Fintech apps tend to offer improved financial products and services. To do so, they must also continually evolve to keep up with the rules and regulations of systems like ACH.
The Automated Clearing House (ACH) system processes trillions of dollars in transactions annually. That system is secured by cooperating banks and enforced by an organization called Nacha.
This article will give a detailed breakdown of Nacha, the rules for ACH transactions, and tips for ensuring your business complies with them.
What is Nacha?
Nacha was initially known by the all-capitalized NACHA, the acronym for the National Automated Clearing House Association. The NACHA organization changed its name to ‘Nacha’ a while ago. A successor to the originating ACH organization, Nacha provides a hands-on service within the financial services industry with expertise in payments, forward settlement, and oversight.
Banks across the U.S. joined forces in the 1970s to create standardized processes around developing automated clearing house solutions to replace paper-based clearing houses. In 1974, the American Bankers Association (ABA) was able to centralize all its regional groups under a national sub-division known as NACHA.
Nacha is an independent nonprofit organization that is tasked with the following:
- Providing clear guidance on federal legislation and executive rules to help banks and other financial institutions
- Providing education, advocacy, and more as a trade organization
- Ensuring a set of regulations is followed by all of the 10,000+ banking institutions
- Push for the development and adoption of the ACH system
Nacha regulates the ACH in the U.S. banking system. With the ACH Network, U.S. banks, financial institutions, and other financial service providers like fintech companies can communicate with one another to quickly process payments from one bank account to another.
Nacha is a governing body that specifies how people should process ACH payments. This means they dictate what rights and responsibilities those who are part of the network have. These regulations address several commonly regulated areas, including consumer disclosures, consents, and all matters involving payment processing.
Credit, debit, direct deposit payments, mortgage payments, or claiming government benefits are all examples of ACH transactions.
When using ACH, an individual can initiate the transaction directly from their bank account. This leads to a faster and more convenient process that doesn't involve mailing sensitive information like a cheque to the other bank and waiting for them to cash it.
ACH transactions are characterized by their settlement time. It typically takes 1 to 2 business days for a credit transaction to be fully processed, while a debit transaction is processed in one day.
What's the Difference Between Nacha and ACH?
Many people are often confused between ACH and Nacha transactions, as they intersect as financial concepts. The critical difference between ACH and Nacha is that ACH pays entities outside of the payer's bank, while Nacha is an organization responsible for setting standards for the ACH Network.
Regarding ACH operators:
- The Clearing House is another banking consortium with a much smaller subset of the central U.S. banks. It was founded in 2012 and today has 24 member institutions. The electronic payment network (EPN) is responsible for the ACH network or the private bank system.
- The Federal Reserve provides FedACH, a payment service for government accounts and entities. This is comparable to EPN, which handles transactions for private clients.
Nacha is an organization that oversees automated clearing house (ACH) payments across the country and ensures participants adhere to the same set of standards when processing transactions. As a result, they can regulate what participants can do with their ACH rights and take responsibility for any of their network's obligations.
Nacha has been propagating U.S. government mandates into rules and standards for The Clearing House and FedACH. The two are following Nacha's directives regarding running their respective systems. Nacha also helps communicate with other members. They act as an advocate for ACH in the financial and payments industry.
Who is Governed by Nacha Rules?
The Nacha rulebook changes all the time, and many of them are mandatory agreements that every of the over ten thousand member organizations in it must follow. These organizations collectively represent most retail banks and credit unions in America. They also apply to all those who process payments, including stores, credit unions, and more.
By 2021, businesses that collect payments over the ACH network need to follow new rules for a better customer experience. This means implementing protection against online ACH debits. Companies must do some due diligence before initiating an online ACH debit.
First, the transfer account number and the balance must meet the bank’s account validation criteria. If it does, verifying the account simply means that the company has to ensure sufficient funds are available. This prevents fraud by providing a consensus across financial institutions.
Nacha's rules aim to keep the ACH network operating in America, making it easier for businesses and financial institutions.
What Do the Nacha Rules State?
Nacha sets the rules for how the ACH Network collects payments. These rules are different for every network participant. Understanding these regulations is an essential step in ensuring efficient transactions, reduced risk, and a lower number of returns.
