The ACH Network

ACH transactions are sent in batches by financial institutions and third-party service providers to ACH operators for processing one or two business days before settlement dates.  The ACH operators deliver the transactions to the receiving institutions at defined times.  The Electronic Payments Network (EPN), one of the two national ACH operators, is a private processor with a significant share of the national market.  EPN is a subsidiary of The Clearing House (formerly known as the New York Clearing House Association). The Reserve Banks process the remaining share of the market.  ACH operators charge a small fee per- transaction to both the originating and receiving depository institutions.

In all ACH transactions, instructions flow from an originating depository financial institution (ODFI) to a receiving depository financial institution (RDFI).  An ODFI may request or deliver funds.  Transaction instructions and funds are linked using record keeping codes.  If the ODFI sends funds, it is a credit transaction.  Examples of credit transactions include payroll direct deposit; Social Security payments; dividend and interest payments; and corporate payments to contractors, vendors, or other third parties.  If the ODFI requests funds, it is a debit transaction and funds flow in the opposite direction.  Examples include collection of insurance premiums, mortgage and loan payments, consumer bill payments, and corporate cash concentration transactions.

When the ACH files are distributed, financial institutions originating credit payments have a binding commitment for payment to the ACH operator.  Settlement for Reserve Bank ACH credit transactions is final at 8:30 a.m. Eastern Time (ET) on the settlement day, when the credits are posted to receiving depository financial institution accounts.  Settlement is final for ACH debit transactions, assuming the RDFI has sufficient funds and there are no returns, when posted at 11:00 a.m. ET on the settlement day. See www.frbservices.org/files/regulations/pdf/operating_circular_4.pdf for Federal Reserve System Operating Circular No. 4 on "Automated Clearing House Items."

 

Figure 3 - ACH Credit Clearing

 

Legend: Solid lines represent the flow of information and dashed lines represent the flow of funds.

Figure 3: ACH Credit Clearing and Settlement

Figure 3 depicts a typical ACH credit transaction.  In this example, the payer is the employer and the payee is the employee.  The payee authorizes an employer to deposit his or her paycheck through direct deposit (step 1).  The ODFI is the employer's financial institution and the RDFI is the consumer's financial institution.  The employer submits its direct deposit payroll ACH files to the ODFI (step 2).  The ODFI verifies the files and submits them through the corresponding ACH operator (step 3).  The ACH operator routes the transaction to the payee's financial institution, the RDFI (step 4).  The RDFI makes the funds available to the payee by crediting his or her account (steps 5).  The ACH operator settles the transaction between the participating financial institutions (step 6).  If the ACH operator is the EPN, final settlement is made using the Reserve Bank's NSS.  If the ACH operator is the Federal Reserve, final settlement is made directly to the financial institution's reserve accounts at a Reserve Bank.

 

Figure 4 - ACH Debit Clearing

Legend: Solid lines represent the flow of information and dashed lines represent the flow of funds.

Figure 4: ACH Debit Clearing and Settlement

Figure 4 depicts a typical ACH debit transaction, in this case a recurring monthly insurance premium remittance.  The payer sends the ACH payment information and authorization to the payee, in this case an insurance company (step 1).  The payee submits this information to its financial institution (step 2), which routes the transaction to an ACH operator (step 3).  The ACH operator routes the transaction to the receiving financial institution (step 4).  Funds are made available to the payee and the payer's account is debited (step 5).  The ACH operator settles the transactions between the participating financial institutions (step 6).  Final settlement is performed as described in Figure 3.

An ODFI or an RDFI may outsource ACH processing functions to a third-party service provider, an entity that performs any processing functions on behalf of the ODFI, the originator, or the RDFI, including creation of ACH files or acting as a sending or receiving point.  A financial institution may provide the third-party service provider with its Electronic Transaction Identifier (the institution's unique routing number that is used in the ACH network).  Third-party senders, customers of the ODFI that provide services to originators, send ACH files on behalf of an originator. NACHA typically uses the acronym TPSP to designate third-party service providers.  Generally, TPSPs are not the same as technology service providers (TSPs), the term the FFIEC uses to denote third-party entities that provide technology services to financial institutions.  It is possible that a particular TPSP may also be a TSP, but for the purposes of this booklet, no such connection is made. In a third-party sender model, the ODFI does not have a direct customer relationship with the originator and must rely upon the third-party senders' warranties regarding its originators.  The lack of customer knowledge of the originators poses additional risk to the ODFI.

Historically, there was little risk in the ACH system because it was a closed system with recurring transactions and relatively few originators.  However, advances in technology and changes in NACHA Operating Rules resulted in significant changes in the nature and volume of ACH activity, with the most pronounced growth being in nonrecurring payments, potentially increasing the risk of ACH transactions for both financial institutions and their customers.  In addition to the primary ACH transactions, retailers and third parties use the now open ACH system for a variety of nonrecurring transactions including:

  • ACH check conversion
    • Account receivable (ARC) entries. Many financial institutions operate retail lock boxes for their corporate customers as well as for their own payments collection.  Lock boxes receive large volumes of check payments.  With ARC, the checks are converted to ACH payments through the transmission of the MICR information on the checks.  This data is batch processed for collection through the ACH network. ARC has improved the efficiency of lock-box operations by eliminating the transport of paper checks and increasing the speed of payment collection.  While ARC has only been in use since 2001, in 2006 it accounted for 16 per cent of all ACH transactions and was one of the fastest growing segments of the ACH network. Recent statistics, however, indicate that ARC is currently decreasing.   
    • Point of Purchase (POP) and Back Office Conversion (BOC) entries. Like ARC entries, POP and BOC entries are created by capturing the check MICR information and sending the transaction through the ACH.  The most common application is with checks drawn on consumer accounts.  Some retailers and third-party service providers have been converting checks to ACH transactions at the POP or during BOC.  BOC was introduced in March 2007 as a new payment solution that allows merchants to collect checks in batches and convert them into debits through the ACH at a central location rather than at the POS.  BOC is similar to POP and ARC in that it facilitates the conversion of consumer checks to electronic formats.  BOC merely consolidates the electronic conversion process from the individual checkout lines to the back office.
  • Internet-originated (WEB) and telephone-initiated (TEL) ACH payments 
    • Consumers and retailers can initiate ACH transactions through the telephone and the Internet.  These ACH transactions are an alternative to providing a credit card or signature-based debit card number.
  • Re-presented check (RCK) entries
    • A physical check that was presented but returned because of insufficient funds may be re-presented as an ACH entry.
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The Automated Clearing House (ACH)
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