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Fintech > Payment Systems in the US > Flashcards

Payment Systems in the US Flashcards

1
Q

What is a payment?

A

A payment is the transfer of value from one end party (the sender) to another (the receiver)

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2
Q

3 Elements of a Payment

A
  1. Initiation of payment
  2. Funding of the payment by the sender
  3. Delivery of payment to the receiver
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3
Q

Definition of Payments System (Rails)

A
  • Defines how value transfers (the 3 elements) are done and provides a framework of rules for users of the system
  • Alternatively, a set of providers who follow common protocol and have common operating rules
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4
Q

Common Elements of Payment Systems

A
  • They operate in a single country on a national basis within that country
  • Are denominated in the currency of that country
  • Are subject, directly or indirectly, to regulation by the government of that country
  • Enable multiple parties to transact with each other
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5
Q

What are the 5 Core Payments Systems in the US?

A
  • Cash
  • The Checking System
  • The Card Systems
  • ACH
  • The Wire Transfer Systems
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6
Q

Open Loop vs. Closed Loop Systems

A

Open Loop

  • Uses chain of intermediaries to complete payments.
  • Most scaled payment systems are open loop (ACH, card systems, wires, even checks) are open loop
  • Pros: effective means of allocating liability through value chain and scale quickly as when a intermediary joins all their customers can join

Closed Loop

  • No intermediaries, the parties must have a direct relationship with the payment system
  • Allows more flexibility & control
  • Example: Macy’s card that can only be used at Macy’s
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7
Q

Open Loop Payment Systems - Chain of Liability

A
  • Open loop systems allocate liaibility and responsibility effectively
  • Networks create operating rules that banks must comply with to use the network, and then in-turn the banks have end-user agreements with their users
  • Thus, if the banks don’t abide by the network operating rules, they are responsible for reimbursement in the case of a refund request, or if the user broke the rules they are, etc.
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8
Q

Annual Count and $ Volumes for Each Major Rail in US

A 
Debit: 74B // $2.3T
Credit: 31B // $2.8T
ACH: 24B // $42T
Checks: 14B // $21T
Cash: 67B // $1.4T
Wires --> Massive amounts from M&A and stuff so excluded
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9
Q

3 Functions of a Payment System (different than elements)

A
  1. Processing - The mechanics/way in which a transaction moves from one party to another. Also includes settlement between parties on the system.
  2. Rules - The rules that parties must follow in order to operate on the system.
  3. Brand - How people communicate that they’re paying (e.g. “I’m paying with Mastercard”)
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10
Q

What are the 6 Domains (purposes) of Payment?

A
  • Point of Sale (POS) - Physical
  • Remote Commerce - Online / Ecomm / mail-order
  • Bill Payment
  • P2P Payment - domestic + remittances
  • B2B Payment - business-to-buisness + financial markets
  • Income Payment
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11
Q

What is a “provider” from the Glenbrook book?

A 
Parties who provide access to the payment system to end users
- Banks
- Networks
- Clearing houses
- Processors 
- Service providers
etc.
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12
Q

Payment network definition

A

Specific organization that writes and maintains rules for its network.
- Examples: the “card payments network” or the “ACH network” etc.

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13
Q

Push vs. Pull Payments, what they are, which rails are what, etc.

A
  • Refers to the action of the party that is entering the transaction into the payment system
  • “Push” = Party A, who is initiating transaction, is sending money to Party B
  • “Pull” = Party A, who is initiating transaction, is taking money from Party B
  • Push Examples: ACH direct deposit, wires
  • Pull Examples: Checks, cards, ACH debit
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14
Q

What are some of the critical differences between the risk of push / pull pay methods?

A
  • Push is inherently less risky, because the person paying is initiating the transaction
  • Push payments can’t “bounce”
  • Pull payments not only can bounce, but rely on the payer authorizing the payee to initiate the transaction
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15
Q

Are card networks push or pull? Why?

A

Card networks are Pull payment networks. They don’t bounce, but they are still guaranteed pull transactions. To accomplish this, the card networks add an “authorization” step in whic hit answers the question “does this account have money”

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16
Q

Gross vs. Net Settlement

A
  • In a net settlement system, the net obligations of participating intermediaries are calculated on some periodic basis - usually a day. Checks, Cards, and ACH all use Net Settlement.
  • In Gross Settlement, each transaction settles as it is processed. The wire system is like this.
  • Advantage of net settlement system is that it allows for fewer actions of settlement (i.e. you only have to settle once a day) though also creates more risk (e.g. if a ban goes out of business during a settlement period)
17
Q

The two primary types of settlement, and how settlement rules are determined

A
  • End-user Settlement & Inter-bank Settlement
  • End-user settlement is the settlement that takes place between the bank and an individual
  • Inter-bank settlement is banks getting “even” with each other
  • These can be independent of each other, i.e. when a bank gives you your money immediately but settles with the bank that owes it at the end of the day
  • Rules of settlement can be determined by the payment system, regulation, or just best practices between parties
18
Q

What are “virtual” payment systems?

