When it comes to the modern payments ecosystem, speed and security are topmost priorities. The automated clearing house (ACH), proven to be a reliable provider of fast and secure payments, has seen steady growth over the last several years, with a 10% compound annual growth rate (CAGR) between 2017-2020 and even larger gains projected through the end of 2021.
However, increases in transaction volume bring commensurate increases in fraud and the mitigation of fraud risks, undermining the benefits of ACH with lengthy remediation processes. One way to nip fraud risk in the bud is with a strong account validation system, but it must continue to allow for seamless and fast payments.
To learn more about how to optimize account validation to mitigate fraud and drive faster payments, PaymentsJournal sat down with Nirmal Kumar, CTO and Head of Product at Aliaswire, and Sarah Grotta, Director of Debit and Alternative Products Advisory Service at Mercator Advisory Group.
ACH spiked with COVID-19
ACH is not a new system – its roots trace back to the late 1960s and early 1970s – but Same Day ACH was only introduced in 2016. When the COVID-19 pandemic drove payments into the digital space, the ACH Network was already in place and ready to accommodate widespread changes in the payments ecosystem.
“There was a tremendous amount of volume pumped through the ACH as a result of the CARES Act and unemployment benefits,” Grotta pointed out. “The pandemic also put a lot of pressure on businesses to stop processing checks, just because it became such a burden, particularly in the B2B and B2C channels.”
Everybody from financial institutions to individual consumers desired greater efficiencies through electronic transactions. “It’s a behavior shift,” said Kumar. “It’s not going to go away.” Some of the growth has come from new digital tools for P2P payments such as Venmo and Zelle, which appear to be different payment mechanisms but which in fact use ACH under the hood.
Kumar highlighted how the ACH network handled a record high of over 26 billion payments in 2020, which translates to about 81 payments per person in the U.S. “That’s how efficient the system needs to be,” said Kumar. “If there’s any friction in the system, that’s how impactful it’ll be across the board.”
The vital role of account validation
As ACH volume grows, it is only logical that fraud, errors, and return rates would grow as well. Anybody with the right credentials can enter an account number, and something as banal as a “fat finger error” can disrupt the flow of payments and introduce friction.
“The entire onus of entering accurate account information is on the payer,” Kumar explained. “Inaccurate information causes what I call the ‘pipe freeze,’ and eventually the [pipes] thaw, the payment is kicked back, and the fraud is realized, but that almost takes four or five days to happen. That slows down the entire system.”
NACHA introduced a new countermeasure rule that went into effect on March 21, 2021, requiring account validation for the first use of any bank account that goes into the ACH network. Still, the U.S. banking system is fragmented across many different banks and accounts, and there is not yet a single unified account validation scheme for everyone to follow. “If account validation is done the right way, it can increase both volume and user experience,” said Kumar.
For years, people have used prenotes and microdeposits (negligibly small transactions to verify account information) as an account validation method, but that process takes time and runs counter to the whole concept of fast payments. “In this day and age of faster payments, that is just not viable,” suggested Kumar. Some sort of account validation is necessary to give users the confidence to use ACH, because if the system is bogged down in errors, people will turn to payment cards instead, which will increase costs for FIs and other account originators.
What strong & modern account validation looks like
Any strong account validation process will provide cost efficiency, reduce drop-offs, and lower risk of fraud. However, historical account validation tools such as prenotes and microdeposits can take 5-7 business days to process, and account aggregators add risk to the equation by sending customer information to a third party. How does one modernize this essential process?
According to Kumar, account validation in the U.S. requires a multi-pronged approach to meet the needs of a fragmented system. “It really has to have a platform approach where you can mix and match different tools to provide the best experience as far as account validation is concerned,” he said. Most importantly, money needs to be able to move at high speed, particularly as open banking finds its footing in the U.S. “As banking becomes more democratized, I think these tools are very important and essential,” Kumar continued.
Account validation must confirm four main things:
- Account status
- Payment history, particularly NSF or chargeback history
- Ownership, and matching ownership to the payment originator
- Consistency of Personally Identifiable Information (PII) including name, address, phone number, email, etc.
Overall, account validation must be built for real-time payments with a sophisticated understanding of how fraud is conducted, and it must be done cost-effectively. “ACH is the most cost-effective way of moving money,” Kumar explained. “But as soon as you add account validation and start using third parties, that cost jumps almost 5-6 times.” A platform approach can minimize that financial burden by proactively using existing data, multiple providers, and relevant payment history. “That kind of cost optimization can only be brought in by a platform approach and not by a single source,” Kumar concluded.
