Chapter 4 - Payment Systems

Foreign Checks

Checks deposited into a bank in one country that are drawn on a bank in another country. Treated as "collection items", and are processed through a correspondent bank in the country in which the foreign check is payable. Subject to FX costs and extra processing fees.

Collection Items

Checks processed outside of normal check-clearing systems

Real-time Gross Settlement (RTGS)

Means that the clearing and settlement of each transaction occur continuously throughout the day. Final when funds are transferred between banks or receiving bank is notified, whichever is sooner.

Continuously Linked Settlement (CLS)

Mitigates settlement risk by allowing simultaneous exchanges of the payments for both sides of the underlying financial transactions (i.e., FX contracts, non-deliverable forward contracts, OTC derivative contracts). This process is managed by CLS Group Holdings AG and includes the CLS Bank International. Regulated by the central banks in the countries in which it operates.

Gross Settlement

Occurs when each transaction results in a separate value transfer between the payor and the payee. This is usually done in real-time, and considered final at the time of processing. (RTGS)

Net Settlement

Occurs when many transactions are combined and the sorted by sending and receiving banks. At the end of the day the net amount is actually transferred. At this point, electronic credit transactions are considered final.

Settlement (Availability)

Occurs when the beneficiary's bank account is credited and the payer's bank account is charged; when the payee can actually use the money involved

Cash

One of the most expense types of payment settlement.

Remote Deposit Capture (RDC)

Checks deposited in this manner may receive faster availability, a later cutoff time, a later deposit deadline, and/or lower service charges because the customer is, in effect, performing a labor-intensive task for the bank.

Sight Draft

Usually presented in combination with other documents that verify the terms of a transaction have been met. Assist in international payments

ACH or Low-Value electronic payments

Value-dated payments, processed in batches, and typically take one to two days to process. Originally intended for low dollar items such as payroll, but are slowly replacing wire payments due to the lower cost.

Society for Worldwide Interbank Financial Telecommunication (SWIFT)

A Communication system used by most of the banks in the world to transmit payment instructions, among other things; an industry-owned, cooperative, interbank telecommunication network that enables banks to send authenticated electronic messages in standard formats.

Clearinghouse Interbank Payments System (CHIPS)

A US based privately owned wire transfer system that settles its transactions through the Fed; handles messages and RTGS for FIs. Claims to be the main electronic finds transfer system for processing international US dollar funds transfers made among international banks in the US.

Payment

A _____ is a system when it uses cash substitutes, such as checks or electronic messages, to instruct the debits and credits that transfer value from one party to another.

Cashiers Check (Official bank check)

A check drawn on a bank's own funds.

Certified Check

A check drawn on a depositors account and funds are withdrawn from the depositors account at the time of certification, to assure payment with a certification or guarantee by the bank.

Faster Payments

A joint development of CHAPS, the UK ACH system, and VocaLink, a large British telecom company, and uses an internet-based system to provide immediate online payments to customers.

Image Replacement Document (IRD)

A paper reproduction of the original check that contains an image of the front and back of the original check and is the legal equivalent of the original check. Can be legally exchanged electronically instead of shipping paper checks and can use the images to print an IRD when a physical document is needed.

Payable through Draft (PTD)

A payment instrument resembling a check that is drawn against the payor rather than the bank. Benefit is that the payor has a chance to review the payment before approving it and the funds are not drawn until the item is approved by the payor; often used by insurance companies.

Money Order

A prepaid instrument issued by various third parties such as banks, postal services, or consumer outlets. The purchaser is the instruments payor, and the money order is the obligation of the issuer.

Payment system

A series of processes and technologies that transfer monetary value from one part to another

Remote Deposit Capture (RDC)

A service that allows a payee to scan any check it receives as payment and transmit the scanned images to a bank for posting and clearing, instead of having to deposit physical checks.

Charge cards

A special type of credit card in which the outstanding balance must be paid off each month.

Magnetic Ink Character Recognition (MICR) Line

A specially formatted line of machine-readable information on the bottom of a check that contains all the information necessary to process the check through the check-clearing system

NACHA (Electronic Payments Association)

A trade organization that is responsible for managing the development, administration, and governance of the ACH system.

