A Complete Guide to ACH

While many may not realize it, Automated Clearing House (ACH) payments are a critical part of most people's daily financial lives. ACH is used in many different payment flows, such as payroll deposits, tax returns, online bill payments, and businesses paying vendors or contractors. ACH, eCheck, direct debit, and EFT all refer to the same type of payment.

What is ACH?

Automated Clearing House (ACH) is a network used to move money electronically between banks within the United States. It allows for automated, electronic debiting and crediting of both checking and savings accounts.

There are two types of ACH transactions: debits and credits. An ACH debit is a type of ACH payment initiated by the payee, pulling money directly from another account. For example, with their permission, a business could collect funds directly from a customer's account. An ACH credit pushes money to another account.

How Does ACH Work?

For the person sending (or pushing) the money, ACH credits are essentially digital versions of paper checks. Rather than fill out a paper check that the payee would give to their bank, the payer gives instructions directly to the ACH network detailing how much money should move from one account to another and when.

Let's look at the ACH process using a personal bill as an example.

Imagine that you just bought a house and now have a monthly homeowner's insurance bill, for which you want to set up automatic bill pay to pay your monthly premium. To do this, you'll need to set up your bank account to allow the insurance company to pull, or debit, money from it. Prior to your first payment, your insurance company will verify your bank account information, usually in the form of a micro-deposit into your bank account.

On the day your premium payment is due each month, the insurance company's bank will automatically create an ACH entry, requesting to withdraw the funds they're owed from your bank account. That request is forwarded to an ACH operator, who is the third party managing requests and settlement of ACH credits and debits between banks. There are two ACH operators in the US—the Fed and the Electronic Payments Network (EPN).

The ACH operator sends a request to your bank from the insurance company's bank to collect money for the premium payment from your account. Those ACH requests are batched and processed in bulk.

Your account is then debited for the amount of your bill. Once that debit is cleared by the ACH operator, the payment is settled and the money arrives in the insurance company's bank account. A typical ACH transaction takes 2-3 days to clear. However if you use same-day ACH or RTP, transactions can get cleared on the same day.

One thing to remember: In this example, we are looking at an ACH debit, but note that an ACH credit follows the same path. The only difference between an ACH credit and debit is that a credit is money being pushed to an account rather than pulled from an account. If your insurance company ever accidentally overcharged you, they would initiate an ACH credit to correct the overcharge.

ACH Origins

Before the automated clearing houses, there were physical clearing houses. Paper checks held instructions for a financial institution to pay funds from one account into another account, either at the same bank or a different one. Check clearing houses were created to assist in exchanging checks and settling check transactions between banks.

The physical clearing house was a gathering place where local bank clerks could convene at the end of each day to exchange checks and bills with other local institutions. Then, in the 1970s, a number of check clearing houses came together with the federal government to build an automated payment system that could be used nationwide.

ACH was first used as a more scalable and secure way to manage and process payments. This regulated, national network of automated clearing houses better allows US citizens and businesses to buy goods, get paid, and send payments easily and quickly.

In 1974, the National Automated Clearing House Association (Nacha) was founded to regulate ACH.

Organizations Involved in ACH

When a company wants to move money, they tell their bank (the originating depository financial institution, or ODFI) to credit or debit money from their counterparty's account (the receiving depository financial institution, or RDFI).

Say we're looking at a payment flow for a disbursement of funds to contractors for a rideshare app, Modern Rides. After a driver completes shifts, Modern Rides initiates an ACH credit from their bank, the ODFI, to the driver's bank, the RDFI. A few days later, money shows up in the driver's bank account.

There are four major players involved in such ACH network transactions.

1. The Federal Reserve Bank

The Federal Reserve operates as fiscal agent and banker to the US government. One critical part of its responsibilities is processing ACH payments on behalf of the government, such as Social Security and government payroll.

The Federal Reserve also operates one of two ACH systems, called FedACH. As of 2020, FedACH processes about 60% of all ACH payments in the US. (Federal Reserve Board Annual Data, 2020; Nacha ACH Network Volume and Value, 2021).

Federal Reserve Banks receive ACH payment files from ODFIs. They sort those payment files, deliver them to RDFIs, and settle by crediting and debiting the ODFI and RDFI settlement accounts appropriately.

The Federal Reserve manages ACH according to the terms and conditions of Operating Circular 4, which incorporates the operation rules of Nacha (see below). There are 11 total operating circulars, OCs 1-10 and OC 12.

