Booklet: Retail Payment Systems
Section: Payment Instruments, Clearing, and Settlement
Subsection: The Automated Clearinghouse (ACH)
 

 

 

 

 

 

The operating rules of the National Automated Clearinghouse Association (NACHA) govern ACH transactions.additional information. ACH transactions are payment instructions to either debit or credit a deposit account. An ACH transaction is a batch-processed, value-dated electronic funds transfer between originating and receiving financial institutions. ACH payments can either be credits, originated by the accountholder sending funds (payer), or debits, originated by the accountholder receiving funds (payee). Financial institutions may contract with third-party service providers to conduct their ACH activities, and independent third parties not affiliated with financial institutions now generate significant ACH payment activity.

ACH payments are used in a variety of payment environments. Originally, consumers primarily used the ACH for paycheck direct deposit. Now, they increasingly use the ACH for bill payments (often referred to as direct payments), corporate payments (business-to-business), and government payments (e.g., tax refunds).

In addition to the primary ACH transactions, retailers and third parties use the ACH system for other types of transactions including:

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 Electronic check conversion. Electronic check conversion is the process of transmitting MICR information from the bottom of a check through the ACH. Its most common application is with checks drawn on consumer accounts. Some retailers and third-party providers have been converting checks to ACH transactions at the point of purchase. In addition, some corporations and financial institutions use it to convert check payments to ACH items at lock box locations.

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 Internet-originated and telephone-initiated ACH payments. Consumers and retailers can initiate ACH transactions over the telephone and Internet. These ACH transactions are an alternative to providing a credit card or signature-based debit card number. In addition, retailers do not pay an interchange fee for ACH transactions.

The ACH Network
 ACH transactions are sent in batches 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. There are two national ACH operators. The Electronic Payments Network (EPN) is a private processor with approximately 30 percent of the national market as of the end of 2002.additional information. The Federal Reserve Banks process the remaining share of the market. ACH operators charge a small per-transaction fee 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 and transaction instructions and funds are linked using codes for record keeping. If the ODFI sends funds, it is a credit transaction. Examples of credit payment transactions include payroll direct deposit, Social Security payments, and dividend and interest payments. Corporate payments to contractors, vendors, or other third parties are also common ACH credit transactions. 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.

Financial institutions originating customer payments have a binding commitment for payment to the ACH operator when the ACH files are distributed. Settlement for Federal Reserve Bank ACH credit transactions is final at 8:30 a.m. Eastern Time (ET) on the settlement day, when posted to depository financial institution accounts. Settlement is final for ACH debit transactions when posted at 11:00 a.m. ET on the settlement day.additional information.

Figure 7: ACH Credit Clearing and Settlement
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Figure 7 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 financial institution makes the funds available to the payee by crediting his or her account and debiting the payer’s account (steps 4 and 5). The ACH operator settles the transaction between the participating financial institutions (step 6). If the ACH operator is the EPN, final settlement is done using the Federal Reserve Bank’s National Settlement Service (NSS). If the ACH operator is the Federal Reserve, final settlement is made directly to the financial institution’s reserve accounts at a Federal Reserve Bank.

Figure 8: ACH Debit Clearing and Settlement
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Figure 8 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 7.

Payments System Risk (PSR) Policy
Similar to financial institutions offering retail payment services to customers, the Federal Reserve Banks are exposed to credit risk when they process payments for financial institutions holding reserve accounts. The Federal Reserve Banks guarantee payments for financial institutions using their systems for Fedwire® Funds, NSS, and ACH credit originations. Due to this payment guarantee, the Federal Reserve Banks may incur losses when institutions fail with overdrafts in their accounts.

The Federal Reserve’s Payments System Risk (PSR) policy controls and reduces intraday credit risk to the Federal Reserve
Banks.additional information. An integral component of the PSR policy is a program to control the use of Federal Reserve daylight overdrafts. Daylight overdrafts can occur in accounts at Federal Reserve Banks as well as at financial institutions. A daylight overdraft occurs at a Federal Reserve Bank when there are insufficient funds in an institution’s Federal Reserve account to cover outgoing Fedwire® funds transfers, incoming book-entry securities transfers, or other payment activity processed by a Federal Reserve Bank.

To control daylight overdrafts, the PSR policy establishes limits, or net debit caps, on the amount of Federal Reserve Bank daylight credit that a depository institution may use during a single day and over a two-week reserve maintenance period. These limits are sufficiently flexible to reflect the overall financial condition and operational capacity of each institution using Federal Reserve Bank payment services. The policy also permits the Federal Reserve Banks to protect themselves from the risk of loss by unilaterally reducing net debit caps, imposing collateralization or clearing-balance requirements, rejecting or delaying certain transactions until sufficient balances exist, or prohibiting an institution from using Federal Reserve payment services.

The PSR policy established daylight overdraft fees to provide a financial incentive for institutions to control their use of Federal Reserve Bank intraday credit and to recognize the risks inherent in the provision of intraday credit. Daylight overdraft fees induce financial institutions to make business decisions concerning the amount of Federal Reserve Bank intraday credit they are willing to use based on the cost of using that credit. The daylight overdraft measurement method, which incorporates a set of nearly real time transaction posting rules, also supports institutions in controlling their use of Federal Reserve Bank intraday credit.

The Federal Reserve Banks use the real time Account Balance Monitoring System (ABMS) to monitor financial institution accounts intraday. For a limited number of institutions, the system is used to prevent them from incurring daylight overdrafts in their Federal Reserve Bank accounts beyond a certain threshold (often set to zero) for Fedwire® Funds, NSS, and ACH credit origination transactions. This is referred to as monitoring the account in real time.

The Federal Reserve Banks require prefunding for any ACH credit origination transactions settling to the accounts of financial institutions that are monitored in real time. ACH transactions for accounts that are monitored in real time are also required to be prefunded on behalf of the account holder and any respondents.Institution accounts that are monitored in real time must have sufficient available funds when they process ACH batches that contain forward credit items (credit or mixed batches with debit and credits). If there are insufficient funds available in the account, the batch will reject and a notice will be sent to the ACH sending point and to the settlement financial institution.additional information.