Networks: From Tomorrow to Today

 

By Peter Lucas

 

The ACH hasn’t had a substantial change to its settlement windows in years. With the Fed offering same-day clearing and NACHA starting a rule-making process, that’s changing. But is it changing fast enough?

 

 

 

Same-day clearing and settlement of transactions through the automated clearing house network seems like a no-brainer proposition. After all, mobile payments and e-commerce are creating expectations among some consumers for near real-time fund flows. To these people, waiting until tomorrow for your money to clear—the usual settlement time for the ACH—is so yesterday.

 

Same-day processing would also enable banks to mitigate risk by spotting potentially fraudulent transactions sooner. Plus, businesses would have a reliable, lower-cost alternative to wire transfers, which would be especially helpful in the event unexpected problems force them to meet payroll at the last minute.

 

Yet more than a year after the Federal Reserve began offering its FedACH SameDay service, adoption is anemic. So far the Fed has registered 31 routing numbers, mostly from small banks. As of August, the largest bank to sign on was Tulsa-based Bank of Oklahoma, a $24-billion regional bank.

 

The primary sticking point is that there’s no mandate requiring all financial institutions that use the ACH to be able to receive and settle transactions the same day they are originated. Since the Fed chose to make its offering an opt-in service on both ends of the transaction, originators have no guarantee the receiving bank can accept the transactions. That makes it hard for originating banks to sell the service to businesses.

 

Nor do vendors have much incentive to rush applications for facilitating same-day ACH settlement to market, because without a mandate the demand for such a product is uncertain.

 

“Same-day ACH settlement will not fly as an option,” says David Fortney, senior vice president for New York-based The Clearinghouse Payments Co. LLC, which operates the Electronic Payments Network (EPN), one of two ACH network switches along with the Federal Reserve. “There needs to be ubiquity in the market and that comes through enforcement of rules regarding participation.”

 

Getting Feedback

 

A mandate would not only create endpoint ubiquity, it would provide originating banks with a stronger business case for selling the service to billers, which payments experts see as crucial to acceptance.

 

“Billers need to get on board, but banks have had trouble selling the service to billers because slow adoption by banks makes the business case a tough sell,” says Bob Meara, a senior analyst for Boston-based research firm Celent LLC. “Banks have to get on board in order for billers to get on board.”

 

So far, only the Fed has introduced a same-day ACH service. Handling about 43% of traffic, EPN has seen the absence of standards requiring bank participation and has said no to same-day settlement.

 

That means all eyes these days are on NACHA, a bank-run organization based in Herndon, Va. The reason? NACHA makes the rules for the ACH, so any systemwide mandate for same-day settlement, along with rules governing that settlement, would have to come from NACHA.

 

NACHA is moving cautiously. After all, same-day clearing represents the first substantial change in ACH settlement windows in years. Currently, it is studying the prospects for adding a late-day processing window that will allow for same-day settlement, or what NACHA is calling expedited processing and settlement.

 

A request for comment is expected to be issued later this month. Depending on what the comments say, a rule mandating participation from ACH banks for expediting processing and settlement would be put to a vote in early 2012.

 

“Industry feedback is what ultimately will move the decision to implement a rule for expedited processing and settlement forward,” says Jan Estep, president and chief executive of NACHA. “Expedited processing and settlement is a way to enhance the ACH network and move person-to-person and mobile payments sooner and mitigate some of the risk for banks between the time of origination and settlement, but adoption is not a minor process. That’s why it is important to first get feedback from the industry before crafting a rule.”

 

The Fed has already done some legwork in this area. Prior to launching its same-day service in August of 2010, the Fed interviewed banks on the subject and discovered there were concerns about how same-day ACH would impact their ability to clear ACH transactions.

 

“There was certainly interest among banks in the service, but also some concerns about being able to support same-day settlement,” says Steven Crodray, retail payments project director for the Retail Payments Office at the Atlanta Fed. “Because we are one of two ACH operators, we decided it best to let banks decide whether or not to participate in the service.”

 

Check 21’s Threat

 

The Fed’s decision to allow banks to opt in as a way to ease their operational burden is in line with the central bank’s history of rolling out new services on an optional basis. One such service is Check 21, which often clears checks the same day they’re received by the paying bank.

 

With Check 21, banks of first deposit can send images of checks to paying banks for clearing and settlement. In the early days of the service, the Fed let banks that lacked the technology to clear images receive paper printouts of the images instead. But now these so-called substitute checks have largely disappeared and image clearing is commonplace.

 

“The Fed’s history is to influence adoption of new services without a mandate,” says Meara. “Check 21 is a perfect example. That was not mandated and while there were many early skeptics, it is now well entrenched.”

 

So entrenched, in fact, that Check 21 is seen as a competitive alternative to same-day ACH, which is why some payments experts believe that NACHA can’t afford to drag its feet on same-day settlement if the ACH is to remain a viable option.

 

“Right now Check 21 is lot more compelling to billers because they don’t have to change workflows,” says Meara. “If it is a question of settling a transaction as a check or through the ACH it is going to come down to cost and the value proposition.”

 

What NACHA hopes to learn by soliciting banks’ opinions on same-day ACH is not only what objections banks have to the service, but also how best to craft a mandate that addresses those objections and substantially strengthens the value proposition for same-day ACH.

