If you’ve ever entered a bank account and routing number to make a payment, you’ve initiated an ACH transaction. Understanding how those ACH transactions work and when they will be processed essentially requires learning a new language and a few acronyms.
With each ACH transaction, there’s an Originating Depository Financial Institution (ODFI) and a Receiving Depository Financial Institution (RDFI).
This blog post will explain the role each financial institution plays in an ACH transaction.
Originating Depository Financial Institution (ODFI)
The ODFI has an agreement with an ACH Operator (either the Federal Reserve or The Clearing House) to transmit entries into the ACH Network on behalf of the Originator.
To be an ODFI, the depository financial institution must—among other things—be responsible for obtaining authorization before crediting or debiting an account. They also are responsible for:
- Protecting ACH data security
- Having contractual relationships with each of its Originators
- Keeping ACH returns below an agreed upon threshold
To mitigate the risk of ACH returns, ODFIs are encouraged to work with Originators to ensure they have proper controls and oversight over their payment processes.
A commercial ACH Originator, usually a business or payment provider, creates one or more Nacha rules-formatted ACH files to submit to their Originating Depository Financial Institution (ODFI) to process payments each day. The ODFI is the partner bank of the Originator and originates ACH transactions.
The ODFI submits files to an ACH Operator, either the Federal Reserve, or The Clearing House. The ACH transactions will be sorted and sent to the designated Receiving Depository Financial Institution (RDFI).
Not all banks choose to be an ODFI because of the necessary requirements and associated fees. But because so many do choose to be an ODFI and accept ACH payments, financial institutions that choose not to participate put themselves at a competitive disadvantage in the market.
Receiving Depository Financial Institution (RDFI)
All ODFIs must also agree to act as an RDFI (Receiving Depository Financial Institution), to receive ACH payments.
A Receiving Depository Financial Institution receives entries directly or indirectly from its ACH Operator for debit or credit to the accounts of its customers. All financial institutions must be an RDFI to allow a customer or member to accept funds via ACH.
RDFIs must accept all entries to their customer accounts to comply with Nacha Operating Rules.
RDFI responsibilities include:
- Timely receipt and validation of all ACH entries
- Proper and timely posting to Receivers’ accounts
- Proper notification to Originators of incorrect information on accepted entries
Financial institutions can choose to be an RDFI without being an ODFI.
Similarities Between ODFI & RDFI
Besides dealing with money, there are other similarities between an ODFI and RDFI.
Both the ODFI and RDFI must have a relationship with an ACH Operator in order to access the ACH Network. Both the ODFI and RDFI pay fees to access these payment rails and face strenuous auditing processes.
Even as faster payments become more popular, the transactions will still go through an Operator.
The Clearing House, a popular ACH Operator, offers an instant payment option through its payment rails, provided that both financial institutions are participating members.
The Federal Reserve unveiled plans for a real-time payment option that should hit the market by 2023 or 2024.
ODFI & RDFI Examples
Let’s illustrate these ACH transfers with real world examples. It is important to remember that no matter what type of ACH transaction—ACH credit or ACH debit—an ODFI and RDFI are always involved.
The ODFI and RDFI can even be the same financial institution. Remember, we never said understanding the ACH Network was easy.
Direct deposit of payroll is an example of an ACH credit transaction, so let’s say Bill works for a company called Fintech USA. When it’s payday, Fintech USA, as the Originator, initiates an ACH debit from its bank account at First Trust Bank, the ODFI in this transaction. First Trust sends an ACH file to its ACH Operator, which then passes the transaction to Bill’s bank, First Mutual, the RDFI, which pushes the funds into Bill’s bank account.
Utility companies offer automatic withdrawal for their monthly bill payment. Let’s say Bill has authorized Central Energy to automatically debit his bank for his heating bill on the first of each month.
After obtaining authorization, Central Energy will initiate a transaction through the ODFI to debit the bank account each month at the RDFI. Once the transaction is initiated, funds are pulled from the account at the RDFI, then credited to the Central Energy bank account with the ODFI.
If the Receiver and Originator have accounts at the same financial institution, the ACH transaction is not required to pass through an ACH Operator.
Some ODFIs will strip off those transactions that are on their own accounts prior to sending their batch file to the ACH Operator. These are known as “On-Us” transactions and are not required to pass through the ACH Operator.