What does ACH stand for?

Breaking down the system we use to move our money

As with any topic that’s become well known by an acronym, many touching the payments system often wonder: What does ACH stand for? ACH stands for Automated Clearing House, which is a batch processing network connecting financial institutions across the United States to facilitate direct electronic payments. In this post, we’ll break down each of the components involved in the question of what does ACH stand for.

What does ACH stand for? CH stands for clearing house

At its most basic level, a clearing house is an establishment where checks and payments from various banks can be exchanged and settled. Clearing houses emerged in the 19th century when checks skyrocketed in popularity; traditionally, bank employees had to hand-deliver checks to every bank they were drawn upon, but soon could not keep up with demand. As a result, employees began meeting in public places to exchange their checks all at once and settle their payments. They were literally using these places for the purpose of clearing checks—hence the name.

Now, clearing houses also exist for clearing the sales and purchases of stocks and securities. Organizations like Fedwire or the CME Group exist to ensure that the two firms entering into a sale of a security honor their commitments to do so.

The ACH Network works similarly in that it acts as a conduit for the transaction between a merchant and a customer. In addition, it relies on physical clearing houses like the Federal Reserve, the American Clearing House Association, New York Automated Clearing House, or VisaNet ACH Services. These clearing houses receive electronic information in batches from a bank that either sends or requests money (called the Originating Financial Depository Institution). The clearing houses process the information and send it on to the second party’s bank (called the Receiving Financial Depository Institution), whose account holders either receive the transmitted funds or are requested to furnish them, in the case, for example, of an automatic bill payment.

What does ACH stand for? A stands for automated

ACH is a batch processing system, which means that transaction information is collected and processed in batches rather than in real time. The batch processing system that the ACH network relies on is run through a series of computers that store information as it comes in and forward it at designated time. This information is sent in ACH files, which adhere to a very specific format. For example, all ACH files have to be 94 characters long and contain specific information such as receiver’s name, number and amount of transactions, and purpose for payment. As a result of this standardization, most ACH payments don’t require any human intervention. This is one of the biggest differences between ACH payments and wire transfers, which seem similar on the surface because they are both electronic payments made directly between bank accounts. Wire transfers, however, are more immediate and require action to be taken by employees at both parties’ banks. This is also part of the reason why wire transfers can cost upwards of $30, while ACH payments are free.

What does ACH stand for? The ACH network

The ACH network began connecting financial institutions across the country in 1974. Since then, it has grown to encompass more than 10,000 banks and credit unions and is responsible for settling more than 24 billion transactions annually.

Whenever a debit or credit ACH transaction is initiated, the automated system goes through several steps to process the transaction:

  • An Originator initiates the transaction with his or her bank, the Originating Financial Depository Institution (ODFI).
  • The ODFI stores all ACH transaction requests electronically, and at designated times send them in batches to an ACH operator, or clearing house, like the Federal Reserve or The Clearing House. These requests contain the information needed to make the transaction, such as the amount and the recipient’s bank information.
  • The clearing house sorts and processes the transaction information and makes it available to the Receiving Financial * Depository Institution (RDFI), which is the bank where the recipient’s bank account is.
  • The recipient’s account is then debited or credited by the RDFI, depending on the type of transaction initiated.

Examples of ACH transactions include direct deposits for payroll, online bill payments, mortgage and loan payments, and peer-to-peer payments made through third parties like PayPal or Venmo.

For businesses, making payments via ACH can be beneficial in many ways. One of the biggest benefits for merchants are lower transaction costs. Accepting payments via ACH is more profitable than being paid with credit or debit cards, because ACH eliminates the card networks’ fees. Using ACH for payroll direct deposit is also a good idea for businesses, because it is more efficient, minimizes manpower, and ensures that employees get paid on time. Faster processing times, increased security, and convenience for recurring billing are also major reasons for businesses to use ACH. Plaid makes accepting payments via ACH even easier, because it eliminates much of the friction involved in making the transaction. For instance, Plaid allows merchants to authenticate user accounts almost instantly and check customers’ balances before debiting their accounts to avoid NSF and other fees.