Check

What Is a Check?

A check is a written order instructing a financial institution, typically a bank, to pay a specific amount of money from the account holder's deposit to a named payee or to the bearer. It serves as a paper-based form of funds transfer within the broader category of payment systems. When an individual or entity issues a check, they are known as the drawer, while the bank on which the check is drawn is the drawee, and the person or entity receiving the payment is the payee. Checks are a crucial component of modern banking systems and have historically facilitated transactions for both individuals and businesses.

History and Origin

The concept of checks can be traced back thousands of years to ancient civilizations, where rudimentary forms of written payment instructions were used to facilitate trade without the need to transport large sums of physical currency. For instance, in ancient Babylon, clay tablets served as primitive promissory notes. In the Islamic world by the 9th century, the Arabic word "sakk" referred to a written promise to pay for goods upon delivery, from which the word "check" is derived.¹⁵

Modern checks began to take shape in the 18th century, with the Bank of England pioneering the use of pre-printed forms in 1717. The need for efficient settlement led to the development of clearinghouses, centralized institutions where banks could exchange and settle checks drawn on one another.¹⁴, In the United States, checks became an integral part of commerce by the late 1800s.¹³ The establishment of a national check clearing system by the Federal Reserve, created by the Federal Reserve Act of 1913, further standardized and streamlined the process, mitigating financial crises and high interbank check-clearing costs.¹²,¹¹ For much of the 20th century, the check was the most widely used noncash payment method in the U.S.¹⁰

Key Takeaways

• A check is a written directive for a bank to pay a specified amount from a drawer's account to a payee.
• It functions as a type of negotiable instrument, allowing for transferability of the right to payment.
• Checks have evolved from ancient payment methods and were standardized in modern banking through the establishment of clearing systems.
• While their usage has declined with the rise of electronic payments, checks remain a significant part of the U.S. payments system by value.
• Legal frameworks like the Uniform Commercial Code (UCC) govern check transactions, defining roles, rights, and responsibilities.

Interpreting the Check

A check represents an order to pay, not a guarantee of funds until it is honored by the drawee bank. When a check is written, it signifies that the drawer has sufficient funds in their account at the drawee bank to cover the amount. For the payee, receiving a check means they have a right to demand payment. The check must be presented to the drawee bank, either directly or through a depositary bank, for collection. The process involves verifying the drawer's signature and ensuring adequate funds are available before the payment is finalized. Understanding the roles of the drawer, drawee, and payee is essential for interpreting the flow of funds and associated responsibilities.

Hypothetical Example

Imagine Sarah needs to pay her friend, David, $200 for a shared dinner bill. Sarah writes a check from her checking account.

1. Issuing the Check: Sarah (the drawer) takes a blank check from her checkbook, which is linked to her bank, "First National Bank" (the drawee).
2. Filling It Out: She fills in today's date, David's name as the payee, the amount of "$200.00" (both numerically and in words), and signs her name.
3. Delivery: Sarah gives the check to David.
4. Deposit: David takes the check to his bank, "Community Credit Union," and makes a deposit.
5. Clearing: Community Credit Union sends the check (or an electronic image of it) through the clearing system to First National Bank.
6. Payment: First National Bank verifies Sarah's signature and confirms she has $200 in her account. They then deduct $200 from Sarah's account and transfer it to Community Credit Union, which credits David's account.

This process ensures David receives his payment and Sarah's account accurately reflects the funds transferred.

Practical Applications

Checks continue to be used in various financial contexts, though their volume has declined significantly due to the rise of electronic alternatives. In 2021, checks accounted for approximately 5% of retail payment transactions in the U.S., but about 21% of the value of retail transactions, indicating their continued use for larger payments.⁹,⁸

Key applications include:

• Business-to-Business (B2B) Payments: Many businesses still rely on checks for vendor payments, payroll, and invoicing due to established accounting practices, detailed payment records, or the need for physical signatures.
• Government Payments: Checks are commonly used for tax refunds, social security benefits, and other disbursements by government agencies.
• Rent and Mortgage Payments: Individuals often use checks for recurring payments like rent or mortgages where the landlord or lender may prefer or require a paper trail.
• Large-Value Transactions: For significant purchases, such as down payments on a home or car, a cashier's check or certified check, which offers greater assurance of funds, may be used.
• Legal and Trust Accounts: In legal proceedings or for managing trust funds, paper checks can provide a clear audit trail.

Despite the shift towards digital options like Automated Clearing House (ACH) transfers and wire transfers, checks remain a part of the financial landscape for specific use cases, as tracked by studies like the Federal Reserve Payments Study (FRPS), which estimates aggregate trends in noncash payments in the United States.⁷

Limitations and Criticisms

Despite their historical importance, checks have several limitations that have contributed to their decline in favor of electronic payment methods:

• Processing Time: Checks take longer to clear compared to electronic payments. While the Expedited Funds Availability Act (Regulation CC) sets maximum hold times for deposits, it can still take several business days for funds to become fully available.⁶,⁵
• Security Risks: Checks are susceptible to various forms of fraud, including forgery, alteration, and counterfeit checks. Scammers often use fake checks in schemes where they induce victims to deposit the check and then send money back before the counterfeit is discovered, leaving the victim responsible for the loss.⁴ The Federal Bureau of Investigation (FBI) provides resources to help individuals recognize and report check fraud and other scams.³
• Cost: Processing paper checks involves higher operational costs for financial institutions compared to electronic transactions, including printing, handling, and transportation.
• Inconvenience: Writing, mailing, and depositing checks can be less convenient for consumers than instant digital payments, especially in an increasingly mobile-first world. Errors in filling out checks can also lead to delays or dishonored payments.
• Lack of Finality: Unlike a wire transfer, a check does not provide immediate finality of payment. The payment can be reversed if the check bounces due to insufficient funds or is found to be fraudulent. This creates a risk for the recipient.

Check vs. Promissory Note

While both a check and a promissory note are types of written instruments involving a promise to pay money, they differ significantly in their nature and function. A check is a demand instrument, meaning it is payable immediately upon presentation to the drawee bank. It is an "order to pay" directed at a third party (the bank). In contrast, a promissory note is a promise to pay a specified sum of money at a definite future time or on demand, made by one party (the maker) directly to another party (the payee). Promissory notes are typically used for loans or debts, outlining repayment terms like interest rates and payment schedules, and do not involve a bank as a drawee. Both are considered negotiable instruments under the Uniform Commercial Code (UCC) Article 3, which governs commercial paper, but their specific requirements for negotiability and their practical applications differ.²,¹

FAQs

Q1: What happens if a check bounces?

A check "bounces" or is dishonored when the drawer's account does not have sufficient funds to cover the amount, or for other reasons like a stop payment order or a forged signature. When a check bounces, the bank typically returns it to the payee's bank, and the payee's account is debited. Both the drawer and the payee may incur fees from their respective financial institutions.

Q2: How long does it take for a check to clear?

The time it takes for a check to clear depends on several factors, including the type of check, the banks involved, and the amount. Federal regulations (Regulation CC) mandate that banks make deposited funds available within specific timeframes, often within one to two business days for local checks, and up to five business days for nonlocal checks. However, while funds may be available for withdrawal, the check itself may not have fully "cleared" and the payment become final for several more days.

Q3: Can I deposit a check using my phone?

Yes, many banks offer mobile deposit services, allowing customers to deposit checks by taking a picture of the front and back of the endorsed check using their smartphone. This method typically offers faster processing than traditional paper deposits and falls under the provisions of the Check Clearing for the 21st Century Act (Check 21 Act), which facilitates electronic check processing.