Remotely created check (RCC)

A type of check used to draw or draft against a payors account. The check is unsigned and the payee (rather than the payor) initiates the transaction. Many banks refuse to accept these for deposit. Reg CC states that any bank clearing a check warrants that the check is authorized by the payor.

Routing Number

ABA number; identifies which financial institution the check was drawn upon.

Cross-border ACH Transaction

ACH transactions that occur between countries rather than within a specific country.

Consumer Checks

About 6" smaller than a business check, and lack the initial, or auxiliary on-us field in the MICR line.

Domestic Transfer

All parties involved in the payment transfer are in the same country; settlement is often handled between the FIs using common accounts held at their central bank.

Ledger Balances

Bank balances that reflect all entries to a bank account, regardless of whether the deposited items have been collected and are available for withdrawal. Important for accounting purposes, because a negative ledger balance can result in an overdraft.

Optical Character Recognition (OCR)

Captures the information in the MICR line of a check using an image of the check; MICR is still used today because of the high volume of MICR readers still in use, but OCR is the only method of pulling the MICR from an image.

Open Loop Cards

Cards that are accepted anywhere the card logo is displayed (i.e., bank-issued cards, AMEX, Discover)

Self-sufficient

Cash payment systems are _______, meaning that cash is the payment instrument and that when the payor gives cash to the payee for a transaction, the physical transfer of the cash represents both the clearing network and the final settlement -- no other settlement infrastructure is needed for that particular transaction.

Check Payment Process

Deposit of check into payee's account; the check is scanned an imaged, and the amount is added to the MICR line. Checks are sorted and sent through the clearing channel as cash letters. Value is subtracted from the paying bank's account at the time of presentment via central or correspondent bank. The paying bank posts the check to the payer's account. In the US banks have 36 hours for finality; Europe is 6 days.

Transit Checks

Deposited checks drawn on other FIs; these require more processing than on-us or on-we checks. Checks are sorted into cash letters, which are transmitted through clearing channels for final settlement.

Correspondent Accounts

Depository accounts bank have with each other, used to settle their customers' funds transfers. More commonly used for cross-border payments involving more than one country, or smaller banks may have them with larger banks to enable more efficient clearing.

Automated Clearinghouse Systems (ACH / Small-Value Transfer)

Electronic networks for the exchange of smaller payment instructions among FIs, typically on behalf of consumers; payment instructions to either debit or credit a deposit account. Typically batch-processed, value-dated electronic funds transfers between originating and receiving FIs. Capable of transferring more info about a payment than can normally be transmitted via most paper-based instruments or most wire transfers.

Network

Entities that choose to transfer payment instructions and funds with each otherIncludes central banks such as the Fed, European Central Bank, or the Bank of England, and commercial entities such as CHIPS or Visa

SWIFT

For corporate customers, provides a limited membership that allows a corporation to utilize the multibank platform to exchange financial information with its banks through one standardized platform. This may allow the corp to reduce or eliminate transaction costs while increasing the speed of payment and minimizing the necessity of maintaining multiple bank connections in order to send/receive information and initiate payments.

Government Warrant

In government finance, this is an order to pay that instructs a treasurer to pay the warrant holder on demand or after a maturity date. Same as a check but routed to the government entity's treasury department for payment.

Originating / Receiving Depository Financial Institution (ODFI / RDFI)

In the ACH network, the terms used in place of depository and paying banks because ACH could be either a credit or a debit.

Originator / Receiver

In the ACH network, the terms used in place of payor / payee because ACH could be either a credit or a debit.

Direct Send (Direct Exchange/Presentment)

In this type of clearing channel, collecting banks may arrange to send cash letters directly to a paying bank or to a nonlocal Federal Reserve Bank. This enables banks to meet various deposit deadlines and achieve faster clearing times.

Clearinghouse

In this type of clearing channel, either formal or informal associations are formed by banks in a geographic area to permit the exchange of items drawn on the member participants. The net value is transferred between the banks by debiting and crediting correspondent accounts or through reserve accounts that each bank maintains with the local Federal Reserve.

Federal Reserve System

In this type of clearing channel, the central bank acts as a check-clearing agent. Depository banks can send checks here, which will then clear the checks and transfer values from paying banks to depository banks.

Correspondent Bank

In this type of clearing channel, the collecting bank maintains a depository account with another bank. The collecting bank sends cash letters to the correspondent bank, which presents the items to the paying bank through a local clearinghouse or the Fed.

