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  AMERICAN BANKING ASSOCIATION

Principles of Banking, Fifth Edition by Paul Carrubba

Encoding Function:

The term encoding, as used throughout this chapter, refers to the system developed in 1956 through collaboration between the American Bankers Association (ABA) and specialists representing check printing firms and equipment manufacturers. The system, commonly known as magnetic ink character recognition (MICR) made possible the automation that has revolutionized check processing in banks. Many functions that previously had to be performed visually and manually are now computerized. MICR made it possible for checks and other encoded documents to be read directly by high-speed equipment.

Each numeral from 0 through 9 was designed to contain a unique quantity of magnetized ink particles so that the machines that read the numerals could not mistake one numeral for another However, certain problems can cause misreading.

The ABA also specified the placement of MICR information on all checks and required that all checks be within a specified size range. A specific place is designated on the check for the routing transit number, the account number, the check number, the amount, and some other special designations. As the MICR program gained acceptance throughout the banking system, the Fed issued a regulation stating that un-encoded checks would not be treated as cash items.

Every financial institution today uses its own system of assigning account numbers to customers. For example, the system may indicate the type of account (business, personal, correspondent bank, or other), and the unit (department or branch) within the bank that handles the account. New checks issued to depositors contain the bank's identifying number (see the "Item Capture" section) and the customer's account number. The individual sequential check number is normally also encoded and is used by the bank in preparing bank statements, stopping payment on checks, providing automated telephone inquiry services, and a number of other uses.

Using the MICR system, banks began supplying customers with deposit slips on which the account numbers were pre-encoded. Whenever a customer asks the bank to provide a blank, un-encoded check called a counter check, all the MICR information must subsequently be encoded so that the item can be processed through automated equipment.Many banks have eliminated counter checks and will not allow customers to use them. Of course, there are exceptions.

Although the customer's account number, the heck number, and the bank's identifying number are typically preprinted on the check, this information must be encoded by the bank on some checks, deposits, and other items. Since the amount of the item cannot be pre-encoded except by a large corporate customer or a correspondent bank, the bank usually has to encode the amount. The encoding machine not only encodes the amount of the check, it also balances the deposits at the same time.

Tellers do not balance deposits when they are made by customers unless the bank uses an on-line posting system. On-line posting systems are typically used by savings and loan associations (S&L's), savings banks, and credit unions that process mostly small-volume personal accounts. The deposit must be balanced to ensure that the amount placed on the deposit ticket matches the amount of the items included in the deposit. The customer may have made a mathematical error, included an extra item, or listed an item that is not included with the deposit. The deposit must be balanced at this point. This is the last time the deposit is balanced individually. After the proof function, the system is balanced on the basis of total debits and credits and not on the basis of individual transactions.

If the deposit does not balance, the proof operator must balance it or pass the out-of-balance deposit on to another area in the proof department to perform this function. If the deposit is missing an item, the deposit is usually made for the entire amount as listed by the customer, and a debit adjustment is made to the account. If the deposit includes an item not listed, the account is given a credit adjustment for the amount of the extra item. If the customer made an error in addition or subtraction, a debit adjustment or a credit adjustment is made to correct the error.

Some large customers provide the bank with special instructions for correcting errors. They may instruct that copies of the transactions be made and sent to the local office and that a copy be sent to the main office. Or they may instruct that correcting entries be made not to the account to which the deposit is made but to another account or handled in another manner.

The items from the proof department are typically batched in groups of 250 to 300 items, or whatever number of items the bank considers manageable. If the work is out of balance or a bundle of work is dropped, the error can be found and corrected much more easily if the work has been batched.

Zero Balance Accounts:

The zero balance account is an account owned by a corporate customer (strawman) in which the balance is always maintained at zero. The corporate customer writes checks on the account, and as the checks are presented to the bank for payment, the bank automatically transfers funds from another account to maintain the account balance at zero. For example, if $10,000 worth of checks are presented for payment against the zero balance account, the bank deducts the checks from the account and automatically transfers $10,000 from the funding account. The funding account could be another checking account or some type of investment account on which the corporation earns interest until the checks are presented for payment. Or the corporation may fund the account from a line of credit established with the bank.

Another form of zero balance account is a type of account in which the corporation makes deposits and may write checks. During the posting process (after all of the debits and credits have posted to the account) any positive balance is swept into another account. If the balance is negative, funds are transferred into the account. Either way, the account balance is maintained at zero. The purpose of a zero balance account is to allow the corporation to maintain better control over its account balances.

Processing Checks:

One reason banks cited for holding funds was the length of time required to return a check. When Congress passed the Expedited Funds Availability Act, it mandated the Fed to reduce the return time. As a result, Regulation CC contained endorsement standards (Chapter 5), required that a check be returned in an expeditious manner to the bank of first deposit (BOFD) within a certain time and allowed the returning bank to return the check directly to the BOFD or to a returning bank. A returning bank is a bank that takes returned checks from a paying bank and returns them to the BOFD in an expeditious manner. All Federal Reserve banks have been designated as returning banks. Although the bank that presented the item to the paying bank remains liable on the instrument, the paying bank can return the instrument to the presenting bank only if (a) the presenting bank is the BOFD, (b) the presenting bank holds itself out as a returning bank, or (c) the paying bank cannot identify the BOFD,

Regulation CC requires that a paying bank return a check in an expeditious manner. A check is returned in an expeditious manner if it meets one of two tests established by Regulation DD; the 2-day, 4-day test and the forward collection test. The 2-day, 4-day test and the forward collection test. The 2-day, 4-day test establishes certain time frames in which checks must be returned depending on whether the check being returned is a local or a non-local check. The forward collection test establishes the return time on the basis of the length of time it takes to send a check to the paying bank.

Midnight Deadline:

The paying bank must also return the check by its midnight deadline. The midnight deadline is defined in the UCC as midnight of the banking day following the banking day of receipt of the item. A paying bank that receives a check on Monday must return the check by midnight Tuesday; that is, the check must leave the paying bank by midnight Tuesday. The bank meets the midnight deadline if the return item is deposited in the mail before midnight or is picked up by a courier before midnight. The midnight deadline may be extended under certain circumstances provided for in Regulation CC.

Physical Return of the items: