2. Payment Systems (16%)

Trade Repositories (TRs)

Entities that maintain a centralized database of transaction data. Similar to CCPs, they have recently grown in importance, particularly in over-the-counter (OTC) derivatives markets *Main Players*: • DTCC Data Repository (U.S.) LLC • ICE Trade Vault • CME Swap Data Repository • Bloomberg Swap Data Repository

Settlement

The final step in *transfer of ownership* involving the exchange of securities and payments

Messaging Systems

Message systems process *administrative messages* and *instructions to move funds* (payment order) FIs, corporations, and other organizations employ wholesale payment messaging systems to originate payment orders for their own benefit or a third party Movement of funds is accomplished by initiating actual entries to debit and credit accounts at one or more FIs If beneficiary related accounts are also with originator's institution, the FI handles the transaction internally through book transfer If beneficiary related accounts are outside originating customer's institution, parties will complete transfer by use of a payments system such as Fedwire Funds Service or CHIPS

ANSI: Transaction Sets

Most common standard is *ASC X12 820 > Payment Order/Remittance Advice* *Other transaction sets used for EDI*: ASC X12 103 > Abandoned Property Filing ASC X12 521 > Income or Asset Offset ASC X12 813 > Electronic Filing of Tax Return Data ASC X12 823 > Lockbox Payments ASC X12 835 > Health Care Claim Payment/Advice UN/EDIFACT > International EDI Standards

Emerging & Alternative Payments

Open Loop: • Visa/Mastercard • Apple Pay • Android Pay • Venmo • Zelle Closed Loop: • Dwolla • American Express • Discover Other Options • Distributed Ledger Technology (Blockchain) • Hawala • Wearable Devices

Federal Funds Transaction (fed funds)

*An unsecured loan* of U.S. dollars to a depository institution *by another depository institution or other eligible entity* Fed Funds excluded from reservable liabilities pursuant to Board of Governors of the Federal Reserve System's *Reg D*: Reserve Requirements of Depository Institutions (*12 CFR 204*), which provides a list of entities who may be sellers or lenders for purposes of excluding such transactions from reservable liabilities (*12 CFR 204.2(a)(1)(vii)(A)*)

Check Clearing vs Collection

*Check Clearing* Refers to *physical path* the check follows *Check Collection* Refers to process of ensuring funds represented by the check are debited from and credited to appropriate accounts

Open Loop Network

*Multi-Party Network * connects & manages flow of value between two FIs: Issuer - Cardholders bank Acquirer - Merchants bank VISA / MASTERCARD are Open Loop

Closed Loop Network

*Owner of Network* provides payment services directly to merchants and cardholders no third-party FI intermediaries AMEX / DISCOVER are Closed Loop

Check System Participants: Payee

*Party or parties* due payment indicated on a check

ACH Credit Flow

*Payment instructions*: Originator > ODFI > ACH Operator > RDFI > Receiver *Funds*: Originator > Receiver

ACH Debit Flow

*Payment instructions*: Originator > ODFI > ACH Operator > RDFI > Receiver *Funds*: Receiver > Originator

Depository Trust Company (DTC)

*Private-sector* Securities Settlement Systems (SSS) and Central Securities Depositories (CSDs) operated by The Depository Trust Company. Participants: Brokers, dealers, banks, investment companies Eligible securities: • Equities • Corporate bonds • Municipal bonds • Money market instruments

Image Cash Letter (ICL) Flow Chart

1. *Image Cash Letter*: Digital images of paper cash letter; includes both the MICR data record and the transmitted check image 2. *Truncation*: Stop Processing of physical paper item(s) and forward electronic image(s) and MICR data 3. *Reconverting Bank*: First FI to create or transfer the Substitute Check 4. *Substitute Check*: A paper reproduction from an electronic record of (or image of) an original paper check that was previously truncated. *Must meet the definition* of a Substitute Check from *Reg CC, Subpart D* and applicable standards (X9.100-140)

Clearing House Interbank Payment Systems (CHIPS)

A *private sector* LVPS (U.S. $) operated by *The Clearing House*, owned by FIs. All payments are prefunded by CHIPs members maintaining a balance account at the *Fed of New York*

Fedwire Funds & Fedwire Securities

A *real-time gross settlement* LVPS *operated by the Federal Reserve* Participants: Federal Reserve account holders An institution that maintains an account at a Federal Reserve Bank is allowed to be a Fedwire Funds participant Institutions send funds, in central bank money, for their own accounts and on behalf of customers

