The act of transferring money from one party to another always involves at least two parties: payer and payee (recipient). Two-party transfers have been familiar to everyone since antiquity: Shoppers buy goods from merchants simply by handing over cash, and money transfers instantaneously. Check floats exist because checking as a payment mode involves at least three or four parties, and it is not instantaneous.
Check Float is Inevitable and Legal
The rise of the banking industry in medieval Europe brought new payment methods into commerce, replacing the simple act of handing over cash with methods that include third parties, multiple steps, and processing time. One such method—payment by hand-signed printed check–became common in Europe and the United States by mid-eighteenth century.
Sellers and buyers, and creditors and debtors have always been acutely aware that some minimal float time is inevitable and legal any time an account holder writes a paper check—even now, when most paper checks process and clear by electronic means. However, float times of 2-7 days also occur with computer-issued echecks.
For this reason, banks caution on-line merchants who accept written checks or echeck payment to delay shipping goods until the funds actually arrive in the merchant's account. Payment is not certain until float time ends.
Check Kiting is Illegal
If the account holder issues a check when the checking account does not have sufficient funds to cover payment, the check writer is practicing check kiting. Kiting is illegal almost everywhere, even if the check writer quickly deposits funds to cover the check. In such cases, the practice is still legally an instance of kiting.
Sections below further explain and illustrate check float and check kiting.
- What are check float and check kiting?
- What is check float time?
- What is check kiting? Why is kiting illegal?
Benefits and Risks in Floating
Check floats operate to the check writers advantage. At the same time, floats create a level of risk for payees, for the banks involved, and for check writers themselves/
- The writer receives credit for issuing payment, even though the recipient cannot use the funds until the float closes. Thus, check writers essentially benefit from a free loan and a few extra hours or days to earn interest before funds leave their bank accounts.
- If the payer has insufficient funds when the check clears, one of the following will ensue:
- The writer's bank allows an overdraft of the writer's account and pays full check value to the payee's bank. This may or may not incur penalties for the writer, depending on bank policy and the nature of the checking account.
- The writer's bank disallows the overdraft and returns the check, unpaid, to they payee's bank. For this, the writer's bank may issue a penalty fee to the writer, and the payee's bank may issue a penalty fee to the payee.
Is Check Float Still Possible in the 21st Century?
Check floating was more common before the twenty-first century, when check clearing always required moving paper checks between banks and a clearinghouse (except when check writer and recipient both had accounts at the same bank). Under those conditions, the time between check writing and final clearance by the writer's bank typically took anywhere from 2 to 10 days. In such cases, the longer float times were normal when check writer and recipient had accounts in different banks in different cities.
Not surprisingly, some individuals and businesses deliberately lengthened float time, by writing paper checks from accounts in small local banks in remote locations, far from the recipient banks. Floats in such cases were legal as long as sufficient funds were already on deposit at the time of writing.
Recent advances in check handling efficiency have shortened check float times everywhere, while increasing drastically the risk of getting caught for kiting. In the United States, for instance, the "Check 21 Act" of 2003, allows the depositor's bank to make an electronic version of the written check and submit that instead of the paper original for clearance (US Federal law, Public Law 100 enacted by the 108th Congress).
Whereas some amount of float time is still inevitable and legal with any written check, the practice of deliberately writing and issuing checks when funds are not on deposit to cover the check is not legal. This practice is kiting, and banking laws almost everywhere ban the practice.
Kiting Paycheck to Paycheck
One mild form of kiting is widespread, especially among those who drain their checking accounts between paydays. This is the practice of paying merchants or creditors with a written paper check on the day before the check writers expect to receive electronic deposits (such as a paycheck) in their accounts. The writer in such cases is expecting or hoping the incoming deposit arrives and receives credit with their bank, ahead of the check they have just written.
Some banks have taken steps to thwart this practice, at least for cases where they receive the check writer's deposit and payment obligation on the same day. The bank's tatctic involves holding all incoming transaction requests for processing until very late in day. The bank then submits the its outgoing payments for batch processing and then, only when the outgoing payments are completed, the bank processes its incoming deposits. This means that an incoming electronic deposit received very early in the day at, say, 4:00 AM, will not be credited in time to cover an incoming payment demand that is received at, say,4:00 PM.
Security officers from different banks cooperate, looking out for another particularly common form of kiting in which an individual deposits and withdraws checks at the same time from accounts at two or more different banks so as to take advantage of the float (the time it takes for the deposit bank to collect from the withdrawal bank). Due to Interbank cooperation and electronic check clearance, this kind of kiting fraud is more likely to suffer exposure than it was a few years ago.
Other Forms of Kiting
Securities traders also use the term kiting, referring to a practice that drives stock prices up by creating artificial trading activity (collusion between seller and buyer, for instance, exchanging the same funds back and forth).