Dangers of Floating Checks
by : Stan Jaslar
Floating a check may seem harmless; after all, check floaters may know they will have the money in their account within a couple of days. They may think that their actions can’t hurt anything. Although that may be true in some cases, floating a check can be costly for consumers and dangerous for banks.
What is ‘Floating a Check’?
Floating a check is when a customer takes advantage of the float to buy a bit of time on a bad check. For example, an account holder might write a check at the grocery store the day before payday. They give the check to the grocery store on Thursday. The grocery store deposits the check in its bank on Thursday evening, and by the time the grocery store’s bank remits the check to the shopper’s account, their direct deposit paycheck has already credited, ensuring they have enough funds to cover the check.
Customer Costs for Floating Checks
Ideally, accountholders should never spend money that isn’t in their account. To continue with the above scenario, what happens if their paycheck doesn’t get deposited for some reason? At that point, their bank may return the check from the grocery store and assess an insufficient funds fee on their account.
Typically, the grocery store presents the check to the bank again, sometimes adding an additional merchant fee, and if there still aren’t funds in the account, the bank may return the check and assess another fee, drawing the account even further into the red. At this point, the customer has amassed two insufficient funds fees and a fee from the grocery store plus any additional fees for direct debits, automatic payments, or any other expenses that have hit their account.
In another scenario, the paycheck may get credited at the right time, but the account holder may begin to make floating a habit. Initially, they just need extra money the day before payday, but one week, they need the funds two days earlier, then three days, and so on. Eventually, they need the funds so soon that they decide to open another account and begin kiting checks back and forth. These activities can put banks at risk.
Risks to Financial Institutions for Floating Checks
Financial institutions can make some money by charging overdraft or insufficient funds fees on bad checks, but those relatively small amounts do little to mitigate a bank’s overall risk. When dealing with overdrafts, banks incur communication costs for reaching out to customers, but even more significantly, they may be stuck with losses and potentially face legal fees as they try to recoup their funds.
In some cases, banks have lost millions of dollars and threatened their solvency due to bad checks. For instance, a $911 million-asset bank in Kansas with $4.6 million in net income over six months lost $5 million due to an overdraft situation created by cashing third-party checks drawn on an account with insufficient funds. A $147.8 million-asset bank in New Jersey had a $2.1 million loss, and a $31 billion-asset financial group suffered a $9 million loss related to an undetected kiting scheme.
Small banks are hit disproportionally by these losses. Scammers may be wary of floating checks or performing other types of fraud at big banks because they know these financial institutions are more likely to have safeguards in place to detect fraud. Because of that, they often target small banks which may not have the capital available to recover from these types of losses.
How to Reduce Check Floats
To minimize the impact of check floating, educate your customers about the dangers of floating checks. Let them know how floating checks can cost them money, threaten their credit, and potentially even force you to close their account. To reduce the burden of fees on customers, some banks are offering overdraft forgiveness programs where customers don’t face overdraft fees on items submitted the day before a direct deposit hits the account. When dabbling with programs like that, it’s important to make sure you are offering a convenience to customers without encouraging them to float checks.
Beyond that, you need tools in place that can help you identify troubling patterns. Then, when an account holder is flagged, you can manually review their transactions, reach out to them with issues, and proactively close their account if needed.
When your customers float checks or taking other actions that draw their accounts negative, your financial institution is at risk for losses. To protect yourself, you need the right fraud partner, and at SQN Banking Systems, we specialize in making fraud protection easy for financial institutions. To learn more about our products, services, and solutions, contact us today.