 

For example, banks have raised concerns that same-day ACH will cannibalize the wire-transfer business, on which banks earn lucrative fees. Both methods push payments from a payor’s account to a payee’s account in short order, but the ACH is a much cheaper option.

 

Still, wire transfers are typically used for large-dollar transactions, such as down payments on homes, not the smaller consumer payments the Fed’s service currently supports.

 

“Cannibalization of wire transfers is certainly a concern, but those concerns can be addressed in the way a rule for same-day settlement is written,” says Beth Robertson, director of payments research for Pleasanton, Calif.-based Javelin Strategy & Research. “Dollar limits can be placed on the size of same-day ACH transactions to prevent any significant erosion of wire-transfer revenue. Other countries have done it.”

 

The United Kingdom, for example, has a version of same-day ACH known as Faster Payments Service, which has had no impact on wire transfers since its launch in 2008, Gareth Lodge, a U.K. payments analyst told an audience at the NACHA-sponsored Payments 2011 conference in April.

 

A Software Void

 

It is also expected that banks will express a desire to see the breadth of same-day ACH broadened to include more payment types. Right now, the Fed supports six standard entry class or SEC codes: four for ACH check conversion and two for telephone and Web transactions. Only ACH debits are supported in the Fed service.

 

Despite the small number of SEC codes supported, they represent 37% of the payment types flowing across the ACH, according to Cordray. “These codes represent a substantial share of transactions,” he says. “Adding codes for business-to-business transactions is a possibility and we are talking to the corporate community about that. There is a lot of interest in this topic.”

 

Indeed, payment experts argue that expanding same-day settlement to include B2B payments will substantially strengthen the business case among banks and billers.

 

Corporations have much to benefit from the addition of B2B codes, such as the certainty of knowing that a payment will be settled same day while the available funds are in their account. That kind of certainty is especially attractive for tax payments that can take several days to be settled. Knowing exactly when a transaction will be settled allows for better accounting of actual funds in a corporation’s demand-deposit account. More accurate accounting of funds improves a company’s liquidity.

 

“We are very supportive of same-day ACH and would like to see additional payment types included,” says David T. Bellinger, director of payments for the Association for Financial Professionals, Bethesda, Md., which represents merchants and other businesses. “But as it is right now, those capabilities are not in place and adoption is taking longer than expected.”

 

The slow adoption of same-day ACH by banks has created a chicken-and-egg conundrum, as software vendors have seen little reason to rush to market with applications to support same-day settlement.

 

That void has only recently begun to be filled. Brookfield, Wis.-based Fiserv Inc. has written an add-on to its PEP+, or Paperless Entry Processing, mainframe application for large banks to facilitate same-day settlement. Citigroup Inc. was scheduled to be the first to implement the upgrade. Implementation was expected to be completed in June.

 

In July, Aptys Solutions, a Rockwall, Texas-based software vendor, announced its PayLogics platform will support same-day ACH. Aptys markets PayLogics to wholesale banks that serve small institutions. Adding same-day ACH capability could ease the way for community banks to offer faster clearing.

 

“Now that supporting software is coming to market, that will help with adoption, but without a mandate to support same-day ACH there is nothing to compel software vendors to automatically support the service in future releases unless demand increases significantly,” says Andrew Schmidt, research director for commercial banking and payments at the Needham, Mass.-based research firm TowerGroup.

 

Next Step: Real Time

 

Many small banks have limited IT budgets and typically do not generate large enough volumes of ACH transactions to justify developing systems in-house. Instead, they typically look to their software vendor to provide that capability as part of a free scheduled upgrade, according to Schmidt.

 

Large banks, too, face financial considerations when it comes to supporting same-day ACH. The large ACH volumes they handle make integration more complex and expensive. “Large banks tend to have ACH systems that are integrated to their credit card, mortgage, and brokerage systems, so they are going to need the infrastructure to make sure same-day ACH transactions get posted to the right account,” says The Clearinghouse’s Fortney.

 

Given the complexity and extent of the changes banks need to implement for same-day ACH settlement, it is likely NACHA will weigh those considerations heavily when analyzing industry feedback. “There are a lot of moving parts that have to be changed,” acknowledges NACHA’s Estep. “The changes needed to support expedited payment and settlement must be weighed against the value of the service.”

 

Another challenge facing banks is making certain consumers and businesses initiating same-day transaction are educated about moving funds to cover the transaction that day, instead of first thing the following morning.

 

Ultimately, strengthening the value proposition comes down to revenue opportunities for banks. “It is a question that has to be addressed,” Fortney adds.

 

If same-day settlement is to fly, the Fed, The Clearinghouse, and ACH software vendors will need to support it, as they are the players that make it possible, according to Estep. “We have a rule-making process and are just starting that process, but we are only a regulatory body,” she says. “The players that facilitate the capability need to support it.”

 

But the risk of not working out a same-day solution is loss of substantial transaction volume to the card networks, Check 21, and other faster settlement options.

 

“The next step after same-day settlement is real-time settlement, so there is no question the ACH has to get faster,” says Fortney. “Right now it is a matter of strengthening the business case so the industry can achieve ubiquity on this issue and making sure there will be no surprises for banks handling these transactions.”