Over the summer, while researching a completely unrelated topic, I found myself falling down the rabbit hole of payment infrastructure and money transfer systems. As a consumer, I never really thought much about how money exchanges hands beyond the physical exchange of paper money. I couldn’t quite reconcile why I could send an instant transfer through Zelle but not through ACH just as quickly.
If you work in this space, I bet you’re rolling your eyes at the sheer naiveté of that statement. But here’s the thing: I surveyed a couple of my friends—who are much smarter than I am—and realized I wasn’t the only one confused about this. Vindication!
While my informal survey is not representative of the general knowledge of the American populace, I thought I’d take a stab at explaining the different systems for electronic money transfers. The first two—ACH and wire transfers—are certainly more well-known, but the last system, real-time payments (RTP), is potentially a game changer for businesses and banks alike.
ACH (Automated Clearing House)
ACH launched in the 1970s when the Fed and financial institutions wanted to move beyond checks and enable the electronic transfer of funds between accounts. Fast forward to today, and this system moves over $70 trillion a year. ACH transfers are slower than other methods because transactions are processed in batches throughout the day rather than being settled instantly. ACH is much cheaper and is more widely available than other options, making it ideal for recurring payments and non-urgent transfers.
To understand how the system works, it’s important to know that three parties are involved in every transaction: the sender’s bank, the receiver’s bank, and the ACH operator. When a transaction is initiated, the sender’s bank debits the sender’s account and sends an ACH file to the ACH operator. The operator processes the transaction and facilitates the transfer to the receiver’s bank, which credits the recipient’s account.
Wire Transfers
Wire transfers have been around since the mid-1910s, when the Federal Reserve Banks established a system for banks to transfer funds quickly. At the time, the U.S. banking landscape was highly fragmented, with over 27,000 banks in operation. Transferring funds between institutions was difficult due to the geographical dispersion of banks. Over the years, the wire transfer system evolved into what we have today.
Wire transfers are more expensive than ACH transactions, so they’re typically reserved for large sums of money. For context, the average size of a wire transfer grew from $0.5 million in 1953 to $5.4 million in 2022.
Unlike ACH transfers, wire transactions are settled individually, which in most cases makes them faster. The sender initiates the transfer through their bank, providing detailed information. The bank then debits the sender’s account and sends wire instructions via a network like the Fed’s Fedwire. The recipient’s bank is notified of the incoming funds, and once the transaction is processed, the recipient’s account is credited. The banks then settle the transfer.
RTP (Real-Time Payments)
The main limitation of both ACH and wire transfers is that they aren’t instantaneous, nor are they available 24/7/365. While RTP doesn’t solve every issue—it has limits on the amounts that can be transferred—it offers significant opportunities for both banks and customers, whether individuals or businesses.
For banks, competitive pressures are driving the adoption of new technology, and RTP is no exception. Imagine you have a loan payment due tomorrow. It’s a Sunday, and you realize that even if you submit the payment today, it will fall outside your bank’s operating hours, potentially leaving you delinquent. But if your bank offers FedNow—the Fed’s RTP system—it could process that payment instantly, allowing you to sleep easier knowing your in good standing with your lender.
RTP systems aren’t new globally—Japan established theirs in the 1970s, and many other countries followed suit. The first RTP system in the U.S. was launched in 2017 by a consortium of banks and technology companies. Six years later, the Fed introduced FedNow in response to growing demand for such services.
Both RTP systems (RTP and FedNow) work similarly: a payment request is initiated and sent to the RTP or FedNow network. The network waits for the receiver’s financial institution to respond. Once accepted, the network debits and credits the accounts using master accounts held at the Federal Reserve.
As founders in the financial services space, we’re always excited to see tech adoption by financial institutions, especially given the common belief that banks’ risk aversion causes them to lag behind in offerings. RTP, in particular, highlights the growing customer demand for speed in money movement. When we focus specifically on small businesses, this means shorter cash cycles as funds start settling through this new payment rail. And with FedNow rolled out in +900 FIs, we can’t wait for what’s in store for the FinTech space!