The end of Cheques? - Treasury Contents

Written evidence submitted by Peter Farley, FCIB

EXECUTIVE SUMMARY

  1.  This memorandum makes five recommendations and provides background information to support why these conclusions were reached.

  2.  Cheque clearing in the UK is systemically important and therefore it is crucial that any approach to eradicating the cheque payment method must be well managed. It must also protect the integrity of a banking system that has recently been struggling with its reputation.

  3.  The detrimental impact on the environmental of cheque clearing processes has to be taken into consideration. In spite of adequate legislation, processes have not been adopted or evolved to minimise the carbon footprint associated with the huge volumes of paper that currently require movement. Although the demise of cheque clearing is forecast for 2018 the assumption by studying consumer needs in various societal groups is that cheque, or a very similar instrument, is a necessity beyond this date. Therefore the present and continuing impact on the environment should be tackled at the earliest opportunity.

  4.  Consumers that use cheque find it a more convenient, inexpensive and less onerous to operate. It continues to use postal services for the 20-30% of consumers who do not have an internet connection. Using cheque should not be penalised by excessive charges by utility providers and others.

  5.  The current UK cheque clearing model makes our payments scheme vulnerable to a variety of natural hazards or malicious events. Moreover, the early declaration of the end date for cheque is likely to weaken the potential for continuity of knowledge and expertise, with an exodus from the industry to seek new careers. Suppliers that provide cheque processing will already be tailoring any advice about choices in a dying industry sector to maximise the large investment they have made or may need to continue to make, protecting the incomes they expect.

  6.  Maximum efficiency, one of the requirements of any payment system, should remain the crux of managing the decline of cheque payments. Carefully thought out strategies are needed that guide the natural decline without unscrupulous coercion from to reduce cheque payments more rapidly. The same or an even more efficient item value collection timescale, under current 2-4-6 rules, should be a goal throughout the decline of cheque.

  7.  Legislation has given banks the opportunity to implement all the benefits of an automated cheque clearing system, placing it alongside the majority of other European countries and a large number of major countries worldwide. Unfortunately, so far, the industry has chosen short term gains and is now faced with major problem based on inefficiencies. The knee-jerk reaction appears to be that abolition will save more face than fixing the situation.

  8.  This memorandum recommends the coming together of two payment schemes, Bacs and Cheque and Credit Clearing, providing an automated payments system that also supports the continuation of cheque for those in the community who need and choose to make payments in this way.

INTRODUCTION TO THE SUBMITTER

  9.  My submission of evidence to the Committee is as an individual who has extensive professional experience as a payments sector specialist. I have not only worked for more than 25 years in a financial institution, but also represented that entity at industry level as a Director of Cheque and Credit Clearing Company Limited for more than seven years. From this experience I have developed a strong technical background that enables me to analyse the potential impact of the Payments Council publication "The Future of Cheques in the UK".

  10.  The UK is participating in an extensive programme of integration at European level to ensure that its banking instruments are in line with EU regulatory development. As a subscriber to the Single European Payments Area, the UK is also attempting to bring a cohesive solution to its population that is well-functioning where methods of payment have low transactional costs that are economic for consumers and profitable for banks.

  11.  My profile is attached to the memorandum as Annexe 2.

PROVISION OF RELEVANT INFORMATION

  12.  The committee are looking to understand cheque trends overtime the base line must be the figures from the Payments Council where they have publically predicted 550 million items a year, 2.5 million per day in 2018. This would be the natural rate of decline but we may find a level of resistance above this level. Historically the numbers published only relate to The English and Scottish Clearings, what has not been provided is the breakdown across the different centres. (England, Scotland & Northern Ireland) Do cheques decline equally across the country or do some areas favour cheques. The publication of an end date is mainly trying to accelerate the rate of decline, this is expected to be further increased by strong pricing measures, similar to the consumer experience in the Netherlands when they truncated.

  13.  The committee are looking to understand the impact of abolishing cheques on particular groups in society. All new payment mechanisms must allow for the fact:

(a) Over 20% of the UK adult population to not have secure internet access.

(b) The replacement of all UK mobile phones to allow for new payment mechanisms is unrealistic within eight years, many families share phones.

(c) Access to bank branches in not always easy or convenient for a majority of customers.

(d) Phone banking is still not considered secure by many.

(e) As direct credits already exist in the Bacs scheme, the introduction of a new form would be confusing and would also not resolve the above issues.

