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Essentials of Treasury Management – Chapter 8 Payment Systems Karen A. Slaughter, CTP Amegy Bank of Texas

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Tricks, Tips and Tools • • • • • • • •

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Chapter 8 - Outline • • • • •

Overview of Payment Methods Paper-Based Payments Electronic Payments Payment System Risk 10 Questions Future of Payments on Exam

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Profile of U.S. Payments in 2005

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Steps in the Payment Process 1. Payment Instructions - Information contained in a payment instrument (i.e., MICR line on a paper check) 2. Payment Generation - Payment item created per the payment instructions 3. Clearing - Transfer of payment instrument and the required payment information 4. Settlement - Actual transfer of value from payor to payee 5

Sample Business Check 1 – Serial Number (Aux on-us) 2 – Fed Bank Code 3 – Fed Office 4 – Bank ID # (ABA) 5 – Check digit 6 – Payor’s Acct # 7 – Encoded Amount

113011258

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The Check Clearing Process • Key event is presentment— the delivery of the original or a substitute check to the paying bank. • Value is subtracted from the bank’s with a Federal Reserve bank (the Fed), a correspondent bank or some other clearing institution.

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Normally also subtracted from the payor’s on the same business day.

Check 21 October 2004

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Federal Reserve Districts

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Interbank Check Clearing • Checks drawn on banks other than the bank of deposit • Clearing channels – Clearing house • Formal or informal

– Federal Reserve Bank (Fed) – Correspondent bank – Direct send or direct exchange

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Steps in the Check Clearing System COMPANY A 1. Payor writes check 7. Deposit funds to cover check

Check

COMPANY B 2. Payee receives check 8. Bank statement

8. Bank statement

Federal Reserve Bank or correspondent bank or local clearing house

BANK A Payor’s depository institution

3. Check deposited

6. Check presented for payment

4. Check forwarded

5. Payment through a debit to payor’s bank

5. Payment through a credit

5. Payment through a credit to payee’s

BANK B Payee’s depository institution

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Notify on items > $2,500

4:00 pm 2nd banking day

Redeposit / Chargeback

Review / authorize / return

Midnight next business day

Presentment

Check Clearing Timeline

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Other Check Clearing Considerations • Electronic check presentment (E) – MICR transmitted electronically – ECCHO - 1990

• Image exchange options – Image Cash Letter (ICL) – SVPCo, Endpoint Exchange, Viewpointe

• Federal Reserve image cash letter options – FedForward: ICL to the Fed – FedReceipt: Inclearings – FedReturn: Returned items

• Deposit processing for end s 12

Settlement and Funds Availability • Factors – – – –

Drawee bank endpoint Time of deposit Day of deposit Bank’s availability schedule

• Endpoints – – – –

City items – 12 district banks or 25 branches RC – Fed regional check processing centers Country items – outside Fed city or RC HDGS – High dollar group sort; >$10M/day 13

Settlement and Funds Availability • Deadlines and Deposit Timing – Defines the start and end of a banking day – The time of day when a deposit must be received to be posted to the depositor’s – Established by individual banks

• Deposit Deadline – The time of day, based on an item’s drawee endpoint, by which an item must be at the depository bank’s processing center ready for transit in order to qualify for the availability stated on that bank’s availability schedule 14

Settlement and Funds Availability • Availability Schedules – Usually 0 – 2 days float – POD method – Part of pricing

• Related Funds Availability – Balances and float: • • • •

Ledger balances Deposit float ($ and days) Collected balances Available balances

– Availability factors: • Pre-encoding • Reject items • As-of adjustments

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Additional Paper Payment Instruments • • • • • •

Payable through draft (PTD) Remotely created check/ pre-authorized draft Money order Travelers checks Sight and time drafts Cashier’s check/certified check

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Returned Items • % of returns increasing • Check verification / check guarantee • Return reason – NSF – closed, stop payment, fraud, etc.

