Clearing Houses

Clearing houses are institutions devoted to the exchange of information and the fulfillment of payment processing. A financial clearing house assures [Page 282]that two parties to a transaction do not default. Financial clearing houses include institutions devoted to the clearing of transactions involving the trading of financial securities and the conduct of specific forms of electronic payments.

Albert Bolles describes the clearing house concept as “one of the most useful agencies called into being by the wants of modern commerce … susceptible to almost infinite expansion.” Indeed the clearing house concept has grown dramatically and increased the efficiency of the payments system. The first clearing house in the banking system can be traced back to the London Clearing House, founded in 1775. The first clearing house in the United States, the New York Clearing House, was established in 1853 based on the example set forth by the London Clearing House. The use of checks created a need for clearing houses in the banking system.

When an individual deposits a check in his or her bank that is drawn on another bank, a clearing house ensures that the funds to cover the check flow from the bank the check was drawn on to the bank it was deposited into. Before the clearing house, the depositor's bank would have had to collect payment via messenger to the other bank. Before modern electronic processing, check clearing was largely a time- and paper-laden process. This process is conducted by the Federal Reserve Bank in the United States today. With the aid of wire transfers, check truncation (Check 21), the automated clearing house (ACH), and the electronic data interchange (EDI), payments conducted with paper have been greatly reduced.

The ACH Network

The ACH network was one of the U.S. payments system's first automated paperless answers to the increasing volume of paper checks. (The first was the wire transfer system Clearing House Interbank Payments System.) It was originally designed to clear small-value, recurring paper-check payments such as payroll deposits and mortgage payments. This system performs similar functions to the United Kingdom's Bankers Automated Clearing Service (BACS). For an ACH transaction to occur both the originating and the receiving bank must be members of the ACH network. The first U.S. ACH began in 1972 in California. The network was developed by bankers, but it was run by the Federal Reserve System.

Later, many small ACH associations developed and worked with the Federal Reserve district banks to clear regional electronic payments. By 1974, the National Automated Clearing House Association was formed to oversee and help coordinate the growing ACH network. Currently, the only operators remaining in the ACH in the United States include the publicly owned Fed ACH operated by the Federal Reserve System and the privately owned Electronic Payments Network (EPN), a subsidiary of The Clearing House. In 2007 more than 13.97 billion transactions, worth more than $28.8 trillion, were sent via the ACH network.

The ACH network sends secure electronic funds transfers in the form of debit and credit transactions to handle payments electronically as opposed to using paper checks. Debit transactions are initiated by the payee (e.g., a consumer paying a utility bill, mortgage payment, or fitness facility fee). Credit transactions are initiated by the payer (e.g., the direct deposit of an employee's paycheck or the reimbursement of an employee's travel or health expenses). Business-to-business, or corporate, payments utilize the electronic data interchange (EDI) format with ACH to exchange information and make and receive payments with trading partners, pay tax withholdings to the government, or for intracompany cash management transfers. Governments use the ACH network for such payments as Social Security, tax refunds, and pensions.

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