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Commercial Banking Solutions Awareness: Return Risk in ACH Debit Origination

John Cliff, AAP, CTP, Senior Product Manager


Automated Clearing House (ACH) debit origination is a cornerstone of modern commercial banking solutions, facilitating efficient and secure transactions between bank accounts. To ensure the reliability of this system, financial institutions must carefully evaluate risks, particularly return risk. 


Central to managing this risk are Know Your Customer (KYC) activities and determining the creditworthiness of ACH Originators. Additionally, understanding the types of transactions, the return timelines, and the specific Standard Entry Class (SEC) codes for each transaction is essential. This comprehensive approach helps mitigate risks, ensuring smooth transaction processing and safeguarding both the Originator and the Originating Depository Financial Institution (ODFI).


The Importance of KYC and Creditworthiness in Commercial Banking Solutions

Know Your Customer (KYC) procedures are vital for any financial institution. They involve verifying the identity of account holders, understanding the nature of their activities, and assessing potential risks. When it comes to ACH debit origination, KYC activities help financial institutions determine the creditworthiness of the Originator—typically a business or entity requesting the debit transaction. By establishing separate debit and credit limits for each Originator, financial institutions can better manage their exposure to potential risks.

Creditworthiness is assessed based on the Originator’s financial history, current financial stability, and the nature of their transactions. Establishing appropriate dollar volume limits for ACH debit origination is crucial; these limits are usually set based on the credit underwriting criteria established at the ODFI. ACH debit and credit limits are entered and evaluated separately. The credit and debit limits should be treated as mutually exclusive figures. 


What is Return Risk?

Return risk is the possibility that a transaction will be returned after funds have been made available to the Originator. This risk is significant because the National Automated Clearing House Association (Nacha) ACH rules specify a threshold of 0.5% for unauthorized transactions. If this threshold is exceeded, it can indicate systemic issues with the Originator’s transactions and a potential increase in the financial institution’s liability.

ACH debit origination allows an Originator to send transactions into the ACH network through their ODFI up to one business day before the transaction’s desired effective date. The basic flow of an ACH debit transaction is:


  1. Originator initiates the transaction.
  2. ODFI submits the transaction to the ACH network (e.g. ACH Operators).
  3. ACH Operator processes the transaction and settles among financial institutions.
  4. RDFI (Receiving Depository Financial Institution) receives the transaction.
  5. Receiver (e.g., payer) account is debited.


Comprehending the Return Risk Timeline

The return risk timeline for ACH transactions varies based on the type of transaction. Consumer debit transactions (classified under SEC codes like WEB, TEL, PPD) have a return period that can extend beyond 60 days due to Regulation E. In contrast, business debit transactions (classified under CCD, CTX) have a two-day return period after the Settlement Date. Misclassifying transactions under consumer SEC codes (e.g. WEB, TEL, PPD) can unnecessarily extend the risk of the entry’s return to both the Originator and the ODFI.

After the ODFI sends the debit transactions to the ACH Operator, it warrants to the RDFI and others that the transactions comply with Nacha rules. If an Originator closes an account or withdraws funds and the ACH items are later returned as unauthorized, the ODFI is liable for these returns. Therefore, it is crucial for financial institutions to understand the types of transactions their clients intend to originate and for Originators to be aware of the specific SEC codes associated with their activities.


How ACH Debit Transactions Work in Commercial Banking Solutions

An ACH debit transaction “pulls” money from one account while crediting the Originator’s account at the ODFI. This is commonly used in scenarios where a consumer has authorized a business – for example a utility (electricity, water, natural gas, etc.) or mortgage company to debit their accounts one-time or on a recurring basis. Trading partners may enter into agreements to credit or debit bank accounts. Finally, businesses or consumers may also authorize local, state, or federal agencies to debit their accounts for tax or other government payments.  

Here’s a step-by-step overview of how ACH debit transactions work:


  1. Authorization: The party receiving the payment (the payee) obtains authorization from the party being debited (the payer or receiver of the debit).
  2. Submission: The payee sends the payment request, including the payer’s routing number and bank account information, amount to be debited, SEC code and target effective entry date, to their ODFI.
  3. Processing: The ODFI forwards the request to their ACH operator(s), such as the FedACH, which has three same-day ACH deadlines and six future dated forward items deadline.
  4. Delivery: The ACH network rebundles the Entries and delivers them to the appropriate RDFIs.
  5. Execution: RDFIs import the transactions, execute or queue them, and send back any return codes in their next batch of ACH transactions.
  6. Settlement: The ODFI releases the funds to the payee once transactions are settled.


Types of ACH Debits in Commercial Banking Solutions

Different types of ACH debits are categorized by SEC codes, each representing a specific use case. Some common SEC codes for ACH debit include:


  • ARC (Accounts Receivable Entry): Converts physical checks received by mail or dropbox into ACH debits.
  • BOC (Back Office Conversion): Converts checks received in person at a point-of-sale into ACH transactions during subsequent, back-office processing.
  • CCD (Corporate Credit or Debit Entry): Facilitates business-to-business transactions.
  • POP (Point-of-Purchase Entry): Converts checks received in person into ACH transactions and the check is immediately handed back to the payer.
  • POS (Point-of-Sale Entry): Processes card payments made via electronic terminals.
  • PPD (Prearranged Payment & Deposit Entry): Directly debits or credits consumer accounts based on authorization.
  • TEL (Telephone-Initiated Entry): Debits consumer accounts for transactions verbally authorized over the phone.
  • CTX (Corporate Trade Exchange): Facilitates business-to-business transactions and carries up to 9,999 addenda records containing detailed, agreed-upon trading information.
  • WEB (Internet-Initiated Entry): Debits consumer accounts for transactions authorized online. 


ODFI’s Monitoring of ACH Return Rates by Originator

ACH Return Rates for Total Returns, Administrative Returns, and Unauthorized Returns should be calculated and monitored by ODFIs for each Originator, ideally by SEC code, at least on a monthly basis. 

When Total, Administrative, or Unauthorized return rates are greater than established industry or organizational limits, the financial institution’s relationship managers or other compliance personnel may engage directly with the Originator to determine what adjustments should be made for the relationship.

Excessive returns in these categories may cause the financial institution to alter, suspend,or discontinue ACH processing for the Originator.

Financial institutions should also actively monitor any third-pParty senders to ensure appropriate reporting and oversight has been established. A third-party sender aggregates and sends transactions to an ODFI on behalf of several Originators, and the ODFI may not have a direct treasury management or other contractual relationship with each Originator on the third-party sender’s files.


Key Takeaways for Managing ACH Debit Origination and Return Risk

Comprehending ACH debit origination and managing return risk are critical for maintaining the integrity and reliability of the ACH network. By conducting thorough KYC activities and accurately determining the creditworthiness of Originators, financial institutions can effectively mitigate risks and ensure smooth transaction processing. Familiarity with the different types of ACH debits and their specific SEC codes further enhances the ability to manage and classify transactions correctly, safeguarding both the Originator and the ODFI.


Interested in diving deeper into Alkami’s commercial banking solutions and how we offer ACH origination and processing?

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Alkami Technology Digital Banking Solutions
Alkami Technology, Inc. is a leading cloud-based digital banking solutions provider for financial institutions in the United States that enables clients to grow confidently, adapt quickly and build thriving digital communities.
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