Retail Processing: Payroll Cards

A cost-effective means of paying wages to persons who lack a traditional banking relationship Payroll info stored on mag stripe or chip Low-cost structure and debit card type functionality - ATM withdrawals - POS purchases without a banking relationship *FRB and CFPB have amended Reg E* to apply to payroll cards

Debit/ATM/Bank Cards

Access devices most commonly associated with access to a balance in a checking or DDA account Debit transactions can be cleared through POS/ATM or through Visa/MC Networks (ATM/Bank Cards are ATM/POS only)

Credit Cards

Access devices to a *lending product* and are *not considered a true payment instrument* Credit transactions are cleared through Visa®/MasterCard®/American Express®/Discover® networks

Prepaid/Stored Value Cards

Access devices to a stored balance Similar to a debit card; except that balance is not associated with DDA or other FI account

Card Payment Participants: Acquirer

Also known as Merchant's Bank Institution that represents merchants in accepting POS debit transactions Depository institution that owns, operates, or controls an ATM network

The Clearing House Interbank Payments System (CHIPS)

An electronic payments system that transfers funds and settles transactions in U.S. dollars. CHIPS enables banks to transfer and settle international payments more quickly by replacing official bank checks with electronic bookkeeping entries.

Central Securities Depositories (CSD)

An entity *for holding securities*, either physical form or electronic form Helps to ensure integrity of securities issues Ensures securities are not accidentally or fraudulently created or destroyed or their details changed

Retail Processing: General Purpose Credit Cards

Associated with consumer cardholder's revolving credit account at a financial institution or other business. • Logo of a bankcard company on the front • Can be used at any location that accepts credit cards from the particular bankcard company • May include bankcards and closed-loop cards • Require agreements and transaction processing arrangements among participants

ACH Participants: Receiver

Authorizes Originator to initiate Entry • Written • Verbal • Notice Can be individual, company or government agency Account holder at RDFI

Fed Funds Rate

Average rate at which these transactions occur is called the fed funds rate

Fedwire Funds and Securities Participants: Originating / Sender Bank

Bank to which payment order of Originator is issued > Initiates transfer

Check Processing

Banking conventions that advanced check processing: *Routing Number Policy*: • adopted by the ABA in 1911 • identifies depository institution where check is drawn *Magnetic Ink Character Recognition - MICR* • national standard for imprinting machine-readable checks

Signature/Offline Debit

Batch settlement through capture Transaction fees (and interchange fees) are higher Subject to Visa/MasterCard rules Debit cards must be branded Visa / MC Eligible for charge-backs MasterCard and Visa offer consumer protection through their zero liability program when processed through their network

Card Payments System

Credit Cards Debit Cards /ATM & POS Cards Prepaid or Stored Value Cards

Card Payment Participants: Card Issuer

Entity that issues credit or debit card to card holder

Retail Processing: EFT / POS - FI and Nonbank ATM Networks

FI and nonbank ATM networks are connected to regional and national EFT/POS networks Regional networks are joint ventures owned and controlled by competing financial institutions Facilitates universal access to FI card-based services Provides participant FIs with interchange system offering auth/clear/settlement services *Acquirers collect interchange fees from* network members (*Issuers*)

Fedwire® Funds and Securities

Fedwire refers to services owned and operated by the Federal Reserve Banks • Fedwire Funds Service • Fedwire Securities Service

Large-value payment systems (LVPS)

Funds transfer system that typically handle large value payments and time-critical payments In the U.S., operated by both private sector and public sector entities

Retail Payment Systems

Funds transfer system that typically handles a high volume of relatively low-value payments *Public sector * • *ACH* - Federal Reserve Bank (FRB/FedACH) • *Check Clearing* - Fed *Private sector* • *ACH* - Electronic Payments Network (EPN) • *Check Clearing* - SVPCo and Viewpoint • *Credit/Debit Card Systems*

Retail Processing: Remotely Created Checks (RCC)

In lieu of signature. it bears account holder's printed or typed name or a statement that account holder has authorized the check Account holder can authorize via telephone by providing appropriate information May be processed through the check clearing networks or converted into an ACH debit Commonly used by credit card companies, utility companies, or telemarketers

Card Payment Participants: Card Holder

Individual who has been issued or authorized to use credit or debit card

Card Payment Participants: POS/ATM/Credit Card Network

Network which provides switching facilities for routing of credit and debit card transactions between Acquirers and Issuers

Third-Party Service Providers (TPSP)

