CUNA Regulatory Comment Call
Electronic Check Council
Issues and Proposed Solutions
February 8, 2000
An administrative return is defined as any ACH item returned because the information captured by the originating company (payee) from the MICR line on a check is not processable as an ACH item by the receiving institution (paying bank). Typical administrative return reason codes include Invalid Account Number (R04) or No Account/Unable to Locate Account (R03).
Administrative returns are occurring more frequently because the ACH Network is being used increasingly for non-recurring payment applications such as electronic check conversion at the point of purchase, telephone authorization, and Internet- initiated payments. The methods used for correcting routing and account information in a recurring payment environment, such as prenotifications and notifications of change, are not suitable tools for non-recurring payments. As a result, new solutions must be found to ensure that the routing and account information can be captured accurately from the MICR line of the check and used to convert or truncate the payment to an ACH item.
This paper discusses the causes and extent of the problem, proposes solutions to the administrative returns problem, and suggests next steps.
Quantifying the Administrative Return Problem
For many years, the ACH Network was used primarily for recurring payments such as direct deposit and direct payment. Certain NACHA Operating Rules, such as the notification of change and prenotification processes, were established to resolve issues concerning enrollment and changes to routing and account numbers used to process ACH payments. These processes work relatively well in a recurring payment environment where the Originator can make changes to routing and account information for subsequent payments.
As the ACH Network evolves, it is becoming increasingly used for non-recurring payment applications such as electronic check conversion at the point of purchase, telephone authorization, and Internet-initiated payments. In a non-recurring payment environment, the tools used for correcting routing and account information, such as prenotifications and notifications of change, no longer work since additional ACH items at a preauthorized frequency and amount from the same Originator are unlikely. As a result, new solutions must be found to ensure that the routing and account information can be captured accurately from the MICR line of the check for an ACH payment.
The seriousness of the administrative returns problem can be illustrated from the recent results of the Consumer Authorization for Non-Recurring ACH Debits Pilot (Telephone-Initiated). Initial pilot results indicate the following:
- Existing Relationship, Consumer calls Company Pilot Scenario1.7 percent administrative returns;
- Existing Relationship, Company calls Consumer Pilot Scenario4.99 percent administrative returns;
- No Prior Relationship, Consumer calls Company Pilot Scenario6.48 percent administrative returns.
The administrative return ratios listed above are similar to those experienced for other non-recurring payment applications such as re-presented check entries and electronic check at the point of purchase. Furthermore, there is no reason to believe that the ratios will be different with Internet-initiated payments. As a result, the rates of administrative returns may become a barrier to entry for any new ACH applications involving non-recurring payments. Administrative return ratios of the extent seen in these programs significantly increases the collection costs to Originators, and in some cases, it has been reported that much of the economic benefit of check conversion or truncation to ACH is negated by the costs of handling administrative returns.
Current Solutions to Administrative Return Problems
1. Overrides for Routing Number
Routing numbers (ABA numbers) that appear on the MICR line of a check are not always indicative of the routing numbers to be used to convert or truncate the items to ACH. The following information details some of the problems and solutions to converting routing numbers from the MICR line to ensure that the item can be processed as an ACH item:
A. According to research from Thomson Financial Publishing, there are 14,032 routing numbers used by ACH active participant financial institutions whose routing numbers are also used in the MICR line. There is generally no problem with converting or truncating these items bearing routing numbers to ACH.
B. 5,772 active ABA routing numbers are flagged to be overridden with 778 routing numbers for ACH processing. These typically belong to large financial institutions possessing multiple routing numbers. These overrides are used to streamline ACH operations. These have long been identified in publications such as The ACH Participant Directory.TM
C. An additional 5,625 routing numbers are retired, but are still used to clear ACH items by the financial institutions that own them. These routing numbers still work when converted to ACH either by using the routing number listed on the MICR line or using a different override number assigned by the receiving financial institution and used by the Originator or Originating Depository Financial Institution to clear the item as an ACH.
D. An additional 2,892 routing numbers use payable through institutions to clear checks and therefore require a different "override routing number to clear items as ACH items.
E. And finally, 5,624 routing numbers are active for the purpose of clearing checks but the financial institutions themselves are not ACH-capable. In terms of actual check volume, this last category represents less than one percent of check payments since most of the financial institutions do not offer consumer demand deposit accounts or are too small to maintain an ACH operation. In cases where checks are issued by these non-ACH capable financial institutions, the Originator or its financial institution can not clear the converted item as an ACH and either must clear it as the original check item or issue a demand draft to clear it.
The use of override routing numbers is a common procedure incorporated into the business practices of Originators and ODFIs. Override numbers can be obtained from the following sources:
(1) The Federal Reserve maintains a Composite Receiver File (CRF) that includes only ACH active routing numbers and, when appropriate, their override numbers. Non-ACH capable routing numbers are omitted from this file.
