During the first week of March, the US Federal Reserve Banks announced plans for financial institutions to clear and settle certain automated clearing house (ACH) transactions in one day. The Federal Reserve is transparent about its motivation for the move to same-day automated clearing for debit transactions. The recent action was caused by the increasing disintermediation by banks that have established direct ACH connections to other banks instead of settlement through one of the two ACH networks.
Like any business, the Federal Reserve recognised the increasing threat of bilateral exchanges developed among the largest ACH players (e.g. Wells Fargo and Bank of America, Citigroup and Capital One with certain institutions). In examining the volumes of ACH going through its network, the Federal Reserve identified patterns of dropping volume. In some cases it estimated significant losses in payments in the tens of millions of dollars.
The direct send relationship also creates inefficiencies and ultimately harms the payment system. Potential damage includes:
- A loss of ACH network revenue, impacting unit cost for all remaining network transactions.
- Higher prices for in-network items.
- Lack of National Automated Clearing House Association (NACHA) governance of rules and risk management and inability to monitor transactions for illegal activities and telemarketing abuses.
- The potential eradication of one of the ACH operators, reducing contingency options, fee competition, and product innovation.
ACH payments generally settle on the first business day after they are originated. With the new settlement window, deposits made by 2:00 pm will be settled by the close of business that day, following schedules similar to those currently in place for the Fed’s Check 21 image exchange services. The expedited clearing will make ACH more competitive with check-image exchange networks.
But the move took five years to happen. The Retail Payments Office (RPO) of the Federal Reserve conducted a pilot program in 2004. It followed with a technical survey of 29 financial institutions, from credit unions to the largest banks, two processors, one software provider and the Department of Treasury. Its findings revealed that three out of four were moderately or enthusiastically interested in same-day ACH. Although the demand was present, until now the ACH network had failed to meet the needs of the market.
Pricing Issues
The creation of value-added functionality for debit transactions has clear benefits. Richard Oliver, executive vice president at the Federal Reserve Bank of Atlanta and manager of the RPO, said: “The service provides the opportunity for corporations, working with their originating depository financial institutions, to accelerate the collection of consumer payments by one day and to be able to identify return items more quickly. I believe that data over time had demonstrated that both of these features should have a positive impact on a company’s collection experience.”
Even though better settlement times will provide quicker fund availability and earlier returns for credit risk management, concerns are being raised by various parties. For banks, one issue is whether same-day credit will cannibalise their more lucrative wire business and even exert downward pressure on the price of wires. Although a possibility, the future strategy of wire transfer systems also needs to become more relevant to make it the payment vehicle of choice for a broad constituency.
The opposite is also true. ACH prices could increase, according to Maureen O’Boyle, chair of the AFP’s Government Relations Committee and assistant treasurer of Shaklee Corporation. But, she said, if ACH prices are attractive: “more companies will gravitate to ACH. We’ll all want it and we will change banks to get it.” In fact, she added, wires may even go the way of cheques: “as fewer organisations use wires, prices will go up.” On potential price increases, Oliver responded: “That aspect of the service will be addressed closer to the implementation date in the second quarter of next year. However, we expect the pricing approach to encourage participation and recognise the benefits to all parties.”
Implementing the New Technology
Another question raised by corporate businesses is whether the new service will require additional format changes. In the current economic environment, businesses are averse to expensive technological upgrades. However, the change – while requiring amendments to the Fed’s operating circular for ACH payments and participating banks to make operational changes – will not require format changes. The faster ACH service will maintain the existing formats for the standard entry class codes and comply with NACHA rules.
Phase one will take effect in the second quarter of 2010. It only applies to a subset of NACHA standard entry class codes: consumer cheques being converted to electronic transactions (ARC, BOC, and POP), and debits initiated by telephone (TEL) or the Internet (WEB). The accelerated settlement service will be voluntary and will require both the originating depository bank and the receiving depository bank to opt in. In order for companies to use the service, they and their trading partners will need to work with participating depository institutions.
There is some fear, though, that this is the beginning of a slippery slope and may affect other forms of payment instruments. Although same-day ACH will not apply to consumer and corporate credit transactions, such as payroll direct deposits or online bill payments, the Fed is considering plans for a second phase of the implementation. It is exploring opportunities to broaden service by accommodating contingency payments like late/hourly payroll and disaster recovery.
The nation’s other ACH network operator, the private-sector Electronic Payments Network, is also looking to implement a similar settlement service. The advantage of having both U.S. operators offer the service is economies of scale and network effects – more users of the network make it more valuable for all. This will be the first material change to the settlement schedules for the Federal Reserve in 35 years. Whether the change will be enthusiastically embraced, or whether there will be further stumbling blocks, we will have to wait and see.