Check Verification - Negative Database

Negative File Verification Systems

Using electronic point of sale terminals to verify checks against a negative file started over 20 years ago. As returned items were processed for collection, they were added to a negative database. Whenever a check writer presented a check, a computer program simply checked to see if the check writer had any unpaid returned checks in the existing database. Although the time for a check to be returned and entered into the database was at least seven days, the merchants saw declines in their returned check losses, and a new industry was born.

Negative file verification systems rely on having as large a database of returned checks as possible. Merchants also place special emphasis on returned items from their specific area, since returned items from one part of the country have little value in other parts of the nation. Experience also shows that current data have far more value than stale data (checks older than 360 days). The contribution of these negative file verification systems includes:

Reduced returned check losses. Customers with current unpaid items can't write more checks (which would likely get returned).

Collection Assistance

Check writers declined at the point of sale have a higher motivation to pay for unpaid items. Clearly, using a negative file rests on one important assumption: people who have current unpaid returned items are more likely to have a check presented to a merchant bounce. It makes no attempt to distinguish between the three categories of bad check writers. Such check writers may be "higher risk" customers, but many checks written by such people clear without any problem. Declining them at the point of sale may lose more income for a merchant than it saves him from returned check losses. This is especially true for the Count Poorlys and Fallen Angels.

It is useful to look at the contribution of returned items as a function of the number of outstanding items in an account.

• Single unpaid items, belong mostly to the Count Poorlys or to Fallen Angels. Since Rip-off Artists rarely stop with a single check, they contribute little to this category.
• Accounts, which have two unpaid items outstanding, more rarely belong to The Count Poorlys and more frequently to Fallen Angels or Rip-off Artists.
• Moving to still larger numbers of returned items in an account, Rip-off Artists own almost all of such accounts.

Stopping every account with a single returned check may not be the best policy. If the system were able to approve checks drawn on accounts with only a single unpaid item, both the merchant and the collection agency could benefit, since most of such checks would get paid, even if they initially bounced. A good check verification system should have the flexibility to allow such a strategy.

Another problem from relying on negative file verification comes from the fact that most checks drawn on an account with unpaid items will clear successfully. Even re-depositing unpaid items typically works in more than half the cases. Therefore, declining checks just because of unpaid items in an account causes unnecessary revenue loss for merchants. Since most of these returned checks would get collected, the actual fraud prevented is a fraction of this amount. This just emphasizes that declining checks using negative file information may not serve the best interests of either the merchant or the collection agency. Effectively, this is a trade-off between fraud reduction versus loss of business or loss of customers.

Summary

Basing a check verification system solely on the presence of negative file information creates multiple problems. These include:

Failure to discriminate between types of bad check writers. Both the merchant and the collection agency lose income if the system declines everybody with any outstanding unpaid items. A modern check verification system should not treat Rip-off Artists the same way as the Count Poorlys or the Fallen Angels. Checks drawn on account with unpaid items do not necessarily bounce. Frequently, having unpaid items on an account does not mean that subsequent checks on the same account will get returned for insufficient funds. Businesses lose more income than they benefit from fraud reduction. The number of fraudulent checks is much smaller than the number of declined checks using negative file information. The difference between these two numbers represents lost income for the merchant and for the collection agency.

Returned checks take a long time to reach the negative database. The normal banking cycle takes approximately 7 - 10 days before returned items get entered into the negative database. During this interval, Rip-off Artists can perpetrate extensive fraud by continuing to pass worthless checks. These factors have caused retailers to seek other techniques for minimizing fraud by selective stopping of the Rip-off Artists. These alternate approaches rely upon detection of abnormal check writing patterns, as they occur to stop accounts long before returned item notifications can appear. They have proven much more effective in reducing fraudulent check writing than systems relying exclusively upon negative file data.

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