Deel 2: European Payment Services

Question 1

What is a payment?

Answer 1

A transfer of funds which discharge an obligation on the part of a payer to a payee.

Question 2

What is a “payment system”?

Answer 2

A payment system is a formal arrangement based on legislation or private contractual arrangements between the member to facilitate the circulation of money.

The complete set of instruments, intermediaries, rules, procedures, process and IFTS’s* which facilitate the circulation of money.

*Interbank Funds Transfer System

A payment system is a formal arrangement based on legislation or private contractual arrangements for the transmission, clearing, netting and/or settlement of monetary obligations arising between its members.

Question 3

What are the three main elements of a payment system?

Answer 3

1. payment instruments: cheques, credit transfers, cash,…
2. processing: the actual payment instruction is being executed; A allows its bank to transfer money to B.
3. settlement for the relevant banks: the banks execute the payment and the money is now officially transferred from A to B

Question 4

Describe the life cycle of a payment.

Answer 4

1. Choice of payment instrument and submission of the payment instruction
2. Bank’s internal processing
3. Interbank processing of the payment
4. Interbank settlement of the payment
5. Bank’s intenral processing
6. Information and communication

Question 5

Explain “choice of payment instrument and submission of the payment instruction” in context of the life cycle of a payment.

Answer 5

Depending on the payment instrument chosen, the payer or payee submits a payment instruction to its bank.

This happens more and more electronically.

Question 6

Explain “bank’s internal processing” in context of the life cycle of a payment.

Answer 6

The sending bank verifies and authenticates the payment instruction in order to establish its legal and technical validity. It also checks if enough funds is available and prepares to payment instruction for clearing and settlement.

Question 7

Explain “interbank processing of the payment” in context of the life cycle of a payment.

Answer 7

Here everything gets double-checked and sorted out before moving to the actual settlement.

Sometimes netting happens here as well, to minimize the amount of cash transferred.

Question 8

Explain “interbank settlement of the payment” in context of the life cycle of a payment.

Answer 8

The settlement asset is transferred from the sending bank to the receiving bank. Now the interbank transfer becomes final (unconditional and irrevocable).

Question 9

Explain “bank’s internal processing” in context of the life cycle of a payment.

Answer 9

The receiving bank credits the account of the recipient.

Question 10

Explain “information and communication” in context of the life cycle of a payment.

Answer 10

The receipt of the payment is communicated to the beneficiary.

Question 11

How can payments be classified on the basis of the different types of payers/payees involved?

Answer 11

• Retail payments: large numbers of transactions, small value per transaction
• Wholesale payments: small number of transactions, large value per transaction
• Commercial payments: payments generated by corporations

Question 12

How can payments be classified on the basis of number of payers and payees involved?

Answer 12

• one-to-one transactions
  
  • C2C
  • C2B
  • B2B
• one-to-many transactions
  
  • government to private households
  • social security payments
• many-to-one transactions
  
  • households to the government
  • taxes

Question 13

What are “clean payments”?

Answer 13

All transportation documents relevant to the trade are exchanged directly between the trading partners.

Question 14

What are “documentary payments”?

Answer 14

Trading partners (almost always international) entrust the handling documents to banks as a way of ensuring that the exporter receives payment for the goods sold and the importer receives and pays for the goods ordered.

Question 15

What is a payment instrument?

Answer 15

A tool or set of procedures to transfer funds from the payer to the payee.

Question 16

What is the most common dinstinction in payment instruments?

Answer 16

Cash vs non-cash payments

Question 17

Explain “cash payments”.

Answer 17

Cash payments are usually associated with face-to-face transactions of low value between individuals where the parties do not exchange information regarding their identity, the payment is said to be anonymous.

Question 18

Explain “non-cash payments”.

Answer 18

Non-cash payments involve the transfer of funds between accounts.

Therefore it means that a payer gives its bank authorization for funds to be transferred (credit push) or by which a payee gives its bank instructions for funds to be collected from a payer (debit pull).

Question 19

How can non-cash payments be classified?

Answer 19

• Physical form (paper-based or electronic based)
• The party submitting the payment instrument for processing (credit push or debit pull)
  
  • Most important credit-based instruments: credit transfers (storten via bank)
  • Most important debit-based instruments: card payments, cheques…
• Electronic money (money stored on a device or in software)
  
  • E-money is more of a settlement than a payment instrument, since it’s effected using one of the core payment instruments (like credit cards, cash, transfers,…)

Question 20

What are the most common non-cash payment instruments?