  14.  In respect of development of alternative payment mechanisms, it's not too late to create a solution for the UK that tackles the issues in this memorandum which allows for the closure of the clearings, the continuation of cheques, while allowing a for further natural decline beyond 2018. This can be done by combining cheque payments with the Bacs direct debit scheme, making this a quick low risk solution to truncation while achieving kudos for modernising cheque clearing.

RECOMMENDATIONS FOR ACTIONS

  The following recommendations are proposed, based on the need to have a professional, controlled and streamlined approach during the anticipated decline in cheque numbers.

  Annex 1 provides extensive background information in relation to the formulation and purpose of each recommendation.

A. Consider an immediate truncation of the clearing system to establish a modern clearings process operating from now until 2018 and longer.

B. Examine how the payments industry can integrate and merge two payments schemes—Bacs and Cheque and Credit Clearing, highlighting the cost savings.

C. Ensure that cheque clearing standards are maintained or improved throughout the decline in cheque volumes, the consumer is not penalised, and the image of the UK banking system is maintained.

D. Urgent consideration should be given to reducing the unacceptably high carbon footprint of cheque and credit clearing.

E. To consider the impact of clearing arrangements on postal orders and traveller's cheques payments.

Annex 1

COMMENTARY ON THE RECOMMENDATIONS

  A.  Consider an immediate truncation of the clearing system to establish a modern clearings process operating from now until 2018 and longer.

Recommendation No.	Background Information
A	1.  Banks should seriously consider the need for them to spend hundreds of millions of pounds over the next eight years. With a significant increase in transactional costs that will be passed onto customers. The Bank of International Settlement definition is "A well functioning payment system should enhance the stability of money transmission facilities, lower transactional costs and make efficient use of resources, improve the financial position and facilitate the conduct of monetary policy". With a fraction of the anticipated expenditure, the Council could be instrumental in achieving the benefits of an integrated and simplified Truncation system, while setting up its proposed "Direct Credit" system. Sweden is a good example of this route. The Swedish central bank realised many years ago that to drastically reduce cheques you first have to automate the process. This way consumers gained confidence that the electronic equivalent of a cheque would follow the same process. They still have a small volume of cheques processed by their systems today, in a far more efficient customer-centric proposition than is being discussed.
	2.  The current modus operandi of the clearings can be subject to a number of risks that have a significant impact on its ability to perform to its contracted standards. These include fuel shortages, blockades and strikes, the impact of freak extreme weather conditions such as high winds, snow and floods that cause interruptions in transportation. The risk of lost or delayed items or batches due to vehicle accidents, fires, breakdowns and terrorism. A further significant risk is the likely brain-drain that the announcement of the demise of cheque will herald. The current status of the cheque clearings has already reached the situation where the banks are no longer the operational experts, the intellectual property and control has been placed with a few companies that potentially have a conflict of interests.
	3.  The truncation of cheques would achieve the vision that was set over 50 years ago when the 1957 Cheques Act was passed and more recently enabled further by the 1996 Deregulation of the Bills of Exchange Act. The self regulation by the Banking sector, as highlighted by the Jack Committee Report (1989) and later by the Cruckshank Report (2000), has caused the cheque system to become out-dated and costly. There is a need for monitoring and control to be firmly placed in the hands of the British Government and the Bank of England.
	4.  Banks have considered Truncation (ie to abandon the need to transport paper vouchers and switch to exchanging electronic images and codeline plus cheque value information) on a number of occasions but have always thought that the financial implications were too high. In hindsight, had they developed the truncation model they would probably have had a return on investment within a relative short period.
	5.  All banks except Santander have outsourced their cheque processing and all are involved in fixed term contracts with their service provider. This contractual obligation entered into by the banks will require them to negotiate a common end date. Was this part of the commercial decision for 2018?
	6.  The Payments Council has alluded that a solution will have to be found for the remaining cheques in use after 2018. Unless this was based on Truncation it would again be costly and not productive in a declining market. Sweden, who are put forward as a model country, went through the cheque truncation route and even today the small number of cheques written in the country are able to use a national truncation system, where any cheque can be cashed at any branch of any bank. The Truncation system they set up also allows for an efficient route for paper "direct credit payments", which are proposed in the National Payments Plan.
	7.  The final decision on the closure of the UK cheque clearings has been publically put off until 2016. This must be seen as a risk-containment exercise as the methodology being promoted by the Payments Council seems to be based on eliminating cheque volumes by whatever means it can. However without an alternative payment method with an equally tangible audit trail, cheque numbers may not be killed off quite so easily. Truncation is a more risk-free and has a flexible option that is readily available, with many examples of success around the world
	8.  Denmark and Belgium underwent the truncation route in the 1980's with the result that cheques are still an available facility for customers. Spain, Italy, France, Portugal and Luxemburg have adopted a two tear approach where low value payments are truncated but high value payments have to be supported by an image or the physical item. A common message that is coming across appears to be that the countries that have successfully reduced the volumes of cheques and maintained the transactional cost during the decline have developed a truncation solution. The Netherlands with the use of high pricing and aggressive actions by the banks appear to be the exception.
	9.  Examples of countries that have either truncated or are in the process of conversion: Singapore— 2003 > completed Malaysia—2008 > completed Spain—2003 > completed Portugal—2003 > completed Kenya—2010 > ongoing Turkey—2005 > completed Hong Kong—2003 > completed New Zealand—1995 > completed Sri Lanka—2005 > completed India—2008 > ongoing target 1.2 billion cheques per annum

