Financial Update (October-December 1999)
Did You Know?
DID YOU KNOW?
ACH Enjoys Moderate but Steady Success as a Payment Option
he banking industry is turning heads with the new products and processes it's offering to the public, thanks to the ever-accelerating pace of technological change. In the midst of all this razzle-dazzle, it's easy to lose sight of some earlier technologies that still have lots of life left in them. For banking, one of those technologies is ACH.
Introduced in the 1970s as a more efficient alternative to checks, the automated clearinghouse (ACH) is a network for electronic payment delivery among financial institutions. The ACH is used most often to process low-dollar, preauthorized recurring retail transactions such as direct deposit of payroll and government benefits, payment of mortgage loans, insurance premiums and utility bills, and corporate cash management.
The most popular ACH application is direct deposit, and the most common type of direct deposit is for payroll. Direct deposit benefits consumers because it saves the time and cost of depositing checks, eliminates the risks of lost or stolen checks, and ensures the funds are available on a consistent, timely basis, without the delay involved waiting for checks to clear. Direct deposit benefits employers and banks by reducing administrative and operating expenses.
Direct deposit is also used for expense and travel reimbursement, pension and annuity payments, retirement and mutual fund distributions, Social Security and veterans benefits, and tax refunds.
A less common but growing use of the ACH is direct payment, whereby a customer authorizes a company to debit her account on a regular basis to pay bills.
The main business use of the ACH has been for cash management — concentration and disbursement of funds. A company spread out over a large geographic area, for instance, can use the ACH to concentrate funds into a central account, putting all its available cash to work, and to disburse funds.
How It All Started
It seems fitting that the first automated electronic clearinghouse was born in California, which has become the chief breeding ground for the computer industry. In 1968 the San Francisco and Los Angeles clearinghouse associations established a committee to explore how to create an electronic clearinghouse. This study led to the first automated clearinghouse, operated by the Federal Reserve Bank of San Francisco, in 1972. Other regional ACHs were also formed during the 1970s, most of them operated and supported by the Federal Reserve System.
Seeing the need for an interregional network, the American Bankers Association formed the National Automated Clearing House Association (NACHA) in 1974. Its charter called for establishing uniform nationwide ACH operating rules and expanding the types of transactions available.
The ACH Network
Today, in addition to maintaining the rules and standards for the ACH, NACHA also develops marketing plans, educational programs and publications to promote use of the ACH network. NACHA's membership is made up of more than 13,000 U.S. depository institutions in its 34 regional ACH associations and more than 550 companies through its affiliate membership program and six industry councils.
The Federal Reserve processes nearly 80 percent of all commercial interbank ACH items in the United States; the remaining 20 percent are handled by three private-sector operators. The Fed also processes all U.S. government ACH transactions, which account for about 20 percent of total ACH transactions.
How Does the ACH Work?
When a person, a company or a government agency authorizes its bank to make an ACH transaction, the bank transmits the relevant information in an electronic file to an ACH processor like the Federal Reserve. This file is made up of batches, each batch representing a series of transactions pertaining to one company or institution. Transactions are individual electronic debits and credits formatted to NACHA standards. The Federal Reserve or private-sector operator sorts the transactions into separate output files for each institution and then transmits these to the receiving banks, where the individual entries are then posted to the recipients' accounts.
Growing . . . But How Fast?
In the early 1970s, the ACH's creators thought that the system would eventually replace checks as the predominant method of making payments. But the use of checks has increased over the last two decades, aided by technological advances like higher-speed check processing machines.
Besides the continued popularity of checks, other factors have slowed the acceptance of ACH. Undoubtedly, in its early years the adoption of ACH for trade payments was hampered by difficulties in establishing a common electronic format that could easily convey invoice information. But improvements and better compatibility in electronic data interchange standards have helped increase the use of the ACH in more recent years. In fact, during the last dozen years the overall volume of ACH transactions has grown at an average rate of more than 15 percent per year.
A report published in 1998 by the Committee on the Federal Reserve in the Payments Mechanism, chaired by Alice Rivlin, then vice chair of the Federal Reserve Board, cited a number of shortcomings of the current ACH system that may be limiting the scope and market for ACH products. These factors include a lack of flexibility and accessibility in originating ACH transactions, the difficulty in using the ACH for ad hoc or one-time transactions, and the lack of a nationally coordinated education and marketing effort targeted toward businesses and consumers. But the industry is working to address these concerns.
Forecast: Mostly Sunny
As part of their educational efforts, the Federal Reserve, NACHA and regional ACH associations have formed the Direct Deposit and Direct Payment Coalition to promote the benefits of direct deposit and direct payments to consumers, businesses and the country.
Some of the other concerns about the ACH system are also being addressed. For instance, NACHA is now conducting a pilot program involving 25 financial institutions in which consumers can authorize, by telephone, electronic debits to their bank accounts to make one-time payments for goods and services.
The ACH is also crossing global frontiers. Prompted by recommendations from the Rivlin Committee, the Federal Reserve is conducting a pilot program involving cross-border transactions between the United States and Canada. NACHA has been involved in establishing a worldwide automated transaction clearinghouse (WATCH), which is developing a low-cost, cross-border electronic payments system based on Internet protocol.
As the ACH system continues to build on its current strengths, seeks to shore up its weak points and expands its horizons, it should continue to be an important payment option for consumers, businesses, the government and financial industries for decades.