Clearing Houses Essay

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Clearing houses are institutions devoted to the exchange of information and the fulfillment of payment processing. A financial clearing house assures that two parties to a transaction do not default. Financial clearing houses include institutions devoted to the clearing of transactions involving the trading of financial securities and the conduct of specific forms of electronic payments.

Albert Bolles describes the clearing house concept as “one of the most useful agencies called into being by the wants of modern commerce … susceptible to almost infinite expansion.” Indeed the clearing house concept has grown dramatically and increased the efficiency of the payments system. The first clearing house in the banking system can be traced back to the London Clearing House, founded in 1775. The first clearing house in the United States, the New York Clearing House, was established in 1853 based on the example set forth by the London Clearing House. The use of checks created a need for clearing houses in the banking system.

When an individual deposits a check in his or her bank that is drawn on another bank, a clearing house ensures that the funds to cover the check flow from the bank the check was drawn on to the bank it was deposited into. Before the clearing house, the depositor’s bank would have had to collect payment via messenger to the other bank. Before modern electronic processing, check clearing was largely a time and paper-laden process. This process is conducted by the Federal Reserve Bank in the United States today. With the aid of wire transfers, check truncation (Check 21), the automated clearing house (ACH), and the electronic data interchange (EDI), payments conducted with paper have been greatly reduced.

The ACH Network

The ACH network was one of the U.S. payments system’s first automated paperless answers to the increasing volume of paper checks. (The first was the wire transfer system Clearing House Interbank Payments System.) It was originally designed to clear small-value, recurring paper-check payments such as payroll deposits and mortgage payments. This system performs similar functions to the United Kingdom’s Bankers Automated Clearing Service (BACS). For an ACH transaction to occur both the originating and the receiving bank must be members of the ACH network. The first U.S. ACH began in 1972 in California. The network was developed by bankers, but it was run by the Federal Reserve System.

Later, many small ACH associations developed and worked with the Federal Reserve district banks to clear regional electronic payments. By 1974, the National Automated Clearing House Association was formed to oversee and help coordinate the growing ACH network. Currently, the only operators remaining in the ACH in the United States include the publicly owned Fed ACH operated by the Federal Reserve System and the privately owned Electronic Payments Network (EPN), a subsidiary of The Clearing House. In 2007 more than 13.97 billion transactions, worth more than $28.8 trillion, were sent via the ACH network.

The ACH network sends secure electronic funds transfers in the form of debit and credit transactions to handle payments electronically as opposed to using paper checks. Debit transactions are initiated by the payee (e.g., a consumer paying a utility bill, mortgage payment, or fitness facility fee). Credit transactions are initiated by the payer (e.g., the direct deposit of an employee’s paycheck or the reimbursement of an employee’s travel or health expenses). Business-to-business, or corporate, payments utilize the electronic data interchange (EDI) format with ACH to exchange information and make and receive payments with trading partners, pay tax withholdings to the government, or for intracompany cash management transfers. Governments use the ACH network for such payments as Social Security, tax refunds, and pensions.

Retailers are now getting in on the ACH system through the increasing use of e-check applications. E-checks are checks converted to ACH transactions at the point-of-purchase (when a voided check is returned to the consumer at the time of purchase), at drop and lockbox locations (called accounts receivable checks or ARC—a check converted to an electronic debit), over the internet, and over the phone. In 2007, 40 percent of all noncash payments in the United States went through the ACH network.

In financial markets outside banking, The Clearing Corporation (TCC) purports to be the world’s oldest independent clearing house. TCC was created to independently and confidentially clear futures transactions for the Chicago Board of Trade. In that role, TCC became a buyer for every seller and a seller for every buyer. Clearing in the securities industry is more complicated than check clearing since it involves the transfer of ownership along with payment. Efficiency greatly increased with the adoption of computer technology in 1963.

The Depository Trust Company

Similar technology led to the development of the Depository Trust Company (DTC) in 1973. The DTC was created to clear securities trades for the New York Stock Exchange. Prior to the adoption of computer technology, securities trading involved a lot of paperwork from the beginning of the sale to the actual delivery of the physical securities certificate from seller to buyer. As trading volume in the securities industry escalated, the DTC was designated to be a single “house” for the physical securities and then trades of ownership of those securities were conducted electronically rather than physically. This greatly reduced the volume of paperwork and increased the efficiency of the securities exchange system.

Today, the DTC is part of the Depository Trust & Clearing Corporation, or DTCC. The DTCC operates through six subsidiaries and provides clearing services for equities, corporate and municipal bonds, government and mortgage-backed securities, money market instruments, over-the-counter derivatives, mutual funds, and insurance transactions. Similar securities clearing houses in other countries include Euroclear (Belgium), Clearstream (Luxembourg), the Canadian Depository for Securities (CDS Ltd), China Government Securities Depository Trust and Clearing Co, Ltd., and Japan Securities Clearing Corporation.


  1. Albert Bolles, Practical Banking (Homans Publishing Co., 1884);
  2. Terri Bradford, “The Evolution of the ACH,” Payments System Research Briefing, December 2007, (cited March 2009);
  3. Electronic Payments Network, The Electronic Payments Network and the ACH: A History, (cited March 2009);
  4. NACHA, “ACH Volume Increases 13.4 Percent in 2007,” (cited March 2009);
  5. NACHA, “NACHA—The Electronic Payments Association,” Understanding the ACH Network: An ACH Primer, (cited March 2009);
  6. The Clearing House, “New York Clearing House: A Historical Perspective,” (cited March 2009).

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