Checks

What Is Checks?

A check is a written order to a financial institution instructing it to pay a specific amount of money from a bank account to a designated payee. It serves as a negotiable instrument within the broader category of payment systems. Checks allow individuals and businesses to make payments without using physical cash, providing a documented record of the transaction. When a check is written, the drawer (person writing the check) instructs the drawee (the bank) to pay the payee (the person or entity receiving the funds).

History and Origin

The concept of a check can be traced back to ancient civilizations that used written instructions for transferring funds, predating modern banking. In medieval Europe, merchants deposited money with trusted individuals who issued receipts, which evolved into early forms of checks allowing payments by transferring ownership of these receipts. The modern check, as we know it, began to take shape with the rise of banking houses during the Renaissance. In England, checks evolved from letters written to goldsmith bankers, enabling customers to make payments to a third party without physically withdrawing money themselves. As banking became more organized, bankers started printing checks for customers to fill in the details. The Bank of England, established in 1694, played a significant role in standardizing banking practices, and by 1717, it issued the first preprinted check forms to combat fraud. Early checks required physical presentation at the bank, a practice that continued for centuries.⁹

Key Takeaways

• A check is a written order directing a bank to pay a specific sum from an account.
• Checks serve as a traditional, documented method for making payments without physical cash.
• The Check Clearing for the 21st Century Act (Check 21) significantly modernized check processing by allowing electronic image exchange.
• While their use has declined, checks remain prevalent in certain business-to-business transactions and for larger payments.
• Check fraud continues to be a significant concern for financial institutions and consumers.

Interpreting the Checks

Checks are interpreted as a clear directive from the account holder to their bank. The presence of a signature validates the instruction, and the amount written in both numeric and long-form (words) helps prevent discrepancies and fraud. Upon deposits, banks typically place a hold on funds from a check, especially for larger amounts or new accounts, until the check "clears," meaning the funds have been successfully transferred from the payer's account to the payee's account. This clearing process involves interbank settlement, often facilitated by a clearinghouse or directly through Federal Reserve systems. Understanding the various fields on a check, such as the routing number, account number, and check number, is crucial for accurate processing and for activities like bank reconciliation.

Hypothetical Example

Suppose Jane needs to pay her landlord, ABC Properties, $1,500 for rent. She writes a check from her checking account.

1. Date: Jane writes the current date.
2. Payee: She writes "ABC Properties" on the "Pay to the order of" line.
3. Amount (Numeric): She writes "$1,500.00" in the dollar box.
4. Amount (Written): Below that, she writes "One thousand five hundred and 00/100 dollars."
5. Memo: In the memo line, she notes "August Rent."
6. Signature: Jane signs her name on the signature line.

ABC Properties then takes the check to their bank for deposits. The landlord's bank sends the check information (now often an electronic image) to Jane's bank. Once Jane's bank verifies the funds are available and the check is legitimate, they transfer $1,500 from Jane's account to ABC Properties' account. This transfer concludes the transaction, and the funds are then available for withdrawals by ABC Properties.

Practical Applications

Checks continue to be used in various financial scenarios despite the rise of digital alternatives. They are often employed for:

• Bill Payments: While many regular bills are paid electronically, some individuals and businesses still use checks for utilities, rent, or specific service providers, particularly where electronic options are not readily available or preferred.
• Business-to-Business (B2B) Transactions: Paper checks still account for a significant portion of B2B payments, especially for small businesses, due to the detailed remittance information they can carry.⁸
• Government Payments: Until recently, checks were a common method for government disbursements like tax refunds and social security benefits, though there is a move towards electronic payments.⁷
• Larger Transactions: For significant payments, such as down payments on real estate or large business expenditures, checks may still be preferred due to the perceived security and the tangible record they provide. In fact, checks still convey three times more value than debit, credit, and prepaid cards combined due to higher average transaction sizes.⁶

In the United States, the Check Clearing for the 21st Century Act (Check 21), enacted in 2004, significantly streamlined check processing. This federal law allows banks to process checks electronically by creating "substitute checks" (legal paper copies of the original check) or by exchanging images, reducing the need to physically transport paper checks across the country.⁵ This has dramatically accelerated the clearing time for checks.

Limitations and Criticisms

While checks have historically been a cornerstone of cash flow management, they come with several limitations and criticisms in the modern financial landscape:

• Slower Processing: Despite Check 21, checks generally clear slower than electronic funds transfer (EFT) methods, which can impact liquidity for recipients.
• Vulnerability to Fraud: Checks are susceptible to various forms of fraud, including forgery, alteration, and check washing. The FBI and United States Postal Inspection Service (USPIS) have reported a significant increase in mail theft-related check fraud, with suspicious activity reports nearly doubling from 2021 to 2023.⁴ In 2023, check fraud resulted in over $1.3 billion in losses for U.S. financial institutions alone.³
• Higher Cost: Processing paper checks is generally more expensive for banks and businesses compared to electronic transactions, involving printing, mailing, and manual handling costs.
• Inconvenience: Writing, mailing, and depositing physical checks can be less convenient for consumers and businesses accustomed to instant digital payments. Consumer check usage in the U.S. dropped over 30% between 2000 and 2021.²

Checks vs. Electronic Funds Transfer (EFT)

Checks and electronic funds transfer (EFT) are both methods of moving money, but they differ fundamentally in their mechanism, speed, and security.

EFT systems, encompassing methods like Automated Clearing House (ACH) transfers, wire transfers, and debit/credit card payments, have largely surpassed checks in volume and speed for many transactions. The primary difference lies in the tangible nature of a check versus the purely digital nature of an EFT.

FAQs

1. How long does a check take to clear?

The time it takes for a check to clear depends on factors like the banks involved and the amount. Generally, funds from a check may be available within one to five business days. The Check 21 Act has significantly sped up this process by allowing banks to exchange check images electronically.

2. Can I deposit a check using my phone?

Yes, many financial institutions offer mobile deposit services, allowing you to deposit checks by taking a picture of the front and back of the endorsed check with your smartphone. This uses the electronic image exchange facilitated by Check 21.

3. What happens if I write a check and don't have enough money?

If you write a check without sufficient funds in your account, it is referred to as a "bounced check" or "insufficient funds" (NSF) check. Your bank may charge you an NSF fee, and the payee's bank may also charge a returned item fee. The check may then be returned unpaid to the payee.

4. Are checks still commonly used?

While the overall volume of checks has declined significantly due to the rise of digital payment methods, checks are still commonly used for certain purposes, such as business-to-business payments, rent payments, and larger transactions where a physical record or specific cash flow timing is desired.¹

5. What is an endorsement on a check?

An endorsement is a signature on the back of a check by the payee. It is required to legally transfer the funds. A simple endorsement might just be the payee's signature ("blank endorsement"), while a restrictive endorsement, such as "For Deposit Only," specifies how the check can be handled, adding a layer of credit safety.