2. The Clearing House

The Clearing House (TCH) owns the Electronic Payments Network (EPN), the other of the two ACH operators. TCH is privately owned by 25 large international banks and manages nearly $2 trillion in daily payments, across ACH, wires, RTP, and checks. That's roughly 25% of all payments volume and about half of total commercial ACH and wire volume in the US as of 2021.

TCH also manages a membership organization of 1000 financial institutions, known as Payment Authority. Additionally, the Clearing House provides thought leadership, policy support, research, and education, both to industry members and the general public.

Although final settlement is managed by the Reserve Banks, the Federal Reserve Banks and EPN process interoperator ACH payments together.

3. Nacha

As mentioned above, Nacha is the steward of the ACH Network. Nacha's main function is to write, maintain, and enforce the rules of the ACH Network. These rules are created with input from operators, regulators, member institutions, and network users.

Within these rules are specific instructions for defining transaction types, product types, and file specifications. The Nacha operating rules and operating guidelines together are comprehensive at over 700 pages long. The guidelines apply equally to both the Federal Reserve and the Clearing House.

In total, Nacha represents over 10,000 financial institutions. Wells Fargo, JP Morgan Chase, Bank of America, and other large financial players are direct members of Nacha, while regional payments associations serve as a connection for smaller financial institutions.

4. Software Vendors and Service Providers

ACH software and support is provided by many types of companies. Here are three examples of software and service providers in ACH:

• Banks provide ACH transmission capabilities to their merchant customers
• Enterprise Resource Planning companies help businesses pay vendors
• Payment operations software, such as the software developed by Modern Treasury, helps companies send and reconcile payments

ACH Timings

ACH payments can be sent one of two ways: as a normal ACH payment or as a Same Day ACH payment. Normal ACH payments generally take 1-2 business days to clear, whereas Same Day ACH payments process within one business day of initiation (often the same day, if the payment is initiated before the cut-off time).

When an ACH payment is processed, the bank collects all of the ACH files that come in for the day before forwarding them as a batch to a clearing house for processing. This is also known as batch processing and it is part of what accounts for the delayed timing of ACH payments.

Normal ACH

For a normal ACH payment, settlement times vary depending on which bank you use. Commonly, ACH debits take longer (1-2 business days) to settle than ACH credits (~1 business day).

Let's break down what an example of timing looks like for an ACH debit payment:

• Monday morning — Customer submits a payment order for ACH debit. The payment order file gets sent to the bank.
• Monday evening — Once a bank's ACH cutoff time occurs, the bank begins to process the payment order.
• Tuesday day — Payment is debited.
• Wednesday morning — Payment has completed; funds are in the bank account from the recipient early in the morning.

Same Day ACH

Nacha created Same Day ACH in 2015 to enable certain transactions to settle within the same day. It is important to note that Same Day ACH is not the same as a real-time payment, as batch processing is still necessary to complete a Same Day ACH transaction.

Same Day ACH works just like a normal ACH transaction, but is batched multiple times a day so that the funds process in less than 24 hours. This means that if you initiate and approve your Same Day ACH payment, it will complete within 1 business day instead of the standard 2-3 business days.

Nacha outlines 63 potential use cases for Same Day ACH. Some notable use cases include:

• Payroll: faster payroll payments for hourly or temporary workers, and faster options for off-cycle payments such as bonuses or emergency payments
• Urgent claims payments and refunds: quick payout of insurance claim payments, disaster assistance payments, and other rebates, refunds, and reimbursements
• Bill payment: faster payment of bills on or after the due date

In all of 2021, over 600 million transactions and over $900 billion were processed over Same Day ACH. In Q1 of 2022, over $154.2 million was processed using Same Day ACH as opposed to $143 million from Q1 of 2021. (Nacha Network Quarterly Growth, 2022).

In March 2022, the Same Day ACH per payment limit increased to $1 million, contributing to the increase in volume.

Same Day ACH windows:

Global ACH

As our world evolves and global commerce becomes further interconnected, US financial institutions have developed new ACH codes and enhanced ACH payment rails to assist sending money abroad, most notably the FedGlobal ACH program.