Answer 20

• credit transfers: instructions sent by a payer to its bank to transfer money to a payee
• direct debits: payer gives authorization to the payee to debit money from his account
• credit cards: payee receives the money, payer can postpone payment
• cheques
• letter of credit
• …

Question 21

What are the trends in the use of payment instruments?

Answer 21

Over the past two decades, the most significant long-term trend in the use of payment products has been the shift away from cash in favor of non-cash payment methods (mostly payment cards) for consumer payments.

The use of internet banking and internet shopping has also increased considerably, allowing payer to make payments regardless of location or time.

Cards were initially introduced to improve face-to-face transactions, they are now more and more being used for telephone or internet purchases. This has, however, increased fraud with as result that new security and authentication measures have to be invented.

E-money schemes such as PayPal, Bitcoin… have used software-based technology that stores funds on prepaid accounts for multi-purpose use.

Question 22

What are “in-house payments”?

Answer 22

Payments that can be done within the same institution.

This means that the payee and the payer have accounts at the same bank.

If this is the case, all aspects of the transaction can be done within this institution, without needing arrangements or discussions with other banks.

There are, however, multiple scenarios regarding in-house payment handling:

• When a bank holds all accounts centrally (at the same level in the organization) all internal payments are processed within the bank.
• When banks decentralize the holding of their accounts (per region for instance) a bank might need to use interbank arrangements to transfer money between its own branches.

Question 23

What are “interbank payments”?

Answer 23

Interbank payments are payments where the payee and the payer have accounts in different financial institutions.

The money will need to be transferred from one to the other through interbank agreements.

The payment information has to be communicated between the two institutions before the settlement can be transferred from the payers’ bank to the payee’s bank.

Question 24

What are the two main types of arrangements to handle interbank payments?

Answer 24

• Correspondent banking arrangements:
  
  • Bilateral arrangements or arrangements involving a third party that provides the service
• Payment systems:
  
  • Multilateral arrangements based on a common set of procedures whereby financial institutions present and exchange data relating to the transfer of funds to other financial institutions.

Question 25

What are “bilateral arrangements”?

Answer 25

Two (bi) banks handle all sorting and processing of the payments themselves.

Question 26

What are “correspondent arrangement”?

Answer 26

The two financial institutions employ a third party. This third party is usually a separate financial institution known as the correspondent.

Bank A and B do not hold account with each other so they used a third party bank, Bank C. Bank C will then withdraw the money from bank A (or extend credit) and transfer it to Bank B and take care of all the paperwork and internal processing.

Question 27

What is an “interbank funds transfer system”?

Answer 27

IFTS is a payment system in which all participants are credit institutions.

This is thus an arrangement through which funds transfers are made between banks for their own account and on behalf of their customers.

(ingewikkelde uitleg om gewoon te zeggen dat twee banken geld verwisselen in opdracht van een klant…)

Question 28

What is a “settlement”?

Answer 28

Is an act which discharges obligations between two or more parties.

Settlement occurs when funds are transferred from the payer’s bank to the payee’s bank.

Question 29

What are the different methods of settlement?

Answer 29

Settlement can be gross or net, and conducted in real time or at designated times.

Question 30

What is a “gross settlement”?

Answer 30

Each payment instruction is passed on and settled individually across the accounts of the paying and receiving banks.

This results in a debit and credit entry for each and every payment.

Question 31

What is a “net settlement”?

Answer 31

All payments are netted, and the number of net claims is smaller.
I**f company A owes company B 1.2M USD combined in 8 bills, and B owes A 850K USD, combined in 7 bills, just charging company A 350K USD is enough instead of 16 individual settlements.

Question 32

What is a “real-time settlement”?

Answer 32

This occurs on a continuous basis during the operational day

Question 33

What is a “settlement at designated time”?

Answer 33

This occurs at pre-specified points in time, ranging from a single settlement cycle at the end of the day, to frequent settlement cycles during the day.

Question 34

What are “central banks”?

Answer 34

Issuers of money.

Question 35

What are the objectives of a central bank?

Answer 35

They have always had a keen interest in the smooth functioning of the national payment system and the way it affects the economy.

They have taken an important role in maintaining trust in the currency and ensuring its smooth circulation.

In payment, clearing and settlement, central banks aim to:

• Prevent systemic risk and maintaining financial stability
• Promote the efficiency of payment systems and instruments
• Ensure the security and public trust in the currency
• Safeguard the transmission channel for monetary policy

Question 36

What are the roles of a central bank?

