The ACH Balance Act

Article excerpt

Competition has arrived at the automated clearing house payment system, and community bankers are not turning out in droves to welcome it.

The camel got his nose under the tent in October 2000 when the Federal Reserve Board of Governors bowed to arguments that the current system of charging banks for ACH processing penalized the Fed's three private-sector competitors: EPN, ACHA (the former Arizona Clearinghouse) and Visa. It approved an apparently modest change in pricing that energized EPN (the Electronic Payments Network, successor to the New York Clearing House) to challenge the Fed to a pricing duel over who

will rule the ACH processing roost.

EPN now is using aggressive price cuts and intense marketing to woo the small group of large banks that generate the greatest volume of ACH transactions. Those few big banks, offered substantial price cuts, are, in many cases, signing up with for-profit EPIC The not-forprofit Fed is losing market share. Community bankers are concerned that profit-driven, deregulated competition will split the market, cutting prices for the high-volume banks and raising them for the low-volume banks that offer less profit opportunity for the processor.

Since most community banks are lowvolume producers and since EPN is an instrument of the big banks, many ICBA members are not happy about the way things are going. Their initial fears were confirmed when the Fed, which is fighting back to retain some of the high-volume producers, announced a new pricing schedule last October. Pertransaction charges were dropped from seven to five mills, creating an effective price cut for the high-volume banks. Meanwhile, flat fees for file processing were raised, causing an effective price increase for lowvolume banks. (For details, see

The good news is that this initial deregulatory move came in an area where prices were low. For most community banks, a cheap service became a little less cheap.

The bad news is that it may not stop here. If the Fed does see its market share erode and if it is forced to continue to raise prices to cover its fixed costs-as it is required to do by the Monetary Control Act of 1980-then community bankers could see a succession of price increases.

But there's more good news. The growth in ACH volume is picking up speed as a result of initiatives that allow consumer checks to be converted, with or without the writer's consent, into ACH debits. It started with checks presented at the point of sale and recently expanded to checks received at retail lockbox processing sites. Payees like the notion-they get quicker availability, an earlier shot at funds if there are not enough in the account to go around and one more presentment in cases of insufficient funds.

In a couple of years, check payments from businesses received in retail lockboxes will be included as well. If there's a battle over market share, it helps that the overall market is growing briskly.

Verdict from Main Street

So far, community bankers are alert but not alarmed by the changes. Fed prices definitely went up Oct. 1 at the $535 million-asset Gardiner Savings Institution FSB in Gardiner, Maine. "We send a lot of small files, roughly 90 a month," reports Jim Fairfield, vice president for electronic banking. "So raising the file fee from $1.75 to $5.00 will cost us about $300 more a month. And we don't have enough transactions to make it up in lower per-item charges."

At this point, a net increase of less than $300 a month is not a source of anguish in Gardiner, but the new competitive environment "is causing us concern. It's definitely on our radar," Fairfield reports.

He sees it as a negative development. "The Fed historically has provided services at a reasonable price for every financial institution, regardless of size." If this minor adjustment in fees works and keeps the Fed in the ACH processing business, then paying more is "the lessor of two evils," he says.

The greater evil would be for the big banks to corner the ACH processing business with their own network and adopt tiered pricing that favors the high-volume players, leaving the Fed as the provider of last resort for community banks, but saddled with even higher processing costs.

For Gardiner Savings Bank, the market has not become more competitive. "Large-bank networks like EPN have no interest in us, so we, like most community banks, really just have one choice-the Fed," Fairfield says. He's hoping that "competition" is not an excuse to raise costs for the one provider he can count on.

On the other side of the country, the story is essentially the same. The Fed's October 2001 price list "definitely will increase our costs but not substantially," says Kay Smith, senior vice president for operations at the $475 million-asset Bank of the Cascades in Bend, Ore. The bank originates ACH payments for about 100 business customers, in addition to the ones it receives.

Smith understands what the Fed is doing and supports it. "They're trying to compete for the large banks with the real high ACH volumes with these new prices," she says. "There will be a small negative impact on banks like ours. We never like to pay more, but the quality of service is a bigger issue for us at this point than a few dollars of increased cost. It would take a much bigger pricing change before we would look at anyone but the Fed for processing."

It's too soon to say whether the market will benefit or suffer from increased competition between the Fed and private-sector operators like EPN, Smith says.

Friendly EPN

George Thomas, president of EPN, scoffs at the idea that his organization is hostile to community banks. While EPN's marketing efforts so far have targeted the high-volume ACH banks, community banks are welcome and will, in fact, save money by processing with EPN instead of the Fed, he argues.

