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Check clearing represents the time in which a payment by check, either paper or electronic, is processed by a bank. Depending on the size of a financial institution, the process by which checks are cleared can vary. Ultimately, a payment is made from a customer's bank account to the payee at the time that a check is cleared.
Before a check can be cleared with any financial institution, however, a customer must have a checking account. Funds are drawn from that account. If the amount of money requested exceeds the size of the account, a check can be returned for insufficient funds and the customer can be charged overdraft fees. Some banks offer overdraft protection, which allows checks to clear even if the funds are not available. Overdraft protection typically comes with limits and fees associated with the service.
Banks depend on the revenue generated from overdraft fees for a significant portion of earnings. These fees represent the largest portion of service charges on deposit accounts for large banks annually. A bank relies even more heavily on fee income when revenues from other financial products, such as mortgages, are under pressure. Customers have the biggest problems with check clearing during the months of November, December and January. A high percentage of these fees are assessed during this time period because consumers tend to spend more money during the holiday season.
In some regions, a bank must indicate the approach it takes for check clearing. For instance, one method is to process checks as they come in, regardless of the value of the check. Another method that is widespread among large banks is to process checks in a high-to-low manner. In this process, the check with the highest value is processed before any of the smaller checks.
If several checks are received by a bank on the same day, and the total sum of the combined checks exceeds the amount available in the customer's bank account, this can wreak havoc on the account. A bank that uses high-to-low check clearing will process the largest check first, followed by the smaller checks in descending order. This increases the likelihood that a checking account will become overdrawn after the first big check is processed, which will result in more overdraft fees for a customer as each of the smaller checks is processed.
Customers can access another form of check clearing with a debit card. A debit card works similar to a check, except transactions typically are processed at the time of the transaction, which could cut down on overdraft fees. In a checking account transaction, funds are drawn when the check is received by a bank, which could be days after a purchase is made.