I’ve been thinking about several active projects going on in Start ups, bank networks as well as the Xoom IPO. Who owns origination risk for ACH?
Here is a good Story… back in 2002 banks did not allow for online fund transfer. If you wanted to move money from one bank to another you had to write a check and deposit it at the ATM.. and wait 5-7 days. Online brokerage services (etrade, schwabb, … ) did provide the service. BAC broke the mold in 2003, and my team at Wachovia followed. Both Wachovia and BAC used Cashedge (now part of FISV and still good friends of mine).
The general transaction flow (after registration and account ownership verification)
– Debit sender’s account, credit settlement account (good funds)
– Credit beneficiary account, debit settlement account (good funds)
Rather simple stuff.. but there was one big problem. Cashedge was using a very small California bank Calnet for settlement. Can you imagine.. everyone of their big banking customers (including BAC) were putting settlement funds into this tiny little bank which was originating transactions DAILY at a value close to its asset size. We caught this in project due diligence and subsequently set up a separate WACHOVIA settlement account in our business banking facilities. In this model Cashedge became a third party sender for us operating as ODFI.
This Fed whitepaper outlines a few of the risks in ACH origination. Today the large banks have taken a regulatory view that they own the risk on EVERYTHING that debits their customer’s accounts. Furthermore they are responsible for every originating transaction (even for MSBs that maintain an aggregate settlement account), particularly KYC.
OCC Bulletin 2006-39 clearly addressed the need for ODFIs to know details about all participants in third party relationships by indicating that financial institutions “should know, at a minimum, for which Originators they are initiating entries into the ACH Network
This KYC issue is one of the things the lead to the death of HSBC retail in the US (See Deferred Prosecution Agreement, and business overview of issues from Reuters). Demonstrating there are big risks for third party senders that don’t know their business clients. This NACHA whitepaper provides results from a third party sender survey with NACHA banks.
US banks are getting out of the business of supporting MSBs as the regulatory burdens increase. The most recent (and significant) are CFPB’s final section 1073 rules.
Section 1073 of the Dodd-Frank Act amended the Electronic Fund Transfer Act to require remittance transfer providers to provide disclosures to senders of remittance transfers pursuant to rules issued by the CFPB. Specifically, remittance transfer providers must give senders a written pre-payment disclosure of specific information applicable to the sender’s remittance transfer. A remittance transfer provider must provide a written receipt that includes both the information on the pre-payment disclosure and additional specified information.
There are a number of “specialist” banks operating in this environment. But a key takeaway for investors is that the costs to “ride the rails” of ACH are increasing. Top 5 banks are taking the position that every bank must KYC the originating customer. Banks are not keen on supporting start ups on their infrastructure, bearing all the risk and cost of running the rails.. while others reap the benefit. This was my point behind Xoom’s $800M market cap.. a company completely built on bank infrastructure.