Electronic Funds Transfer

Electronic funds transfer (EFT) is the modern alternative to the old check-clearing process when sending and receiving funds between a payer and a payee. An EFT is done through the system of automatic clearing house (ACH). In the U.S., the Federal Reserve and the private Electronic Payments Network (EPN) are the two ACH operators, with each handling 60% and 40% of the total transactions respectively. The two terms, EFT and ACH are sometimes interchangeable both referring to the process in which funds are electronically moved via the automatic clearing house system.

Parties Involved in EFT Processing

A payer, a payee, the payer’s financial institution, the payee’s financial institution, and the ACH operator are the parties involved in order to initiate and complete an electronic funds transfer. Funds can be sent by the payer instructing his or her financial institution, or alternatively requested by the payee instructing his or her financial institution. The depository financial institution initiating a transaction instruction on behalf of a customer either to send funds or request funds (receiving funds), is called originating depository financial institution (ODFI) and the depository financial institution at the other end receiving instruction is called receiving depository financial institution (RDFI).

Credit Transaction and Debit Transaction

For a transaction instruction to go through, the instruction initiator, be it the payer or the payee as facilitated by the bank, must have first obtained the authorization from the instruction receiver, the corresponding payee or payer, to be allowed the access to the receiver’s account. Having been given the account number and the bank routing number for the receiving end, the transaction initiator sending or requesting funds can then effectively deposit funds into or take funds out of the transaction-instruction receiver’s account.

Therefore, depending on the direction of the instruction flow, when the instruction is to send funds to the instruction receiver by the payer, it is a credit transaction with funds deposited into the instruction receiver’s account, the payee‘s; when the instruction is to request funds from the instruction receiver by the payee, it is a debit transaction with funds taken out of the instruction receiver’s account, the payer’s.

Example of Credit Clearing and Settlement

Setting up a bill pay with your bank. Step1, obtain account information from your payee: a lender, the cable company, the utilities, or etc. Step 2, make and confirm a bill payment on your bank’s website. Step 3, your bank as the ODFI sends your payment instruction to the ACH operator. Step 4, the ACH operator routes the transaction to the payee’s financial institution, the RDFI. Step 5, the payee’s bank makes funds available to the payee by crediting his or her account. Step 6, the ACH operator settles the transaction between the participating financial institutions.

Example of Debit Clearing and Settlement

Making an online credit card payment on your credit card company’s website. Step 1, submit your account information to your payee. Step 2, your credit card company requests your payment through their bank. Step 3, the credit card company’s bank verifies the payment request and as the ODFI, sends the instruction to the ACH operator. Step 4, the ACH operator routes the transaction to the payer’s financial institution (your bank), the RDFI. Step 5, your bank takes funds out of your account per request. Step 6, the ACH operator settles the transaction between the participating financial institutions.

Electronic funds transfer is defined as any transfer of funds that occurs in a paperless manner. This includes that transactions that take place at a point of sale system in a retail store, as well as transactions that take place online, via telephone, or by fax. These payments utilize EFT processing to ensure the money is sent to the correct account quickly. This term is often used synonymously with ACH processing.  The ACH or Automated Clearing House network operates on a batch-oriented funds transfer system. It uses the Federal Reserve Bank’s network to receive and transmit files through its various associations so that payments made from one account are deposited into the intended account.

The file contains information pertinent to the transaction so that there is proper documentation of the process and confirmation that it was received. There are many ways that EFT processing can be used to improve cash flow and reduce expenses. Using the paperless method, the risk for processing checks is dramatically reduced. If the funds are verified in the account, the entire transaction can be completed with only a small charge. This is several days faster than if a paper check was used. If there are insufficient funds, the transaction is not attempted and the check is returned.

This saves money in bounced check fees as well as the personnel required to settle the account. The advantage for EFT processing for checks is that they are posted before paper checks. This means the electronic version will receive any funds in the account first, reducing the number of returned payments. Electronic payments can be submitted automatically up to three times, increasing the chance of collection in a shorter period of time than if attempted by other methods. Having payment entries automated cuts down on data entry errors, decreases the total transaction time and saves money on the personnel required for the task.

Payroll costs are reduced and the recovery of funds is achieved in a significantly short period of time. By taking advantage of EFT processing, businesses are able to collect funds faster and spend less to do so. However, it is not only on the payment side of the transaction that funds are saved. Administration expenses are drastically reduced as invoices and payment notices can be sent automatically at pre-determined timeframes. There are no invoices to be printed, envelopes to be stuffed or trips to the post office required. This helps businesses control their expenses and operate more efficiently.