Automated Clearing House

In the previous article, we have learned about how check payments work with the help of a clearing house.

However, in the modern world, the concept of check itself has become outdated.

As a result, people prefer to transfer funds electronically. This is where the clearinghouse is being replaced by an automated clearinghouse or an ACH.

The Automated Clearing-House (ACH) is by far one of the most popular modes of payment in the United States and even in the entire world.

In this article, we will have a closer look at the meaning of ACH and its importance.

What is an Automated Clearinghouse (ACH)?

An automated clearinghouse is a set of rules and formats which the payers need to follow when they transfer payments. This fixed format allows the execution of the entire transaction to be done electronically i.e. no manual touch is required for processing the entire payment.

ACH transactions can be international. However, in most cases, the ACH networks only work within the boundaries of a given nation.

Also, since the entire payment happens automatically, there is no labor cost involved. The only cost involved is related to infrastructure.

Hence, if the number of transactions increase, the per unit cost of the transaction decreases. This makes ACH one of the cheapest form of money transfer.

As a result, the ACH is generally used for low value high volume payments. Most bill payments, salary payments and other such transactions take place via the ACH system.

Also, ACH payments happen relatively quickly. Normally, ACH payments are credited to the beneficiary on the next business day.

However, for a small additional fee, they could also be credited to the beneficiary on the same day. This gives payees the flexibility to choose the speed of their payments.

History of the ACH

During the 1970’s, a committee was formed in the United States to increase the amount of paperless entries in the banking system. This was done since the volume of transactions was increasing manifold and hence more and more paper backed entries meant a higher administrative cost had to be borne.

This committee came up with the idea of an automated system. This became the ACH and the first ACH payment was made in 1970. The payment format was created by North America Clearing House Association (NACHA).

This is the reason that the format which is used to transfer payments between banks is called the NACHA format.

Which Transactions are Included in the ACH System?

The ACH system is extremely flexible since it includes almost all payments. This means that debit as well as credit transactions are included in the ACH system.

For instance ACH is used for paying payroll and corporate dividends which are credit transactions. At the same time, it is also used to receive payments for insurance, mortgage etc which are debit transactions.

ACH is also commonly used by companies to make loan payments and even pay federal and state taxes.

Also, there are no restrictions on the amount that can be transferred via the ACH system. This means that large dollar as well as small dollar transactions can be routed via ACH.

Similarly, there is no restriction on the type of account which can be used in an ACH transaction. ACH transactions can be posted to savings, checking or even a loan account. Corporations, private individuals or even governments can be parties to an ACH transaction.

Also, the ACH system also offers the users flexibility to make a single payment or recurring payments. The ACH format has various predefined codes which are used at predefined places in the format. These codes make the format flexible i.e. the same format can be used for a wide variety of payments.

Parties to an ACH Transaction

• Originator: An originator is the party which initiates the ACH transaction. It need not be a payer always.

  In some cases, transactions are originated by payers whereas in other cases, they are originated by payees. In order to initiate the transaction, the originator has to first receive the authorization from the recipient.

• Originating Depository Financial Institution: The originator cannot directly enter the ACH network. This is because only financial institutions are allowed to enter the network.

  Therefore, the originator has to employ the services of a financial institution. This is called the originating depository financial institution. The originator sends a message to the institution which then begins the process.

• The ACH Operator: The ACH operator is an electronic payment network which helps transmit payments to the correct beneficiary. In the United States, this role is played by the Federal Reserve which is also the central bank of the nation.

• Recipient Depository Financial Institution: Just like the originator, the receiver also has to deploy the services of a financial institution since the ACH network is exclusive and individuals or non-financial organizations are not allowed to access the network.

• Recipient: Finally, the recipient is the party which receives the ACH transaction. The entire process begins only after authorization from the recipient. Hence, it would be fair to say that the ACH transaction begins and ends with the recipient.

It would therefore be fair to say that the ACH system is an integral part of the larger financial system. In countries like the United States, it forms the backbone of the payments system.

Authorship/Referencing - About the Author(s)

The article is Written and Reviewed by Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.