How money moves today (still not well)

This is the fourth post in our series "From old money to Smart Money." If you haven't read the first three, we recommend you start here.

Modern Checking

The system today — even with electronic check deposits — really hasn’t changed that much from the Pony Express days.

• When you deposit a check, your bank will digitize it by automatically scanning hard-coded information on the check
• These new digital files are sent in batches, usually a couple times a day, to large, regional intermediary banks
• Sometimes, if they haven’t upgraded their technology, the regional bank will print out a picture of the check you sent, and then re-scan it into their system (yes, you read that right)
• The regional bank sends the file off to a clearing house
• Usually, that night, the check will get processed and settled
  

What have we upgraded here? We send the checks digitally (although still in batches) rather than using riders on horseback. But the chain of multiple banks remains intact. Batches are only sent and processed a few times a day (often once), with transfers still having to pass through multiple intermediaries.

And guess what else is still true?

What happens when a check clears? Shockingly, the answer: still nothing. Once the check-writer’s bank gets the check back, even digitally, nothing else happens.

Each bank along the way is just left to assume that the check has cleared on the other end, as long as they don’t receive bad news. But they have no way to know this for sure. Why? Because like we said, it would have been a huge pain back in the Pony Express days to be sending notices of completion back and forth all the time.

So instead, banks just assume the check was fine (in banking, the term “no news is good news” is still used today — so long as you don’t hear any bad news, assume the payment cleared).

They need to give the payee their money anyway. So now there’s a massive structural vulnerability in the system, ripe for fraud. And guess who ends up bearing the costs of that? You, the customer — either directly (banks will charge you for the fraud if you don’t dispute it), or indirectly (through their fees and business models).

ACH saves the day?

ACH transfers are the backbone of how we send money today. They’re how we usually get paid, how we link our bank accounts to apps like Venmo or Robinhood, and more.

ACH came about in the 1970s when banks were getting overwhelmed by the number of physical checks and decided to develop an “Automated Clearing House.” Why send checks when you can just send the data from the checks?

This was a smart idea, except… they didn’t actually change anything. ACH transfers use the exact same processes as checks do. They just don’t have a piece of paper associated with them. The electronic “batch files” (just like Pony-Express-managed bags of checks) are passed from bank to bank. And yes, those digital files move faster than people on horses, but they get processed and re-batched every step of the way, between every bank and clearing house.

The same vulnerabilities exist here as the checking system: you can pull money out of an empty account, and not realize it until days later!

Making an ACH payment from St. Louis to small-town California could follow the same path of correspondents as the Pony Express did, back 150 years ago. And just like the Pony Express, the ACH batches only depart a couple times a day from each bank.

It’s feasible — seriously — that a Pony Express check could beat an ACH payment today. Oh, and we forgot to mention: unlike ACH, the Pony Express was also open on weekends!

That doesn't sound good, but we do keep hearing about lots of "fintech" innovation recently. What's that all about? You can read on for more...