There are several different kinds of payment. These include simple payments, for example those made in cash, and more complicated payments, for example card payments where one or more
intermediaries are required to make the payments. Three different types of payment and the demands they impose on the financial infrastructure are described below.
SIMPLE PaYMENTS
a simple payment involves, for example, the buyer paying the seller with banknotes or coins. No intermediary is required for such a payment and there is no time lag between the initiation and completion of the payment. Figure 5 provides an example of a simple payment.
PaYMENT USING aN INTERMEDIaRY
The major difference between a simple payment and a payment using an intermediary is that the latter requires an underlying and supporting structure. More parties are thus required than those directly involved in the transaction.
an example of a payment using an intermediary is an account transfer between two individuals with accounts at the same bank where the payer initiates the payment by instructing the bank to transfer the money. The bank then transfers the money from the payer’s account to the recipient’s account and informs the recipient that his/her account has been credited. When the transfer is executed the payment is settled and thus completed.
Figure 6 illustrates the transaction between a and B when a and B have accounts with the same bank. The bank receives information on the transaction, debits a’s account and credits B’s account by the same amount.
PaYMENT USING SEVERaL INTERMEDIaRIES
The picture becomes more complicated if a and B have accounts with different banks. It is then necessary to have more systems and a more developed financial infrastructure to be able to transfer information on the transaction between the parties concerned. Such an infrastructure covers not only systems but also all the routines and regulations required to manage an account-based payment from beginning to end.
Consequently, there is usually a time lag between the initiation and
Figure 6. Example of a payment using an intermediary
Payment Product or service Information a’s bank account B’s bank account
A B
Bank
B A
A
Buyer
Seller
B
Figure 5. Example of a simple payment
Payment Product or service Buyer
A
Seller
B
the completion of the payment.98 The financial infrastructure that is required for this type of payment is illustrated in Figure 7.
a and B may, for example, be private individuals, companies or authorities. a buys a product or service from B, and pays for it by making some type of payment to B.
The processes used for this type of payment can generally be summarised in three stages. In the first step, the payment is verified and authorised. This often takes place in connection with the actual payment and involves verifying the identities of the parties. The balance in the account of the payer is also checked in this step. If the verification shows that there are sufficient funds the payment can be approved, i.e. authorised.
The second step entails clearing the transaction. This involves compiling instructions and information about the transfer. The
transaction is cleared by a clearing organisation. In the example shown in Figure 7, clearing involves a compilation of the transactions between two parties, a’s and B’s banks, and is therefore referred to as bilateral clearing. If more accounts and payment intermediaries are involved the compilation of transactions can be conducted for all the counterparties at the same time, so-called multilateral clearing.
Clearing orders can be calculated as either gross amounts or net amounts. a’s bank may, for instance, need to pay B’s bank SEK 100, while B’s bank has to pay a’s bank SEK 50. If the clearing order is calculated in gross amounts, that is in terms of the total sums, then this means that a’s bank pays SEK 100 and B’s bank pays SEK 50.
alternatively, the clearing organisation can use bilateral netting. This consists of two parties offsetting their debts and claims against one another. The effect is to reduce the parties’ risk exposures to each other and thus their liquidity requirements. If the clearing positions
98 Recently, however, some institutions have begun to offer what are known as real-time payments where the time lag shrinks to a few seconds. One example of this is the banks’ new payment service Swish.
Figure 7. Example of a payment using several intermediaries
Buyer
A
Bank ASeller
B
Bank B
Clearing-house
Settlement system Bank A Bank B
are compiled, then a’s bank will pay SEK 50 to B’s bank. Multilateral netting involves all the participants’ debts and claims being offset against one another. Each participant then will have a single amount due from or payable to the other participants.99 In some cases, clearing can instead be conducted through a central counterparty.
In the third and final step, the payment is settled. This means that the actual transfer is made from the payer’s account to the recipient’s account. Prior to settlement, it is checked that there are liquid funds in the accounts that the banks themselves hold for this purpose in a settlement system. The payment leads to the sender bank’s account being debited and the recipient bank’s account being credited with the amount transferred. The sending bank debits and the receiving bank credits the customers’ accounts.
This settlement process is normally conducted using the accounts that the banks and some other financial companies, for example the clearing organisations, have with the relevant national central bank.
Settlement thus takes place using central bank money in the accounts in a settlement system that can be likened to a bank for the banks.
Read more about the Swedish settlement system in the section on RIx and on the settlement system Payments in real time in the section on Bankgirot.
When the three steps of verification/authorisation, clearing and settlement have been carried out, the payment is complete – it is usually said that the payment is final and irrevocable after settlement.