The History of ACH and FinTech Services Innovating Money Transfers Today
I published an article a few months ago about the history of electronic payments and how the US banking system pioneered the original infrastructure that much of modern banking has been built upon. The article also touched on ACH, a financial network regulated by Nacha, formerly known as the National Automated Clearing House Association.
This electronic funds transfer system connects more than 25,000 financial institutions across the United States and revolutionized online payments making it so large volumes of transactions could be processed at once for the first time.
In this article, I wanted to delve deeper and explore precisely what ACH payment is, how it got started, some of its shortcomings, and the FinTech business models filling a need within the current payment system. Let’s dive in.
What is ACH and how did it get started?
The ACH system, one of the oldest payment systems in the US, is a way to transfer money from one bank account to another without needing to use paper checks, wire transfers, or cash. Also known as direct deposit or direct pay it is used in the US today for many automated payment services, including payroll, direct deposits, mortgage and credit card bills, and tax-related payments.
ACH was developed in 1968 when a group of bankers in California became concerned about the growing volume of paper checks and whether the technology and equipment used to clear them would be able to keep up with the increased demand. This coincided with a sponsored study commissioned by the American Bankers Association looking for ways of improving the nation’s payment system.
These events led to the ACH association forming in California in 1972 which aimed to handle electronic payments. Other regional ACH networks soon appeared, and in 1974 they formed Nacha to administer the ACH Network, leading to the first national ACH Rules being drafted.
In 2021, the ACH Network processed more than 29 billion payments, which marked the seventh consecutive year in which it added more than 1 billion new payments.
When you make a payment to another account using ACH, it always follows the same payment process:
A direct deposit or direct payment transaction is made using the ACH network via debit or credit to another bank account.
An ACH operator (The Federal Reserve or The Clearing House) will sort the entries into deposits and payments.
The ODFI (originating depository financial institution) batches the request with other ACH transactions, to be sent out three times throughout the day.
These are received by the RDFI (Receiving Depository Financial Institution) who debits the customer with the value.
The transactions are settled between both banks at the end of the day.
As discussed in my previous article, though more modern forms of electronic money transfer — built upon the US system — have become popularized in other parts of the world ACH remains the dominant payment system in the US. This comes with positive aspects and some unique challenges.
What is a particular challenge with ACH?
Because transactions are processed in batches, ACH payments can take several days to deposit into the receiving bank depending on when they were initiated. This differs from more expensive wire transfers which don’t use a batch system so are guaranteed to arrive the same day.
In 2015, NACHA created Same Day ACH, intending to settle transactions within the same day. Though this is a big improvement Same Day ACH is still not real-time and continues to rely on batch processing. This has both positive and negative effects.
One major benefit of the delay of ACH payments is that it helps decrease fraud. By providing a buffer banks can cancel payments if it is found out that there was fraudulent activity On the flip side, there are certainly challenges with ACH.
First of all, there is no confirmation when money is deposited in ACH — the only communication a sender receives is if the money did not reach the account and is returned to the bank for some reason. Additionally, because ACH can take several days, it can delay financial transactions and thus slows down business.
So are there viable solutions to this? Well yes and no. Let’s discuss.
New apps and services that innovate within the ACH framework.
If the US financial system ever moves to RTP — a system that powers multiple bank accounts into a single mobile application, thus offering the efficiency of instant interbank and intrabank transfers — then existing financial institutions will need to innovate their infrastructures. In our previous article, we discussed RTP in greater detail and its advantages and limitations.
The reality is that the move to RTP requires a significant overhaul of the US financial system, and, while steps are being made to that end, the majority of transactions are still carried out via the ACH network. So, to make financial transactions happen more quickly, FinTech companies need to innovate within the bounds of the ACH infrastructure.
An app that is doing just that is Plaid (and Sardine), a platform that processes payments instantly, guaranteeing immediate ACH transfers with no risk. Of course, this only gives the appearance of automatic deposits for the receiver and behind the scenes, the ACH process is still working as usual.
By taking on full liability for chargebacks and returns and offering complete fraud prevention and compliant infrastructure, businesses can offer their customers a faster service without taking on any risk themselves. Sardine is now becoming available as a payment option for a growing number of businesses across the US, filling in the current gap between ACH and RTP.
Looking to the future of FinTech
It is an interesting time within FinTech as we consistently look for faster and more secure ways to transfer money and cryptocurrency while working with current limitations. The US financial industry is understandably complicated, so fundamental change is tough to implement.
But there are already advanced payment processing methods — like RTP — available, so hopefully, change comes sooner rather than later. In the meantime, companies like Sardine will continue to innovate on top of what we already have today because some progress is better than no progress.