Ever wonder why money transfers take so long to complete anywhere? When you’re trying to pay your friend through Paypal, they state the funds will take 3-5 business days. When you’re transferring money from your bank to another bank/brokerage, they state the funds will take 3-5 business days. But why is this?
In today’s age, you’d figure that technology would make everything instantaneous, like sending a text message or e-mail. You’d think that the bank could do a quick balance confirmation on your account, send funds on your behalf, then debit your account at the end of the day when they do book-balancing. Afterwards your money transfers would be complete immediately. Right?
Believe it or not, banking technology for money transfers is actually years behind.
Every night, banks send money to a central clearing system. More often than not, this is the “ACH Transfer” you see when you’re making the transfer. ACH stands for Automatic Clearing House. The clearing house then processes all the money received and send it off to its final destination.
Why Do We Use a Clearing House?
The clearing house acts as the middle point of transfer for all banks and institutions. The job of the clearing house is to make these transfers much more efficient.
If Wells Fargo
Money Transfers: 3-5 Business Days
On Monday: you create a transfer to send money from your bank, Wells Fargo, to your friend’s bank, Capital One. You initiate the transfer of $100 and send it off.
Monday night: your bank, Wells Fargo, sends the money to the clearing house for processing.
Tuesday morning: the clearing house has your money and begins processing. Tuesday night, transactions happen again and the clearing house sends the money off to your friend’s bank, Capital One.
Wednesday morning: Capital One has your money. Depending on how fast they work, your $100 may be put in a pending state (not available for withdrawal yet). By this point, $100 will be completely credited to your account by the next morning and there’s your 3 days.
Worst-Case Scenario: If you make a late transfer on Monday, the bank may not have completed processing your transfer that night and so they may end up sending the money on Tuesday night instead, thus adding on an extra day. This is why they will state that the whole transfer takes between 3 to 5 days.
Why Don’t Banks Do Direct Money Transfers To Other Banks
Banks do not send money directly to other banks which is why the ACH is there. But why do banks have to use an ACH?
To keep things efficient actually.
In our scenario, let’s pretend you’re transferring $100 from Wells Fargo to Capital One. At the same time, John Bob is transferring $25 from Capital One to Wells Fargo.
When the ACH receives these two transfers the next day, do they transfer $100 from Wells Fargo and $25 from Capital One? No, that’d be terribly inefficient. It’s like if I said “hey you owe me $10 from lunch but I owe you $3 from that soda”. Do I take $3 out of my pocket to pay you while you take $10 out of your pocket to pay me? No, we just debit and calculate the net amount which is you owing me $7.
The ACH calculates the net amount and only transfer $75 going out from Wells Fargo to Capital One since there’s is an expected $25 going into Wells Fargo.
Take this an multiply exponentially with the thousands of customers submitting money transfers every day and that’s how we keep the system efficient.