A
  • Systems in which there is no formal system that intermediaries “join”
  • Cash and Checking both are virtual systems in the US
  • Cash is obvious/intuitive, but checking is also technically virtual, although many banks usually join a clearing house to settle checks
19
Q

Bank and Non-Bank owned payment systems in the US

A
  • Bank-owned: ACH, Fedwire (technically owned by the fed reserve banks), CHIPS
  • Non-Bank-owned: Amex/MC/Visa/Discover, STAR, NYCE
  • No Ownership: Cash, Checking
20
Q

What are the typical topics of private systems / open loop systems operating rules? (i.e. rules for joining/participating in a system)

A
  • Technical standards: Data formats, data security standards, etc.
  • Processing standards: Time limits for submitting/returning transactions, etc.
  • Membership requirements: Types of institutions that can join, cap requirements, etc.
  • Payment acceptance requirements: Constraints on ability to selectively accept payments (i.e. you couldn’t refuse payments from a certain race, etc.)
  • Exception processing / dispute resolution: Rights & requirements of end-parties to guide the transaction disputing process
  • Fees: Rules governing charges paid to the system and interchange to intermediaries
  • Branding: Standards for use of payment system brand
21
Q

Who is the primary issuer of payments regulations in the US?

A
  • The Fed Reserve Board

- Each private system has its own private rules too

22
Q

What is interchange?

A
  • Interchange is a transfer of value from one intermediary in a payments transaction to the other intermediary in that transaction.
  • Interchange creates an incentive for one “side” of the transaction to participate in the system (issuers in the case of card networks)
  • Exists in some open loop networks, most notably the card networks in US. ACH, wire, checking don’t have interchange.
23
Q

What are the 7 primary risk areas in a payments transaction?

A
  • Credit Risk
  • Fraud Risk
  • Liquidity Risk - Risk that a member isn’t able to complete settlement
  • Operational Risk - If a party fails to do something they’re obliged to do due to failure of some process (missed a deadline, software fails, etc.)
  • Data Security Risk - exposure to fraud use of data PCI-DSS is attempt to manage this
  • Reputational Risk - People lose faith in the integrity of a given system
  • Regulatory Risk - Unclear parts of the regulatory equation
24
Q

Overall Evaluation Criteria for Comparing Payment Systems (basically review of overview)

A
  • Open or Closed Loop?
  • Push or Pull?
  • Net or Gross Settlement?
  • Private or Public ownership? Bank/Non-bank?
  • Batch or Real-time?
  • Economic Model (interchange? fees?)
  • Regulation - what operating rules & regulations are there?
  • How are exceptions/disputes handled?
25
Q

Basic Payment Systems Overview - Cash

Ownership / Regulation, Operating/Processing Rules, Push/Pull, Interchange Yes/No, Risk Management

A
  • Virtual Ownership, Fed Res Banks (FRB) + US Law
  • No Txn Processing, no Settlement
  • Push
  • No Interchange
  • Recipient bears counterfeit risk
26
Q

Basic Payment Systems Overview - Check

Ownership / Regulation, Operating/Processing Rules, Push/Pull, Interchange Yes/No, Risk Management

A
  • Virtual Ownership, Fed Res Banks + US Law
  • Batch Txn Processing, Net Settlement, electronic intrabank settlement
  • Pull
  • No Interchange
  • Recipient bears fraud & non-sufficient funds risk
27
Q

Basic Payment Systems Overview - ACH

Ownership / Regulation, Operating/Processing Rules, Push/Pull, Interchange Yes/No, Risk Management

A
  • Owned by Banks, NACHA & FRB regulation
  • Batch Processing, Net Settlement, Electronic
  • Push OR Pull
  • No Interchange (except same-day ACH)
  • Recipient bears fraud and NSF risk for Pull transactions
28
Q

Basic Payment Systems Overview - Credit Card

Ownership / Regulation, Operating/Processing Rules, Push/Pull, Interchange Yes/No, Risk Management

A
  • Public or Private Ownership (Non-bank), Network-set rules & FRB Regulation
  • Real-time Auth but batch clearing, Net Settlement
  • Pull
  • Yes Interchange
  • Recipient guaranteed good funds and protected from fraud (card-present transactions)
29
Q

Basic Payment Systems Overview - Debit Card

Ownership / Regulation, Operating/Processing Rules, Push/Pull, Interchange Yes/No, Risk Management

A
  • Public or Private Ownership (Non-bank), Network-set rules & FRB Regulation
  • Real-time Auth but batch clearing, Net Settlement, PIN or Signature cardholder verification
  • Pull
  • Yes Interchange
  • Recipient guaranteed good funds and protected from fraud (card-present transactions)
30
Q

Basic Payment Systems Overview - Wire Transfer

Ownership / Regulation, Operating/Processing Rules, Push/Pull, Interchange Yes/No, Risk Management

A
  • Bank ownership, FRB regulation
  • Real-time clearing and settlement
  • Push
  • No Interchange
  • Recipient guaranteed good funds and protected from fraud
31
Q

What are the Fed Reserve Banks?