  B.  Examine how the payments industry can integrate and merge two payments schemes—Bacs and Cheque and Credit Clearing, highlighting the cost savings.

Recommendation No.	Background Information
B	1.  This is a highly beneficial method in which to potentially manage cheques and other paper-generated payment instructions. Possibly supported by the 1996 Deregulation (Exchange of Bills) Act. The core provision of the order, Article 4, amends the 1882 Act to allow notification of the essential features of a cheque by electronic data to be sufficient to obtain payment. It would provide the UK with a system that utilises the existing Bacs process, which is a tried and tested automated payment solution. This method would provide cost benefits quicker and with greatly diminished risk. It would allow businesses, groups and individuals within the community that traditionally prefer cheque payments to continue using cheques and postal orders for one-off payments. The clearing exchange centres can close prior to 2018.
	2.  A cheque would be converted into an electronic Bacs payment by treating it as a one-off Direct Debit mandate. This methodology was identified by SEPA (Single European Payment Area) as a necessary component for an adequately flexible direct debit payments system. This customer focused feature is currently missing from the UK Direct Debit payment rules.
	3.  Cheques and Direct Debits are both "pull payments", where the receiver of the funds pulls the value from the payer's account. The idea would be for a cheque payment to be designated as a mandate to initiate a Direct (cheque) Debit. This would allow industry users of the Direct Debit schemes to process cheques in the same way as other payments. If these items are returned they would also follow the Direct Debit rules, allowing industry to have a single method of adjusting, communicating and servicing customer accounts, policies etc.
	4.  This would make a considerable saving to initiators of Direct Debits, as a single system would prevail. Banks already allow these companies to manage and retain mandates. Allowing them in addition to manage the envisaged cheque mandates would effectively implement cheque truncation. I can envisage new services and more automation developed by the initiating company, while drastically reducing their costs
	5.  Existing cheque payments made at banks and building societies could continue, with financial institutions utilising the Bacs Direct Debit infrastructure. In this case they may have to consider the need to send images to the paying bank, for all or just high value payments. The use of the IBDE (InterBank Data Exchange) network may be a temporary solution.
	6.  The Payments Council is in a strong position to ensure that cost efficiencies are achieved by bringing various schemes and infrastructures together. Using the Bacs infrastructure is an opportune method that would negate the need to develop another new, replacement or "coping mechanism" for cheques beyond 2018.
	7.  The National Payments Plan 2008 has already alluded to the introduction of a "Direct Credit", paper-based process for which payments would then be made via internet banking or at a bank or post office. A giro-style (one-off payment) voucher would be issued and the payment information would be sent electronically from the point of payment to the creditor's account. (This is a method of paper truncation at the paying branch or office, is similar to the Swedish Model). To make these payments via the Bacs system would be a more beneficial solution. One-off bill payment facility systems have been in existence for over 20 years and although have contributed to the reduction in cheques it does not have the same resilience as the Direct Debit approach. It is noteworthy that the Direct Credit process would not direct the payment immediately to the creditor's account. An incorrectly transmitted credit transaction is both costly and difficult to recover for the consumer, when they in essence can confirm they have in good faith paid the organisation.
	8.  The advantage of using a Direct (cheque) Debit is that if an organisation changes its banking arrangements and wants payments sent to another bank or account, its customers will not need to initiate new instructions. The corporate customer is able to make decisions on their banking arrangements, knowing that they control the collection of funds.

  C.  Ensure that cheque clearing standards are maintained or improved throughout the decline in cheque volumes, the consumer is not penalised, and the image of the UK banking system is maintained.