FedGlobal ACH goes beyond payment SEC codes to build an entirely new extension to the ACH system: a way to truly send ACH payments globally. Designed by the Federal Reserve and sold to banks, FedGlobal ACH is an ACH payment that gets sent directly to the Federal Reserve. From there, the Federal Reserve can send payments in bulk to partnering foreign institutions, and the economies of scale and reach of the network allows payments to be sent much cheaper than the alternatives. Because this is a product sold to banks, the biggest dependency to using this new rail is understanding whether or not a given bank supports it.

ACH Reversals

An ACH reversal is an incorrect ACH payment that a payment originator requests to take back—or reverse. In reality, payment errors happen even despite the best efforts to avoid them. Errors that warrant an ACH reversal can include discrepancies in deposit or withdrawal amounts, deposits sent to the wrong recipient, or any other incorrect information before a payment is initiated.

Nacha is responsible for the process of ACH reversals. A reversal must be sent to the bank within 24 hours of noticing the error, and no later than 5 banking days after settlement. After notifying the bank, the payment originator must also reach out to the payment recipient to inform them of the reversal.

An ACH reversal can only be initiated for one of the following reasons:

1. Duplicate payment
2. Incorrect payment recipient
3. Incorrect payment amount
4. Payment date earlier than intended (ACH debit only)
5. Payment date later than intended (ACH credit only)

ACH Returns and Common Return Codes

A return is a credit or debit entry initiated by the RDFI that returns a payment to the ODFI. Unlike a reversal, an ACH return occurs when an electronic payment transaction does not go through.

There are a wide variety of reasons why an ACH transaction could be returned. Currently, there are over 80 return codes to identify the reason for an ACH return and Nacha is constantly adding and updating return codes as new situations arise.

Each code begins with 'R' followed by a two digit number. As an example, 'R04' indicates that an invalid account number was provided for the transaction. As a result, the ACH network returns that payment to the originating party. Payments returned in this way are typically referred to as ACH returns.

Nacha has separate rules for handling each return code, as each code represents a unique situation. ODFIs and RDFIs are both responsible for handling ACH return codes according to these rules.

For an ACH return, the RDFI is responsible for initiating the return entry. The return must be for the total amount of the original payment, as partial ACH returns are not allowed. Additionally, ACH returns have specific timeframes in which they must be received—though that timeframe is not standardized across all return codes. They also must include the same level of information in the return as was in the original payment.

Some of the most common return codes:

Faster Payouts

Modern Treasury is a third-party service provider, allowing for faster payouts than using a third-party sender. We connect directly with our customers' bank accounts to automate the movement of their money. So when they need to make an ACH payment, that payment is initiated directly from their bank account and never passes through a Modern Treasury-owned account. This means we never hold funds—something that would delay payment processing times.

Faster payouts are particularly useful for our marketplace customers, like Outdoorsy.

Outdoorsy is the fastest growing peer-to-peer marketplace for RV rentals. Outdoorsy's marketplace facilitates the entire transaction between renters and owners: Anyone looking to rent an RV can sign up for Outdoorsy, search for an available RV in their area, and book it through the platform. Outdoorsy handles payments as well, charging renters and depositing the rental fees into owner accounts.

Outdoorsy chose Modern Treasury to automate their payouts to RV owners. Outdoorsy's previous payment process had a long wait time that forced RV owners to wait 3-5 days for payment. This frustrated their customers who were eager to get paid. That frustration also took a toll on Outdoorsy's technical and customer support teams. That's because not all payment processes are ideal for a peer-to-peer marketplace. With Modern Treasury, they can move money directly from their corporate bank accounts to RV owners, decreasing payout times to 24 hours.

"The faster transit times have allowed us to store and move all funds through our master account, which has improved our relationship with our bank." — Tyler Stillwater, Lead Backend Developer at Outdoorsy

Automatic Reconciliation

The multi-day processing time for ACH transactions can often make it more challenging to tie a payment a customer makes (or expects to receive) to the actual transaction that posts to their bank account. This process is called reconciliation, and it is essential for tracking how completed and in-progress transactions add up to the account balance.

Most finance teams try to solve the issue of reconciliation with manual reconciliation processes that typically involve exporting transactions from the bank portal to a spreadsheet and manually matching them with payments. At Modern Treasury, we've built a better solution that helps finance teams save time and minimize errors: Automatic Reconciliation.

With Automatic Reconciliation, we automatically match payments and returns to transactions as they are made available by any bank. We tentatively reconcile a transaction when it's pending and complete the process when it posts. ACH processes transactions in batches, so a large number of transactions on a bank statement are likely to represent multiple distinct payments. Reconciled transactions are reflected in the balances available through our API and web application, allowing customers to reliably monitor cash across all their business bank accounts.