Other Entity that *performs any function on behalf* of Originator, ODFI, or RDFI

Check System Participants: Correspondent Bank

Private depository institution, Bankers' Bank, or Federal Reserve Bank providing clearing or settlement services to Paying Bank or Collecting Bank Comparable to ACH Operator

Clearing

Process of transmitting, reconciling, and in some cases, confirming *Payment orders* or *financial instrument transfer instructions* prior to settlement

Retail Processing: EFT / POS Networks

Process, route, clear, and settle ATM and online POS debit card transactions by linking card participants thru telecommunication gateways PRIMARY FUNCTIONS -Route transactions thru switching gateways -Clearinghouse to settle network member on-us transactions -Forwarding "foreign" nonmember transactions

Retail Processing

Retail (consumer) Payment Clearing and Settlement Systems: • ACH network (TEL, PPD, WEB Debits) • Card networks (ATM/Credit/Debit) • Check clearing system Challenges: Retail payments often move through multiple channels. Lack of integration Amalgamation of data makes them a prime target for cyber criminals

Fedwire Funds and Securities Participants: Originator

Sender of first payment order in a funds or securities transfer

National Settlement Service (NSS)

The *FRB's multilateral settlement service* • Agent submits an electronic file of net positions • Debit positions deducted from participant account > then credits are processed • Same day finality 8:30-5:30pm EST Agents: Central Counterparties (CCPs), Securities Settlement Systems (SSS) and LVPS Participants: Federal Reserve account holders

Foreign Exchange (Forex)

The exchange of one currency for another or the conversion of one currency into another currency, typically between two different countries Also refers to the global market where currencies are virtually traded 24/7/365 Common uses are conversions by travelers at airport kiosk or financial institution, and financial institutions and governments

Retail Processing: EFT / POS - Visa and MasterCard

Visa and MasterCard own and operate the two national EFT/POS networks: *ATM/EFT Networks:* Visa Plus, Cirrus (MasterCard) *POS Networks:* Interlink (Visa), Maestro (MasterCard) National networks serve as bridge between regional networks, allowing them to route transaction information among them

ANSI: ASC X12 Terminolgy

*Data Element* is the smallest unit of information in a standard NACHA Standard is Delimiter * (asterisk) • Separation of elements *Data Segment* consists of logically-related elements in a defined sequence NACHA Standard • Terminator \ (backslash) or ~ (tilde) • End of segment

Fedwire Securities Service

*Fedwire Securities Service* Real-time, delivery vs. payment (DVP), gross-settlement system Allows for electronic issuance, transfer, and maintenance of securities issued by • U.S. Treasury • Federal Government Agencies • Government Sponsored Enterprise • Certain international organizations, along with funds payments (if any) associated with delivery of securities

Society for Worldwide Interbank Financial Telecommunications (SWIFT)

*Global network, XML-based messaging services* supporting correspondent banking and financial market utilities Not a Payment or Settlement system *FIN* = Financial Application Participants/Members: Large financial institutions (e.g. banks, securities broker/dealers), financial market infrastructures (e.g. payment systems)

Wholesale Processing: FI Security Program Elements

*Maintain signature lists* *Call back to authorized individuals* for both internally and externally generated telephone instructions *Procedures covering standing instructions* that protect against unauthorized change *Periodic review* to validate accuracy, and ensuring execution under the agreed terms

On-Us vs Transit Checks

*On-Us Checks* Payor and Payee have accounts at same financial institution *Transit Checks* • Sent to another depository institution for collection • Sometimes through one or more intermediary financial institutions All checks are classified as local items

Retail Processing: Debit Cards

*Online* PIN (and chip) authentication via merchant terminal Transactions are authorized in real time at POS using electronic funds transfer (EFT) networks that handle ATM transactions Transactions typically settle at end of day via ACH Network *Offline* Signature-based Transactions are processed in batch mode through bankcard networks and transactions typically settle at the end of the business day *Acquirers pay fees to* network members (*Issuers*)

Retail Processing: Card Authorization - Signature vs PIN

*Signature-based* Credit/Debit Card transactions are processed in *batch mode*. > Settlement is delayed until batches are processed. *PIN-based* Debit Card transactions, although processed in *real time* at the POS > Settlement is typically at the end of the day via ACH Network

Check System Participants: Check 21

*Truncating Bank* Creates an image of original check *Reconverting Bank* Produces the Substitute Check (or IRD)