Recommendation No.	Background Information
C	1.  To meet the timescales of the 2-4-6 rules, as required by the OFT, the Clearing Banks have time-limited contracts with suppliers to provide transportation and processing at centres. To a considerable extent it appears that the timing of closing the clearings is based on these contractual relationships rather than looking for ways to improve payment systems in the UK.
	2.  Any single bank could remove the chequebook from their product range, but to do so would result in a loss of customers. It appears that this risk is too great for individual banks to take either now or in the next decade. The actions of the Payments Council appear to be a tactic to achieve cheque removal without any bank needing to break rank. Allowing them to work in concert. The OFT might wish to examine whether the Banks are hiding behind the Payments Council on this matter.
	3.  The Payments Council has declared that the potential savings to corporate customers that cease to use cheques will be in the order of £750 million per annum. But the Council has also stated that "as for the calculation of bank savings, this figure will reduce over time beyond 2018". As Banks will continue to have expenses associated with cheque clearing, it would seem that the direct impact of this will be to force up the transactional cost to the consumer who continues to choose to pay by cheque as cheque volumes fall. In opposition to the expectations by The Bank of International Settlement.
	4.  The banks have already significantly increased charges levied on corporate account holders relating to cheques to ostensibly pay for the previous decade of cheque decline. Are banks going to be permitted to continue to increase transaction charges rather than be encouraged to adopt new technology and simplify methods? There are clear examples emerging of coercion as a means to discourage cheque use. (This was the similar model adopted by the Netherlands to precipitate the eradication of the cheque.)
	5.  Businesses and the public who wish to pay by cheque are being penalised. BT is charging £9 per cheque to businesses and £6 to personal account holders to process each cheque remittance. Consumers who pay by cheque often do so because they are unable to use other methods such as the internet. Although the percentage of households with an internet connection has slowly risen to an average of 70% in 2009 (80% in London) according to the Office for National Statistics, there are likely to remain pockets in society that do not engage with or assimilate the necessary skills to make electronic payments.
	6.  The credit crunch and enormous losses incurred by banks in the UK has tarnished its reputation. With two banks now under public ownership, the Payments Council must be prudent in the steps it takes in respect of cheque. Any action must be carefully considered and planned in risk-free phases to ensure its success, without U-turns and other embarrassments to the Government.

  D.  Urgent consideration should be given to reducing the unacceptably high carbon footprint of cheque and credit clearing.

Recommendation No.	Background Information
D	1.  One or more transportation phases take place by road, rail, air and sea during the clearing process. The current processing model has three exchange centres in Milton Keynes, Belfast and Glasgow. Cheques and credits are transported from bank branches or direct from customers to the processing centre their Agency or Clearing Bank utilises. A secondary dissemination takes place to move payments to the clearing centre for the region (UK, Northern Ireland, Scotland) where the bank on which it is drawn is located.
	2.  Bacs commissioned Carbon Footprint Limited to assess the carbon emissions of a monthly Direct Debit. This concluded that a Direct Debit can result in 94% less carbon emissions that a cheque payment. This statistic seems to have been conveniently ignored so far by the cheque and credit clearing industry and suppliers. This statistic alone should bring about the immediate change to the processing model and as rapid as possible implementation of Truncation and the system proposed in this Memorandum for Direct (cheque) Debit to replace cheques. There is an urgency that cannot be under-estimated.
	3.  During the reading in the House of Lords of the Deregulation (Bills of Exchange Order) way back in 1996 Lord Mackay of Ardbrecknish made the following comment "It is high time that the 1882 Banking Act was reformed. The idea of lorry loads of cheques traversing the country throughout the night from one set of banks to another in this modern day is long past its sell-by date".
	4.  In the Daily Hansard for 13 and 25 January 2010 Sarah McCarthy-Fry is quoted as saying: "The closure of Cheque and Credit Clearing is a commercial decision and one that the Payments Council, an independent body that sets the strategy for UK payment systems, will take." Environmental considerations should rank higher than the purely commercial needs of an organisation that has already missed opportunities to modernise its industry

  E.  To consider the impact of clearing arrangements on postal orders and traveller's cheques payments.

Recommendation No.	Background Information
E	1.  Postal orders allow people to send money securely without the need for a cheque. They can be used to pay bills, or shop by mail order. It is possible to buy or cash a Postal Order in 47 countries, worldwide. They provide protection against fraud as no personal data required and can be paid into a bank account
	2.  Postal Orders have regained popularity, especially as a form of payment for shopping on the Internet as they are drawn on the Post Office's accounts so a vendor can be certain that they will not bounce.
	3.  One of the main benefactors of the demise of cheques and postal orders would be PayPal—the company that was developed to enable payments on "e-bay". Interestingly they hold a voting position on the Payments Council.
	4.  As traveller's cheques do not need a bank account to be held in the currency of issue, they are popular with tourists coming to the UK, so that carrying money can be avoided. There are certain circumstances when overseas credit and debit cards are not readily accepted or can be less prevalently used in the country of origin.