(2) Thomson Financial Publishing maintains several directories and databases of override information included in its ACH Participant DirectoryTM and its MICR conversion system, EPICWareTM; and
(3)Some Originators or their financial institutions maintain proprietary directories of this information based on their processing experience.
Use of these routing number directories significantly reduces the number of administrative returns. Even for items that cannot be converted to ACH because the receiving institution (paying bank) is not ACH-capable, a routing number directory can be used to identify these non-processable items at the front-end. This allows the Originator or its institution to process the item as a check and nearly eliminate the possibility of cost or risk from an ACH administrative return.
2. Checking Account Number Structure
According to Thomson Financial Publishing, an estimated 147,000 account number structures are in use by the over 20,000 financial institutions in the U.S. Banks with greater than $100 billion in assets average 255 different account number structures per institution. On the other hand, banks and credit unions with less than $100 million in assets have an average of 4.2 account number structures per institution.
The variances in the number of account number structures per institution are generally caused by mergers and acquisitions among larger financial institutions. While many bank names have disappeared, their account number structures and routing numbers continue to be used due to their customers use of old check stock.
When a check with outdated routing or account information is cleared as a check, the paying bank is responsible for mapping the item and posting it to the correct account. An example of this occurs when a merged institutions customers continue to write checks against accounts that may vary in size and the algorithm used to determine valid demand deposit accounts for the acquiring institution. However, these same institutions often fail to institute the same programs in their ACH system to map old account structures to the new ones required for posting ACH items. Some payable through institutions also fail to forward ACH items sent to the payable through institution as a result of converting or truncating a check to ACH.
Each financial institution establishes its own process for handling the types of situations outlined above. Some financial institutions change the account number indicated on the MICR line or add digits to it so the transaction can be processed and posted as an ACH item. For instance, a bank may require a prefix of 01 to be added to the account number if the MICR line is converted to an ACH item. Many other methods are employed to map demand deposit account data into paying banks posting systems. In converting or truncating these items into ACH, the account number often must be modified before it can be processed by the RDFI (paying bank) and, if the item is not modified properly, the item is rejected and returned. Thomson Financial Publishing estimates that there are approximately 15,000 account algorithms tied to 6,000 different routing numbers that indicate a reformatting of the MICR displayed account number.
Administrative returns caused by routing number issues can be effectively eliminated through the use of routing number directories. However, until recently, originating companies, third-party processors and ODFIs have had to rely on their own resources to prevent administrative returns caused from account number problems. Some of these organizations have developed proprietary databases that have accumulated data on a trial and error basis regarding the account number structures of RDFIs. While these efforts provide these organizations with a significant benefit for their customers, they are not commercially available to the rest of the marketplace.
To address this problem universally, and in anticipation of future growth in non-recurring payments over the ACH, NACHA asked Thomson Financial Publishing in 1996 to develop an account number structure database. The goal of this effort was to build and implement a resource that would identify every account number structure/algorithm in the U.S. and to make that directory available to any business. By October 1998, Thomson had released a product it called EPICWare that addressed the account number structure problem.
To populate the EPICWare database, Thomson has collected the account number structures for approximately 80 percent of the commercial banks, 75 percent of the savings institutions and 48 percent of the credit unions in the U.S. Based on the routing numbers and relevant override numbers, and the account number structures and account algorithms for each financial institution, EPICWare can be used to make the following decisions regarding check conversion to ACH:
(1)Use the routing and account number as is;
(2)Modify only the routing number based on the appropriate override;
(3)Modify or reformat only the account number based on the account structure and algorithm; or
(4)Modify both the routing number and account number.
Based on Thomsons stratified sample of data, test files analyzed show that administrative returns were reduced by more than 75 percent when EPICWare was used to verify account number structure at the point where the item is accepted. With over 50 customers using the product, similar results have been reported in a live environment.
The EPICWare product is effective in reducing the number of administrative returns. However, the database must be fully populated by every commercial financial institution in the U.S. before it is completely effective in eliminating administrative returns. The database, which is now updated monthly, must be updated daily and made available to users for online verification. More complete information is also needed regarding non-truncatable items such as convenience checks and certain types of corporate checks. Finally, Originators with high error rates in converting MICR to ACH need to improve their equipment or processing procedures.
Proposed Solutions to the Administrative Returns Problem
1. Develop Account Structure/Algorithm Database
A. Encourage Greater Participation of Receiving Depository Financial Institutions in Providing Routing Number and Account Structure/Algorithms to Commercially Available Databases
The goal of this proposed solution is to expand the population of commercially available routing number and account structure/algorithm database solutions. Currently, there is only one commercially available solution; all other databases are proprietary. This commercially available database was proposed by NACHA in 1996 in anticipation of a growing need to handle non-recurring ACH payments.
