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F ederal Reserve Bank of Dallas DALLAS, TE X A S 75222 C i r c u l a r No. 78-47 A pril 21, 1978 TO ALL BANKS AND OTHERS CONCERNED IN THE ELEVENTH FEDERAL RESERVE DISTRICT: For some time now, th e Bank A dm in is tra tio n Institu te , A m erican B a n k e r s A ss o c ia tio n , a n d Federal R e s e r v e System h a v e b e en w o r k in g t o g e th e r , t h r o u g h a g r o u p known a s the J o in t I n d u s t r y Exception Item T a s k F o rce , on a p ro g r a m to r e d u c e th e p ro b le m s a n d c o s ts a s s o c ia t e d with in te r b a n k c a s h letter e r r o r s . S ta n d a r d i z e d p r o c e d u r e s a n d forms w e r e d e v e l o p e d a n d t h e i r e ffectiv en ess m e a s u re d t h r o u g h a pilot t e s t in vo lvin g some 80 b a n k s a c r o s s the nation. Data g a t h e r e d d u r ing th is te st in d icate th a t all b a n k s , r e g a r d l e s s of s ize , would be n efit from adoption of th e p r o p o s e d s y s te m . Since a key ele m ent in the p ro g r a m is a h igh d e g r e e of s t a n d a r d i z a t i o n , th e am ount of in d iv id u a l b a n k s a v i n g s is d e p e n d e n t on the total n u m b e r of b a n k s that a d o p t th e p r o p o s e d m eth ods. In a n effort to a c q u a i n t a s many b a n k s a s p o s s ib le with the p r o g r a m , the Bank A d m in is tra tio n In stitu te (BAI) is p l a n n in g a s e r i e s of h a lf-d a y t r a in in g s e s s io n s t h r o u g h o u t th e c o u n t r y , c o v e r i n g the re com m en d ed p r o c e d u r e s a n d s t a n d a r d i z e d fo r m s . Each s e s s io n will be s p o n s o r e d by a local BAI c h a p t e r a n d many will b e a tte n d e d b y Federal R e s e r v e c h e c k a d ju s t m e n t s p e r s o n n e l . Additional inform ation, in c lu d in g locations of t h e s e s e s s i o n s a n d in d iv id u a ls to c on tact r e g a r d i n g d e t a i l s , will be r e l e a s e d b y BAI soon. T h e e n c lo se d r e p r i n t of an a r t i c l e w r itt e n for Bank A dm inistration M agazine b y Walter W. Stafe il, BAI P r in c ip a l S yste m s S p e c ia list, in c lu d e s an o v e r view of th e c o n s i d e r a t i o n s a n d re c o m m e n d a tio n s, a s well a s the r e s e a r c h th a t led to th e d e v e lo p m e n t of th e s t a n d a r d i z e d p r o c e d u r e s a n d fo rm s. I hope each b a n k in the Eleventh D is tric t will a tte n d one of the t r a i n i n g s e s s i o n s a n d p a r t i c i p a t e in the p r o g r a m t h r o u g h ad o p tio n of the p r o c e d u r e s a n d form s. S in c e r e ly y o u r s , R obert H . Boykin F irst Vice President E n c lo s u re This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) 9~umuu 55558 Joint Industry Exception Item Task Force Recommendations By Walter W. Stafeil Principal Systems Specialist B ank Administration Institute Park Ridge, Illinois items and adjustments. An over view o f the considerations and recommendations of each working group and of the full task force fol lows. Reject Working G roup In251973. nearly three out of every checks written became ex ception items (MICR rejects, re turn items and cash letter adjust ments). These exception items in creased the industry’s 1973 total direct check processing cost by 25% or $285 million. These find ings are from a BAI research study which also projected the industry’s cost of handling exceptions would grow to $1.6 billion by 1980 unless actions were initiated to reduce either the volume or processing cost of these items. BAI initiated a number of studies to investigate possible im provements for the processing of these items. The results were pre sented at an Exception Item Con ference in March. 1976. Based upon the feedback from confer ence attendees, a Joint Industry Exception Item Task Force (JEITF) was formed to identify and pursue feasible solutions to the exception item problem. The JEITF was sponsored by Bank Administration Institute, the American Bankers Association and the Federal Reserve System, and was comprised principally of bank operations personnel. It was divided into three working groups, each dealing with a specific area of exception items: Rejects, return The reject working group inves tigated five possible solutions to al leviate the problems associated with the handling of MICR rejects. One solution was for the indus try to utilize the regulatory agen cies to monitor reject rates. If a bank’s reject rate exceeded an es tablished standard, the fact would be recorded and brought to the at tention of senior bank manage ment. The working group did not recommend this action because of the difficulty in defining and estab lishing a standard reject rate for different types of equipment and various methods used to calculate reject rates. The use of dual or redundant MICR lines on each check was also studied. With two sets of MICR characters, a digit that could not be read in one set might be read in