volume, NSF items passed in their stores have decreased
approximately 20 percent. The Federal Reserve Bank of Minneapolis reported 9.34 returns per
1,000 checks processed in 1970 but an average of only 7.64 in 1973. This system for screening
prospective customers was a major factor in reducing the volume of return items.
Other systems that are in operation provide information about a customer's check-writing
history, with each individual being assigned a rating based on the frequency of his overdrafts. A
system of this type is being used in the Dallas area, primarily by large chain discount and gro­
cery stores. An individual wanting to cash a check at a participating store provides some form
of identification that is transferred to a central service bureau. The customer’s rating is trans­
mitted back a few seconds later via computerized network, and the likelihood of the store cash­
ing a bad check is minimized. This same system could be utilized by banks. It is relatively inex­
pensive and would be effective in preventing bad checks from entering the check collection
system.
Bankers are urged to review their return item policies and practices, especially in the area
of individual checks for less than $50 that are returned because of insufficient funds. Return
item processing costs can represent an unnecessary drain on bank profits, but adoption of more
definitive policies would help eliminate a major portion of these costs.
Bankers are also encouraged to recognize that policies to reduce the return item volume
must be adopted by all banks before they can be fully effective. Implementation of the recom­
mendations made by the BAI, for example, will require individual banks to change their pro­
cedures in the belief that others will change theirs.
Policies to limit return items could result in near-term benefits for the entire banking
industry. In addition, however, they would give the industry time to encourage equipment
manufacturers, EFTS committees, and related groups to develop return item processing meth­
ods that are less labor-intensive.

8


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102