How payment networks work: cards, ACH and FedNow

A payment network is the set of rules, messaging systems and settlement arrangements that move money from a payer to a payee through banks and other institutions. Every card swipe, bank transfer and instant payment runs on one. The networks differ in speed, cost, who bears the risk and which consumer protections apply, but they share a common structure: a message that asks for or confirms the payment, a process that reconciles the transactions and a final step that settles the money between institutions. This guide explains the main U.S. networks and the rules around them, and is the starting point for following payments news.

In brief

• Card payments run on a four-party model with authorization, clearing and settlement steps.
• ACH moves batches of credit and debit transfers between depository institutions through national operators.
• FedNow is the Federal Reserve’s instant payment service, running around the clock.
• Fees, such as interchange, depend on the network and, for debit cards, on federal rules.
• Consumer protections differ by payment type, and Regulation E covers many electronic transfers.

The basic building blocks

Whatever the network, five roles recur. The payer and payee are the parties to the transaction. Their financial institutions hold the accounts. An operator or network provides the rails and rules for exchanging messages and moving funds. A settlement mechanism, often accounts at a central bank or a settlement bank, finalizes the movement of money between institutions.

Three stages describe most systems. Authorization confirms that the payment can be made. Clearing exchanges and reconciles the transaction details. Settlement transfers the actual funds. The networks differ mainly in how quickly these steps happen and in which party carries risk in the meantime.

Card networks: the four-party model

A Federal Reserve Board staff paper on interchange fees and payment card networks lays out the standard model. Four parties take part in each transaction: the cardholder, the issuer (the cardholder’s bank), the merchant and the acquirer (the merchant’s bank). The card network, such as Visa or Mastercard, sits between the issuer and acquirer and coordinates the information and money flows.

Authorization. The merchant sends a request for the amount and the cardholder’s identity to the acquirer. The acquirer forwards it through the network to the issuer, which checks the account and returns an approval or decline along the same path.

Clearing. At the end of the day, the merchant sends its transaction records to the acquirer, which reconciles them against the earlier authorizations and passes them to the network. The network calculates each bank’s net position, including interchange and network fees.

Settlement. Banks exchange payments based on those net positions through accounts at settlement banks. The Federal Reserve paper says this usually takes about two days for credit and signature debit and about one day for PIN debit.

Who earns what

The paper describes several layers of fees:

• Interchange is a fee the acquirer pays the issuer on each transaction. The network sets it, and it is typically a large share of a merchant’s costs.
• The merchant discount is the acquirer’s charge to the merchant, the gap between the transaction’s face value and what the merchant receives.
• Network switch fees are charged by the network to the acquirer and issuer.
• Cardholder fees or rewards are fees charged to, or rewards paid to, consumers by some issuers.

This structure explains why card rewards, merchant surcharges and interchange regulation are linked topics.

Debit interchange and routing rules

For debit cards, federal rules apply. The Federal Reserve’s page on Regulation II says the rule sets standards for judging whether a debit card issuer’s interchange fee is reasonable and proportional to the issuer’s costs, and allows a fraud-prevention adjustment if the issuer maintains qualifying policies. Exemptions exist for certain small issuers, government-administered payment programs and reloadable general-use prepaid cards. The regulation also bars issuers and networks from limiting the networks over which debit transactions can be processed to fewer than two unaffiliated networks, and from inhibiting a merchant’s ability to route a debit transaction over any network the issuer has enabled. The Board’s page does not state fee amounts, so consult the regulation itself for current figures.

ACH: batch transfers between banks

The Automated Clearing House (ACH) network handles payments such as payroll deposits, tax refunds, mortgage payments and utility bills. The Federal Reserve describes it as a nationwide network through which depository institutions exchange batches of electronic credit and debit transfers.

The originating depository financial institution sends a file of payments, and the receiving depository financial institution gets them. In between sits an operator. The Fed’s page says the Reserve Banks and the Electronic Payments Network (EPN) are the two national ACH operators. For each payment, an operator receives the files, edits and sorts the payments, delivers them to the receiving institution and settles by crediting and debiting the institutions’ settlement accounts. When the two institutions use different operators, the operators rely on each other, and the Reserve Banks settle those interoperator payments.

