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Thursday, January 16, 2014

How the Federal Reserve regulates check writing


Check writing is regulated by the U.S. Federal Reserve. The laws that underlie these banking regulations are codified in Title 12 of the U.S. Code of Federal Regulations. The U.S. Code is a compilation of numerous pieces of legislation that also include Title 26 or the U.S. Tax Code. Several specific rules pertaining to financial instruments such as checks are implemented through the Federal Reserve system. The diagram below demonstrates just how involved with banking the Federal Reserve is.

The Federal Reserve risk mitigation and compliance process 

Federal Reserve oversight process diagram
Banking efficiency is enhanced through a multi-purpose regulatory process
Processing

The Federal Reserve letters its legislative derived regulations. An example of such regulations that apply to check processing is Regulation CC. Moreover, “The Expedited Funds Availability Act”, is the legal basis upon which rules within Regulation CC are founded. For example, it limits hold times on checks deposited in financial institutions. Other rules determine how banks communicate in regard to notice of nonpayment and in what way returned checks are handled.

Endorsements


Another important area of check regulation is check endorsements. Checks are endorsed in many different ways, so in order to avoid confusion regarding payments, the Federal Reserve issues rules illustrating exactly how checks must be endorsed for specific purposes. For instance, a check payable to a third party is endorsed by writing the words “Pay to the order of” on the reverse side of the check along with other payee details.

Security

Maintaining strict security standards that include the safety of check information is an important concern of the Federal Reserve. Moreover, checks are financial instruments, and because the central bank is the part of the federal government that creates monetary policy and supervises banking regulation, ensuring sensitive financial data is not stolen is a key role. This is done by the monitoring and involvement of bank compliance with inter-agency security guidelines.

Transactions

Check clearing is a part of the check deposit transaction governed by the “Check Clearing for the 21st Century Act”, which is also called Check 21. The Federal Reserve lists the rules associated with this law on its website and helps financial institutions understand and carry out proper check clearing procedures. Additional examples of regulations pertaining to check transactions include rules about using substitute checks and how checks obtained from an online checks order can be used for electronic transfer of funds.

Liability

Another important set of rules regarding checks is liability. If a financial institution fails to carry out its legal obligations to maintain security and follow check handling safeguards, then it may be liable for loss due to check fraud. These losses potentially extend to check owners, third parties, depository banks and depository bank customers. These kinds of check regulations serve to protect banks and banking clients rather than limit their banking freedoms.

Without a formal regulatory body, the banking industry would likely be less standardized across the nation. Furthermore, many of the rules overseen by the Federal Reserve maintain or improve efficiency in banking practices such as check processing and payment procedures. This in turn helps ensure the financial system as a whole is functional and beneficial to the broader economy.

Image source: FederalReserve Compliance Handbook