Transaction Facilitators

Include information transmission mechanisms and payment systems (i.e., SWIFT, Fedwire, BOJ-NET)

Wire Systems

Include: FedWire (US), CHAPS (UK), Canada (LVTS), CNAPS (China)

Payment Process

Includes 4 elements: 1. Payment instructions, 2. Payment generation, 3. Clearing, 4. Settlement/Finality

"On-We" check clearing

Involves a group of banks that use a common third-party vendor to process their checks for them; very similar to "on-us" checks.

"On-Us" check clearing

Involves a single bank and occurs when a payee deposits a check in an account at the same bank on which it is drawn; funds are generally available same-day and processing fees are lower.

Debit Card

Issued against a deposit account belonging to the cardholder.

Credit Card

Issued against a line of credit that the institution or to the merchant has extended

Payment Types

Options in a payment system include: Checks: Payments initiated when one party writes a check to another RTGS: Wire transfers ACH: Value dated and processed in batches; typically take 1-2 days to settle Card-based: payments that settle though one of the large card-processing networks, ATMs or POS systems

Credit and debit cards

Payment cards issued to individuals and businesses for the purchase of goods, payment for services, and/or access to cash advances and withdrawals.

Real-Time gross Settlement (RTGS)

Payment systems that offer immediate and irrevocable value (i.e., wire transfer systems); with other payment systems, the value is contingent on the payor or the payer's bank not attempting to retract the payment (i.e., check, ACH, cards)

Fixed-to-Fixed (USD to USD)

Payments are both transferred and received in US dollars. Settlement is between participating US FIs and the FRB in US dollars.

Fixed-to-Fixed (FX to FX)

Payments are both transferred and received in foreign currency. The FX rate and settlement are managed and processed by participating US FIs and the respective foreign gateway operators via their foreign correspondent banks.

Identities

Payments are often differentiated based upon the __ of the various parties involved: B2B: Payments from one business to another, historically by check or wire (primarily check), slowly being replaced by electronic or card. B2C: Payments from businesses to consumers, typically for payroll. C2B: Payments from consumer to business, typically cash and check payments in the US or cash and giro in Europe. Now often cash or card, or electronic. C2C: Payments from one individual to another for individual transactions. B2G: Business to government; normally taxes G2C: Various government-issued payments such as retirement, social security, and welfare; usually electronic or card-based G2B: Vendor payments, usually electronic or card-based

Checks or Drafts

Payments that are initiated when one party writes a check to pay another; one of the oldest forms of noncash payment systems. Represent the largest number of commercial or business payments in the US.

Card-based Payments

Payments that settle through one of the large card-processing networks or through one of the ATM or POS systems . Not always a physical representation.

Traveler's Check

Prepaid instruments similar to money orders; two signatures usually are required by the purchaser: one at issuance and another at the time of payment.

Time Draft

Presented in combination with other documents that verify the terms of a transaction have been met, but is not payable until a specific future date.

Clearing

The process where the FIs use the payment information to transfer money between themselves on behalf of the payor and the beneficiary, either directly or through some external network

Collected Balances

Refer to the average ledger balance minus the deposit float. Used to determine the earnings credits on account analysis statements.

Available Balances

Reflect the amount of funds available for withdrawal from an account, based on the bank's availability schedule and/or local regulations that require specific availability for certain funds.

Debit Filters

Restrict the ability of somebody who knows a business's routing transit number and account number from withdrawing money from the account using an ACH transaction.

Wire Final Settlement

Settlement that is both irrevocable and unconditional

Encoded Amount of Check

Should agree with the amount writing on the check by the payor; typically encoded on the check by the depository bank and appears in the lower right-hand corner of the processed check

External Processing Code (EPC)

Single-digit optional field for special purposes, such as image processing codes, located to the immediate left of the routing number.

Availability Schedule

Specify for each drawee endpoint, when a bank grants available credit or collected balances for deposited items. In order to receive the stated time, the deposited item must have been received by the assigned deposit deadline. If the deposit deadline is missed, then availability is delayed. Affects flow balances.

Wire Settlement

Th actual transfer of funds between the payor's FI and the payee's FI

TARGET2

The European RTGS (wire payment system) developed under SEPA implementation.