Additional Check Clearing Paths

Checks can be cleared and collected via: 1. Image generated by BOFD/Collecting Bank > Transmitted > Paying Bank 2. Image generated by BOFD/Collecting Bank > Transmitted to Clearing House or other clearing facility > Clearing House generates Substitute Check/IRD > Present > Paying Bank 3. ACH debit Entry based on information in MICR line (ARC, BOC, POP, RCK)

Continuous Linked Settlement Bank (CLS)

A *private sector* LVPS settlement system for foreign exchange transactions. *bilateral FX* LVPS for 17 currencies *Payment-versus-payment (PvP)* ensures that final transfer of one currency occurs only if final transfer of the other currency/currencies also takes place Participants: Large financial institutions

ANSI: American National Standards Institute

A non-profit group that develops cross-industry national standards Special committees within ANSI focus on standards for bank cards and financial communications ANSI Accredited Standards Committee (ASC) X12 develops format requirements and data specifications for the different EDI standards used by corporate/business Originators and their financial institutions

Securities Settlement Systems (SSS)

A settlement system that enables securities to be transferred by book entry. *Free of Payment (FOP)* is a delivery of securities that's not linked to a corresponding transfer of funds. *Delivery-versus-Payment (DvP)* is the most widely used payment transaction where a trade is settled against payment. Must match the counterparty's securities and ensure that the purchaser has provided the means to pay.

Cross-Border

Broad term used to describe a transaction that involves individuals, corporations, settlement institutions, central banks in at least two different countries • Monetary or non-monetary Landscape has been evolving rapidly, with changing volumes and composition of flows through internationally active banks and a recent increase in importance of nonbank debt

ACH Participants: Originator

Can be individual, company, government agency Has relationship with Receiver • Requires Authorization to initiate ACH Entries • Debits or credits Receiver's account Establishes agreement with ODFI to transmit ACH on its behalf ODFI Agreement binds Originator to NACHA Operating Rules

ACH Participants: ODFI

Carries warranties for all Entries transmitted Must also act as a Receiving Depository Financial Institution (RDFI) Has relationship with Originator Has agreement with Originator Receives payment instructions from Originator Forwards payment instructions to ACH Operator Retain copies of all records for *six years*

ACH Participants: ACH Operator

Central clearing facility for ACH Entries • Federal Reserve Bank (FRB) • Electronic Payments Network (EPN) > private sector Edit and process Entries received according to NACHA Operating Rules Establishes processing schedules Determines and inserts Settlement Date based on Effective Entry Date and process date Retain copies of all records for *one year*

Real Time Payments (RTP)

Continuous Input/Output Clearing 24/7 Continuous Settlement Immediate Confirmation = Simplified Reconcilliation Real-time posting and visibility

Retail Processing: Electronically Created Items (ECI)

Does not begin as a paper item Merchant takes payment instructions then places in template that creates an electronic file for processing through the check clearing networks Initiated with online or telephone instructions from the consumer and bear no direct evidence of the customer's authorization

ACH Payments

Electronic method to exchange transactions Debit or Credit • Savings or Checking account • General Ledger account • Credit to a Loan account Single or Recurring Entry Batch process, store, and forward net settlement payment system • Can be Same Day

Retail Processing: ACH

Electronic network for exchange of payment instructions among FIs on behalf of their customers Payment instructions to either debit or credit a deposit account Batch-processed, value-dated electronic funds transfers between ODFI and RDFI FIs may contract with third-party service providers

Electronic Data Interchange (EDI)

Electronic transmission of information related to payments, invoices, and other business functions (no fax or email) "EDI Capable" is a term used to describe the receiving FI's ability to process and report remittance information that accompanies payments A major player in EDI is the American National Standards Institute (ANSI) Accredited Standards Committee (ASC) X12

Card Payment Participants: Merchant

Entity that has agreed to accept a credit or debit card for purchase of goods and services at its retail locations

Fedwire Funds and Securities Participants: Federal Reserve Bank

Entity that processes and settles Fedwire funds transfers AND book-entry securities transfers at instruction of participants

Retail Processing: Credit Card Networks

FIs issue cards in conjunction with three major credit card association networks: *Open Loop Networks* (MasterCard, Visa) a.k.a. FI-issued FIs can compete in card-issuing and merchant acquiring *Closed Loop Networks* (American Express, Discover) a.k.a. Retailer-issued Firms that serve as both card issuing agent and merchant acquirer *Card-issuer and Merchant Acquirer can be different organizations* *Acquirers pay fees to* network members (*Issuers*)

Financial Market Utilities (FMUs)

