How Does ACH Work?

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What's a Clearing House?

When you swipe a debit or credit card at a retail checkout counter, there is a slight pause while the system verifies that your account actually has the money or your credit is available. The response comes back to the clerk as either approved or decline, letting them know how to proceed. This is the essential function of a clearing house, the role of "middle man." Any transaction can involve some uncertainty, but especially ones where the funds used as payments only exist as digits in a computer or, at best are far away in a bank. A clearing house sets the ground rules for the transaction, accepts the funds from the payer and assures the payee that the transaction is good. The clearing house then actually effectuates the transfer of funds from one account to the other.

The Automated Clearing House

The Automated Clearing House (ACH) is a computer network of financial institutions that carries out 98 percent of electronic transactions in the United States. These include direct payroll deposits, debit card transactions, automated online bill payments, business transactions and e-commerce purchases. All are conducted through the ACH, running in the tens of trillions of dollars every year. The protocols for how these interbank communications occur is determined by the National Automated Clearing House Association, also called "NACHA: The Electronic Payments Association," a non-profit organization of banks and industry councils. ACH transactions are a hallmark of the electronic age, just as sure as the global economy. In fact, a worldwide ACH network called the Worldwide Automated Transaction Clearing House (W.A.T.C.H) is designed to begin supervising electronic transfers globally. While these services are convenient, ACH transactions are also used to track the movements of fugitives and is sometimes sold (by the payees) to private marketing groups. The digital banking and commerce system tends to consolidate control of financial transactions in a relatively few unsupervised and unregulated banking organizations.

Anatomy of a Transaction

Strangely, the entity that makes an electronic payment is known in the ACH system as the "receiver." This is because their bank will receive a request for funds to be transferred to another party. The "originator," then, is the retailer or any other entity whose devices are used to swipe a card or otherwise initiate an ACH transaction. With the authorization of the receiver, they instruct their bank to make a claim against the receiver's bank in cyberspace. The originator's financial institution (ODFI), receiving the instructions, makes the actual claim against the receiver's financial institution (RDFI), who debits the funds from the receiver's account. If these financial institutions are banks in the Federal Reserve system, it's likely that the Fed will be providing the communications connection between them and acting as the intermediary for their transfer, but other institutions also fill this role. If the receiver's funds are good, the ODFI is authorized by the system to make a credit in the originator's account, and the funds are thus made available.