the second set. The cost of placing two MICR lines, the extra reading head needed and the software cost far exceeded the benefits to be gained. Thus, this consideration was eliminated. The third solution was for each federal reserve bank to produce a monthly report showing in ascend ing sequence the reject rate for each bank it processed items for. The reject rate would be deter mined from the cumulative number o f items processed and would identify the bank’s name. The working group anticipated that this report would stimulate each bank to improve its perfor mance. Another positive effect would be its impact on machine vendors. Bankers would be able to compare the rate from their pres ent equipment to other vendors’ equipment, and this would act as an incentive for manufacturers to maintain quality. The working group recom mended that the Federal Reserve Banks issue monthly reject re ports. However, the ranking would be eliminated because the assign ment of a numerical rank implied a judgment concerning relative per formance. The monthly reports would contain the following infor mation: ■ Highest reject rate experi enced from a bank during that month. ■ Lowest reject rate experi enced from a bank that month. ■ Average reject rate for all banks during that month. ■ The individual bank’s reject rate experienced by the Federal Reserve Bank during that month. The Federal Reserve System agreed to produce the report and has completed the necessary pro gramming. At this time most banks in the nation that send items to a Federal Reserve office are receiv ing it. The fourth solution studied was in the area of quality control. The working group’s initial intention was to create a quality control handbook containing the do’s and don’ts of MICR processing. This guideline would assist banks in es tablishing a quality control func tion and/or improving the effec tiveness of existing quality control units. After much discussion the work ing group recommended that all The Return Item Working Group studied prevention, endorsement, standardization, extended deadlines and automation of return items; the cost, volume and implementation time of each were considered. banks adopt and implement a qual ity control program. The handbook was not produced, but a strong recommendation emerged that an industry group be formed to pro duce these guidelines. The fifth area o f study con cerned full MICR line reject re pair. Full reject repair is defined as fully reencoding the complete MICR line on add-on stripes” or “ carrier envelopes” for items that rejected during the first pass on automated reader/sorters. Fully repaired items should be able to be read by subsequent high-speed processing equipment and should be no different from the original encoded items. Both are MICR encoded according to check specifications, and each item should have the complete MICR line encoded. While the working group concluded that full reject re pair. accepted industrywide, could reduce the cost of processing re jects. it cautioned banks about the disadvantages inherent in the cur rent state of the art. A number of legal issues are in volved with full repair when the MICR line is reencoded. One type of encoding error occurs when the repairing bank misencodes either the routing number or the dollar amount. This type of error is simi lar to what can happen today. An encoding error in the routing field would cause the item to be misrouted but eventually found. An error in the dollar amount field should be discovered during rec oncilement. The unknown liability occurs when an encoding error happens during the repair of the on-us field. If an erroneous account number is encoded on the repaired item, the possibility exists that the item could be posted to the wrong ac count. While there are some safeguards in this process—a check digit may cause the item to be unposted, or the error may create an overdraft which might be discovered while returning the item, or the error might be discov ered during check filing—the legal liability is unknown. It is impor tant to note that this error would only effect debits. Credits are not processed by other banks. The working group encourages banks within clearing house associations that have the equipment to repair reject items fully without manual intervention to repair these rejects. However, it cautions participating banks to be alert to the legal issues if an error occurs and to establish agreements for this liability prior to implementing full reject repair. Return Item Working Group The Return Item Working Group began its task by identifying four measures that could reduce the ef fects of return items. The mea sures studied were prevention, en dorsement standardization, e x tended deadlines and automation of return items. The cost, volume and implementation time of each measure were considered. The prevention of return items involves aiding banks in identify ing accounts that may cause them. By publicizing services that pre vent return items, the overall vol umes could decrease. Various techniques were studied: Identification codes, new account services etc. Prevention was not recommended as a na tional solution, but instead as one that is more effective on the local level. Banks in local areas should participate in various plans to re duce the number o f these ac counts. The second measure considered was the standardization of en dorsements. A proposal for a standard endorsement specifica tion was drafted that called for the identification of the bank of first deposit, or first encoding bank, on the reverse side of a check in a clear band area. All subsequent bank endorsements would be * placed sequentially in another area on the back of the check through the use of a symbol, with the technology prescribed by the ANSI X-9 Committee. The endorsement specification was developed as an evolutionary specification. That is. as banks modified their proof machines to place their endorsements in the clear area, the first step toward e n d orsem en t stan dardization would occur. As more banks mod ified their machines, the current problems associated with identifi cation of the bank of first deposit would be reduced. If a method for identifying sub sequent endorsements is de veloped through ANSI, the indus try could then comply with the specification and a major problem associated with the processing of return items would be minimized. The third measure studied was the automatic processing of return items. This proposal was to return items directly to the bank of first deposit. All items would be qual ified with routing number of the bank of first deposit and the dollar amount. With the use of either add-on stripes, color-coded carrier envelopes or another MICR clear band on the check, the items could be sorted by reader/sorters and then routed through the Federal Reserve’s check processing sys tem. The working group deter mined that, while the concept was appealing, the standardization of endorsements was necessary be fore it could recommend the entire industry pursue this solution. The fourth measure studied was the return item deadline issue. A proposal presented at the Excep tion Item Conference was to ex tend the present 24 hours from midnight of the day the items were received to 72 hours for nonsuffi cient fund items under $25 in value. The proposal to extend the return item deadline offered a sig nificant reduction in cost while limiting the loss exposure of the paying bank. An overwhelming majority of the participants at the conference indicated support for the proposal and that their banks would cooperate by accepting late returns from other banks in their areas if the proposal were adopted. A number of factors contributed to the conclusions drawn by the working group; and in some in stances they were not related to the statistical data. The reasons included the emotional impact of delaying returns on customers, the marketing policy of different banks and operational control considera tions. After careful evaluation and col lection of additional information, it appeared that control problems would be monumental and require costly system changes with a 72hour deadline. A 48-hour deadline appeared to be more controllable and less costly to implement. The group also considered that, for this proposal to be effective, a larger share of the total N SF volume should be included. The results of the 1974 NSF survey showed that nearly 45% of all NSF items were under $25 in value and that nearly • ■ ■ ■ ■ 80% were under $100 in value. Because of the legal implications of the UCC and Regulation J. this recommendation should be im plemented at the local level. The working group encourages local clearing house associations to pur sue this recommendation. Clearing house associations electing to amend their deadline rules will find legal support for this action in Sec tion 4-103. paragraph 2 of the Uni form Commercial Code. Since there is no track record in this area, clearing house associations accepting this recommendation are requested to report to the task force the overall effect of the change during the first year. Adjustments Working Group The A d ju s tm e n ts W orking Group was charged with the re sponsibility for determining methods of reducing the volume of adjustments (and thereby their re lated cost to the industry) and proposing standardized adjust ments procedures and forms in cluding testing their validity, cost justifying their impact and guiding their implementation on a national basis. The procedures and forms studied by the adjustments work ing group had been reacted to and reviewed at the Exception Item Conference. A majority of the at tendees felt that the concept of adjustments standardization would be beneficial to the banking indus try. After considering the feedback from the conference attendees, the working group reduced the number of procedures originally presented from 12 to seven and the number of forms from 15 to three. The seven procedures and three forms relate to the adjustments caused by interbank