Payments Processing Elements

Payments are the financial instruments that people and corporate globally use to transfer funds. This helps corporate to mange Cash, DPO and DSO effectively and efficiently. Payments in itself are a very vast because of the availability of many payment systems in a given country and each system have unique way of processing. At the same time payment system has to work in accordance with the regulatory requirement of the country. Since each country uses to have their unique currency, it adds additional flavor to processing. Payment landscape is all set to change drastically in coming years with the advent of new technologies e.g. PayPal, Bit coin, Block Chain and SWIFT GPI.

With gradual technological advancement Payments landscape is constantly changing day by day. There are around 750 Payment system throughout the world and with the advent of PayPal, Bitcoin , Block chain and SWIFT GPI, stage is all set for Payments Landscape to enter in the next phase .

This blog provides information about the essential elements of a payment processing system and the participants.

Any Payment Processing system must be characterized by following:-

1. Payment System :-

A payment system is a set of processes and technologies that transfer monetary value from one entity to another. Payments are typically made in exchange for the provision of goods, services, or to satisfy a legal obligation. They can be made in a variety of currencies using several methods such as cash, checks, electronic payments and cards. The essence of a payment system is that it uses cash-substitutes, such as checks or electronic messages, to create the debits and credits that transfer value.

The value that is being transferred is typically stored in depository accounts at banks or other types of financial institutions. The banks, in turn, are connected to a set of payment systems that they use to process payments on behalf of their customers or depositors. Most US banks are members of a number of different payment systems such as NYCE (New York Cash Exchange, a subsidiary of FIS), CHIPS (Clearing House Interbank Payment Systems) and Fed wire (US Federal Reserve Bank network). Non-US banks are connected into similar national systems such as CNAPS (China), BOJNET (Japan) and SPEI (Mexico). Banks operating in multiple countries connect to payment systems in each of the countries where they operate either directly or through a correspondent bank. Significantly for the settlement process and for the discussion of less conventional payment systems, banks in many countries typically maintain accounts with their central bank and participate in the central bank's payment systems. In the Euro zone, the authorities have taken it a step further by creating SEPA, the Single European Payments Area, under the authority of the European Central Bank (ECB). SEPA was created to provide standardized payments processing and costs among all the various countries within the Euro zone.

In the simplest case involving the traditional banking system, payments involve four participants:

• The payer: Makes the payment and has its bank account debited for the value of the transaction.
• The payer's financial institution: Processes the transaction on the payer's behalf.
• The payee's financial institution: Processes the transaction on behalf of the payee and generally holds the value in an account.
• The payee: Receives value of the payment by credit to its account.

This is illustrated in the Diagram 1  at the bottom of the blog.

In the simple case illustrated here the two banks may choose to transfer payment instructions and funds directly with each other. It is also possible for the banks to use various intermediaries to help facilitate the transaction.

In the real world the intermediaries includes central banks such as the Fed (US Federal Reserve), ECB (European Central Bank) and The Bank of England and clearinghouses such as CHIPS. There are also information transmission mechanisms such as SWIFT (Society for Worldwide Interbank Financial Telecommunications) and payment systems such as Fedwire and BOJNet which also include information transmission systems. Entities such as payroll processors, check printers, systems providers and card systems such as Visa and MasterCard that are outside of the four corners model also participate in the payment process. Non-traditional payment systems such as Bitcoin/Bock Chain bypass the banking system almost entirely by fulfilling the role of financial institution, currency and network themselves.

Payment processing involves four basic steps:

>> Payment instructions are the information contained in a wire transfer or check. These instructions are from the payer and tell the paying bank to transfer value to the beneficiary through the intermediaries and receiving bank.

>>Payment generation is when the instructions are entered into the system—printed on a check or transmitted via ACH or wire.

>>Clearing is the process where the banks use the payment information to transfer money between themselves on behalf of the payor and the beneficiary.

>>Settlement is the final step in the basic process and occurs when the beneficiary's bank account is credited and the payor's bank account is debited. Final settlement occurs when the banks pass value among themselves, a distinction that has important treasury implications.

The actual payment process will depend on the type of payment instrument that the payer and payee choose to use.

2. Payment Channels

Processors for the payment systems can use different channels to make a payment and each has different operating characteristics, rules and settlement mechanisms. Broadly, all payment systems can be placed into one of the following four payment channels:

• Paper-based systems such as checks or drafts. Payments are initiated when one party writes an instruction on paper to pay another. These systems are one of the oldest forms of non-cash payment systems. Checks are a common paper-based channel and are still widely used in the United States and a few other countries.

• RTGS (Real Time Gross Settlement) or High-Value Payments; called wire transfers by most people. Wires came into being in the late 1800s with the invention of the telegraph but did not become widely used until the early 1900s.

• RTNS, or Real Time Net Settlement systems or Automated Clearing House (ACH) batch payments were introduced in the early 1970s and were designed to replace checks with electronic payments. Unlike wires, which are processed individually, ACH payments are processed in batches and were originally intended for small payments under $100,000 such as payroll and consumer transactions.

• Cards are a payment channel that includes credit, debit and stored value cards. They are a fast growing segment of the methods for making and receiving payments.

3. Payment Processing and Control

Payment Processing and Controls is a more individual/business-centric process consisting of six essential steps:

• Entry into the obligation to purchase goods or services or the incurrence of a legal obligation. This could result from a purchase order or an oral commitment to make a purchase.
• The obligation is approved and entered into an accounting system by the payer.
• The payment method, such as check, ACH, or wire, is selected keeping in mind that this might have been specified when the obligation was incurred. Since the speed and cost of receiving a payment are partial determinants of a seller's profitability, many sellers specify payment types and terms.
• Initiation and execution of the payment by the purchaser.
• Funding and settlement of the payment.
• Transaction reconciliation between company systems and external bank accounts.

4. Settlement

Settlement refers to the actual movement of funds from the payer's account to the payee's account. In other words the time at which the payee can actually use the money involved. It is different from finality which is the point in time when the payee knows that the money involved cannot be taken back by the payer or the payer's bank. Settlement becomes final when a payment is unconditional and irrevocable.

Finality varies depending on the payment system and the parties involved in the transaction. Payment systems that offer immediate and irrevocable value are called Real Time Gross Settlement (RTGS) systems. Others, such as check based systems, provide immediate information with value following shortly. But the value sometimes is contingent on the payer or the payer's bank not attempting to retract the payment, a right which can exist for a number of days , depending upon the payment system. This can be a major issue for global companies using many different low value payment systems that feed into some sort of cash pooling or concentration system. While the amount of a rescinded payment may not be large, accounting for the rescission can prove challenging, particularly when it involves two currencies.

From the bank perspective the actual transfer of funds, or settlement, can be handled in several different ways. In a domestic transfer, one in which all parties are in the same country, settlement is often handled between the banks using common accounts held at their central bank. In the United States these accounts are held at the Federal Reserve Bank and referred to as reserve accounts. In a cross-border payment involving more than one country, banks typically use depository accounts with each other, called correspondent accounts, to settle their customers' funds transfers with the correspondent banks using their reserve accounts on behalf of their clients.