Direct deposit works through the Automated Clearing House (ACH) network—you instruct your bank to prepare a payroll file and it disburses employees’ pay electronically to their banks. It’s clean and usually error-free because NACHA (the National Automated Clearing House Association), the electronic banking organization, has rules and protocols controlling the process.
However, there are other ways to send money electronically, not through the ACH network and not directly through banks. And you should be wary of them, according to the Consumer Financial Protection Bureau.
Just say no
Conventional wisdom advises against paying employees through smartphone apps. But sooner or later, an employee will ask for it and you’ll be in the hot seat. After all, smartphone apps can turn your lights on and off and raise and lower your window shades, so why can’t they be used to pay employees?
What’s wrong with this? Plenty, according to the CFPB. We’ve all learned about the importance of FDIC protection for bank accounts after several mid-sized banks collapsed last spring.
The CFPB names three apps—PayPal, Venmo and Cash App—and notes they’ve grown rapidly in the past few years. But they aren’t banks, which means money transferred into them doesn’t garner FDIC protection, unless users take extra steps to link the app to their bank account.
Problem: Compared with the ease of downloading an app, taking the extra steps the app requires for FDIC protection may not be intuitive to most people. In addition, app users may just assume their accounts are FDIC-protected.
In addition to apps lacking FDIC protection, the CFPB noted the following:
- App user agreements often lack information on where funds are being held or invested, whether and under what conditions they may be insured, and what would happen if the company or the entity holding the funds were to fail.
- Some states have enacted consumer protection laws. But these state laws generally don’t require customer funds to be stored in or automatically swept into FDIC-insured bank accounts.
- Even if an app claims to hold its customers’ funds on deposit at an FDIC-insured bank in accordance with FDIC regulations, these claims are extremely difficult to verify before a bank fails.
Transferring money via a nonbank transaction isn’t new. Western Union has been handling wire transfers for decades. But recipients of wire transfers wouldn’t ever think their money is FDIC-protected while it was in transit.
It’s also important to understand what we’re not talking about. All major banks have apps you can download on your phone. Whether employees do isn’t your concern; you’re still using the ACH network to deposit their pay. Smartphones can be hacked, and the FTC’s Data Spotlight notes that 2022 saw a surge in copycat bank fraud prevention alert texts. The phony text will often ask whether you attempted a pricey purchase and then prompt you to respond yes or no. It’s easy to imagine what comes next.
Right now, we have seven emails sitting in our spam folder purporting to be from Cash App. How much more of a clue do you need to realize phishers are exploiting these apps for identity-theft purposes?
For unbanked employees, paycards are a safe alternative to direct deposit. And finally, to pay an employee via an app, you’d have to download the same app. Would you really want to do this?