Answer 36

• as the operator of a payment service
  
  • issuing cash as a direct payment instrument
  • issuing deposit claims
  • operating systematically important settlement networks
  • managing settlement accounts and providing settlement credit for participants
• as a catalyst
  
  • initiating or coordinating work
  • give advice
• as an oversight authority
  
  • publish guidelines and policies
  • monitor existing or planned systems
  • provide advice or promote changes to payment systems
• as an user
  
  • participate in or use systems owned or operated by external parties to make or receive payments on behalf of its own customers (such as the government or government agencies);
  • participate in or use securities settlement or depository systems for its own operations;
  • use correspondent banking services for other central banks or financial institutions.

Question 37

What trends are affecting the role of the central bank?

Answer 37

Four trends are affecting the role of the central bank:

• innovation and technological progress
• increased interdependencies
• de-location
• concentration

Question 38

Explain “innovation and technological progress” in context of the trends affecting the role of the central bank.

Answer 38

Innovation and technological progress allow improvements to be made in existing payment, clearing and settlement arrangements. This improvement allows new products, services and processes to be introduced.

More and more non-bank parties are becoming introduced at various stages of the payment chain (Google Wallet, Apple pay, PayPal…). Central banks need to monitor and analyze these innovations and make sure they are safe and efficient.

Question 39

Explain “increased interdependencies” in context of the trends affecting the role of the central bank.

Answer 39

Payment, clearing and settlement systems are becoming increasingly connected with each other. Whilst this has advantages, it also means more risk. There could be more vulnerabilities, allowing disruptions to spread from one system to another, or from one market to another.

International cooperation and consensus building – both with other central banks and with domestic and foreign banking supervisors and securities regulators – are gaining in importance for central banks.

Question 40

Explain “de-location” in context of the trends affecting the role of the central bank.

Answer 40

This means a change in the location of systems. Regional integration, globalization and innovation have allowed many banks and markets to expand across borders. This means more and more services are being offered by international players.

Central banks will need to look at whether offshore or more international infrastructures strike the right balance between safety and efficiency.

Question 41

Explain “concentration” in context of the trends affecting the role of the central bank.

Answer 41

When two large banks merge, they will be able to do more in-house payments and processing. However, they will also internalise an increased amount of risk. And as an institution, they will become more critical for the financial system.

Central banks will have to cooperate even better with banking supervisors and security regulators to minimize exposure to systemic risk.

Question 42

What is “TARGET2”?

Answer 42

TARGET2 is the real-time gross settlement system owned and operated by the Euro system.

TARGET stands for Trans-European Automated Real-time Gross Express Transfer system.

Payment transactions in TARGET2 are settled one by one on a continuous basis, in central bank money, with immediate finality.

Since the account of the receiving institution is never credited before the account of the sending institution has been debited, the receiving institution is always certain that funds received are unconditional and irrevocable.

TARGET2 has to be used for all payments involving the Euro system, as well as for the settlement of operations of all large-value net settlement systems handling the euro.

A Dutch importer places an order with a Spanish company. Payments to and from the accounts of the buyer and seller are channeled via central banks. The Spanish exporter‘s bank gets a credit with the Banco de España, which in return has a claim on the ECB. The Dutch importer’s bank owes its local central bank, leaving de Nederlandsche Bank with a debt at the ECB.

Question 43

What are the main objectives of TARGET2?

Answer 43

• supporting the implementation of the Euro system’s monetary policy
• minimizing systematic risk in the payments market
• increasing efficiency of cross-border payments in euro

Question 44

What is SEPA?

Answer 44

SEPA stands for the Single Euro Payments Area.

It is a payment-integration initiative of the European Union for simplification of bank transfers denominated in euro.

SEPA consists of the 28 EU member states, the four members of the EFTA (Iceland, Liechtenstein, Norway and Switzerland), Monaco and San Marino.

Question 45

What are the goals of SEPA?

Answer 45

The project’s aim is to improve the efficiency of cross-border payments and turn the fragmented national markets for euro payments into a single domestic one.

SEPA will enable customers to make cashless euro payments to anyone located anywhere in the area, using a single bank account and a single set of payment instruments.

The project includes the development of financial instruments, standards, procedures and infrastructure to enable economies of scale. This would, in turn, reduce the overall cost of the European economy of moving capital around the region

Question 46

What is a “continuous linked settlement”?

Answer 46

CLS, is a settlement system for foreign exchange trades that eliminates settlement risk through netting.

The system is mostly run by the CLS Bank International, which is a special purpose bank dedicated to settling foreign exchange trades. It is owned by 73 financial institutes, all with an equal share. This makes it one of the world’s largest special banks.

Every day, members of the institution can buy whatever currency they need, and have it by the end of the day. The CLS Bank has accounts in each of the central banks in the world and thus access to all these currencies.