What Is a Nonpar Item?
A nonpar item is a negotiable instrument, such as a check or a bank draft, that is cashed at a discount to its face value when deposited at a bank other than the one from which the instrument was written.
Nonpar items used to be commonplace prior to the creation of the modern check collection system in 1916. Today, however, transactions involving nonpar items are rare.
- Nonpar items are negotiable instruments, such as checks or bank drafts, that are deposited at a discount to their fair value.
- This difference in value would be factored in when the bank receiving the instrument differed from the originating bank that the nonpar item would be from.
- These fees were justified as a credit risk management measure.
- Since the Federal Reserve created a nationwide check collection system in 1916, the difference from nonpar items has been rendered largely obsolete.
- For example, if a check for $100 written from Bank A was deposited into Bank B, there would be a portion of funds deducted from the $100 total.
Understanding Nonpar Items
From the bank's perspective, this was done in an effort to reduce credit risks. After all, the risk of a given check bouncing would be greater if it originated from another institution, since the receiving bank would not be able to verify whether the writer of the check does indeed have the funds to make good on that promise.
Because of this concern, individual banks would create so-called "par" banking relations with one another, in which their account holders would be able to transfer funds between par banks without any penalty. Non-par banks, however, would continue to charge substantial fees.
With the reforms introduced by the Federal Reserve, this system of par and non-par relationships became obsolete, as the new reforms effectively made the entire national banking system function on an at-par basis. This initially entailed a significant loss of revenue from the various fees which had been collected. On the other hand, it also expedited the processing time for negotiable instruments and undoubtedly increased the efficiency of the banking system overall.
Example of a Nonpar Item
To illustrate, suppose that Carl is a client of ABC Bank, and he wishes to write a check to his brother, Arnold. His brother, however, is a client of XYZ Financial, which does not have a banking relationship with ABC.
For this reason, a portion of the funds sent by Carl will be deducted from the face value before being deposited into Arnold's account. For instance, if Carl writes a check for $200, then Arnold may only receive $190; the $10 difference would be deducted by XYZ Financial as compensation for bearing the risk that Carl's check might have bounced.
This example has become increasingly rare since the passage of the Federal Reserve's check clearing reforms in 1916. Today, these deductions would seldom if ever occur. The speed of transactions, meanwhile, has significantly improved on average.