In order to fully address the administrative return problem, commercially available databases, such as EPICWare, need to obtain all ACH-capable financial institutions account number structures and algorithms. The RDFI cost to handle an ACH return is as high as $2.00 per item (see Federal Reserve ACH Price Schedule) for just the Operator return fee. Even for automated operations, RDFI internal costs for processing returns is as high as $0.50 per item. Therefore, it is of tremendous benefit to all RDFIs to eliminate administrative return problems at the front-end.
This RDFI benefit needs to be more effectively communicated to the RDFIs that are asked to provide account number structure/algorithm data. It is recommended that a campaign be undertaken to educate RDFIs on the benefits of providing this information. At a local level, NACHA should work with its member regional associations to encourage RDFIs to provide this data. Nationally, NACHA can work with the trade associations that represent community banks and credit unions such as CUNA, NAFCU, ICBA and the ABA in order to increase awareness of the administrative return problem and to supply account structure information to a commercially available database. CUNA, ICBA and ABA have agreed to promote the benefits of providing this data.
B. Encourage Competitive Pricing
It is further recommended that NACHA work closely with the current and future providers of these database services to ensure that pricing is competitive for both large and small Originators and their financial institutions.
C. Provide Online Access to Commercially Available Database
Online access to the commercially available account number structure/algorithm database is needed in the short term. Features will include daily updates to the database and online access by users. It is recommended that this capability be in place by October 1, 2000 and be commercially available by January 1, 2001.
2. Assign Digit to Position 44 to Indicate Non-truncatability
If a check payment cannot be converted to ACH or any other electronic payment mechanism, a digit signifying non- truncatability could be placed in Position 44 of the MICR line. The benefit of this approach is that the Originator would know immediately that the check could not be truncated or converted to an ACH and would not run into the problem of having the item returned.
NACHA is proposing to ANSI Accredited Standards Committees X9 and X9B, which oversee the appropriate MICR standard, that a digit be assigned to Position 44 to indicate that the item bearing the digit cannot be truncated. The formal proposal has been sent to X9B (February 6, 2000), and the project needs to be completed by July 1, 2000.
Efforts to market this concept to financial institutions need to start by yearend 2000. It may take a number of years for financial institutions to convert position 44 of the MICR line of their non-truncatable check stock. This approach can also open up the possibility of truncating/converting corporate checks since truncatable items could be identified by the lack of the digit signifying non-truncatability.
Due to the fact that many companies print their own checks, the corporate marketplace also needs to be educated on how to utilize position 44 if they want to take advantage of this feature. Once ANSI X9B approves the use of position 44 to indicate non-truncatable items, a comprehensive education plan needs to be developed and implemented to train companies on its use.
3. Require ODFI Warranty
A NACHA Operating Rule should be considered that would require ODFIs to warrant that a routing number, account number/algorithm database (proprietary or commercially available) has been used for verification before checks are truncated or converted to ACH items. By complying with such a warranty, the number of administrative returns could be reduced by at least 75 percent. A fully populated database of routing number and account number structure/algorithm information from every ACH-capable financial institution, as proposed with the first recommendation in this paper, could nearly eliminate the administrative returns problem if ODFIs and their customers utilize these databases.
4. Consider Future Solutions
A. Verify Account NumbersThe ability of the Originator or its financial institution to actually verify the account number of the checkwriter could be used as an enhanced tool to reduce the risk of administrative returns. It is recommended that NACHA work with check stationery companies such as Deluxe, Harland and Clarke American to develop a commercially available database for verifying actual account number data. It is anticipated that this information would be useful in further reducing the administrative return rate, particularly from misreads. However, security and privacy issues would need to be addressed before this database can be developed.
B. Reduce Other Types of Return Items
If the first three recommendations outlined in this paper are implemented, it is anticipated that the administrative return rate would probably be reduced to well below one percent. These recommendations, however, do not address the issues of account closed or insufficient funds which account for a return rate of over two percent in most ACH debit applications.
Primary Payment Systems (PPS) has developed a database that reduces the probability of returns from closed accounts. SVPCo, Visa and the Star Network are developing database products that verify account balance information and thus reduce returns from insufficient funds. At this time, it is recommended that Originators, third party processors and ODFIs investigate these commercially available databases to determine the risk management benefits to their respective organizations.
This White Paper is intended to solicit comment on the proposed solutions to the administrative return problem. The Administrative Returns Ad Hoc Work Group will review the comments and will instruct NACHA whether to proceed with the recommendations contained in this paper.
Additional suggestions for solving the administrative returns problem will also be considered. If this papers recommendations meet with the appropriate level of support, appropriate actions will be taken to develop rules and/or enhance database offerings. These recommendations will also be publicized in order to promote the solutions that the paper offers.
Please send your written comments directly to Nancy Grant, Senior Director, Electronic Check Services at the NACHA office. She can be contacted via email at email@example.com, fax number at 703-787-0996, and telephone at 703-561-3911. Thank you in advance for your input regarding these recommendations.