The Automated Clearing House (ACH) system is a secure, private network that connects banks to one another by way of the Federal Reserve Board or other ACH operators. This network enables electronic payments, such as automatic payroll deposits and debit card purchases, to be handled and processed.
Even though the ACH is privately configured, the Internet is fast becoming a critical component. Because executing ACH payments is cheaper and faster than processing paper checks, both business-to-business and business-to-consumer e-commerce activities are becoming ever more dependent on the ACH system, thus forcing it to evolve.
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For example, the National Automated Clearing House Association (NACHA) in Herndon, Va., which sets the rules and standards for ACH transactions, recently released a set of guidelines for e-commerce merchants that accept ACH payments on their Web sites.
Previously, there were no rules except those set by the merchants' banks. As of March 16, however, merchants were required to have an authentication system in place so they can identify their customers electronically, says NACHA spokesman Michael Herd.
In addition, merchants must now have systems in place to verify routing numbers, conduct annual security audits and have a security equivalent of 128-bit Secure Sockets Layer encryption or better.
In the future, NACHA may also be required to develop standards for wireless and person-to-person payments, said James VanDyke, an analyst at Jupiter Research in New York.
Pump It Up
Still, e-commerce isn't the only factor driving increased volume on the ACH network.
The total number of corporate ACH payments last year was more than 902 million, up from 818 million in 1999, according to NACHA Executive Vice President William Nelson.
This figure includes both business-to-business and government-to-business payments, as well as business-to-consumer payments such as payroll deposits. The dollar amount of these payments exceeded $11.6 trillion last year, according to Nelson.
Some of the biggest growth occurred through financial electronic data interchange (EDI) networks, where businesses exchange payment information with established partners.
"B2B on the Internet is contributing to the growth of financial EDI because payments still need to be made, no matter how the transaction is originated," Nelson says.
One of the reasons why ACH has become such a popular payment mechanism on the Web is that it's less expensive than most alternatives.
For example, the cost of receiving a credit card payment over the Internet averages approximately 2.5% of the total transaction cost plus a flat fee ranging from 15 to 30 cents per transaction, compared with a fee of just 2.5 to 25 cents per ACH transaction.
In addition, credit card limits are typically too low for most businesses to use to finance big-ticket items such as industrial equipment, says Avivah Litan, an analyst at Stamford, Conn.-based Gartner Inc.
According to Gartner research, 17% of business-to-business payments are now made electronically; the rest still involve paper checks or paper money orders. Of the transactions that are now conducted electronically, 33% are ACH payments and 39% are wire transfers.
Wire transfers also go through the Federal Reserve, but they differ from ACH payments in several important ways. For instance, ACH payments are processed in batches, so a transaction can take a day or two to be completed. Wire transfers, on the other hand, take place immediately.
In addition, ACH payments can be repudiated. There's a window of time in which a consumer or business can decide to cancel the payment. Wire transfers can't be canceled.
There also isn't any guarantee that an ACH payment won't bounce in the event that there isn't enough money in an account to cover it. Merchants can try to minimize such risks by signing up with services from firms like TeleCheck Services Inc. in Houston to look up a bank account in a database, but wire transfers are guaranteed.
On the upside, ACH transactions cost considerably less than wire payments, although actual costs vary by bank. A simple ACH transaction usually costs less than 25 cents, Litan said, whereas a wire payment typically costs between $10 and $40.
That's why ACH payments are a common option with peer-to-peer payment systems such as that of Palo Alto, Calif.-based PayPal Inc., which lets individuals send money to one another via e-mail.
In addition to PayPal, several other banks also offer consumer-oriented payment services: Citigroup Inc. in New York has c2it, Wells Fargo Bank NA in San Francisco touts BillPoint, and Bank One Corp. in Chicago offers eMoneyMail. CIBC National Bank in Orlando is the engine behind Yahoo Inc.'s PayDirect service.
"It's going to become a ubiquitous feature on online banking sites," says Paul Jamieson, an analyst at Waltham, Mass.-based Gomez Inc.
The biggest disadvantage to sending money through the ACH system is that it doesn't transmit a lot of information along with the money.
This isn't much of a concern for individuals, who only need to know, say, the address of a service station where they bought gas. But corporations using electronic payments for business-to-business transactions usually need more information - not just where the money went, but what account it needs to be charged to internally, whether there was an invoice and whether the account was paid in full.
To address this issue, several companies have developed ways to attach bills, invoices or other data to ACH transactions.
"These companies take the best of the ACH network - that it's a low-cost way of moving money - and they build these value-added services like digital signatures, guarantees of payment and online validation, like you get with a credit card," said Litan.