What is a payment system?
What is a payment system? I am reminded of lengthy debates
around the office on just this question - and the heated and, at
times, passionate discussion that ensued. My antagonist, who is
also my partner, took one view and I took the other. The thrust
and parry of the dialogue ebbed and flowed ... long into the
night over innumerable cups of coffee.
The Bank for International Settlements (BIS) definition of a
payment system states; "A payment system consists of a set of
instruments, banking procedures and, typically, interbank funds
transfer systems that ensure the circulation of money". (From "A
glossary of terms used in payments and settlement systems",
Committee on Payment & Settlement Systems. BIS, Basel,
Switzerland. March 2003 (Revised Edition)).
Armed with this definition we can examine the components that
make up what we so glibly refer to as a "payment system". This
examination will help us see what a payment system really is.
The BIS definition focuses on "... instruments, banking
procedures ... interbank funds transfer systems". Let us examine
each in a little more detail.
* Instruments - a mere half century ago this was easy to define.
Payment instruments were basically cash and cheques. Today
however there is a vast range of payment instruments. Apart from
the cheque and cash we now have giro-payments, electronic
transfers, internet payments, debit orders, standing orders,
credit cards, debit cards, electronic "cash" and so on. And the
nature is each is vastly different from the other.
* Banking procedures - these cover a huge area. Anything that
is not an instrument or that does not relate to how that
instrument is moved, must, by definition, be related to a
banking procedure. Here there are internal bank procedures (such
as how a branch initiates payments), payments systems rules, the
agreements (such as those between banks, between banks and their
customers, between banks and the clearinghouse), national and
international payment laws and payment regulations. We must also
not forget the actual operational procedures, either manual or
technology driven within individual banks that are used to
initiate, verify and process the payment. All of these
procedures are simply to get the payment ready for the next
step, to move it to a transfer system.
* Interbank transfer systems - this covers local and national
clearinghouses (for physical instruments such as paper), ACHs
(automated clearinghouses for the electronic ones), message
carriers (such as S.W.I.F.T. - Society for Worldwide Interbank
Financial Transactions), switches for ATM transactions, the
national and international credit card networks and so on.
Missing from the BIS definition is the intrabank systems that
give effect to payment instrument transfers within the same
bank. These are transfer systems too.
The key word in the definition is "set" - for all these
components have to be combined to make up a complete unit which
achieves the desired outcome - just like a tea set with its
cups, saucers, tea-pot, strainer (or perhaps a tea-bag holder),
milk jug and sugar bowl are just the thing for carrying out
correct ritual for brewing and serving tea.
Sure, one can have tea without all this but it's not really the
same.
The analogy, while useful as a description ends here - in a
payment system the missing components give rise to a serious
problem - Risk.
Risk takes on many forms; credit risk, liquidity risk, legal
risk, operational risk, settlement risk, systemic risk and put
the whole fabric of the payment system in danger.
Despite this we often associate the word "system" with only the
technology; the bits and bites, the hardware and the software.
We tend to forget that there is a lot more that goes into making
up a payment system.
So the next time that you write out a cheque or take that credit
card from your wallet, give a thought to the process that you
are initiating in a complex structure that we take so for
granted - the payment system.