What is ACH?

The automatic clearing house (ACH) is a secure network used to connect banks to each other. It is through this network that direct deposits, electronic payments, certain transfers, and debit-card payments are processed. The network is also used for business-to-business payments, electronic payments, and certain local, state, and federal tax transactions. ACH processing was initially introduced in the 1970s as an alternative to traditional check payments.

The Federal Reserve Board, Visa, the American Clearing House Association, and other operators act as central clearing facilities for the ACH network. The Federal Reserve is the sole public sector entity serving as a central clearing facility in the United States. It is charged with handling the majority of the nation’s ACH transactions. Commonly referred to as FED ACH, the Federal Reserve Board clearing facility is primarily used to handle repetitive retail transactions that feature low dollar amounts.

To use the FED ACH, a financial institution must first become a member of the system. The financial institution would then be able to transmit batches of payments and debits into it. The ACH system would, in turn, sort the payments and debits from among all the received batches, sending them on to receiving institutions. Some examples of transactions handled in this manner include payroll, Social Security, utility, and corporate payments. Insurance premium payments are often handled in this manner as well.

In addition to clearing house processors, there are other important parties involved in ACH transactions. The person, company, or entity that submits an entry is referred to as an originator. A member financial institution that initiates ACH entries, in keeping with an agreement with its customers, is called an originating depository financial institution (ODFI). A financial institution that is authorized to receive entries is called a receiving depository financial institution (RDFI). A receiver is a person or company that provides authorization for an originator to submit an ACH credit or debit to an account at an RDFI.

Though ACH was initially designed to serve as a check processing alternative, it went on to develop into a system for processing billions of electronic credits and debits throughout the United States. Today, it is commonly used by billions of individuals, as well as companies of all sizes. To ensure that ACH processing meets certain standards, the National Automated Clearing House Association (NACHA) maintains operating rules that govern acceptable formats. The NACHA also serves to determine the rights and responsibilities of those taking part in transactions, including financial institutions.