Regulation CC: Check This Out

ERM / CMS

Until last year, Regulation CC had not changed in about a decade, which allowed us to become comfortable with the regulation and how check processing should operate. However in May 2017, the Federal Reserve Board announced updates to Regulation CC that are effective in July 2018. The changes relate to check processing and collection, not to the availability of funds, and unlike previously, the changes now recognize the processing of electronic checks and electronically-created items.

Availability of Funds
Just to be clear, the updates to Regulation CC do not include changes to the timeframes funds can be available, disclosures, or coverage. And depending on your perspective, this is a good thing. You won’t need to adjust your training, procedures, disclosures, and policies relating to funds availability—at least not as a result of the current updates. But there is always the possibility that the Regulation CC availability of funds rules could change in the future!

Collection of Checks
Although changes were made in multiple sections of the regulation, the core of the changes are in Subpart C, and they center on the collection and processing of checks and returned checks.

Return Requirements
Regulation CC has specific provisions relating to the processing of returned items (i.e., unpaid checks, including checks designated “not sufficient funds,” or NSF).

Regulation CC was created by the Expedited Funds Availability Act and the name “Expedited Funds Availability” says it all. The regulation isn’t just about how long funds are placed on hold, but it also requires the timely processing of checks. In theory, by expediting the processing of checks, institutions are able to reduce the amount of time a check is placed on hold.

To that end, the regulation requires a paying bank (the bank where a check is drawn) to return a check “expeditiously” when the bank makes the decision to not pay a check (i.e., due to insufficient funds, unauthorized signer, account closed, etc.). Under the current requirements of Regulation CC, in order for a return to be “expeditious,” the paying bank must return the check as provided under either the “two-day test” or the “forward-collection test.” (§229.30) Under the “two-day test,” the paying bank has to return the unpaid check to the depositary bank by 4:00 pm (local time of the depositary bank) of the second business day following the banking day the check was presented to the paying bank.

If the returned (unpaid) check is $2,500 or more, the paying bank must provide a notice of nonpayment. Under the current rule, for the notice to be timely, the notice must be received by the depositary bank no later than 4:00 pm (local time of the depositary bank) of the second business day following the banking day the check was presented to the paying bank. The notice can be provided by the return of the check/item, or through the use of a written notice that contains the following information:

  • Name and routing number of the paying bank;
  • Name of the payee(s);
  • Amount;
  • Date of the endorsement of the depositary bank;
  • Account number of the customer(s) of the depositary bank;
  • Branch name or number of the depositary bank from its endorsement;
  • Trace number associated with the endorsement of the depositary bank; and
  • Reason for nonpayment.

Effective July 1, 2018, Regulation CC makes six changes affecting check processing:

  1. The “forward collection test” for expeditious returns is eliminated, leaving only the “two-day test”;
  2. Returned checks/items, both paper and electronic, are covered by the rule regarding expeditious returns and notice of nonpayment;
  3. The timeframe for returned checks/items will change. They must now be received by 2 p.m. (local time of the depositary bank) of the second business day following the banking day the check was presented to the paying bank;
  4. The notice of nonpayment will change, too. The notice will need to be received by 2 p.m. (local time of the depositary bank), and only items of $5,000 or more are covered by the new rule (an increase from $2,500);
  5. The content of the notice of nonpayment will change to require only the following:
    • Name of the payee(s);
    • Amount;
    • Date of the endorsement of the depositary bank;
    • The bank name, routing number, and trace or sequence number associated with the endorsement of the depositary bank; and
    • Reason for nonpayment.
  6. The regulation contains a new incentive for banks to process returned items electronically. The incentive is that the depositary bank can hold the paying bank (or a returning bank) liable for an untimely return (not “expeditious”) of a check/item only if the return was received electronically.

Electronic Check Collection and Return
Currently, Subpart C of Regulation CC applies only to paper checks. This means that the current provisions of Subpart C related to acceptance of returned checks, presentment, and warranties do not apply to electronic images of checks (“electronic images”) or to electronic information derived from checks (“electronic information”). The collection and return of electronic images and electronic information are governed by agreements between the banks, not by Regulation CC.

However, effective July 1, 2018, this changes. Regulation CC includes indemnities for electronically-created items, which are defined as “an electronic image that has all the attributes of an electronic check or electronic returned check but was created electronically and not from a paper check” (i.e., an electronic payment order). The indemnities for electronically-created items are for losses resulting from:

  1. The electronically-created item not being authorized by the account holder; or
  2. A subsequent bank paying an item that has already been paid.

In addition, a bank transferring an image or an electronically-created item indemnifies each subsequent bank in the collection or return process against any loss, claim, or damage that results from the fact that the image or information was not derived from a paper check.

Additional warranties now apply to electronic checks and electronic returned checks:

  1. Returned-check warranties;
  2. Notice of nonpayment warranties;
  3. Settlement amount, encoding, and offset warranties;
  4. Transfer and presentment warranties related to a remotely-created check;
  5. Banks will not be asked to pay an item twice; and
  6. Electronic images and electronic information are sufficient to create a substitute check.

These warranties ensure that a bank that receives a check for collection, presentment, or return receives the same warranties regardless of whether the check is in paper or electronic form.

Regulation CC also provides for another new indemnity. A depositary bank that receives a deposit of an original paper check is indemnified against loss—if the check is returned unpaid because the check was previously deposited through a remote deposit capture service and paid. If there is a restrictive endorsement, such as “for mobile deposit only,” there is no indemnification to the bank holding the original paper check.

Action Plan
Since there are only a few months until the changes to Regulation CC become effective, here are some actions to consider:

  • Update your Regulation CC procedures. There is no impact to your procedures relating to check holds, but your back office procedures relating to check processing and liability will be affected. Be sure to include the new warranties/indemnifications in your procedures.
  • Consider requiring restrictive endorsements (i.e., “for mobile deposit only”) on checks deposited through remote deposit capture. And if you do, ensure that the use of restrictive endorsements is addressed in your account agreement. Without the restrictive endorsement, you may have liability to an institution holding the original paper check.
  • Regulation CC (§229.14) requires institutions to begin paying interest no later than the business day on which the bank receives credit for the funds. If your financial institution follows this practice, review your calculated availability schedule you use to pay interest to ensure it is consistent with when you actually receive funds. For example, if you rely on the calculated availability schedule from the Federal Reserve, but process a class of checks via image exchange, ensure your calculated availability schedule is updated accordingly. You also want to be sure that you are using the most current version of the calculated availability schedule.
  • Update your training. The training for your front line relating to check holds and funds availability most likely won’t need to be updated, but your back office training will need to be updated. And don’t forget to review your online training from third-party vendors to ensure that it is current as well.
  • Notice of nonpayment. Be sure the timing required by the regulation is correct in both your training and procedures.
  • System changes/change control. Are there any system changes required? Consider the system that generates your notice of nonpayment and the new timing requirements. Does your remote deposit capture system provide a restrictive endorsement?
  • Third-party vendor agreements. Do any of your agreements with third parties relating to check/item/image processing need to be updated as a result of the changes in warranties and indemnifications?