"The latest (October 2001) Fed prices screw the small bank in favor of the large bank," he charges. "They added a $20-a-- month flat fee on top of a $25-a-month flat fee they already had. That hurts the community bank." EPN's prices are lower, and they're not tiered, he insists.

EPN has an ACH pricing spreadsheet that it will send to community banks that request it, and Thomas promises to post it at the firm's Web site, "Community banks do have a choice," he emphasizes.

EPN's customer list includes at least 100 ICBA members, Thomas says. But he concedes that they are all in the Second Federal Reserve District (New York), where EPN's parent, the New York Clearing House, has been essentially the sole ACH processor for a long time. He can't name any community banks EPN has signed up outside the Second District.

One of the loudest cheers for the new competition is coming from the National Automated Clearinghouse Association. NACHA pushed for a larger role for private-sector operators and welcomes the change. "We think the competition will be good for community banks," says Elliott C. McEntee, president and CEO (and a former Fed staffer). "Now both the Fed and EPN are looking for ways to improve their services to banks. Everybody should benefit. I'm optimistic that we'll see double-digit annual growth in ACH traffic for some time to come."

Fed Fights Back

The Fed, meanwhile, is not giving up a market it has long dominated (roughly 85 percent market share) without a fight.

"The price changes of Oct. 1 were intended to better align our revenue structure with our cost structure and to make the Fed as attractive a processor as possible to all ACH originators but especially those with high-volume files," explains Rich Oliver, senior vice president of the Atlanta Fed and product director for the Fed's retail payments office. "Where those price changes have created additional cost burdens, we have offered to work with financial institutions to find ways to reduce the impact of those changes. Many originators send us several small files daily. If they could consolidate those files, they could reduce the impact of the increases in file processing fees."

While the flat fee increases may more than offset lower charges per item at community banks, the overall trend is for the Fed to cut its costs and pass on the savings to ACH banks-- both receivers and originators, Oliver insists. "This is just the first step in a strategic plan to further reduce ACH transactions fees and encourage growth in ACH origination." Look for additional price cuts early in 2002, he hints.

There's no question that EPN is taking volume away from the Fed and that the Fed has a high investment in fixed costs that it must, by law, cover with the prices it charges banks for services they use. Oliver is well aware that fixed costs and shrinking volume could set off a destructive spiral in which lower volumes force higher prices, which in turn lead to lower volumes and still higher prices.

"The moves we announced in October and the ones we will announce soon are meant to keep that from happening," he says. "We're trying to make file origination and receipt attractive to larger institutions and keep the economies of scale we need so that all financial institutions will be able to use the ACH at inexpensive rates."

Slowing EPN

EPN is hardly a juggernaut whose dominance of the ACH processing market is now assured. For one thing, it may be less of a bargain than it seems. The EPN three mills-per-transaction fee is an unbundled price quote that may not include other charges, such as research requests, says Oliver.

Service quality is at least as important to banks as price. If any operator has quality glitches, it will slow its momentum. And after the events of Sept. 11, large banks now are more inclined to split their processing so they will have credible back up if anything happens to one of their processors.

It also helps that the Fed is unlikely to lose the business of the federal government. While EPN is pitching its services to the Treasury and FMS, that's business the Fed will retain for the foreseeable future.

Better Marketing

The Fed is now trying to offset its loss of market share to EPN by encouraging increased use of the ACH and increasing the overall volume in the market. That could mean additional support for community banks. "A lot of smaller financial institutions have not developed sophisticated marketing programs to promote use of the ACH by their customers," Oliver says. "When they meet with their corporate customers, they don't always have the expertise to show them how the ACH can save them money and to answer their questions. We're developing materials and personal contact programs that will augment the marketing efforts of banks of all sizes."

Whether that means putting Fed ACH gurus on Main Street side by side with community bankers to help them sell ACH to their business accounts remains to be seen. Such a program has been discussed behind the scenes, but both Fed officials and community bankers reportedly see logistical problems in making it work.

Of course, community bankers would not stand by wringing their hands if the market moves against them. They might turn to bankers' banks, a trade association or some other ACH file consolidator that could pack a lot of small files into one big file and send it through at the volume-discounted rates. But for thousands of community bankers, the U.S. payment system in general and ACH processing in particular wasn't broke and doesn't stand to benefit from getting fixed.

[Author Affiliation]

Richard H. Gamble is a free-lance writer in Grand Junction, Colo.