The Nacha Operating Rules and Guidelines book focuses on the following:
- Standardization: A collaborative effort that works to make sense of formatting, timelines, and requirements
- Improving usability: With new measures, there would be an equal distribution of core innovations among the users in a few years.
- Fraud reduction: There is an expectation that members do due diligence to reduce abuse of the system. These features also include setting limits for ACH transactions and utilizing the reversal process.
- Data security enforcement: It's essential to keep customer data secure, so it is not stolen or accidentally leaked.
Nacha has rules for different payment transactions, but the focus is always on protecting the funds. This means that Nacha has specific regulations for one-time transfers, invoices, government payments, and a standard framework for payments from sender to recipient.
To use the ACH, you first need to have accurate information stored. Nacha guidelines help ensure that transactions can be processed smoothly and under federal law. Nacha has a system that validates your account and ensures all transactions are processed promptly.
Operating rules help businesses, and banks understand their responsibilities within ACH by providing a legal framework. This includes requirements to enforce the rules and audits.
Why is Nacha Compliance Important for Fintech?
Being Nacha compliant is crucial as you won't be penalized if any member breaks the rules. This can result in errors and more returns when processing transactions which could lead to a fine by the ACH network. Regulations and standards are suitable for all because they provide a safer and more secure system. The network is accessible and helps to regulate usage.
Nacha rules apply to many organizations in the financial services industry. There are good reasons for adhering to these regulations, especially for fintech developers.
For instance, if a business continually breaks Nacha's rules and causes high error rates, its bank may impose a fine and risk cutting ties with them. Financial institutions and fintech companies that aren't compliant with Nacha are more likely to have transactions with errors and returns or be less effective at preventing fraud.
If one of the members in a network doesn't follow the standards or requirements, such as enforcing daily limits, this can lead to service failures and significant consequences.
ACH Return Rates
ACH returns are a part of life and happen when transferring money from one bank account to another. There is always a chance of account information being incorrectly entered, funds becoming unavailable, or an account closing without knowledge.
An ACH return is a message to the Originating Depository Financial Institution (ODFI), letting them know that the ACH Network couldn't complete a payment-in-full to or from a customer's account. Typically, the RDFI returns a message with their ACH, but on some occasions, the ODFI or even the ACH Operator will send such a message. All ACH returns must be sent within the time frames established by Nacha rules.
Another way to classify ACH transactions is by a Standard Entry Class (SEC) Code.
Faster payment is vital for any business. Fintech companies may appreciate using an automated system to release outgoing payments to ensure they get their funds promptly.
The SEC Code is a three-letter code that assigns transactions a reason for happening. It will enable the financial institution to know whether it's being used by the subscriber, coming from another institution, or because of fraud.
Some examples of SEC codes are:
- PPD (Prearranged Payment and Deposit Entries) — A credit is a type of entry made to an account in the form of a credit or debit.
- WEB (Internet Initiated/Mobile Entries) — A credit or debit entry in the form of online payment or a mobile transaction is processed for a customer.
- POP (Point of Purchase Entries) — A debit entry for transactions made at the physical point of sale.
ACH returns are unauthorized returns (R05, R07, R10, R11, and R29), overall return rates, and administrative returns. Each type can't go over a given threshold.
You can find an ACH Return Code list listed in Sila's documentation.
A Nacha inquiry is instituted at a rate of 3.0% for administrative returns, which is why it is important to keep your return rate low with up-to-date information.
How Can Fintechs Meet Nacha Criteria?
Routing transactions can be an excellent first step to avoid mistakes like depositing money into the wrong account or sending funds to an expired account. NACHA requires all accounts to be verified before transferring funds to prevent fraud.
There are currently four Nacha-approved ways to verify a consumer's banking information:
- Microdeposits
- Manual Validation
- Pre-notes Database Verification
- Instant Account Verification
Besides the Instant Account Verification method, these other methods usually take days to complete and require customers to provide the information they typically don't have. This can be annoying because they need to be faster, often contain irrelevant data, and sometimes require the customer to call or undergo an additional I.D. verification process.
Using an API with integrated compliance can help fintech companies provide better service, enhance flow and deliver better security.
A good API will provide the following:
- KYC/KYB checks
- AML features
- Other compliance features