Payment Building Blocks: Infographic & Quiz

Payment Building Blocks

Explore the fundamental infrastructure that underpins global payment systems.

Introduction: The Evolution of Payments

Payments have dramatically evolved from simple barter to highly automated, electronic formats. They are an integral part of any country's economy, facilitating both domestic and international commerce. The process, however, is complex and diverse, with many countries operating multiple payment systems.

What is a Payment?

A sum of money, an asset or a service given in exchange for a good or service, or the act of this exchange.

Key Evolution Drivers

• Advances in technology and security
• Changes in consumer habits and lifestyle choices
• Increased electronic payment adoption globally

The Foundation: Global Payments Ecosystem

The global non-cash payments ecosystem is built on several key components, illustrated as a pyramid.

Base: Payment Building Blocks

• Central banks & money
• Settlement finality
• RTGS & DNS systems
• Correspondent banks & time zones

Middle: Core Payment Types

• High/Low value payments
• Instant payments
• Card payments

Upper: New Forms of Money (DLT)

• Private cryptocurrencies
• Central bank digital currencies
• Stablecoins

Top: Channels & Connectivity

• Online/mobile banking
• Mobile wallets, P2P networks
• Traditional channels

Central Banks & Payment Systems

Central banks play a crucial role in maintaining financial stability and operating systemically important payment systems (SIPS).

Central Bank Roles

• Maintaining financial stability
• Setting monetary policy & controlling money supply
• Issuing physical/electronic money
• Operating RTGS systems (SIPS)
• Regulatory oversight over DNS systems

Central Bank Money & Accounts

Money held electronically in an account at a central bank or physical banknotes issued by a central bank. PSPs directly interacting with central banks maintain settlement accounts for fund transfers, ensuring settlement in central bank money.

Liquidity

Refers to a payment participant having adequate money or available balances in their settlement account.

Settlement Finality

A critical concept ensuring the irrevocable transfer of an asset, even in cases of bankruptcy or insolvency. It mitigates settlement risk.

Key Aspects

• Legal and regulatory construct: precise moment of irrevocable transfer.
• Discharges obligations between parties.
• Mitigates settlement risk (e.g., one party failing to pay).
• Achieved at different times depending on payment system (RTGS: at payment, DNS: often after, but instant payments guarantee irrevocability).

RTGS vs. DNS Payment Systems

Real-Time Gross Settlement (RTGS)

• Usually owned and operated by central banks.
• Payments are made and settled immediately.
• Offers settlement finality at the time of payment.
• Participants maintain appropriate balances in central bank settlement accounts.
• Minimizes settlement risk.
• Higher processing costs due to risk mitigation and central bank money use.
• Often referred to as High Value Payment Systems (HVPS).
• Examples: CHAPS (UK), TARGET2 (Eurozone), Fedwire (USA), RITS (Australia).

Deferred Net Settlement (DNS)

• Often operated by private sector companies with central bank oversight.
• No immediate settlement of payments.
• Transaction values are netted among participants.
• 'Balancing' settlement transactions made at predefined intervals (daily/intraday) via an RTGS system in central bank money.
• Requires significantly less liquidity than RTGS.
• Lower processing costs per transaction.
• May introduce settlement risk depending on settlement finality timing.
• Used for low-value and instant payments.
• Examples: Faster Payments Service (UK), Bacs (UK), Nacha (USA), Bankgirot (Sweden).

Connecting to a Payment System

Payment Service Providers (PSPs) connect to payment systems either directly or indirectly.

Direct Connectivity

• Provider is a direct participant.
• Must adhere to scheme rules and standards.
• Typically banks, but increasingly other regulated firms.
• Maintains settlement account with relevant central bank.

Indirect Connectivity

• Provider uses a direct participant (sponsor/agent) to make/receive payments.
• Sponsor/agent ensures indirect member's obligations are met.

Cross-Border Challenges

National payment systems are generally not interoperable, leading to complexities in cross-border payments.

Correspondent Banks

• PSPs use correspondent banks and messaging networks (e.g., SWIFT) to facilitate international payments.
• A bank in one country opens an account with a bank in another country.
• Can result in higher processing fees.

Time Zones & Herstatt Risk

• 24 time zones complicate clearing and settlement as payment systems may be closed.
• Herstatt Risk: Risk of loss in foreign exchange trading where one party delivers foreign exchange but the counterparty fails to complete its end of the contract.
• CLS (Continuous Linked Settlement) was created to mitigate Herstatt risk by ensuring payment versus payment settlement.

Infrastructural Transformation

Many countries are modernizing their payment infrastructures to improve efficiency, reduce risk, and enhance functionality.

UK Initiatives

• New Payments Architecture (NPA): aims to replace existing FPS infrastructure, consolidate payment schemes (Bacs, FPS, ICS).
• RTGS Renewal Programme: future-proofing, higher resilience, broader access, wider interoperability, ISO 20022 adoption.
• Synchronised Settlement: investigating 'atomic settlement' (payment linked to asset transfer).

Project 27 (Nordic)

• Aim: increase efficiencies in intraregional, cross-border payments.
• Intended to use open access, common infrastructure operated by Mastercard.
• (Note: Project's future uncertain as of 2023 withdrawal of clearing license application).

Australia & North America

• Australia: New Payments Platform (NPP) - hybrid infrastructure, real-time retail payments, direct link to RTGS, 24/7/365, ISO 20022, enhanced data.
• USA & Canada: Multi-year initiatives to offer 24/7/365 real-time fund transfers using ISO 20022.

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