U.S. banker recently bosted a roundtable discussion on automated clearing house issues, with key executives from leading ACH banks around the nation participating. Those who met in New York for the discussion were: Chase manhattan Vice President Steven E. Bernstein, Richard C. Erole, president of Huntington Treasury Management Co.; Chemical Bank Vice president Anne Friedman; Andrew Higgins, director of Business Banking Support Services for Barnett Banks and NACHA chairman; First Chicago Senior Vice President Michael S. Kresler; NACHA President Elliot McEntee; bank of Boston Division Executive Ted Mertz; Nations Bank Senior Vice President Michael Paulette; Citicorp Vice Prsident Seymour Rosen; and IntraNet President Tony Smith. U.S. Banker Publisher Wanda Cantrell moderated the event, which was sponsored by IntraNet of Newton, MA.
USB: Cash management has become an extremely important business for banks, with their emphasis on fee income and better customer relationships. What directions do you see this important business?
Mr. Paulette: I see ACH as a complementary delivery vehicle that complements other types of delivery mechanisms: the check system, the domestic wire system, international wire. ACH is just one of those key delivery systems. The universality of the ACH system, both in terms of usage and the participants, as well as the fact that you can originate debits or credits, makes it very versatile in the banking system today.
Mr. Rosen: On the debt side, essentially it's equivalent to a check system, which is a debit transfer system. And on the credit side, it's the equivalent to a wire transfer systems. The difference is that, even though it overlaps to some extent both systems, the extent of the risk controls that are present in the ACH is significantly different that the wire system today and somewhat different than the check system.
Mr. Bersntein: In terms of ACH growth and development, ACH has been perceived as a low-cost alternative for payments and as one of the payment mechanisms that is cheap. In terms of its growth, to make it approach the ubiquity of the credit card, per se, there does need to be some work relative to risks. And that's being worked on aggressively. ACH is sort of at a crossroads right now because its growth has been fundamentally sound - in the 15% to 16% neighborhood - for the last few years. I think growth will accelerate to a more rapid point in the future.
Mr. McEntee: During the past five years, bank revenue from the ACH business has been growing faster than any other category of revenue in the cash management category. It has been running about 18% to 25% a year. From a evaporate standpoint, ACH has become a lot more important than it was a few years ago, when businesses, were looking for a cash management bank.
Mr Erole: Elliott is right that the corporate client definitely sees ASC as an important product in a bank's product line, but from a bank's perspective, I still make more money off a check. And my margined are better off a check. We have to find a way to replace the revenue and profit that we lose by converting the check to ACH. We banks handle paper very, very efficiently. One of the challenges we have is to replace that revenue and profit margin strength with other products that are going to give us like margins. It's just a matter of time. As we dump more transactions into the electronic world, we can drive our unit costs down. Hopefully at some point, the electronic margins are going to be better than paper-based margins.
Mr. Kessler: There's no question that the ACH is an extremely important vehicle for us to process low-dollar-value, high-volume transactions, and there's certainly a tremendous growth coming down, whether we use home shopping, the Internet, whatever. The things that concern me are the revenues that we might lose from processing, and one of the bigger issues from my perspective is the risk in the ACH and the movement of some high-dollar-value payments into the ACH.
Mr. Metz: I share your concern. We need to make sure the infranstructure keeps pace with the fact that it is no longer, if it ever was, just a low-dollar system - that, in fact, there are enourmous dollars flowing through it today. And we need to manage it more like money transfer.
USB: It seems that the worlds of wire transfer and ACH transactions are coming together now. What are banks doing to address the risks inherent in this union?
Mr. McEntee: The ACH and large is a substitute for the check-collection system in 99.99% of the transactions that go through the ACH network. If you look at the dollars going through the ACH system and compare that to the dollars going through the checks system, it's about a 6-to-I ratio: About $60 trillion are collected though the check-collection system every year; about $10 trillion through the ACH systems. If you look at losses in the check system compared to losses in the ACH system, the ratio runs more like 50-to-I to 100-to-I, so there's certainly risks out there in the ACH system, but I think it's important to compare that to the check-collection system where the risks are far greater, the loss is far greater But using the ACH netwotk as a substitute for wire transfer does concern me. I think some banks are not aware of the risks associated with the fact that the ACH network is used as a wire-transfer substitute. The risks arc quite different.
Mr. Rosen Unless an ACH transaction is pre-funded by the customer, which in general it is not, the bank is taking a risk on the credit side for that corporate they're not funded until the actual value date of the transaction. Also, the wire systems typically run in real time, so if you're making a payment on behalf of a customer, you normally can control your exposure effectively to the cent. From a risk standpoint for a bank, certainly the risk is much greater on the part of the ACH. There is a very significant risk relative to initiating payments on the ACH without systems in place to be able to properly manage and control that risk.
