Table of ContentsWhat is ACH? A brief historyWhat are ACH transactions and what are they used for?What are the two types of ACH transactions?How does the ACH network work?Who runs the ACH network?How long does an ACH payment take to process?What are the benefits of ACH transactions?What are the downsides of ACH transactions?Is ACH secure?Which banks use ACH?Can ACH be used globally?What’s the future of ACH?
ACH is the financial tool that many rely on and few understand. Despite supporting tens of billions of transactions within the US every year (including ~94% of payroll), many consumers know ACH by other names, and businesses may still be unclear on both how to drive consumer adoption and how to make sure all involved get the most from it.
What is ACH? A brief history
ACH (Automated Clearing House) is a network for electronically moving money between bank accounts in the US. It’s the direct evolution of the paper check—just transformed into a digital process to improve efficiency and reduce the need for human inputs.
As consumer mobility and payment preferences evolved in the early 1970s, banks struggled to keep up with the volume and geographic spread of checks. So they turned to newly commercialized computer technology to establish an automated solution. They then named their new system ACH in honor of the “clearing house”, a central location (originally a tavern) where banks went at set times to exchange checks and settle transactions.
What are ACH transactions and what are they used for?
An ACH transaction instructs member institutions to debit/credit accounts based on the details found on a physical check (e.g., account number, routing number). It’s why employers often ask for a voided check to set up payroll: to get those specific numbers.
Confusingly, these transactions are also popularly referred to by other names: “eChecks”, “direct deposit”, “direct debit”, “automatic withdrawal”, and so on. But they’re all different expressions of ACH, a means by which:
Consumers send funds between accounts
Employers pay their employees
Customers pay service providers
Taxpayers send funds to the IRS
Business pay suppliers
While ACH transactions aren’t the only way to move money, their advantages are compelling: over $62 trillion changed hands via ACH in 2020.
What are the two types of ACH transactions?
All ACH transactions fall into one of two categories: debit (“pull”) or credit (“push”). In an ACH debit transaction, an organization could be "pulling" money from a customer account for an automatic bill payment. In an ACH credit transaction, an organization could be "pushing" money to an employee’s account to pay wages.
While one party’s credit is another party’s debit in a literal sense, the naming convention simply identifies which party originated the request. An employer generally asks the ACH network to push money from one of its accounts to an employee’s, making it a credit. If the employee had initiated the request, it would be an ACH debit transaction even though they received the funds.
How does the ACH network work?
In essence, the ACH network acts as a financial postal system. Individual transactions are like letters that ACH operators sort and deliver between various banks, where each bank is acting as a post office on behalf of their respective account holders.
Member institutions and their processing partners regularly pass ACH messages to the network’s operators in the form of specially-formatted digital batches, which the operators re-bundle by recipient and pass on at regular intervals each business day. Each of these bundles contains a structured set of messages instructing the receiving party to make a credit or debit to an account they control.
Note that transactions aren’t settled directly, in that at no point do any two banks in the system exchange a stack of money or a pile of gold. The ACH network keeps a tally of net settled payments for each transaction window, and the banks involved jointly ask the Federal Reserve after each window to credit/debit their respective accounts accordingly.
Who runs the ACH network?
Nacha, originally an acronym for National Automated Clearing House Association, is the rulemaking body representing ACH-using financial institutions in America. Though what we call the ACH network is really two intertwined systems run by two different operators:
The Electronic Payment Network (EPN), run by The Clearing House (a collective of 24 large banks)
FedACH, run by the Federal Reserve banks to handle ACH transactions on behalf of the federal government
As for the dynamic between these operators, imagine if UPS and FedEx each had their own zones and sometimes passed off mail to the other to deliver on their route. Government financial institutions are serviced by FedACH, and private banks by EPN.
So Nacha, working closely with various government agencies, sets the rules, and the two operators then work together to route and deliver all ACH messages accordingly. Then ultimate settlement happens between the respective banks via the Fed.
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How long does an ACH payment take to process?
ACH payment processing timelines vary from hours to a few business days, largely based on:
When in the day the transaction was initiated
Whether the transaction returns an error message before the target settlement date, say for incorrect information or insufficient funds
Whether the originator paid for expedited same-day service
Now that ACH messages (as of March 2021) are being delivered up to 5x per business day, the default is a bit faster. And the network can now accommodate same-day processing. That said, uptake of same-day ACH has been fairly modest. Just $460 billion of ACH transactions in 2020 were same-day, or about 0.7% of the whole. This lackluster adoption can be attributed in part to the added expense, and in part to the fact that faster processing doesn’t necessarily mean faster settlement in a final sense.
Unlike a wire transfer, ACH transactions are recallable and timelines around recalls and returns are complicated. The system works on a “no news is good news basis” where the absence of a return code is the closest thing offered to a confirmation. Consumers have up to 60 days from when the statement containing the first unauthorized transaction was transmitted to the consumer to report an unauthorized ACH debit to their account. In practical terms, this can mean some binding reversal requests being received up to about the three-month mark, though most come through in the day or two following.
So, depending on a given institution’s standard practices, as well as their assessment of the risk involved, the actual release of customer funds may be delayed until the maximum deadline, even if the receiving institution already has the details in hand. Though funds for credit transactions are occasionally released prior to settlement as a sort of low-risk loan.
