The ACH system is hugely important in the U.S. Its remit includes payroll direct deposits, Social Security payments, income tax refunds, mortgages, and utility bills. At a time when the volume and value of internet-initiated ACH transactions is at an all-time high,1 smart agreements, which automate actions such as verification of signer-entered payment data and invoice creation, have a significant role to play. Let’s outline three dominant ACH trends before considering the function and value of smart agreements in payment transactions.

Trends

  1. Better validation methods are on the rise
  2. The cost of fraud is better known
  3. Transactions are getting faster and more seamless

ACH validation

Automated verification is on the rise. First, the basics: ACH validation refers to ensuring that a customer’s bank account “is a legitimate, open account to which ACH entries may be posted at the RDFI [Receiving Depository Financial Institution].”2 Automated ways of verifying accounts streamline the process by using technologies to route account data for comparison against trusted sources and retrieving responses in seconds.

The most obvious factor for the gaining prevalence of automated ACH verification is the easy choice of electronic ACH payments over checks. This was clear even before the pandemic: 2018 was the first time the number of check payments (14.5 billion) was less than the number of ACH payments (16.6 billion).3 Greater demand for ACH payments has meant more verification options beyond the basic methods—prenotifications (essentially, $0 transactions) and microdeposits—that are largely manual or take days or both.4

The upcoming Nacha regulations have moved ACH validation higher up in the agenda for businesses. Nacha, originally NACHA or National Automated Clearing House Association, governs the ACH Network and establishes the guidelines for operating within the network. Its members include individuals, financial institutions, financial technology companies, and the Federal Reserve. Starting on March 19, 2021, the Nacha Operating Rules will require businesses that initiate web-based ACH payments to verify customers’ account information for the first payment and subsequently any time the account number is changed.

Against this commercial and regulatory backdrop, validation services are making themselves heard. There are many such companies, and they fall under two main categories:

Customer account aggregators: Companies that offer this service build integrations with banks’ user credentialing systems, and provide an interface for users to give permission to use their data using their online banking credentials.

Databases consortiums: Companies that offer this service combine data from banks that agree to give direct access to customers’ account information.

Many providers combine these types of services and even add other (non-bank) data verification capabilities from other sources (e.g., phone, address, credit). Nacha alone lists 24 of these services.5

Fraud

Better detection techniques and technologies is making it easier for businesses to understand the cost of fraud. Global payment fraud losses are striking and continue to grow (see chart).6

Increased fraudulent activity in alternative payment methods to ACH, such as credit cards, is bolstering the case for ACH. COVID-19 has produced dramatic increases in fraudulent and opportunistic chargebacks.7 The incidence of fraud in ACH transactions is lower than other payment methods.8,9  

While the ACH method is comparatively secure, the concern for fraud still exists. The 2020 AFP Payments Fraud and Control Survey suggests that, with 22% of companies reporting it, ACH credit fraud is on the rise from the previous year while ACH debit, at 33%, represents a 5% increase from 2017.10  Government disbursements during the pandemic have been subject to significant fraudulent activity. Unemployment disbursement frauds have wreaked particular havoc across the U.S.11 This has moved government agencies to look to mitigate fraudulent disbursement more effectively and quickly using technology. (Nacha estimates that 100 million second Economic Impact Payments will be made by the IRS via ACH Direct Deposit.12)

2020 showed a spike in account takeovers.13 This includes stolen bank accounts, which would make simple bank account and routing number validation in ACH transactions insufficient. Protecting against fake or compromised accounts or, worse, synthetic fakes,14 should be a consideration when selecting verification services for payment transactions. Services that incorporate risk-based models can be highly impactful. Predictive engines fueled by multiple datasets combining demographics and behavior patterns can generate risk-based verification responses about identity that improve all facets of business performance: cost, revenue, profits, and customer experience.15,16 Holistic approaches to identity verification can be effective at not just detecting fraud, but reducing false negatives, which, as the unwanted byproduct of fraud detection systems, is one major source of the cost of fraud.17

Faster and more efficient ACH payments

ACH payments have been getting faster and more efficient. ACH stands out as a remarkably cost-effective option for payment originators of all stripes. It is far cheaper than wire transfers and, of course, credit card transactions. The median internal cost for processing ACH payments is $0.29.18

In addition to cost, ACH payments can be processed in a matter of days or, even, hours, due to the capabilities of Same Day ACH. Introduced by Nacha in 2016, Same Day ACH transactions went from 14.8 million to 93.9 million payments in the third quarter of 2020.19  The transaction flow is also a boon for the customer experience: a payment can be initiated with only a few clicks to send funds directly to the customer’s bank account, which means that the customer does not have to take any manual steps to accept the payment.