FMUs are *multilateral messaging systems* provide infrastructure for • Transferring • Clearing • Settling payments, securities, and other financial transactions May be designated as systemically important by the Financial Stability Oversight Council (Council) under Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) > *Too big to fail*

Fedwire Securities Transfers

Fedwire Securities provides a mechanism for issuance, transfer, maintenance and safekeeping of Fedwire-eligible securities Securities are held and transferred in electronic form known as Book-Entry securities Debit / pull system with regard to payments • Sender initiates transfer • Automatically debits payment from Beneficiary Bank's Federal Reserve Bank account Opposite of Fedwire Funds Transfer flow

Foreign Exchange

Forex market is where currencies are traded No central marketplace for currency exchange Currencies are traded worldwide among the major financial centers of London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris and Sydney

Retail Processing: Prepaid or Stored Value Cards

Generally issued to persons who deposit funds into an account of the issuer During the funds deposit process, most issuers establish an account and obtain identifying data from the purchaser (e.g., name, phone number) Requires cardholders to pay in advance, reducing nonpayment risk for issuing FI Card programs can operate in closed-loop or open-loop systems

Fedwire Funds and Securities Participants: Beneficiary's Bank

Identified in payment order to be credited pursuant to order

PIN / Online Debit

Immediate funds transfer Flat transaction fees are more cost effective Subject to ATM / EFT Network rules Process both ATM only and most Visa / MC branded debit cards Not subject to charge-backs Customer liability for unauthorized use is addressed by: Federal EFT Act AND Regulation E

Financial Markets: Federal Funds

Manage financial risks, by ensuring their daily reserve requirement with the Federal Reserve has been met Fed Funds can be used for unsecured loans Federal funds rate is closely related to short-term interest rates in the broader market and directly impacts the Eurodollar Effective feds funds rate is announced at the end of each trading day

Check System Participants: Payor

Party obligated to pay on a check a.k.a. Check Writer, Maker or Drawee

Check System Participants: Bank of First Deposit (BOFD)

Payee's Bank / first depository institution where a check is deposited. a.k.a. Depository Bank or Collecting Bank Comparable to ODFI for ACH debit Entry

Check System Participants: Paying Bank

Payor's Bank / FI associated with check's routing number a.k.a. Checkwriter's Bank, Payor's Depository FI or Payor Bank Comparable to RDFI for ACH Debit Entry

Fedwire Funds and Securities Participants: Beneficiary

Person or entity to be paid

Fedwire Funds Transfers

Processed transfer-by-transfer (one at a time) Once processed by FRB, settlement is IMMEDIATE, FINAL and IRREVOCABLE Settled by adjusting reserve/clearing balances of depository institutions held at Federal Reserve Banks Inter-bank settlement of transactions (examples) • Federal funds purchases • Corporate payments • Other large value payments

Fedwire Securities

Public-sector Securities Settlement Systems (SSS) and Central Securities Depositories (CSDs) operated by the Federal Reserve • Delivery-versus-Payment (DvP) • Real-time gross settlement (RTGS) Participants: Federal Reserve account holders Eligible securities: Securities issued by the U.S. government (US Treasuries), government-sponsored enterprises, and certain international organizations

ACH Participants: RDFI

Receives Entries from ACH Operator Has a relationship with Receiver Posts Entries accurately and timely to Receiver's account Must accept all types of Entries Does not have to be ODFI Retain copies of all records for *six years*

Wholesale Processing

Relies on *internal* funds transfer systems & networks for: • Wire transfers and corporate ACH payments • Large-dollar payments • Settling payments Supports: • Treasury • Cash Management • Straight-through-processing (STP) Modules • Automated Payment Order Processing

Retail Processing: Cards

Three types: 1. Pay Later (credit card) 2. Pay Now (debit card) 3. Pay Before (prepaid or stored-value cards) Account associated with pre-paid debit card may be the liability of an FI

Payment Systems defined

Transfer of funds between or among participants

Retail Processing: Electronic Check Conversion (ECC)

Two models of ECC: 1. MICR and Check images transmitted to Paying FI 2. Only MICR is transmitted to Paying FI via ACH or Dedicated Network (Check images stored in remote archives)

Third-Party Sender (TPS)

Type of TPSP serving as an *Intermediary between Originator and ODFI* Originators may use for outsourcing payment services ODFI has agreement with TPS but does not have direct agreement with underlying Originators

Financial Markets: Participants

U.S. commercial banks U.S. branches of foreign banks, savings and loan organizations, and government-sponsored enterprise FIs use Financial Markets for • Cash management • Management of financial risks