Automated Clearing House Payments

Automated Clearing House (ACH) payments were first established in the 1970s by the Federal Reserve System and the banking industry. Up to that point, cash and checks had been the principal methods for retail payments in the United States. ACH payments, which are initiated electronically, were envisioned as a more-efficient payment method.

At first, ACH payment volumes were relatively low, and the Fed processed far more ACH payments than private-sector ACH operators. Over time ACH payments have grown and become an integral part of the US retail payment system, used most commonly for recurring payments such as payrolls and monthly consumer bills. The Fed continues to provide ACH services today to promote efficiency and market competition, to ensure broad access by financial institutions to ACH, and to safeguard the ACH system from potential disruptions.

The Development of the ACH Network

In the late 1960s and 1970s, the Federal Reserve and the banking industry shared the common goal of moving beyond paper checks. Some contemporaries feared "that the check system was going to grind to a halt" because of growing volumes (Howard 1981). Policymakers saw a gulf in the efficiency of retail check payments compared with large-value payments through wire transfers, which could be executed nearly automatically. In 1970, Fed Governor George Mitchell commented on the vast machinery of paper checks that required "sorting, batching, proofing, shipping, resorting, rebatching, reproofing, reshipping, and so on that continues until the document itself is repatriated for the drawer's final proofing and filing." He envisioned that "electronic technology now available and of proven capability can provide a vastly more efficient functional performance if permitted to slough off paper tracers and by-products" (Mitchell 1970).

Clearing houses have long been a part of payments systems to facilitate the exchange and settlement of many different types of payments among members. Automated clearing houses apply an electronic mechanism to this long-standing concept. The Federal Reserve Bank of San Francisco began operating the first ACH in 1972, after developing the system with a number of California banks. Additional ACHs were quickly formed in other cities, and in 1978 the Fed linked these ACHs together to communicate and process inter-regional transactions. The Fed consolidated its ACH operations into one standardized national network in the mid-1990s (Federal Reserve Bank of Dallas 1993a).

ACH transactions were initially transmitted to the Fed through physical media, primarily magnetic tapes and later floppy disks. One magnetic tape could contain payment information equivalent to 1.5 million checks (McKelvey 1976). Banks delivered these media to Federal Reserve Banks along with other deliveries such as paper checks or currency (Board of Governors 1976). Given the somewhat cumbersome nature of magnetic tapes, at the time ACH payments were best suited for routine payments such as payrolls or monthly consumer bills that could be prepared in advance.

Slower-than-Expected Growth

Despite high initial hopes for ACH payments, checks remained enduringly popular and ACH transaction volume remained limited for many years. In 1987, Board Governor Wayne Angell looked back and observed that "our early estimates were overoptimistic" for ACH volumes (Angell 1987). In 1996, Chairman Alan Greenspan made the same basic observation, lamenting the "paradox" of the US payment system in which retail payments remained largely paper-based while large-value wholesale payments through Fedwire had been electronic for more than twenty years (Greenspan 1996).

As the US Treasury's fiscal agent, the Fed benefitted from the US government's interest in ACH when building out ACH operations. Some of the federal government's first efforts to use ACH included Social Security benefits and Airforce payrolls. Corporate adoption lagged, however. Incorporating ACH payments into corporate accounting systems turned out to be a significant barrier to adoption (Federal Reserve Bank of Atlanta 1986b). In addition, the check processing system proved to be more resilient to rising volumes than anticipated—in part because of steps taken by the banking industry and the Fed to improve the efficiency of check processing and lower costs. Corporations also often continued to prefer checks over alternatives such as ACH because of the "float" they received, as they continued to earn interest on funds that stayed in their accounts until the check payments settled (McAndrews 1984).

