After reading George Thomas' Sept. 26 Viewpoint, "Direct Send Pacts Threat to ACH System," I wanted to add a few thoughts to the dialogue on what the financial services industry can do to eliminate the need for direct sends altogether.
Let's start with the premise of why banks are involved in direct sends. The primary reason for creating one is to reduce both credit and transaction risk for the originating bank, with float reduction coming as a secondary gain. Credit and transaction risk reduction is accomplished by posting payment transactions one day earlier, which results in a return item from a closed account or a nonsufficient funds item coming back one day sooner.
Receiving returns one day earlier may not seem like much, but if I made a $1,000 payment on my credit card, and I did not have the funds in my checking account, I have artificially increased my buying limit by $1,000 from the time the payment is being cleared until it is returned. And most would agree that every hour a credit card company can reduce credit risk results in significant loss reduction.
Now let's look closely at float. As an industry, we tend to think of float in large part as being between customers and their bank. But in the credit card example, the float is between the credit card issuer and the customer's bank. A consumer who makes a payment on a credit card bill receives credit the day the payment is received and processed. If the billing bank converts the item to an ARC transaction, it will collect the cash for the payment from the customer's bank the next business day, best case, resulting in a one-day float benefit for the customer's bank and a one-day cost of float for the originating/billing bank.
Remember, float is a zero-sum game. If one bank picks up a day of float, it is an absolute that some other bank just lost one day.
If you move this process to same-day ACH as direct sends, it is apparent that all the benefits would accrue to the originating bank. The receiving bank is not at risk for returns, as long as it meets its operational deadlines, and all the float benefit goes to the originating bank at the expense of the receiving institution. So why would anyone on the receiving side ever want same-day ACH?
There are two reasons. First, the big banks are both originators and receivers, so they may lose on one side, but they gain on the other. Second, a large receiving institution can negotiate terms with the originating bank and share some of the benefit under direct sends.
Now we reach the crux of the problem with direct sends: They are really only viable for large banks and large credit card issuers.
Expensive technology is required to set up a direct send, not to mention the security and contractual provisions necessary between the parties. I can assure you, if you are a small bank in Kansas, and you want to set up a direct ACH send with a top 10 originating financial institution, it will let you know, in no uncertain terms, that you do not bring enough value to even consider it. That means this practice will always be between the big players, and the rest of the industry will be locked out, competitively and operationally, unless something is done.
Here is what I hope Nacha, with its new board and leadership, will do to solve this problem for the entire industry. It must create later cutoff times for ACH check conversion products to enable same-day posting of items and to settle funds between the banks, just as we do today, the next day.
By being able to post debit check conversion products the same day, all banks will reduce risk between the parties involved.
Next-day settlement between the banks will give every receiving institution cause to do this for three main reasons. First, it reduces consumer balances at the receiving bank, thus reducing FDIC insurance expenses (which are almost certain to increase). Second, the receiving institution would eliminate the capital required for those funds. Third, if an account bears interest, the bank will eliminate one day of interest expense.
All these expenses occur while keeping the cash on the receiving bank's balance sheet, making it available for investment purposes until the following day.
Additionally, same-day posting would drive nonsufficient funds fees higher at the receiving bank by catching people playing the float game — hoping their payment does not hit their bank account for a day or two.
If we were to make these changes, the only reason for a bank to set up a direct send would be to reduce transaction fees from bypassing the ACH network. This may be possible, but any savings would probably be negligible if you account for the setup effort and ongoing costs.
The change to same-day posting and next-day settlement would also allow large banks to reach every institution, instead of just a handful, while sharing the benefits with the receiving institutions, which would be giving up deposit balances on a permanent basis on their balance sheet.