What are checks, and how do they work?

You reach for your wallet and it’s not there. Panic gives way to despair when you realize that
your wallet is gone and so is your cash. Chances are you’ll never see the cash again.

The consequences are not nearly as serious if you lose your checkbook. All you do in that case
is close your checking account and open a new one. After that, your lost or stolen checks are
worthless to anyone who might try to use them.

Because they are safe and convenient, checks have become a popular method of paying for
things or transferring money. But what exactly is a check?

In simple terms, a check is a written set of instructions to your bank. When you write a check,
you are instructing your bank to transfer a specific amount of money from your checking
account to another person or an organization. You can even write a check to convert some of
the money on deposit in your checking account into cash.

When you fill in the blank spaces on one of your checks, you are telling your bank three things:

1. how much of your money you want to transfer,


2. when you want to transfer it, and


3. to whom you want it to go.

You authorize the transfer by signing the check.

So, if your favorite aunt sends you a $50 check for your birthday, she’s actually telling her bank
to transfer $50 from her account to you. But when you go to cash her check or deposit it in
your account, how does your bank know if your aunt actually has enough money in her account
to cover the check?

The answer to this question isn’t what it used to be.

Up until 2004, the check had to travel all the way back to your aunt’s bank by truck or by plane.
If there was enough money in her account to cover it, her bank would “clear” the check.

If there wasn’t enough, her bank would stamp it “NSF”—Not Sufficient Funds—and “bounce”
it back to your bank. And on top of all that, your aunt’s bank had to send her cancelled checks
back to her every month, along with her account statement.

All that paperwork might have been OK back in 1940, or even 1970, when Americans wrote
fewer checks. But as checks became more popular, banks spent more and more time and
money moving billions of pieces of paper around the country each year—not the best use of
resources, especially when new technology offered a more efficient way to do things.

In 2004, Check 21 went into effect. The new federal law made it possible for banks to handle
more checks electronically. Instead of physically moving checks from one bank to another,
banks can now electronically transmit images of the checks they process. It’s a lot faster and
less costly.

For more information on Check 21, see Frequently Asked Questions about Check 21,
http://www.federalreserve.gov/paymentsystems/truncation/faqs2.htm

Instead of physically moving checks from one bank to another, banks can now electronically transmit
images of the checks they process.

Source from : http://www.bos.frb.org