Over time, ACH eventually became the integral part of the payment system imagined by its early proponents. Commercial ACH volume at the Fed rose from about 600 million transactions in 1988 to 10 billion in 2008, when ACH overtook declining check volumes for the first time. ACH volume at the Fed reached 18.5 billion transactions in 2022.¹ Initially, the core categories of ACH payments were direct deposit of payrolls and consumer bill payments. More recently, internet-based payments and business-to-business payments have become substantial as well; and, for a time in the early 2000s, checks converted to ACH were also an important use.²

Promoting Faster Payments

The increased use of ACH in part reflected improvements in the convenience of ACH payments, including faster payment speeds. When the Fed began operating ACH payments in the 1970s, it processed transactions in one batch per day. In 1979, it began offering a second "night" processing cycle, initially on a limited basis and eventually for all types of transactions (Federal Reserve Bank of Dallas 1993b). A major impediment to additional speed improvements was the communication of transactions through physical media, such as magnetic tapes, diskettes, or even paper output. Until 1993, when the Board mandated that all ACH participants establish electronic connections, some ACH transactions had to be originated up to two days prior to the settlement date to accommodate the slowest endpoints (Federal Reserve Bank of New York 1991). After electronic conversion, the Fed began processing payments four times per day instead of two. As of 2023, the Fed delivers standard ACH payments six times per day.³

Another area of improvement relates to the settlement stage, which follows the delivery of ACH payment information to financial institutions. Faster settlement has been a longstanding priority of many banks and their customers (Krause 2002; Board of Governors 1998). Electronic ACH communication sped up the return of rejected ACH transactions enormously compared with the 10 to 15 days a return payment typically took when initially communicated through paper (Federal Reserve Bank of Atlanta 1986a). Another improvement came in 2001, when Reserve Banks made ACH payments final on settlement day (Federal Reserve Bank of Dallas 1999). Finality of payment removed a source of risk to receiving banks, who had been "reluctant to encourage ACH payments" up to that point because of the possibility of a payment being reversed (American Banker 2001). More recently, the advent of same-day settlement, first in 2010 and later expanded in 2016, has been designed to meet demand for faster receipt of funds (Todd 2010; Board of Governors 2015).

At the same time that the Fed was pursuing same-day ACH settlement, it also began a broader process to bring faster retail payments to the US. This process culminated in the launch of FedNow in July 2023, which operates in addition to FedACH and other Fed payment services. While ACH handles transactions in batches and settles at specific times, FedNow provides final settlement of payments instantly and at any time, using new technology that was not available when the ACH system was first designed in the 1970s.

Promoting Competition

The Fed was by far the largest ACH operator from the 1970s to the early 2000s. In 1981, for example, the Fed operated 37 of the 38 ACHs, and until the early 2000s the Fed processed 80 percent or more of all ACH transactions. Private-sector interest in operating ACHs was generally low until demand for ACH transactions increased enough to justify the fixed costs of running an ACH.

The first privately operated ACH was the New York ACH, established in 1975 and later renamed the Electronic Payments Network (EPN).⁴ Other privately run ACHs included one operated by VISA beginning in 1987 and regional exchanges such as those in Arizona and Hawaii. For a time, private ACHs connected with each other through the Private ACH Exchange (PAX), established in 1994. In the early 2000s, a number of these private-sector providers exited the market, stating that they could not compete with the larger operators, FedACH and EPN, which have since been the two nationally operating ACHs (Kingson 2002).

The Monetary Control Act of 1980 sought to promote efficiency in the payment system by encouraging competition between the Fed and private-sector payment providers. It required the Fed to begin charging for its payment services, including ACH, while also extending access to Fed payment services to financial institutions beyond member banks. The ACH market was still nascent at the time of the Monetary Control Act's passage, as the Federal Reserve sought to foster development of ACH payments by building out capacity in advance of demand (Lee 1981; Moore 1981). The Fed phased in its pricing of ACH services, continuing to subsidize ACH transactions to some extent up to 1985. Later, the Fed substantially changed its pricing practices in 2001 in response to concerns expressed by private ACH operators that its pricing practices created barriers to competition (Board of Governors 2000).

Looking back on the Fed's promotion of ACH payments, Alan Greenspan worried that "efforts by the government to choose and support a single technology—the ACH in this case—may have slowed efforts by the private sector to develop alternative technologies" (Greenspan 1996).⁵ Greenspan appointed a commission, led by Vice Chair Alice Rivlin, to examine the Fed's role in retail payments, including ACH, with fresh eyes. The Rivlin Commission's report concluded that the Fed should remain a provider of both check and ACH services because exiting these markets would negatively impact market competitiveness and reduce the resilience of payment systems by creating single points of failure. The Fed noted that commercial ACH providers served a limited set of institutions and that smaller and more remote banks relied on the Fed for ACH. The Rivlin report therefore re-emphasized the public policy goals the Fed has had as a central bank in providing payment services, including efficiency, accessibility, and safety (Committee on the Federal Reserve Payment Mechanism 1998).