Annex 2

PROFILE

PETER FARLEY, FCIB

BUSINESS AND TECHNOLOGY SOLUTIONS DESIGN AND IMPLEMENTATION

2.1  PROFESSIONAL ROLES

1977-2006	Senior Management—Nationwide Building Society
1999-2006	Director—Cheque and Credit Clearing Company Ltd (C&CCC)
2006-ongoing	Independent Payment Consultant

  Peter has a wealth of banking and financial sector experience, gained through a career which spans roles at Branch and HQ level, in an influential Clearing Bank. He has worked on business strategy as well as technology design and implementation, giving him a broad spectrum of insights into process development and management. His representational role in the UK Payments Industry governing body raised his perspective for analysis to industry level.

2.2  BANKING AND PAYMENTS INDUSTRY EXPERIENCE

— Current Account (Implementation)—technical design and implementation

— Return Cheque Process—conception and execution

— ATM initiated Bill Payment facility—design and implementation

— BACS—technical project management for entry as full member

— UK Cheque & Credit Clearing system—management of entry strategy & implementation

— Image-Based Clearing System—championed and participated in Steering Board for conversion

— Integrated Payments blue-print—technical architecture design team leader

— Payments Strategy—UK clearings, recommendations to and from industry bodies

2.3  PAYMENTS INDUSTRY ADVISER (THROUGH DIRECTORSHIP C&CCC)

— Develop Industry plans for the future of cheque processing

— Chaired Technical Implementation Committee

— Review of Interbank Data Exchange standards

— Business & Technical Truncation Pilot (between NBS and Abbey National)

— OFT review of UK payments industry—Cheque Working Group (2006)

— Speaker at payments industry and Cheque Forum events

Annex 3

COMMENTARY ON CHEQUE LEGISLATION

  3.  The banking industry has been pushing the various governments over the past 50 years to allow them to modernise the cheque clearing processes:

3.1 Cheques Act (1957) this act enabled the cheque payment industry to take advantage of the then latest technology Section 89.—(1) A banker may present a cheque for payment to the banker on whom it is drawn by transmitting, by electronic means, an image and the electronic payment information of the cheque, instead of presenting the cheque itself.

3.2 Cheques Act (1992) this act enabled the cheque payment industry to resolve the issue associated with the Bill of Exchange Act (1882) which allowed cheques to be endorsed across to other people. This ensured that cheques were crossed and paid into bank accounts.

3.3 Deregulation (Bills of Exchange Order) 1996—Following on the recommendations by the Jack Committee 1989 again freeing up the cheque payment industry to make the appropriate efficiency gains and promote the efficient use of financial resources. The core provision of the order, Article 4, amends the 1882 Act to allow notification of the essential features of a cheque by electronic data to be sufficient to obtain payment. This will allow banks and building societies to retain cheques at an earlier point in the clearing cycle instead of having to send them to the paying branch. These changes will allow banks to adopt new, up-to-date and cost effective practices, and help them offer customers a more efficient service

  3.3.1  Treasury Minister Angela Knight said "Response to our proposals has been very encouraging. We can now get rid of the outdated rules that prevent banks getting the maximum benefit from modern computer technology and communications." Paperless settlement of cheques—or "truncation"—is already commonplace in many European countries. The main details of a cheque can be transmitted and cleared electronically, making the physical presentation of a cheque unnecessary. UK banks are already computerised, but they must still present cheques physically at the paying bank branch under current law.

  3.3.2  During the reading in the House of Lords—Lord Mackay of Ardbrecknish made the following comment "It is high time that the 1882 Banking Act was reformed. The idea of lorry loads of cheques traversing the country throughout the night from one set of banks to another in this modern day is long past its sell-by date".

3.4 Cheques (Scotland) Bill (2000) allowed the Scottish Banks the flexibility of not having to reserve funds to allow for a dishonoured cheque being represented to have those funds earmarked.

February 2010

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Prepared 16 April 2010