The Automated Clearing House (ACH)
The ACH system was developed in the 1970s in a banking industry attempt to replace the paper check. The ACH system supports both debit (e.g., automatic payment of mortgages) and credit (e.g., direct deposit of payroll) transactions. Since electronic checks (echecks) are debit transactions, this white paper provides a high level comparison of some of the main differences between the ACH debit system and echecks. These differences are reviewed in five main categories: terminology, business practices, underlying technology, transaction authorization, and risk management.
2015 Update: Note that the original text below for ACH vs. eCheck was written nearly two decades ago on eCheck.org, back when eChecks were still a new process. Since then, eCheck and ACH have become synonymous with each other. On a technical level, there are some differences as ACH is a system that supports many different transactions while eCheck transactions in 2015 UTILIZE the ACH network to process the transactions between the customer’s bank account (usually through third party software such as Payment Gateways like PayPal) and the recipient of the payment (store, website, payment gateway).
When the ACH system was created, it was an entirely new ground breaking electronic payment solution; it developed a new vocabulary based on the role it played in the new system. The familiar terminology of checks was replaced in many cases. Table 1 below summarizes the terminology.
|Provides funds||Payer/ Issuer||Receiver||Originator|
|Bank starting with funds||Paying/ Issuing Bank||ReceivingDepositoryFinancialInstitution (RDFI)||OriginatingDepositoryFinancialInstitution (ODFI)|
|Obtains funds||Depositor/ Beneficiary||Originator||Receiver|
|Bank ending up with funds||Depository Bank||ODFI||RDFI|
Since echecks are the complete electronic analogies of paper checks, there is no need for development of new terminology. Electronic checks are signed, co-signed, endorsed, deposited, cleared, and settled, like paper checks.
Because the ACH system is significantly different than paper check processing, a new trust model, set of business practices and rules were developed to manage ACH transactions. Implementing these new practices caused most large banks to establish completely separate departments, and staffs to handle ACH transactions. Similarly, some businesses find it difficult to have the same policies and staff handling both paper check processing and ACH transactions, since different procedures are used for authorization management, origination, settlement and reconciliation, general ledger updates, accounting, and particularly in handling exceptions (which is much improved by ACH). One particularly significant business practice issue related to ACH is that control of origination of ACH debits is often given to the party receiving the funds through a blanket authorization for recurring transactions, rather than the account holder whose funds are being taken.
Since echecks are modeled closely after the paper check, the trust model, business practices and laws that are used for paper checks apply, with the elimination of a number of manual steps such as opening envelopes, manual deposit preparation, balancing, etc. One of echecks great strengths, in fact, is the automation of verification of signatures, allowing all authorizations to be validated by either the paying or depositing bank. In smaller businesses, which use paper based filing systems and photocopy paper checks, electronic check records can be printed and included in the current filing infrastructure without requiring extensive changes to procedures or policies, yet providing the same efficiency benefits of ACH. Control of the issuance of the transaction remains with the check writer, while the depositor can control acceptance and clearing. As a result, echecks co-exist with paper checks gracefully, easing the transition away from paper transactions.
The ACH system was conceived during the 1970s, and the system was based on the technologies and file structures used at thattime. It provides an efficient, robust system, but is somewhat rigid and constrained in field layouts and record sizes, in part due to links back to field sizes used in MICR lines of paper checks. For example, the ACH system only supports names up to 16 or 22 characters in length depending on the type of transaction. It should be noted, however, that one ACH transaction type (CTX), used in business payments and for Financial EDI (FEDI), can support 800,000 characters of remittance information.
The electronic check system has been recently designed, taking advantage of the latest technologies developed in support of the Internet and electronic commerce. The primary design focus of the eCheck is to enable transacting parties to securely exchange payment authorization and transaction information directly. As a result, the same technology and approach used to create echecks can also be used to create electronic ACH credit or debit authorizations, or used in place of a voided paper check to help setup recurring ACH transaction authorizations. FSTC and NACHA are working together to explore these options. Electronic checks use a flexible document structure and can be linked with documents in any form, including WWW pages or EDI transactions.
Beyond the transaction and file structure lies the heart of the difference between echecks and ACH: transaction authorization and information flow. This difference is illustrated in Figure 1 below for non-FEDI transactions. ACH was designed primarily to ensure efficient processing and electronic transmission between financial institutions, using small transactions. As a result, and given the technology available at the time, ACH transactions are separate from the authorization. Frequently, the detailed transaction information is separate, and is faxed or mailed on paper from the Originator to Receiver.
Electronic checks integrate the transaction and authorization in the same document. The authorizations are accomplished totally electronically through the use of strong digital signatures based on available public key cryptographic algorithms. Since the eCheck is a bank payment suitable for use over the Internet, the detailed transaction information, in any amount or format, may be sent directly from the Payer to the Payee with the eCheck. It is also important to note that while echecks are different than ACH, due to the underlying legal framework, the same approach and technology used to create echecks may be used to create ACH transaction authorizations.
One of the most important roles a bank serves is managing the overall risk of transactions and the payment system. As Figure 1 above indicates, in ACH debit transactions, the ODFI typically does not see any form of authorization from the Payer from whose account the funds will be taken, and the RDFI never sees an authorization with the transaction. Under ACH rules, all transactions become the obligation of the ODFI, which attempts to protect itself through its contract with its customer, the Originator. This has resulted in many banks limiting ACH debit origination capability only to more trustworthy, financially stable companies, with originations being managed as an extension of credit. In fact, ACH debit origination has become a somewhat specialized business, with two major banks accounting for over 50% of the transaction originations, and a handful accounting for the majority of the total dollars.
Electronic checks, like paper checks, are generally not obligations of the bank, and combine both authorization and transaction into a single document. As Figure 1 illustrates, the paying bank can receive the authorization for each transaction. Banks can therefore manage the risks sufficiently to offer this capability to all customers who have checking accounts. This is particularly important for small to mid size businesses that are currently under served by existing electronic payment systems (see Payment Usage Matrix).
ACH and electronic checks represent different transaction and business models, and provide significantly different information flows, legal frameworks, and risk management capabilities. This is actually a good thing, since it enables different products to meet different business needs and market requirements.
eChecks use new capabilities, not available when ACH was first developed, to facilitate direct customer controlled funds transfers over the Internet while providing tools to substantially reduce the risks associated with traditional check payments. They enable a bank electronic payment solution suitable for all bank customers, from consumers and small businesses to the largest enterprises. eChecks provide banks an additional payment choice to offer to their customers.