Dikkii's financial tips #5: How the hell do cheques work?

Welcome to Dikkii's financial tips.

This is a series where I attempt to provide some sort of guidance to financial matters without breaching the Corporations Act by actually providing advice.

Anyway, I have to return to banking just one teensy weensy last time, because I did promise regular commenter Plonka a round up of cheques.

Cheques, as I responded at the time, are amazingly complex instruments. The law as it relates to cheques is remarkably finicky, and horrible. There are so many different bits to them, that I could not begin to explain - but I'll have a go. It's worth knowing.

Back in the day, they were explained to me as a three way agreement between the person signing the cheque, the person that they're giving the cheque to and the bank that the cheque is drawn on.

I prefer to think of it as an IOU.

In any event, what normally happens is this. You write out a cheque, you hand it over, and money flows from your account to the other person's.

Let's look at all the bits - and there are many.

The drawer

(Pronounced: draw-rer)

Not someone's undies, this is the name of the account from which the cheque is drawn. It's usually indicated on the cheque somewhere between the amount in words bit and the space for the signature. Usually looks like "JM BLOGGS", "MP AND LF CITIZEN", "MEGA CORPORATION LTD" or even "J AND P DOE TA SMALL BUSINESS ITF THE DOE FAMILY TRUST".

Note the shorthand - I always thought this looked unprofessional, but it appears to be commonly accepted that AND indicates a joint account or partnership, TA indicates a registered business name ("Trading As") and ITF stands for "In Trust For".

The drawee bank

(Pronounced: draw-ree)

This will be normally shown up on the top left hand corner of a cheque. Underneath that will be the drawee branch. This is the bank and branch of the drawer's account.

The payee

This is the person, persons, company or other entity to whom the cheque should be paid. It will normally have the word "pay" at the start of the line and the words "or bearer" or "or order" at the end. Sometimes it will be made out to cash, in which case, the words "please pay cash," or just plain "cash" will be written.

"Or bearer"

This means that the cheque can be accepted by anyone holding it. Under current conversion laws a bank would be pretty stupid to rely on these words, however a bit of lenience is normally given (within reason). Normally a bank will not allow third party bearers to deposit a cheque made out to someone else - it's just too risky for the bank.

I am reliably informed the stolen third party cheque lawsuit involving a certain "Mr Cash" is an urban myth.

"Or order"

The opposite of "or bearer". This means that the cheque must go into an account name that matches that whom the cheque is made out to. Crossing out the words, "or bearer" means the same thing as "or order".

For example - a cheque is made out to "Tom and Sue Jones or order" - this must go into a joint account set up in the name of Tom and Sue Jones. No exceptions.

Usually, an "or order" cheque needs to be endorsed (signed on the back) by the payee, but the bank is normally deemed to be acting in good faith if it follows the rules in the above paragraphs.

Amount in words vs amount in figures

These need to match up. If one is different to the other, the lesser figure only may be accepted. This is always fun with Generation Y who, according to stereotypical "research", are illiterate, innumerate and belligerent.

Signature

The cheque must be signed in accordance with the operation method of the drawer's bank account. If the account requires two signatures, then the cheque must have two signatures.

I used to get a good laugh when young kids would come into the bank with one of their parent's cheques made out to cash, and only one dodgy signature where two were required. Cheeky little rascals!

The crossing

This is normally two parallel lines drawn vertically or diagonally across the cheque. Occasionally you'll see the words "not negotiable" as well. They mean the same thing - the cheque must go into a bank account and cannot be cashed.

Sometimes you might see the words "account payee only" written - this has the same effect, plus it also does the job of the words"or order" - the cheque must go into a bank account in the name of the payee specifically and it cannot be cashed.

Crossings may be pre-printed on a cheque which can cause great confusion - attempting to cash a cheque made out to "cash" with a crossing is nigh on impossible.

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So what happens when a cheque is deposited, and why does it take so long?

Let's follow one along the trail.

1. Day one.

A cheque is deposited into a bank account. Normally, a cheque debit is processed off-site, usually overnight. The only thing that may (but not always) happen immediately is that an amount is credited to your bank account. If this deposit credit is processed off-site with the cheque, it will also be processed overnight.

Any amounts credited to the payee's bank account during the day on day 1 will be subject to clearance - that is, they will actually be in their bank account that day, however, a hold is placed on those funds so that you can't touch them. Normally for three working days.

And even though some bank branches are open on weekends, now, this does not include those days.

2. Day two

Transactions processed off-site go through some batch reconciliation process which means that you won't notice the deposit in your bank account until the next day.

What will also be noticed the next day, is that the drawer's bank account will also have been debited.

But if you check both accounts, you'll see that they're showing transaction dates of day 1.

So why does clearance still apply?

Well, imagine that the drawer has overdrawn his account. Debits have to fund a credit, and the credit (the deposit) must be processed. Therefore, so too does the debit (the cheque).

The overdrawing will show up on a report which the drawee branch manager gets the next day (day 2) first thing. The manager has two options - allow the overdrawing, or dishonour the cheque.

If the manager dishonours the cheque, she will create a credit dishonouring the cheque and crediting the funds back to the drawer's account. The debit that funds this credit must be made to the payee's bank account. Both sides of this transaction will be processed off-site and will go through the same overnight batch reconciliation process I alluded to above.

Needless to say, the dishonour will not show up in the depositor's account until day 3.

3. Day three

Both sides of the dishonour will have the same date as day 2, but they normally will process overnight.

This means that when the payee checks their account that morning (day 3), the funds that were subject to clearance will have gone from their account.

If the cheque is not dishonoured, the funds will still be subject to clearance that day, though, because it won't be until this time that the cheque will have had a chance to physically make it back to the drawee bank for perusal.

Not all cheques get looked at by the drawee bank, but some do. Any irregularities such as funny signatures, third party cheques etc will have one more window for dishonour. This will happen overnight. So will the lifting of the hold on any uncleared funds that haven't been dishonoured.

4. Day four

Normally, this will be when the payee is finally able to access their funds, assuming that the cheque has been honoured.

With Credit Unions and Building Societies, a couple of extra days may be allowed. Their paper trail is somewhat more convoluted than banks.

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So, if you've read this far, you're probably about to ask, "What about pay cheques? My bank let's me draw against them straight away."

Firstly, banks are under no obligation to do this - this may be done as a favour. Nothing more. No magical solution gets around the paper trail that must be followed above.

Secondly, history shows that employers who aren't organised enough to do their payroll properly are most likely to be ones who dishonour cheques. Resign immediately and get a job with a more organised employer.

Thirdly, fraudsters are all over badgering bank staff to let them draw against uncleared cheques by calling them "pay cheques".

And finally, if your liquidity situation is such that you need to access those funds immediately, then you have a different set of problems.

But what about bank cheques? Aren't they as good as cash?

In a nutshell, no. Bank cheques can be forged or stolen. Thus they're subject to the same rules as every other cheque.

Try to get anyone paying you money to credit your account directly. It's far less messy than cheques. Cheques are, as I mentioned before, a form of IOU, and as with all IOUs, it's the payee who bears the risk.

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Standard but necessary disclaimer: This is not advice. Only a complete idiot would think that any of this constituted advice. It's not even vaguely reasonable to consider this to be advice. If you are in any doubt as to the content of this, see a good, independent financial adviser immediately. They do exist.