• RCK • FedReturn

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Electronic Payments • Card-based – Debit or credit – MasterCard, VISA

• Participants in a card transaction – – – – – – –

Cardholder Card issuer Merchant Merchant acquirer Acquiring processor Issuer processor Network operator

REGULATIONS Credit Cards – Reg Z Equal Credit Opportunity Act Truth in Lending Act Debit Cards – Reg E Payment Card Industry Data Security Standards (PCIDSS)

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Credit Card Payment Clearing Process 1. Credit card presented to merchant for purchase

2. Authorization request

Merchant

Merchant Bank 5. Charges sent for clearing

6. Hold converted to charge

Consumer 3. Hold placed on credit limit

Issuing Bank Authorization =

6. Funds remitted 4. Authorization granted

Clearing =

Credit Card Network Settlement = 19

Varieties of Payment Cards • Purchasing • Travel • Debit – Signature-based – PIN-based

• Stored value cards • Smart cards

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Electronic Funds Clearing Systems Automated Clearing A network of regional House (ACH) System associations, interbank associations and private-sector processors Fedwire

The Federal Reserve funds transfer system

Clearing House Interbank Payments System (CHIPS)

An independent large-dollar funds transfer network operated by the New York Automated Clearing House 21

Checks and ACH Transactions Checks

ACH Transactions

Paper-based.

Electronic.

Limited to payment instructions.

Can transmit additional paymentrelated information.

Parties are termed the payor and the payee.

Parties are termed the originator and the receiver.

Can only debit a payor’s Can be either a debit or a credit and credit a payee’s . transaction; credits move funds from the originator’s and debits move funds from the receiver’s .

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Electronic Payments: ACH System Participants

Originator

Originating Depository Financial Institution (ODFI)

Originating ACH Operator

Receiving ACH Operator

Receiving Depository Financial Institution (RDFI)

Receiver

Credits are considered final Debits are considered final after 2 days (unless unauthorized, duplicate, etc.)

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Check Conversion through ACH • Point-of-purchase (POP) check conversion: Systems that allow customers to have checks scanned, capturing the information from the MICR line at the POP. • s receivable conversion (ARC): Eligible checks received at a lockbox or drop box can be converted into electronic debits and processed as an ACH. • Back-office conversion (BOC): Conversion of eligible checks to ACH debits in the back office at the point-ofpurchase or other manned bill payment locations. NACHA Eligibility Rules Do not contain Aux-on us field <$25,000 and US$ Not third-party, credit card or home equity cks Not travelers cks, cashier’s cks or money orders Not US Treasury

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Types of Wire Transfers

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Wire Transfer Security • Physical security and limited access • s and personal identification numbers (PINs) • Test keys and codes to validate wire transfers • Repetitive wires to limit where and to whom funds can be transferred • Electronic security measures (e.g., encryption, message authentication and digital certificates) Regulations • Dual approval Reg J • Security devices or keys UCC Article 4A 26

Clearing House Interbank Payments System (CHIPS) • Bank-owned, large-dollar funds transfer network operated by The Clearing House Association. • Real-time intraday net settlement system providing finality of payment at time of release. • Clearing and settlement (in USD). – CHIPS member banks fund New York Fed CHIPS s (transfers received/authenticated midnight–5 p.m.).

• CHIPS formats: Fedwire, S.W.I.F.T. – Dollar volume is 80% of Fedwire volume.

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Society for Worldwide Interbank Financial Telecommunication (S.W.I.F.T.) • Not a funds transfer network; transmits information about financial transactions. • Settlement occurs through Fedwire, CHIPS, correspondent s or other RTGS systems.

www.swift.com

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Payment Systems Risk Systemic risk

Failure of one bank potentially causing other banks to fail and a collapse of the entire system.

Credit risk

The party funding a transaction defaults on its settlement obligation.

• Wire transfer • ACH origination

• holder daylight overdrafts. • ODFI has credit exposure from ACH file release until settlement. • Return items exceed funds in .

• Return item

Fraud risk

Altered transactions or false items that could cause loss for the disbursing party.

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Questions

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