Denied payments - the duality of Risk and Expense

For years banks have borne the brunt of returned payments. It is easy to agree that the happy path flow of a payment that travels with no manual intervention and gets successfully posted to the receiver’s account is the most beneficial use of the payment infrastructure. Denied payments i.e returns represent unproductive activation of the physical market machinery along with significant wasteful effort put in by all parties.

Faster payments have put the spotlight on various dimensions of payment network inefficiencies. Excessive levels of returned payments are recognized as a malady though what is an acceptable benchmark cannot be quantified. Nevertheless, the study of payment returns, reveals the futility of a payment order traversing the network only to return to the point where it emanated.

The reverse flow of returned payments consumes valuable processing bandwidth for all payment network participants and therefore carries a cost. The list of return codes published for a payment network obliquely represents a glossary of expense codes linked with blemished use of the network.

This results in diminished efficiency index for batch of payments in a file to which it belongs, the associated clearing cycle in which the file was sent and the entire day’s payment volume handled by banks and the clearing house / the central bank. At the RDFI (Receiving Depository Financial Institution)’s end, cost is incurred in investigating and resolving claims from the receiver i.e customer of the RDFI, customer communication, preparing the items for return and so on.

Direct Debits hurt more..atleast appear to..

Crediting the originator (customer of the bank that originate a payment for self or on behalf of another customer) towards the value of the direct debit and being unable to recover the funds when the item is returned poses credit risk. This is heightened when the debits are non recurring especially if adequate transaction history for newly on-boarded customers have not been built. Prohibition in the form of amount caps for direct debits, insisting on zero dollar debits, help in case of B2B originations, though, in a limited way as these do not instill perpetual discipline. Consumer debits such as a point of purchase or a Web authorized ACH debits can turn bitter if the bank has not known the customer enough.

Payment Network Upliftment:

Percentage of returns of the total payment origination from a bank in a clearing cycle or in a day is hardly benchmarked nor is there any inhibition on the origination of ‘afflicted’ payments. Returns are ‘anti patterns’ to the pattern established by successfully posted payments. Banks are beginning to see them as such.

Policy research has been set in motion in US since 2010, to create a machinery to measure and control ACH returns. A Method for Improving the Benchmarks Used to Monitor ACH Returns | Federal Reserve Bank of Minneapolis

The first salvo..

.. is targeted towards containment of returns.

The recent operating rule promulgated by NACHA https://www.nacha.org/rules/improving-ach-network-quality-unauthorized-entry-fee coming into effect from August 2016, to charge return fee for unauthorized direct debits, seeks to usher quality in the FedAch network through the tracking of returns. This preliminary step could lead to profound changes in creating deterrence on various fronts and can be an eye opener to other payment network sponsors desirous of network upliftment.

The penalty is in the form of applying an unauthorized debit entry fee to be paid by the ODFI (Originating Depository Financial Institution) to the RDFI . The focus is not just on return of debits as unauthorized but also on the general rate of returns as a percentage of overall origination by an originator. The latter may trigger an inquiry instituted by the ODFI or the third party sender on the originator.

For unauthorized direct debits, the ACH operators would apply a fee to the credit of the RDFI which in turn would be applied to the originator. The fee is likely to be in the range of USD 3.5 to 5.5 per instance and is broadly indicative of the monetary cost for a bank handling a return.

Creating a framework to protect against network abuse:

The NACHA rule provides an impetus towards the creation of a framework of liability against the perpetrators of subpar ACH items at different levels..

At the ACH operators’ end, through the association of fee codes to return codes that triggers fee debit to the ODFI with offset credit to the RDFI. The fee could be applied on a consolidated billing basis with configurable billing frequency – monthly, quarterly, yearly with a second level breakdown that provides the fee amount attributed to each originator. Originator code wise break down of the applicable return fees will be required in order for the ODFIs to be able to transmit the liability to their originators. This rule also promotes closer monitoring of the distribution of returns against the return codes allowing the inclusion of newer return codes into the ambit.

At NACHA’s end, through inclusion of returned item traffic volume data in quarterly network volume statistics classified on the basis of return codes. This could reinforce its stance on improving quality of submitted payments

At the ODFI’s end, through the passing on of the return fees to the originator. This would need the ability to reconcile the quantum of return fees for each originator for a return code with the amount charged by the ACH operator. The ODFIs will also need to match what is actually applied with the fee amount projected. When passing this onto the customer account, the account analysis statement would carry a detailed listing of returns with elaboration of the ACH items

• date of origination,
• amount, trace numbers,
• return code and other details

Imaginatively speaking, it may even lead to

a)   preemptory screening of direct debit origination on the basis of debtor mandates that would be shared by the originator with its bank for direct debits,

b)   creation of verifiable process for on-boarding both originators and their counterparties

At the RDFI’s end, through setup of return thresholds for originators and automatic suspension of originator profile on breach of the thresholds

Better citizenry on Payments Highway

This operating rule is likely to bring cheer to FedAch participants although a fee based approach that reprimands ACH items that end up in a return, may push originators towards check based invoice and bill payments as a mode of collection. This would challenge the end goal of that of an all pervasive multi-purpose electronic payment environment. This threat of disenchantment with electronic payments cannot be quantified but may become serious enough to take steps towards its mitigation. Accelerated proliferation of same day ACH could be a possible savior.

It is time for better citizenry on electronic payments highway through ownership of origination. Can enforcement shape free will? Remains to be seen..