USB: What is the answer, though, to corporate clients who say, "I want to move this amount of money, and the wire is just too expensive. Do it through the ACH."
Ms. Friedman: Misuse is the biggest risk to the network. Education is one of the most important tools in helping people understand that while it's a lower cost, it's a higher risk. The ultimate cost to that corporation may be much higher, if something goes wrong with the transaction or if something goes wrong with the trading partner. Helping them understand the fundaments of what they're trying to accomplish is really the responsibility of the financial institution. As we begin to educate the masses, and as we begin to give them tools to access that payment network through home banking and other services, we need to be cognizant of what new risk controls we need to put in place to ensure that fraudulent activity does not occur over the ACH.
Mr. Rosen: There's another very key aspect relative to the ACH payment system and the question of what banks charge for the service. Because of the way the Fed posts Reserve accounts, with respect to the fact that the Fed currently charges for daylight overdrafts on Reserve accounts, effectively ACH debits get posted at a certain point of time during the day. And in reality, due to the fact that in the current environment the majority of, if not all, banks are not charging their customers for daylight overdrafts on Feed wire on the funds wire, it's very possible that a bank has incurred significantly larger costs for the ACH transaction than it has for the wire transaction.
Mr. McEntee: That's a good point, Sy. When a bank originates an ACH credit payment, its account at the Federal Reserve is debited at the opening of business. The first entry to a Reserve account each morning is their ACH credit payment activity. So, if you have a company that has originated a large number of large-value payments the previous evening that are going to settle the next day, there's a good chance that that bank's Reserve account is going to go into a daylight overdraft position at the opening of business, which means that bank is going to incurring higher charges at the Federal Reserve.
Mr. Kessler: We get back to: Are we charging the customer for risks? And the answer obviously is that we are not. Unless we get to the point where we actually start asking the customers to pay for daylight overdraft risks or other risks relative to the payment system, they're going to continue to put pressure on the banks to make those payments in the least-cost method possible.
Mr. Bernstein: If you were going to take a strong stand and draw a line in the dirt, then that company may go elsewhere if there's a bank not measuring that risk. There are a number of banks out there unfortunately for whom risk a four-letter word.
Mr. Ercole: I think we have done a lot to control the fraud in ACH. That doesn't bother me. It's over-capacity - there's too many of us banks around and we're all cutting each others' throats with price.
USB: How are the needs of your clients changing?
Mr. Paulette: First and foremost, our corporate customers are expanding globally, so we have a set of customers that have cross-border needs.
Mr. Smith: There's been interest for quite some time in cross-border payments. There have been various initiatives, both between correspondent banks and also the one that's been led by NACHA, which is to come up with standards for banks to participate in cross-border payments.
Mr. Kessler: What customers are looking for today is ease of making payments and low costs. And I think they're looking for integration. Our customers are looking for an easy way to give us payment instructions and for those payments to happen as simply as possible, whether it's a dollar payment or a cross-border payment.
Mr. McEntee: The Bankers Roundtable last year surveyed a number of companies concerning what the corporations were looking for in terms of improved payment services, and most of the corporations said they were expanding their businesses overseas and want to be able to make international payments basically the same way they make domestic payments. And that's been of one of the objectives of NACHA in establishing this cross-border program where ACH transactions can be exchanged between the United States, Canada and Mexico initially, and then eventually expanded to Europe and around the rest of the world.
Mr. Rosen: One of the things we've found on the corporate side is the fact that some of the very large worldwide corporations are doing a greater recentralization of their treasury function and their treasury operations - where, from one major center in the world, they are actually making payments worldwide.
Mr. Mertz: We see the same trend as well. The treasury function wants to effect payment in a low-cost fashion, and they want somebody else to bother with the routing and formatting.
Ms. Friedman: They want choices; they want convenience; they want integration. I think you need to look beyond just the ACH for that. And that's where EDI comes into play as a vehicle for communication with your client.
USB: It seems that we're getting into value-added sevices, and that's were you can differentiate yourselves so you're not all alike and running each other out of business with pricing.
Mr. Ercole: Right. They want reliability and consistency. What they're willing to pay extra for, though, is the information that goes along with that payments and a timeless of that information. We started delivering ACH information before it's even posted to the client's DDA account. The clients love it, and they're willing to pay extra for it. I don't want to be in the commodities business. There's no future in commodity businesses.
Mr. Kessler: From a futuristic perspective, a customer would send us their payment instructions and have enough confidence in the bank for the bank to sift through those payments and make those payment through whatever medium is the most risk effective and the most cost effective for that customer, without the customer having to choose. I think that would be a value-added service for the customer.
