Banking 101: What is Check Kiting and How to Avoid Getting Scammed

You may not think of writing a check as making a promise, but that's essentially what you're doing: You promise the recipient that your account has the funds needed to clear the transaction. Check kiting happens when a person knowingly makes out a check his account can't cover, deposits the bad check with a financial institution separate from the one his account is at, and then withdraws money from the second financial institution.

Check kiting takes advantage of “the float,” or the lag time between when an individual provides a check as payment and when the recipient cashes the check and the recipient’s bank requests funds from the check writer’s bank.

Payouts from check kiting can reach into the millions, as in the case of the CFO of a Dallas used car dealership, who used check kiting to help defraud banks and lenders of more than $50 million (he was eventually caught and convicted).

How check kiting works

In its simplest form, check kiting involves three actors: two different banks or credit unions (which we'll call Bank A and Bank B) and the check writer (whom we'll call Chuck). Here's how it goes down:

• Step 1. Chuck has a checking account with Bank A with a $1,000 balance. Chuck writes a check from this account for $5,000, which is greater than his account can cover.
• Step 2. Chuck strolls down the street to Bank B, where he has a checking account as well. Chuck deposits his $5,000 check from Bank A into his checking account at Bank B.
• Step 3. Before Bank B can process Chuck's check and realize it's been had, Chuck withdraws $5,000 in cash from his account at Bank B — which has already credited his account with the $5,000 from the bad check.
• Step 4. Chuck has just made $4,000—the $5,000 he withdrew from Bank B, minus the $1,000 deposit he made with Bank A.
• Step 5. Many fraudsters keep up the gig for more than one round. Chuck writes a bad check for $5,000 (or more) from another financial institution (let's call it Bank C) and deposits it in his account at Bank A to cover his deficit. Chuck then repeats the cycle until he is satisfied with his ill-gotten gains, and blows town.

Again, these schemes can add up to big money for the scammers—at least until they're caught. One resident of Staten Island, New York made off with $5 million before the authorities apprehended him, thanks to his ability to shuffle around approximately $82 million in checks and wire transfers.

Why check kiting works: Float time

If banks could communicate instantaneously and seamlessly process checks drawn from accounts at other institutions, check kiting wouldn’t exist. The whole scam lives in the float, or the gap between when a check is deposited by a customer and when the money from the check writer's account is actually transferred to the check recipient’s bank.

The implementation of the Check Clearing for the 21st Century Act into federal law in 2004 shortened total float time by allowing banks to perform check-processing via digital means. Before this change, they would physically move checks from one institution to the other. After passage of the act, checks could clear in as little as 24 hours if deposited on a business day.

How to avoid becoming a victim of check kiting

You may think that the only victims of check kiting are banks and credit unions, but individuals can get wrapped up in the con as well. If you're making a personal financial transaction with a stranger—say selling something on Ebay or Craigslist—and you're paid with a check, a scammer might immediately contact you and say he or she accidentally wrote you a check for too large an amount.

The fraudster may then ask you to wire or otherwise send them the difference before you realize they've written you a bad check in the first place, and by the time you realize you've been passed a bad check, the scammer has made off with the money you sent them.

Fortunately you can easily avoid getting scammed like this. Don't wire money to strangers or accept checks from any potential customers (there's a wealth of peer-to-peer payment apps and services that can help you avoid the problem of bad checks from strangers).

The penalties for check kiting

Penalties for check kiting vary from case to case, but the headline-grabbing cases involving millions of dollars can end with sentences of more than 10 years in prison and high fines. Even smaller or first-time infractions can result in harsh penalties, as befits the serious nature of the crime.