A

The Federal Reserve System is composed of several layers.

  • It is governed by the presidentially appointed board of governors or Federal Reserve Board (FRB).
  • Twelve regional Federal Reserve Banks, located in cities throughout the nation, regulate and oversee privately owned commercial banks.
  • Nationally chartered commercial banks are required to hold stock in, and can elect some of the board members of, the Federal Reserve Bank of their region.
  • The Federal Open Market Committee (FOMC) sets monetary policy. It consists of all seven members of the board of governors and the twelve regional Federal Reserve Bank presidents, though only five bank presidents vote at a time (the president of the New York Fed and four others who rotate through one-year voting terms).
  • It has a structure unique among central banks, and is also unusual in that the United States Department of the Treasury, an entity outside of the central bank, prints the currency used.
32
Q

What are ISVs and ISOs? What are the 3 partnership methods for payments?

A
  • ISV = When a company integrates applications—like payment processing capability—into their software, thereby becoming an integrated software vendor (ISV)
    3 Partnership Methods for Software Vendors (these act on a spectrum):
  • The referral model = In this scenario, the software vendor simply refers new merchant leads to their payment partner, who is responsible for all sales and support functions. As a result, this model generally provides the smallest revenue share amongst the three models.
  • The agent program = With this model, the software vendor is generally responsible for the sales and onboarding process, while the payment processor’s role is limited to training, activation, and customer support.
  • The ISO program = If the software provider functions as an Independent Sales Organization (ISO)—hence the reference to ISO in the title of this article—the organization keeps all sales and support functions in-house. With this model, the software solution has the most control over the user experience and can maximize revenue generation, though the associated costs and share of responsibility are higher as compared to the other two models.
33
Q

Where/when did ACH come about? How did it become popular?

Payment Systems Chapter 4 - Core Systems: ACH

A
  • Started in the 1970s
  • Started by bankers working with checks who asked, “why don’t we just use the data from the checks directly instead of extracting them from checks?”
  • Government encouraged adoption by offering to pay social security benefits via ACH, bringing depository instituions into the fold
34
Q

Which type of ACH is a Push? Which is a Pull? Why does the difference matter?
(Payment Systems Chapter 4 - Core Systems: ACH)

A
  • An ACH Credit is a Push, and is initiated by the payer of funds who sends money to a receiving party
  • An ACH Debit is a Pull, and is initiated by the receiver of funds who pulls money from the paying party.

-

35
Q

What is the core value chain for the ACH system?

Payment Systems Chapter 4 - Core Systems: ACH

A

Parties + Steps:

  • Originator: Enters a transaction into the ACH payments system. Delivers the transaction to its bank, the ODFI.
  • Originating Depository Financial Institution (ODFI): Credits or Debits its customer’s account (depending if push or pull) and then forwards the transaction to its ACH Operator.
  • ACH Operator: The operator passes the transaction onto the RDFI.
  • Receiving Depository Financial Institution: Bank of the receiving party. Debits or credits its receiving customers account (depending if push or pull).
  • Receiver: Final recipient of the credit or debit.
36
Q

How is ACH settlement done & how often? Who are the two ACH Operators?
(Payment Systems Chapter 4 - Core Systems: ACH)

A
  • ACH operators calculate net settlement totals for their banks on a daily basis
  • These totals are then passed to the Fed which manages the actual settlement process using its National Settlement Service
  • Two ACH Operators = Fed Reserve Bank & Electronic Payments Network (owned by The Clearing House)
37
Q

Who owns the ACH system? What is NACHA’s primary role? What does NACHA NOT do?
(Payment Systems Chapter 4 - Core Systems: ACH)

A
  • The ACH system is owned by the banks that belong to it
  • NACHA is a nonprofit association that oversees the network
  • NACHA’s primary role is rule making for the system
  • NACHA does not play a role in marketing or brand creation, which is why there isn’t an ACH “end-brand” and why NACHA’s role is limited
38
Q

Who regulates the ACH? Who decides ACH Rules? What are the 3 groupings of ACH rules?
(Payment Systems Chapter 4 - Core Systems: ACH)

A
  • ACH transactions are governed by both the private NACHA rules and by Fed Reserve Bank regulations
  • NACHA rules bind the ODFIs, the RDFIs, and the ACH operators
  • Rules are voted on by the members of NACHA

3 Rule Groups:

  1. Rules that apply to all ACH transactions
  2. Rules that apply to ACH Debit or ACH Credit
  3. Rules that apply to specific ACH types

Fintech (3 decks)

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