For more on these timelines, see our companion article on how an ACH transfer works.
What are the benefits of ACH transactions?
ACH transactions have three primary benefits:
They’re cost-effective. To organizations that use them, ACH payment fees range from a few cents to a few dollars, depending on transaction size and volume. This is generally quite favorable compared to domestic wires (tens of dollars), credit cards (mostly in the 2%-4% range), and paper checks (variable, but usually at least a few dollars).
They’re repeatable. Cards expire and get lost/stolen, breaking continuity every few years. In contrast, the average US checking account is 14 years old and generally only needs to be linked once to establish a payment connection. This makes ACH a frontloaded investment where transaction failure risk drops with each subsequent transfer involving the same accounts.
They’re convenient. Older methods necessitate worse experiences. Handling paper checks is labor-intensive for everyone, wire fees annoy the recipient, credit cards require a lot of data inputs and aren’t built to hold positive balances, and cash is a security risk that necessitates trips to the bank. ACH is often the golden middle child, and modern services built atop ACH can make the experience even better.
What are the downsides of ACH transactions?
ACH transactions have two interrelated pitfalls:
Speed. Default ACH transactions can take multiple business days to process, and even same-day ACH isn’t always truly same-day. This can leave parties with difficult decisions about whether to allow withdrawals, ship products, or honor service contracts in the intervening time. With slow processing may also come confusing balances, where consumers forget about a pending debit and end up with an overdraft or NSF.
Risk. As parties won’t know for hours or days if a debit transaction cleared, scammers and other bad actors have historically taken advantage. This risk has both crimped ACH’s adoption for single-transaction use cases and forced retail banks to place limits on how much consumers can transfer via ACH and on how fast the funds clear.
Is ACH secure?
Though all systems have vulnerabilities, ACH is quite secure, and creative solutions have been built atop the network in recent years to make it even better. While no system is perfect, using the right combination of ACH solutions can bring risks towards zero.
From a business perspective, some common problems can include:
Ensuring a customer’s banking details and/or credentials are stored in a secure manner
Identifying fraudulent transactions
Minimizing the risk of a customer fraudulently reversing a transaction in an attempt to claw back payment for a good or service they already received
Solutions to these problems may include, but are not limited to:
Bank details and credentials can be kept secure by reducing the number of parties who see them (e.g., tokenization, encryption, and secure vault payments)
Validating financial accounts (e.g., micro-validation transactions and digital authorizations)
Accounts can be checked for telltale patterns of fraud and NSF risk (e.g., current balance check and transaction history assessments)
Which banks use ACH?
All banks in the US are able to utilize ACH in at least some fashion, as the minimum requirement to receive ACH transfers is simply a valid bank account and routing number. In addition to banks, payment processors like Square, PayPal, and Stripe utilize ACH as well. Because all US banks use ACH, Plaid is able to connect accounts from 11,000+ financial institutions for ACH transfers.
Learn why more consumers are choosing to pay with their banks.
Can ACH be used globally?
Though the ACH network was built for US financial institutions, it can support international transactions—but only where bilateral agreements exist between originating and receiving institutions.
While Nacha has worked to establish interoperability with its global counterparts, adoption has been slow and limited. This is partly because it’s a hassle for banks to build out functionality that not many of their customers use, and partly because most international banks would prefer that their customers didn’t use ACH. International wires are easier and more lucrative for them.
What’s the future of ACH?
Technologies as ubiquitous as ACH have many stakeholders, which means that changes, when they come, tend to proceed slowly. Still, some innovators are renovating ACH; some are building on top of it; and some are building alternative systems altogether.
Renovating. Nacha continues to push for enhanced same-day capabilities; they’ve been talking about real-time possibilities for years. But they can only move at the speed of their slowest member banks, so reforms will be unrushed and incremental.
Enhancing. New ACH solutions such as Instant Account Verification bypass the historical pitfalls of the ACH system, making it a more attractive tool for ecommerce and other business uses. For example, many investment apps and cryptocurrency platforms now use enhanced ACH for account funding and USD withdrawals, and services like Venmo and CashApp use it for peer-to-peer money transfers.
Competing. Emerging money transfer solutions are competing with ACH, including Zelle, which offers free bank-to-bank money transfers that can settle in minutes. Because Zelle is free and fast, it is a strong competitor to ACH transfers, but it is only available to customers of participating banks. The Federal Reserve is also working on their own real-time product, FedNow, that they’re hoping to bring online by 2024.
Asked about the future of ACH, Plaid product manager Brian Wey said, "We’re excited to continue closing the gap with real-time payments while preserving the low costs of ACH solutions.” He also expressed confidence that this work “will help financial service providers continue to develop products that elegantly solve for user needs."
All said, enhanced ACH will surely continue to unlock new use cases. The larger ACH ecosystem also stands to benefit from the continued migration from paper checks, which still make up one-quarter of overall US payment volume by dollars. Meanwhile, we’ll see further development of real-time products from traditional banks, the Federal Reserve, and crypto startups. For consumers, the resulting competition for market share is likely to yield positive results: lower costs, faster speeds, and better features.