Many organizations still rely on paper checks, with no immediate plans to phase them out. However, one of the key issues with checks is that criminals favor them as well.

Last year’s AFP Payments Fraud and Control report found that checks are the most frequently targeted payment method for attempted payments fraud—nearly twice as much as ACH transactions.

In a recent PaymentsJournal podcast, U.S. Bank’s Scott Pope, Senior Vice President, Senior Manager of Risk and Compliance; Consumer and Small Business Payments and Mike Watercott, Vice President and Working Capital Consultant, Treasury Management, as well as Jordan Hirschfield, Director of Prepaid at Javelin Strategy & Research, discussed the vulnerabilities of paper-based payments and the advantages of shifting to electronic transactions, particularly through prepaid disbursement options.

Check fraud has been the impetus behind the rising prevalence of mail theft, with criminals robbing postal carriers for arrow keys to access blue mailboxes. Once checks are in their hands, they have numerous ways to either sell the data or manipulate it for fraudulent purposes.

Though these crimes may seem like isolated incidents, check fraud is often carried out by sophisticated criminal networks.

“In many cases, it’s a sophisticated supply chain of bad actors, where the person stealing the checks and posting them for sale on the dark web is just one link in the chain,” Watercott said. “Fraudsters may alter or ‘wash’ stolen checks. Washed checks may also be copied, printed, and sold to third-party fraudsters on the dark web, generating even more fraudulent transactions.”

Beyond fraud or theft, issues with checks don’t always stem from nefarious activities—sometimes mail is simply lost or misdelivered. These vulnerabilities increasingly make paper-based instruments a liability.

“It starts with control,” Pope said. “When a company is using a paper check, once they have signed that check and placed it in the mail, they have lost control of it. In contrast, with electronic payments, including prepaid, the control is always there. If the payment has been misdirected or stolen, there are processes in place to quickly replace it and to end its access to the underlying funds.”

In addition to their vulnerabilities, checks also lack many of the fraud prevention tools that electronic payments provide. With digital transactions, the sender can proactively investigate recipients before ever sending a payment.

For example, the payer can verify whether the account is open and in good standing and whether it is owned by the intended recipient. With prepaid payment methods, additional controls are built into the card activation process.

Though some fraud mitigation tools exist for paper checks, such as positive pay, these processes aren’t as robust as their electronic counterparts. Positive pay verifies checks by matching them against a customer’s issued records. Any discrepancies are flagged as exceptions, requiring the customer to approve or reject payment.

“Just as the check payment process is manual and time consuming, so is the fraud mitigation process,” Watercott said. “You’re sending check issue files to the bank, you’re reviewing and reacting to positive pay exceptions daily, and then you’re reissuing checks. As you move away from checks, you gain opportunities to tap into more proactive risk mitigation before payments even happen.”

In addition, regulatory requirements at both the state and federal levels provide protections for prepaid and electronic transactions that don’t exist with checks.

Once a check clears, the only data typically available in statements or transaction histories is the check number and amount. In contrast, electronic transactions and prepaid cards provide organizations with a wealth of additional details, such as the merchant’s name, terminal ID number, location, and phone number.

Many organizations use this information to identify potential fraudulent transactions. For example, a business owner might recognize the merchant where a transaction took place but not the city in which the purchase occurred.

Once they report a suspicious transaction to their financial institution, the bank is legally obligated to investigate and determine whether the transaction was fraudulent. If fraud is confirmed, the customer  can receive a full refund of the transaction amount.

“Throughout that entire process there is a level of transparency; financial institutions are required to send notices and information to the customer during the process, which adds to the outcome,” Pope said. “From a regulatory and risk management perspective, I clearly see electronic payments and the use of prepaid cards as dramatically safer than checks.”

Electronic payments offer enhanced security and controls, along with tangible benefits driven by improved efficiency. Chiefly, they elevate the customer experience—the convenience of credit, debit, and prepaid cards is a key reason these payment methods have outpaced checks.

While consumers will certainly cash a check if they receive one, electronic payments are preferable to paper checks sent by mail, which require a trip to a brick-and-mortar financial institution.

“Electronic payments reduce so much friction in the whole process,” Hirschfield said. “It’s the opposite of the tortoise and the hare. We always hear about how slow and steady wins the race but here, quick wins the race. The tortoise is going to run into roadblocks—be it bad actors or just unforeseen circumstances—that get in the way. You want to be the hare in a payment, the one who is getting there quickly.”

Another integral aspect of a positive customer experience is the freedom of choice. Supporting a wide array of electronic payment options allows consumers to customize their payment experience to suit their preferences.

Beyond consumer benefits, electronic payments offer powerful advantages for businesses as well. While some businesses have leveraged the float inherent in check transactions, electronic payments provide greater working capital benefits. With a known settlement date and increased transaction visibility, payers can better manage cash flow and financial planning.

“I think of the visibility of checks as like ordering something online but receiving zero shipping tracking,” Watercott said. “If that check is stolen, you might not know about it until you get a call weeks later asking, ‘Where’s my payment?’ Just removing the payment from a check is already a step in the right direction in terms of fraud risk reduction.”

As organizations transition to electronic payments, there are many considerations. First and foremost, they must understand the scope and breadth of the unique rules that govern electronic payments.

For example, there are regulations like the Electronic Fund Transfer Act, also known as Regulation E, which was enacted to protect consumers’ rights in electronic transactions. Additionally, network rules, such as those governing the ACH process, provide protections for both consumers and the organizations using these services. Ensuring compliance with all applicable rules and regulations becomes even more complex when third-party vendors are involved.

However, financial institutions still have strict compliance mandates that remain in place regardless of outsourcing certain tasks to third parties. If a fintech fails to uphold its share of the compliance burden, the bank—not the fintech—will ultimately be held responsible.

“As institutions are transitioning from paper to electronic disbursements, they need to be aware of the organizational structure that they will be involved in,” Pope said. “Are they looking to leverage a fintech as part of this process, and how does that fintech manage their risks associated with partnering with banks? There is a lot to consider, depending on the model that you’re going to be engaging in.”

Though the task may be daunting, the benefits of payments modernization make the transformation a necessity. For many organizations, an incremental approach is the best way forward.

“In the grand scheme of things in the industry, there’s no finish line to this,” Hirschfield said. “There’s never going to be a world without fraud—we have to be realistic about that—and there’s never going to be a world without payments. It’s all about continuing to progress so that we are working in a world with less fraud and with increasingly faster payment options.”

However, as organizations transition to faster payments, they can’t fully abandon legacy payment methods.

“Payments is a balancing act,” Watercott said. “You have to be both a master in defense, I call that checks, but also be on the offense by embracing digital payments. The sports cliché that defense wins championships doesn’t always apply to payments. It has to be a balance of embracing innovation, but doing it in a secure, risk-oriented way. Work with your partners towards setting a goal of making check issuance an exception and not the norm.”