Two main ACH Operators

The FRB processes most of the ACH transactions, while a private operator, the Electronic Payment Network (EPN), processes the remainder.

Gateway Bank

The bank or service provider who will receive the transactions in one country and then forward them to the ACH system of another country. The US FRB provides this service, called FedGlobal ACH Payments.

Availability

The below items affect and influence __: 1. RDC/Image Capture 2. Reject Items 3. As-Of Adjustments 4. Value Dating

Real-time Gross Settlement (RTGS)

The clearing and settlement of each transaction occur continuously during the processing day. Payment to the payee is final and irrevocable when the RTGS processor (central bank or equivalent) either credits the amount of the payment order to the receiving bank's account or sends notice to the receiving bank, whichever is earlier.

On-Us Account Number

The customer account number as assigned to the payor by the drawee bank

Canadian Checks

The exception to foreign checks, these checks avoid FX and processing costs because they issue checks with a US routing number and are deposited to a US bank using standard check-processing channels.

Giro

The functional equivalent of an ACH credit; the payor, typically a consumer, authorizes his/her bank to pay the payee, typically a business, through a direct transfer. Although the original authorization from the customer may be received through either paper or electronic bill payment systems, the payment itself is electronic and is usually sent through the country's ACH system.

FedGlobal

The gateway bank for the US (issues ACH payments to foreign banks) that also provides a range of transaction currency options: 1. Fixed-toVariable (USD/Foreign) 2. Fixed-to-Fixed (USD/USD) 3. Fixed-to-Fixed (Foreign/Foreign)

Payment Instructions

The information contained in an electronic transfer or a check from the payor telling the paying bank to transfer value to the beneficiary through the receiving bank

Endpoints

The location of the paying bank where final settlement occurs. Determined by the routing information, such as the RTN or sort code on the check.

Presentment

The physical delivery of a check to the paying bank. Check image processing has changed this process quite a bit.

Finality

The point in time when the payor knows that the money involved cannot be taken back or retracted by the payor or the payer's bank; when a payment is unconditional and irrevocable. Cash = Immediately Checks = Several weeks or longer (stops, etc.) ACH = 1-2 days Wires = Immediately

Value Dating

The practice of debiting or crediting a particular transaction on some date other than the processing date.

Settlement Risk

The risk that one party to the transaction pays out the currency it sold but does not receive the currency it bought.

Ledger Cutoff

The time of day when a deposit must be received in order to be posted to the ledger of a depositor's account; items received after this time are considered to be received by the bank on the next banking day.

Deposit Deadline

The time within the banking day when an item must be ready for transit at the depository bank's processing center to qualify for the availability stated in the availability schedule.

Checks

The traditional method that payors have used to access their accounts. Preferred method of B2B payments.

Wire Clearing

The transfer and confirmation of information between the payor's bank and the payee's bank.

Reject Items

These items must be repaired and reprocessed; most items arise because of physical defects in the MICR line or because the MICR line does not meet banking industry specifications.

Auxiliary On-Us Field

This number is frequently the check number.

Fixed-to-Variable

US dollars are converted to a variable amount of a destination currency based on a competitive exchange rate. Settlement is between participating US FIs and the FRB in US dollars.

Clearing Channels

When a check cannot be cleared through 'on us' or 'on we' channels and must be sorted into cash letters and transmitted to the paying bank either directly or via intermediary processors called __ __; examples include a central bank, clearing facility, or correspondent bank. Specifically: -Clearninghouse -Correspondent Bank -Direct send or Direct Exchange -Federal Reserve System

As-Of Adjustments

When a check takes longer to clear than the initial availability that was granted, a bank may add the additional time as part of the collected-balance calculation. Normally reduce available balances, so can also increase bank fees and in extreme cases even result in overdraft.

Payment Generation

Where the payment instructions are entered into the payment system itself

Real-Time Gross Settlement (RTGS) or Large-Value electronic payments

Wire transfers; existed since the late 1800s with the invention of the telegraph, became widely used in the 1900s.

Cash Letters

typically a file of check images and related control information but can also be used to refer to a physical bundle of checks and related control documents. Derives from the fact that bundles of physical checks were sent to a paying bank in exchange for "cash" or some form of bank credit.