References

American Banker. "Fed Catches Up to Market on ACH Credit Finality." July 3, 2001.

Angell, Wayne. Remarks before the Annual Conference of the National Automated Clearing House Association. March 17, 1987.

Board of Governors of the Federal Reserve System. "Federal Reserve Operations in Payment Mechanism: A Summary." Federal Reserve Bulletin, June 1976: 481-489.

Board of Governors of the Federal Reserve System. "Settlement-day Finality for Automated Clearing House Credit Transactions." December 14, 1998.

Board of Governors of the Federal Reserve System. "Federal Reserve ACH Deposit Deadlines and Pricing Practices for Transactions Involving Private-Sector ACH Operators." November 3, 2000.

Board of Governors of the Federal Reserve System. "Enhancements to Federal Reserve Bank Same-Day ACH Service." September 28, 2015.

Bradford, Terri. "The Evolution of ACH." Federal Reserve Bank of Kansas City, December 2007.

Committee on the Federal Reserve in the Payments Mechanism. "The Federal Reserve in the Payments Mechanism." January 1998.

Electronic Payments Network. "The Electronic Payments Network and the ACH: A History." N.d., archived copy via the Internet Archive Wayback Machine.

Federal Reserve Bank of Atlanta (1986a). "The ACH in a New Light." Economic Review, March 1986. 

Federal Reserve Bank of Atlanta (1986b). "The Automated Clearinghouse Alternative: How Do We Get There From Here?" Economic Review, April 1986. 

Federal Reserve Bank of Dallas (1993a). "Consolidation of Federal Reserve Automation Services." Notice 93-36, March 19, 1993.

Federal Reserve Bank of Dallas (1993b). "New Fed Automated Clearinghouse (ACH) Services." Notice 93-46, April 19, 1993.

Federal Reserve Bank of Dallas. "Settlement-Day Finality for Automated Clearinghouse Credit Transactions." Notice 99-108, December 17, 1999.

Federal Reserve Bank of New York. "Circular No. 10465. All-Electronic ACH Requirement." June 27, 1991.

Greenspan, Alan. Remarks at the U.S. Treasury Conference on Electronic Money and Banking: The Role of Government, September 19, 1996.

Greenspan, Alan. Age of Turbulence. Penguin Press, 2007.

Howard, James. Testimony. Should the Federal Reserve Offer Electronic Funds Transfer Services? Hearing Before a Subcommittee of the Committee on Government Operations, House of Representatives, 97th Congress, 1st Session, October 22, 1981.

Kingson, Jennifer A. "ACH Shakeout: Two Players Retrenching." American Banker, December 3, 2002.

Krause, Gene. Testimony. Is the Payroll Industry at Risk Due to ACH System Used for Direct Deposit? Hearing before the Subcommittee on Tax, Finance and Exports of the Committee on Small Business, House of Representatives, 107th Congress, 2nd Session, April 9, 2002.

Lee, John F. Testimony. Should the Federal Reserve Offer Electronic Funds Transfer Services? Hearing Before a Subcommittee of the Committee on Government Operations, House of Representatives, 97th Congress, 1st Session, October 22, 1981.

McAndrews, James. "The Automated Clearing House System: Moving toward Electronic Payment." Federal Reserve Bank of Philadelphia Business Review, July/August 1994: 15-23.

McKelvey, Rosemary. "Automated Clearing Houses – with them, banks can cross bridge from paper-based systems to EFTs." Mid-Continent Banker, April 1976: 33.

Mitchell, George W. "The Needle in the Paper Stack." Remarks at the Senior Banking Forum of the American Institute of Banking, Kansas City, Missouri, March 19, 1970.

Moore, W. Robert. Testimony. Should the Federal Reserve Offer Electronic Funds Transfer Services? Hearing Before a Subcommittee of the Committee on Government Operations, House of Representatives, 97th Congress, 1st Session, October 22, 1981.

Todd, Richard M. “Managing Risk in the ACH Network.” News from FedACH, July 2010.