As ACH payments get better, its growth potential remains massive. Less than 5% of online retailers offer ACH as a payment option.20 In February 2020, Nacha reported that the ACH Network moved 24.7 billion payments in 2019, a 77% increase from 2018, and totaling $55.8 trillion.21

While the presence of newer alternatives, like the Clearing House’s Real Time Payments,22 creates added—and welcome—pressure on ACH, Same Day ACH offers the benefits of a mature system with its well-understood mechanics and rich integrations, all of which amount to increased efficiency.23

Role of smart agreements

The case for automated verification is now settled. The question is: what technologies and mechanisms are integral to a customer and payment verification system?

The market recognizes that agreements, and the software used to manage them, is more central to business performance than ever before.24 When it comes to payments, agreements should be one among a group of key tools and sources of data used to manage risk and provide seamless transactions for customers. Your agreements are a crucial point at which customers promise to share accurate information needed to do business with you. Detecting inaccurate information while agreements are being executed sets the stage for better business relationships.

The signing experience is one of the most important contexts in which customers are engaged with businesses.

Smart agreements open up the data in your contracts to critical data sources and the most advanced systems in evaluating risk. The data your customers enter in your documents are connected not only to systems of record and authoritative data sources, but also advanced technologies like machine learning, decisioning algorithms, and computer vision used in fraud and verification programs.25

Consistent with other areas of digital transformation, smart agreements enhance the user and customer experiences, and this is no different in fraud systems that make use of them. A signing experience with smart agreements offers customers contextual verification at higher speeds, which results in higher conversion or transaction completion rates.

Incorporating validation upfront, before the customer signs an agreement and finishes a transaction, results in fewer returned transactions. Today, there are hundreds of ACH return codes, administered by Nacha, that deal with different scenarios of money being returned. Some of the most common return codes (such as Insufficient funds (R01), Account Closed (R02), and No Account/Unable to Locate Account (R03)) can be anticipated and thus prevented using solutions like GIACT’s gVerify®, to detect if accounts exist and are open, and Plaid’s Balance, to confirm sufficient funds.

Customers are used to sharing financial data in simple forms and legacy contractual documents that expose their sensitive data in plain or otherwise insecure formats. This is as true in purchasing insurance and financial products as it is when signing up for memberships or subscriptions. Smart agreements supplement security measures by delegating the task of collecting and processing payment information to code, using encryption and secure connections to trusted sources.

It’s important to distinguish digital contracts that extract metadata to sync with other systems from smart agreements. Still more, smart agreements built on a common standards and structured data framework are distinct from (and preferable to) individual attempts to model agreements with code.  Payment data clauses built on Accord Project templates ease the transition from paper-based, manual payments to automated transactions. The data model behind Accord Project templates can read data inputs by signers and pass that data for execution of payments and other actions on external systems. Adopting common data frameworks makes building interoperable systems that communicate with agreement data easier and more efficient. Clause’s smart agreement platform, built on Accord Project codebase, further reduces complexity by offering configuration-only solutions.

The friction with ACH adoption has traditionally been in the technical costs of setting up payment integrations. Smart agreements reduce that complexity into simple components that can be drag-and-dropped into documents, ready to be used during the critical juncture of contracting with customers. Before sending for signature and without writing code, users can add payment data sections and fields into the document to allow for automated validations. A smart agreement can layer in multiple checks to bolster businesses’ risk management and compliance postures. Individual and business identities and OFAC checks (to verify that a customer or transaction participant is not on the U.S. Treasury’s Office of Foreign Asset Control’s Sanctions Program Listings) alongside payment details can be verified prior to agreements being signed.

With their ability to make transactions more seamless for customers and their ease of implementation, CIOs, CROs, and CFOs would do well to make smart agreements a fixed part of their organizations’ transaction stacks.

ACH Transactions with Smart Agreements: Sample use cases