Reconciliation is essential for all businesses, but especially for those whose businesses handle payments for essential services like healthcare. One example is Modern Treasury customer, Sana. Sana provides self-insured health care and employee benefits to small and medium businesses and was created to address the lack of affordable care in the United States. Sana sells their plans directly to employers, cutting out insurance brokers so that they can build a product around their customers' needs.

Payments are essential to Sana's promise of providing a great member experience and transparent, affordable care. Sana collects member and employer premiums and pays health care providers through their system, and all this money movement poses a particular payment operations challenge. A health care dollar will pass through five bank accounts before settling in its final destination, and that becomes unwieldy when Sana moves hundreds of payments, totaling thousands of dollars, every month. Sana uses Modern Treasury's APIs to integrate payments (and automatic reconciliation of those payments) directly into their product.

"Moving money is critical to our business, and when we looked at the problem, it broke down to three component costs. First, the cost of having our engineering team build and maintain this system themselves. Second, the ability to scale infinitely by capturing data in the moment, and ensuring that data is available to the finance team later. And third, reducing the perils of manual entry, because it's healthcare—we just can't afford to make mistakes." — Will Young, Sana Co-Founder

Approvals

Businesses who want to optimize their payments operation strategy must have a robust approval system. Approvals help facilitate the movement of funds, increase transparency, and add an additional layer of security and control on top of payments.

Businesses using Modern Treasury can create custom payment approval rules for ACH transactions based on the amount, bank account, or custom metadata filters for full control over payment initiation. Approval rules can be adjusted as a business grows or their business needs change.

For each ACH payment that's created, our rules engine checks the payment against your organization's custom approval rules. When a rule's conditions are met, the payment requires approval as per the rule's specifications—and you can feel confident in authorizing the payment.

One space where security and approvals are especially important is cryptocurrency. BlockFi, a cryptocurrency platform, handles millions of transactions every month, with each product and service requiring custom money movement flows. They also need to connect to multiple banks and manage several bank accounts for funds segregation and tracking. Due to the complex nature of their business, security is paramount and custom user permissions were also required.

Having already built an integration with their first partner bank for wire transfers, they also needed a solution that would simplify using ACH with the same bank. Modern Treasury provided BlockFi with an easy-to-use and reliable API that abstracted the complexity of generating ACH files, establishing robust approvals, tracking payment status and bank cutoff times, and handling failures and returns. "It would be really difficult at this point to imagine doing ACH payments without Modern Treasury. Your APIs made it really easy on the backend to get it working." — Brian Cady, Product Manager for Fiat Payments at BlockFi

ACH: Automated Clearing House, the electronic network used to communicate financial transactions.

ACH credit transfers: Direct deposits and payments made over the network.

ACH debit transfers: Direct debiting for credit, debit, and ATM transactions.

Clearing house: An intermediary between ODFI and RDFI.

Direct Debit: An authorized ACH debit, such as when a bill payer authorizes an insurance company to withdraw money from their checking account at regular intervals using the ACH network.

eCheck: An electronic version of a paper check.

EFT: Electronic Funds Transfer, another name for ACH since all payments are communicated digitally.

EPN: A second large-scale clearinghouse, or operator; the EPN is a subsidiary of The Clearing House, a banking association and payments company owned by the largest commercial banks.

Originator: The institution, merchant, or person that initiates the transaction.

ODFI: Originating Depository Financial Institution, the partner bank that facilitates the request for transfer.

Operator: Another name for a clearinghouse.

Prenotes: A zero dollar payment to validate the account number and routing details of a bank account before debiting or crediting it.

Returns: The equivalent of a bounced check, an electronic payment that does not go through.

Return Codes: An identifier for the reason an ACH payment was returned by the recipient's bank. 'R' followed by a two digit number.

Reversals: An erroneous ACH payment that the originator requests to take back or reverse.

Same-Day ACH: An ACH transaction that settles in the same business day it was initiated.

SEC Codes: A three-letter code that describes how a payment was authorized by the consumer or business receiving an ACH transaction.

RDFI: Receiving Depository Financial Institution, the partner bank that receives the ACH file requesting a transfer.

Settlement Account: The well-funded account ACH-participating banks use to fund and accept transfers.