Automated Clearing House (ACH)
A network that works as a payment system for banks to process electronic money transfers domestically.
What is an Automated Clearing House (ACH)?
The Automated Clearing House is an online network that processes electronic transactions like direct deposits or direct payments.
Almost everyone uses this; whether an individual is receiving their paycheck or a business is receiving a day’s sales, they all go through the ACH network.
ACH is widely used as 93% of American workers receive their paycheck through ACH direct deposit; the network is managed by Nacha, a non-profit organization incorporated in 1974. In 2021, Nacha processed 29 Billion payments valued at $73 Trillion.
The network is run through fees charged per use or an annual fee to an institution, the fees are usually minimal to make ACH a convenient solution for small payments, but with Nacha’s 9000 participating financial institutions, the fees add up.
Although Nacha manages and governs the ACH network, they are not involved in processing the transactions; the processing is handled by the Federal Reserve and the clearing house.
The ACH network has made the economy much more efficient. It only takes one business day for payments to be processed and is used by every individual and institution, like government entities, businesses, non-profits, etc.
ACH payments are sometimes rejected for various reasons, and each reason gives back a specific code; those codes are sent directly to your bank.
- RO1 Insufficient funds: This error code comes up when there aren’t enough funds on the initiating customer’s account.
- RO2 Bank account closed: This happens when the receiving bank account that was previously active is closed.
- RO3 No bank/ unable to locate the account: This error code happens when the banking details provided don’t match any existing bank accounts.
- R29 Reject: This happens when a bank doesn’t allow the withdrawal of funds from a bank account.
When these errors happen, a customer will typically be charged a fee and have to rerun the transaction with the correct information or additional information.
How do Automated Clearing House payments work?
Automated Clearing House payments use a batch processing method where transactions are put into batches and processed three times a day.
Every ACH transaction involves three parties connected by the Automated Clearinghouse Network (which combines all banks in the United States):
- The Originating Depository Financial Institution (ODFI) is where the transactions start.
- The Receiving Depository Financial Institutions (RDFI) are where the transactions are received.
- NACHA, which is the governmental entity that manages and regulates ACH payments
For example, if your employer wants to send you your pay cheque, the employer will contact their bank (the ODFI) with the amount of the pay cheque and the receiving bank account information.
The ODFI will then contact your bank (RDFI), and if there are enough funds in your employer’s account, the funds will be transferred to your account.
ACH payments are processed in batches, meaning that when you initiate the payment with your bank, the bank takes your transaction and nets it with a group of other transactions that are processed together sometime during the banking day.
advantages of Automated Clearing House (ACH)
Alternative to using this network, an individual or a business can use paper checks or credit cards, each with its advantages and disadvantages.
Compared to paper checks, this network offers the following features.
- An electronic method of payment
- Cheaper processing fees
- Shorter processing time
- Better security
- Automated payments
- Better reliability
ACH can save so much money in businesses that process many transactions compared to paper checks. ACH payments are also easier to integrate into accounting systems, saving the business on data entry wages.
Credit cards and wire transfers can also be alternatives to ACH payments; the biggest advantage of ACH is its much cheaper transaction costs. For example, credit card merchant fees can go up to 3.5% of every transaction, and wire transfers can cost $30 per transaction.
In comparison, ACH payment fees are charged as a flat fee (which ranges from $0.25 to $0.75 per transaction) or a percentage fee (which can range from 0.5% to 1%). These fees vary by the financial institutions involved.
Another advantage of these payments is reducing human errors that are inevitable with paper cheques, and those mistakes can be very costly.
It is much more efficient and secure to use ACH payments on recurring bill payments as it’s all automated, and the probability of a mistake is much lower.
Although it can be a convenient and cheaper payment method, it also has many drawbacks. These include:
- It can take several days to process.
- Most financial institutions have a maximum amount you can send using ACH in a specific period.
- If initiated before a weekend or at night, ACH payments may take longer to process
- These networks usually only work within the same country.
Automated Clearing House (ACH) Vs. Real-time Gross Settlement (RTGS)
The main difference between ACH and RTGS is that ACH transactions are gathered in a batch and then processed three times in a banking day; on the other hand, RTGS transactions are processed individually in real-time.
Because real-time processing RTGS usually takes one business day for the funds to be available while ACH takes up to 3 business days, RTGS is a more secure transfer method as it has minimal errors and fraud. On the other hand, ACH is more vulnerable to delivery risks.
The differences between the two systems make ACH ideal for non-urgent low-value payments and RTGS ideal for high-value urgent payments; those payments can be between individuals or banks, but banks always initiate and receive the transactions.
The way these transactions are processed is also different; in ACH, the central bank’s debit and credit are taken into account, but in RTGS, it’s immediate, and no debit or credits will be taken into account. As a result, cash comes out of one account and ends up in another.
What countries use ACH payments?
Although the US is the largest user of these payments, the World Bank’s gpss survey identified 107 ACH systems serving 87 economies. ACH systems can also be shared between many countries, or a specific country can have many ACH systems.
Unlike the cheque-clearing systems, most ACH systems are not operated by central banks because the private sector in many economies directly introduces these systems. Furthermore, these systems can be very different when we look at how they operate.
For example, after netting a “batch,” most countries use an RTGS system for the final settlement; some countries, however, use central bank money for the final settlement. As a result, the number of processing times during a banking day can differ from country to country.
Some ACH systems support international payments, but many banks usually provide these services. Typically consumers will use wire transfers to move money abroad, but ACH can be a cheaper and more secure alternative.
Compared to Wire transfer costs of 10-50 USD, international ACH is often free, and the time it takes for an international ACH to be available can vary depending on the receiving currency and the receiving bank’s process; wire transfers usually are cleared within five business days.
Automated Clearing Houses (ACH) FAQs
It is a network that works as a payment system for banks to process electronic money transfers domestically.
Direct deposits, government benefits, payroll payments, and bill payments are all common uses of ACH.
Domestic ACH payments usually clear in one business day or less; however, the receiving financial institution commonly chooses to hold the funds for one business day.
In addition to banks, many financial apps use these payments, including PayPal, Venmo, and Zelle.
While every bank may have its limits on these payments, the regulating entity (NACHA) allows up to $1 million per payment for businesses and consumers alike.
If the transaction results in an error, a reversal will automatically be processed, and the funds will be returned to the originator’s account.
However, the bank will have to be notified within five banking days of the intent to reverse if the payment went through.
The transaction will automatically be reversed if the receiving account is non-existent, but you might get charged a fee.
However, if the bank exists, the transaction will be processed normally, and you will have to notify the bank of the error within five banking days.
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