Essentials of Treasury Management –

Chapter 8
Payment Systems
Karen A. Slaughter, CTP
Amegy Bank of Texas

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 Chapter 8 - Outline
• Overview of Payment Methods
• Paper-Based Payments
• Electronic Payments
• Payment System Risk 10
• Future of Payments Questions
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

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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— „ Normally also
the delivery of the original subtracted from the
or a substitute check to the payor’s account on the
paying bank. same business day.
• Value is subtracted from
the bank’s account with a
Federal Reserve bank (the
Check 21
Fed), a correspondent bank
October 2004
or some other clearing
institution.

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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 Check COMPANY B
1. Payor writes check 2. Payee receives check

7. Deposit funds 8. Bank 8. Bank

to cover check statement statement

Federal 3. Check 5. Payment

Reserve Bank deposited through a
or correspondent bank credit to
or local clearing house payee’s
account
6. Check
presented 4. Check
BANK A forwarded BANK B
for payment
Payor’s Payee’s
depository 5. Payment depository
institution through 5. Payment institution
a debit to through a
payor’s bank credit

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 Presentment

Midnight next Review / authorize

business day / return

4:00 pm 2nd Notify on items >

banking day $2,500

Redeposit /
Chargeback
Check Clearing Timeline

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 Other Check Clearing
Considerations
• Electronic check presentment (ECP)
– 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 users

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 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
– RCPC – Fed regional check processing centers
– Country items – outside Fed city or RCPC
– HDGS – High dollar group sort; >$10M/day

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 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 account
– 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

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 Settlement and Funds Availability
• Availability Schedules
– Usually 0 – 2 days float
– POD method
– Part of pricing
• Related Funds Availability Terms
– 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
– Account 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
REGULATIONS
– Merchant Credit Cards – Reg Z
– Merchant acquirer Equal Credit Opportunity Act
– Acquiring processor Truth in Lending Act
Debit Cards – Reg E
– Issuer processor Payment Card Industry Data
– Network operator 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 Consumer
converted Account
to charge 3. Hold placed on credit limit

6. Funds remitted Credit Card

Issuing Bank 4. Authorization granted Network

Authorization = Clearing = Settlement =

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 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 An independent large-dollar funds
Interbank Payments transfer network operated by the
System (CHIPS) New York Automated Clearing
House

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 Checks and ACH Transactions
Checks ACH Transactions
Paper-based. Electronic.
Limited to payment instructions. Can transmit additional payment-
related information.
Parties are termed the payor Parties are termed the originator and
and the payee. the receiver.
Can only debit a payor’s account Can be either a debit or a credit
and credit a payee’s account. transaction; credits move funds from
the originator’s account and debits
move funds from the receiver’s
account.

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 Electronic Payments:
ACH System Participants

Originating Receiving
Depository Depository
Financial Originating Receiving Financial
Institution ACH ACH Institution
Originator (ODFI) Operator Operator (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
account information from the MICR line at the POP.
• Accounts 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-of-
purchase 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
• Passwords 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

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 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 accounts
(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 www.swift.com
through Fedwire, CHIPS,
correspondent accounts
or other RTGS systems.

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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 • Account holder daylight overdrafts.
• ACH origination • ODFI has credit exposure from ACH file
release until settlement.
• Return item • Return items exceed funds in account.
Fraud risk Altered transactions or false items that
could cause loss for the disbursing party.

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 Questions

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