Nacha, the rule-making body for the network, publishes the operating rules, and the Reserve Banks align their services with them, for example in same-day ACH. ACH is generally low in cost per payment and well suited to recurring and large-volume transfers. Because it works in batches, it historically did not offer instant availability, which is the gap instant payment systems address.

Instant payments and FedNow

The Federal Reserve says the FedNow Service went live on July 20, 2023. It is a platform for sending instant payments from one depository institution account to another, with interbank clearing and settlement so that funds move in near real time. Individuals and businesses use it through accounts at participating U.S. depository institutions, and those institutions and their service providers can build added services on top.

The Fed describes the service as designed for uninterrupted processing, running a 24-hour business day that includes weekends and holidays. Participants can join initially as receive-only. Optional features cited at launch included fraud prevention tools, request-for-payment capability and tools for handling payment inquiries, with more planned over time. Settlement works through Federal Reserve accounting records, with participants able to access intraday credit on the same terms as other Federal Reserve services. A liquidity management transfer lets participants move funds between one another.

FedNow is not the only instant system. The Fed’s page notes that a private-sector instant payment service can be backed by a joint account at a Reserve Bank. For consumers, the practical difference from ACH is speed and availability on weekends and holidays. For banks, it is the need to manage liquidity around the clock.

Consumer protections

Different payment types come with different legal protections. The CFPB’s FAQ on Regulation E says the rule protects consumers using electronic fund transfers from accounts held for personal, family or household purposes, including checking, savings and prepaid accounts, and it can cover some nonbank peer-to-peer payment providers. An unauthorized transfer is one that someone other than the consumer starts without actual authority and from which the consumer gets no benefit. After a consumer reports an error, the institution must promptly investigate, report its results and correct any confirmed error. The CFPB page also says a consumer can give notice within 60 days after the institution sends the periodic statement showing the unauthorized transaction, and that private network rules that are less protective do not override these obligations.

Credit card disputes fall under different federal laws, and rules for business payments differ again. Check the CFPB and the card issuer’s terms for the protection that applies to a specific payment.

A worked example

A shopper taps a debit card at a store. The terminal sends an authorization request to the store’s acquirer, which routes it through the card network to the shopper’s bank. The bank approves, and the shopper leaves with the goods. That evening the merchant submits its day’s transactions, the network clears them and calculates net positions, and in a day or two the banks settle. The merchant receives the sale amount minus its discount. Separately, the shopper’s paycheck arrived earlier that week as an ACH credit batched with others, and a friend repays a loan through a bank that offers FedNow, so the money arrives in seconds. All three use different networks with different speeds, costs and protections.

Common misconceptions

• “A card swipe moves money instantly.” The authorization is quick, but clearing and settlement take longer.
• “Merchants pay one fee.” Several fees stack, including interchange, network fees and the acquirer’s charge.
• “Instant means unlimited.” Participants and institutions can set their own limits and controls, and the Fed’s pages do not set dollar limits.
• “All electronic payments get the same protections.” Coverage depends on the payment type and account.

FAQ

What is the difference between ACH and FedNow?

ACH moves batches of payments through operators on a schedule. FedNow clears and settles individual payments in near real time, around the clock, according to the Federal Reserve.

Who runs the ACH network?

Two national operators, the Reserve Banks and the Electronic Payments Network, process the payments, and Nacha publishes the operating rules.

What is interchange?

A fee paid by the acquirer to the issuer on each card transaction, set by the network. For debit cards, Regulation II sets standards for it.

Do I need a special account to use FedNow?

You use it through an account at a participating depository institution. Whether your bank takes part is something to ask the bank.

Are payments covered by Regulation E?

Many consumer electronic fund transfers are, including those from checking, savings and prepaid accounts. See the CFPB for the details.

Is this financial or legal advice?

No. This guide is general education. Check official sources and your financial institution’s terms for your situation.