Large banks are establishing direct payment connections with trading partners to provide faster and cheaper settlement for automated clearing house transactions, and the move could raise costs for smaller institutions.
Two major banks are already sending ACH files directly to large trading partners, according to Nacha, the rulemaker for the ACH industry, and Elliott C. McEntee, Nacha's chief executive, said the direct-send model, while widely used with checks, "is fairly new to the ACH network."
He declined to name the two banks, but George Thomas, the principal of Radix Consulting Inc. and a former executive with the Clearing House Payments Co. LLC, which operates one of the ACH networks, said the two banks currently using direct sends are Citigroup Inc., the fifth-largest originator, and Capital One Financial Corp., which ranks 10th.
Mr. McEntee said one large bank began sending ACH files directly to a single receiving depository financial institution this year as a test. A second has been doing so with a small group of large receivers for about three years.
Mr. McEntee did say both originators are large credit card issuers that are processing a significant number of ACH payments.
The goal of these direct-send arrangements is to accelerate the clearing of the payments and to receive faster notification of returns for insufficient funds. Mr. McEntee said the originating banks could achieve same-day settlement with their biggest trading partners through direct sends, in contrast to payments that are routed across the two ACH networks and typically settle the next day.
Mr. Thomas said direct-send arrangements have enabled some of the biggest originating banks to move a significant number of payments off the two ACH networks, which poses a threat to the existing payments infrastructure. He said more banks are considering using these arrangements to make their payments operations less expensive and more efficient.
"The shame of it is, you're creating a parallel network when that could be done on the existing ACH network," Mr. Thomas said.
(The existing ACH networks offer next-day clearing and have weighed same-day settlement.)
Spokespeople for Citi and Capital One would not say whether the companies are using direct sends, but both have track records as ACH innovators.
Capital One has been experimenting with decoupled debit since 2007, capturing the interchange revenue from debit transactions and using the ACH network to withdraw funds from cardholders' accounts at other banks.
Citi has been working with alternative payment systems such as the mobile phone payment company Obopay Inc., which uses the ACH networks for its person-to-person transfer system.
Mr. McEntee said the benefits of direct-send arrangements, in payment float and risk management, would likely be offset by higher operational expense.
With a direct send, an originator would have to identify and extract the eligible payments from its main flow of ACH files, transmit the files securely to the receivers, and work out settlement arrangements with its trading partners, most likely by wire transfer.
Mr. McEntee also noted that the vast majority of ACH payments are sent to banks that are not likely not participate in direct-send arrangements. While much of the originating volume is concentrated in a few large banks, practically every institution in the country, down to the smallest credit union, participates as a receiver.
Mr. McEntee conceded that direct sends will affect ACH operators. "It's obviously a concern, because it's less business for them," he said.
Aaron McPherson, the research manager of payments at Financial Insights Inc., a unit of the technology publisher International Data Group Inc. of Boston, said that if direct-send arrangements lead big banks to move a sizable chunk of their volume off the ACH networks, the banks that continue to use the networks could be required to shoulder more of the costs to support the fixed expenses of running the payments systems. Big banks probably can lower their costs by making private arrangements with key trading partners, Mr. McPherson said. "The losers on this are everybody else."
The Clearing House would not provide an executive to comment for this story. The Federal Reserve System is its main competitor, and it too declined to comment.
Mr. McPherson said the recent wave of bank consolidation will further concentrate ACH volume among the biggest originators and pull even more volume off the networks. Washington Mutual Inc., which was the No. 24 originator, has been acquired by JPMorgan Chase & Co., by far the largest originator. And Wachovia Corp., No. 4, is selling itself to No. 5 Citi.
As these institutions combine their operations, it increases their ability to clear ACH transactions "on us," within the single institution, without using the operators' networks. Financial Insights estimates that a third of the total ACH traffic in the United States already clears on-us.
(Direct sends are less of a concern to Nacha, Mr. McEntee said, because the payments still adhere to ACH policies. "We still get the fee income that the banks owe us for using the ACH rules and the ACH formats," he said.)
Other companies are developing or using direct-send arrangements. Mr. McEntee said some banks in Hawaii have a long-established direct-send system that does not involve the mainland network operators.
In May, Bank of America Corp. and Wells Fargo & Co. announced an ACH joint venture called Pariter Solutions LLC that they plan to use to settle their joint payments. Jennifer Roth, a senior analyst at TowerGroup, an independent research firm owned by MasterCard Inc., said that "Pariter could definitely become another private" ACH network for the two banks, which are among the top ACH originators.
Spokespeople for B of A and Wells Fargo declined to comment.
Both are also among the co-owners of Viewpointe LLC, which operates a massive check-image archive and image clearing system, and which agreed last month to acquire PaymentsNation, a Dallas regional payments association that offers settlement and ACH services. Mr. Thomas said that it would be an easy step for Viewpointe, which has long advocated an image-sharing model for settling checks electronically, to use PaymentsNation's capabilities to create a similar ACH settlement system for its owners and users.
Mr. McPherson said ACH network operators are not the only payments systems watching this trend. He said such bilateral agreements were a big topic last month in Vienna at the Sibos conference, organized by the global financial cooperative Swift.
Executives of Swift took pains to stress their system's efficiency and low costs, Mr. McPherson said. "I don't think they would be making that case that strongly if they weren't concerned about banks making bilateral settlements."