Mr. Bernstein: I think that customers are certainly looking for one source to make their payments, whether it be wire or check, or ACH domestic or ACH cross border, or EDI or financial EDI. It all harkens to building a more powerful engine for your customer, and if you could build as many bells and whistles with that one source as possible, price may not be that big a deal.
Mr. Higgins: In the area of value added, I think information is the key, with payments kind of taken for granted. How can we be a lot more effective with providing the right information to our customers? NACHA did a study that showed 80% of the customers would like both data and payment to go together. We need to provide that type of service, and that's where we can build some revenues. It's going to be very tough if we're just handling they payment side of business.
USB: Volume won't be enough? Volume alone?
Mr. Higgins: There won't be enough volume to make that up.
Mr. McEntree: The ACH network gives the tools to the banking industry to provide those types of products and services that the corporate customers are looking for. As far as customized services are concerned, it's a lot easier and more cost effective to develop a customized niche service for a corporation if it's electronic-based rather than paper-based.
USB: What technologies are on the horizon that will affect your businesses?
Ms. Friedman: Artificial intelligence is helping us manage our business better, and also just broader interconnectivity - communications technology, globally. And with some of the satellite communications technology, you've enabled smooth, reliable communication globally. I think that those are very important aspects of new technology.
Mr. Paulette: I agree with Anne on the interconnectivity. I believe the developmental languages and the computer tools and the midrange computers and the downsizing of the computers to a lower-cost, effective delivery system is very important.
USB: What areas of your business will these changes affect most?
Mr. Rosen: We already have a good deal of interconnectivity on the wholesale side, and we have to make it easier for the customer on the retail side. For example, Citibank recently announced in this marketplace that it would drop charges for electronic transactions. The idea is to get the customer to have an economic incentive to change the way they're doing banking.
Mr. Bernstein: For my money, the PC is probably the thing that is going to change the landscape the most, because when you get to the point where PC's are as ubiquitous as televisions, somebody paying six to 10 bills a month through that device is where the future is for payments through the ACH.
USB: And who will benefit from that volume increase? Is there no Fed-bashing to be done by this group?
Mr. Rosen: The Fed certainly will become a more difficult competitor when they consolidate their processing, as they currently are doing, both for the ACH as well as for the wire, simply because they're going to centralize effectively their processing nationwide as opposed to having what I call the fiefdom of 12 different systems, one per Reserve Bank. That will certainly make the Fed a much more effective and efficient processor from a cost standpoint relative to the private sector. I think you'll see much more of a direct-send type approach in the ACH world, where banks from different regions of the country join private-sector ACH processing that previously was only limited, or open, to those in their same region. We've already seen this in New York and we anticipate that we'll see that even more with some of the other, what I call ACH processors.
Mr. Mertz: I have always found it interesting and have always tried to rationalize why we have not seen in the ACH the evolution of local clearinghouses as we have in the check world. Has it been because heretofore there wasn't sufficient volume to warrant the effort? Was it software limitations? Is there some volume level that a one-to-one direct send, a la a local check clearinghouse, makes sense?
Mr. Bernstein: We've been active in approaching other banks about a direct exchange between one another, but I don't think the time has been right thus far to promote that. If we said unilaterally here that we're going to exchange amongst each other, that would be great. We bypass both the Fed and the private-sector processor.
Mr. Smith: I think there is a technology direction which is going to get us to the same effective position of a drop-off window, and that is ubiquitous communications, because you really are just talking about a bunch of files that have to be move around among banks. I agree that environment is not there today, but there is potential to be able to do this.
Mr. Higgins: Several years ago, we did a study in Florida on private-sector processing, and the results were that if wouldn't make sense at that time, just to do Florida. The reasons were that there wasn't enough volume and there wasn't enough cost savings, and there were software deficiencies among most of the banks. We expanded it to look at the Southeast, and it started making a lot more sense because of the volume. So, I think it is going to happen. It will look a lot like clearinghouse for checks.
Mr. Ercole: When there's only a limited number of players, the business case doesn't look as good. We have to say, "Let's get together, us financial institutions, and let's do something together because together we have the volume and the wherewithal." We joined the Visa Net, even though I have very little transactions in Visa Net, but the more banks I can get in may area to join Visa Net, then the more items I can drive through Visa Net, which gives me much better functionality in the ACH world. I can get connectivity to any bank that joins Visa Net with one transmission. The reason I push a Visa Type of thing is because it's a bank-owned initiative, and I think that's what we have to look at. We want to keep this thing within the financial institution purview. What we want to do is take the volume out of the Fed, put it through a common system that we all share in, and we're going to get better functionality, lower costs, better product to our clients.