errors. The custom er/bank procedures and forms were eliminated because they are an individual bank’s policy issue. The working group discovered no reliable data to use in studying the impact of adjustments upon banks and upon the industry in to tal. Statistics were not available to determine the average days an item is outstanding, average dollar value per adjustment, lost invest ment opportunity to the industry for funds associated with adjust ments. rate of backlog increase or decrease, volume in dollar data by classification of adjustments, or ■ ■ ■ ■ ■ impact on volume and dollars if ad justments are made on a direct debit/credit to a Federal Reserve Bank rather than requesting a debit/credit. The working group recom mended a pilot test to collect the information necessary for compar ing the current industry proce dures for resolving adjustments with the proposed procedures and forms along with their impact upon adjustments on an industrywide basis. Eighty banks that participate in BAI’s annual Check Collection Performance Measurement Survey were asked to perform the test. They were divided into two groups—control and test. Control banks processed their adjustments using their current systems and forms. Each bank tracked every adjustment it processed during the test and summarized all adjust ments during the reporting period. Test banks tracked every adjust ment they processed in the same manner as the control banks; how ever. their procedures for resolving adjustments were quite different. When test banks resolved an ad justment between another testing bank or through participating Fed eral Reserve Banks, they followed the procedures revised by the working group and used the pro posed forms. Only when testing banks resolved items between nonparticipating banks and Fed eral Reserve Banks did they use their current procedures and forms. Prior to conducting the test from the middle of March. 1977 through April 30. 1977. a training meeting was held in Chicago to re view the procedures and forms that would be used during the test. The pilot test yielded a number of measurements with regard to adjustment processing. The analysis indicated that all banks, regardless of size, would benefit by following the proposed proce dures and forms. The average number of days an item was outstanding was 1.6 days less between test banks and 0.7 days between test and control banks. Banks that processed fewer than 2.000 adjustments during the test gained the most benefit. The adjustment test identified numerous benefits if the proce dures and forms were used to re solve interbank differences. Each bank could improve its control of adjustments, install a productivity measurement technique in its ad justment area, improve the interac tion between management and ad justment staff and participate in an industry effort to solve the prob lems by using the standardized procedures and forms. The standardization would also produce a number of other benefits such as reduction of total outstand ing adjustment dollars, reduction in cost of forms, easier training of adjustment staff, standardized manuals, reduction o f followup correspondence, reduction of staff to resolve adjustments, and fewer charge backs to customers result ing from a reduction of the number of late charge backs and a reduc tion of number of items outstand ing during reconcilement. Based upon the information de veloped during the adjustment test, the Adjustment Workihg Group recommended that the in dustry implement the following six procedures and three forms to re solve differences between com mercial banks and Federal Reserve offices: Procedures Free item Loose items Missing items Listing error adjustments End point sort adjustments Encoding errors Forms Request for claim or debit-credit Request for credit-debit Loose item notification The post sending procedure was not recommended. The procedure was designed to eliminate dupli cate paperwork during the test. However, it contributed to extra paperwork and increased the number of days an item was out standing. For these reasons the working group only recommended the procedures listed above. Conclusion The task force believes that banks adopting its recommenda tions will improve their ability to process rejects and return items. Industry improvement will only occur if banks work together cooperatively to solve problems. The industry will continue to be plagued with the complex system presently used to resolve adjust ment if only a few banks imple ment the procedures. If many banks implement them, however, they and the industry in general will achieve benefits. At some point in the future the present complex nature of resolving ad justments can be simplified, and the industry will then be able to di rect its attention to solving other industry problems. ■ Reprinted from April, 1978 THEM AGA ZINE OF ia(*TMnistration PUBLISHED BY BANK A D M IN IS T R A T IO N IN STITU TE P.O. BOX 500, PARK RIDGE, ILLIN OIS 6006S
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