ACH and Third Party Payment Processors

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1 ACH and Third Party Payment Processors

2 Definition of Third-Party Relationship Entity with which financial institution has entered into a business relationship Facilitate customer access to bank services or products Perform functions on the bank s behalf Bank or non-bank, affiliated or nonaffiliated, regulated or non-regulated, domestic or foreign 2

3 Definition of Third-Party Payment Processor What is a Third-Party Payment Processor or Processor? Depositor that uses its banking relationship to process payments for its merchant clients Benefits: Fee income Large deposit balances Capital injections Concerns: Merchant clients several entities removed Nested or aggregator relationships Merchant client activities 3

4 Financial Institution Responsibility Board and management oversight tailored depending on the relationship The Board and management are responsible for managing activities conducted through third parties as if the activity were conducted directly by the institution Indemnity agreement not enough 4

5 Risk Management Framework Four Key Elements Risk Assessment Due Diligence Contract Structuring and Review Oversight 5

6 2012 FDIC Revised Guidance on Payment Processor Relationships 6

7 FDIC Financial Institution Letter FIL January 31, 2012 FDIC releases Revised Guidance on Payment Processor Relationships Replaces & updates 2008 Guidance on Payment Processor Relationships (FIL ) 7

8 Specific Risks of Processors Credit Risks Charge-backs from unauthorized transactions Regulation CC warranty Operational Risk Compliance Risks Reputational Risks Financial institution tied to merchant clients Legal Risk Class action lawsuits 8

9 Processor Red Flags Targeting problem financial institutions in need of capital/earnings Smaller financial institutions with limited resources for proper monitoring Processors with relationships at multiple financial institutions at the same time Consumer complaints High Unauthorized Return Rates (URRs) or returns/charge-backs 9

10 Financial Institution Protections Due diligence (initially & ongoing) Know Your Customer( s Customer) Policies & procedures for monitoring (URRs/Returns, complaints, etc.) Be aware of potential Compliance Risks 10

11 Types of Payments Types of Payments Remotely Created Checks (RCCs) Automated Clearinghouse Items (ACHs) 11

12 Remotely Created Checks What are RCCs? Regular paper check that the Merchant creates No consumer signature Consumer provides account number & bank routing number, and merchant prints check Merchant submits for regular check processing 12

13 Remotely Created Check (example) 13

14 Risks of RCCs Consumer complaints regarding unauthorized withdrawals from account High volume difficult to monitor High URRs and returns/charge-backs Unregulated environment 14

15 Basic ACH Terms Parties Originator, ODFI, ACH Operator, RDFI, Receiver. SEC Type 23 Standard Entry Class Codes, such as WEB, TEL, IAT, POP, RCK. Return Codes R01-R83 Credit Risk 2 banking days from processing to settlement. Debit Risk 60 day returns from statement date. Direct Access third party uses the ODFI routing number. Terminated Originator Database kept by NACHA 15

16 ACH Origination Process TPPP Originator TPPP TPPP Nested 8 RDFI TPPPs Originator ODFI Operator (FRB/other) RDFI Direct Originator ODFI Originating Depository Institution RDFI Receiving Depository Institution Originator has a direct relationship with the Bank TPPP third party payment processor (third-party sender) who has the relationship with Originators (merchant clients) and nested TPPP. Nested TPPP a TPPP who processes for others and sends the files to the TPPP. RDFI

17 Audit NACHA Operating Rules and Guidelines published annually. Appendix Eight Audit required by December 31 each year. Note that this is an audit on following operating rules by NACHA. Focused on if the transactions are processed correctly. The audit needs to be independent by a qualified individual. 17

18 Risk Assessment NACHA s Risk Management and Assessment rule (effective 6/18/10) requires that all Participating DFIs conduct a risk assessment of their ACH activities and implement risk management programs based on the results of such assessments Requires overall review of the business of doing ACH Could include: Allowed and prohibited business lines Contracts Policies Third party payment processor arrangements Staffing Limits (underwriting like a loan) 18

19 Risk Assessment Risk Assessment Objectives: Determine risks/threats in ACH activities Determine overall inherent risk Review of the key control practices to limit those risks Evaluate residual risk (risks vs. controls in place) and determine if level is acceptable Test controls for effectiveness 19

20 What s Changed Fee Income revenue source as net interest margins shrink. Federal Reserve Statistics unauthorized returns (.03%), returns rates (1.01%), and % forwarded to assets (8%). Volume - ACH Volume Increases 2.4% in 3rd Quarter 2012 with 4.11 billion transactions moving approximately $9.1 trillion. Fraud PATCO ACH Fraud Ruling Reversed: Appeals Court calls Bank s Security Commercially Unreasonable only log-in and password credentials. $500,000 drained from deposit accounts. Risk - Third-Party Payment Providers (TPPP) in FIL and FIL Internet Banking Environment FIL

21 Themes and Trends No Board-approved policies/procedures Growth beyond financial institution s resources/abilities Increase in fee income short-lived due to charge-backs Underestimate potential reputation risks 21

22 Red Flags Transaction Volume Swings Originators whose business or occupation does not warrant the volume or nature of ACH activity Outbound (known) illegal Internet gambling debit(s) for commercial client(s); Originators whose origination activity suddenly exceeds projections/credit limits with no reasonable explanation for such. 22

23 Red Flags Originators (especially TPPPs) generating a high rate or high volume of invalid account returns, unauthorized returns, or other unauthorized transactions; R05 (Corp. Debit posted to consumer acct not authorized) / R07 (Authorization Revoked), R10 (Consumer advises not authorized), R29 (Corp advises not authorized) where return rate exceeds 1% (NACHA guideline). R03 (No Acct.) / R04 (Invalid Acct.) if volumes exceed normal 23

24 Yellow Flags R01 (NSF) / R09 (Uncollected funds) R02 (Acct. Closed) R08 & R52 (Payment stopped) 24

25 Questions? 25

26 Thanks! Pete Martino Field Supervisor FDIC 26

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