Payment and Settlement Systems

Payment systems are a vital part of the financial infrastructure and market economies, and by functioning reliably and efficiently they contribute to general stability and efficiency in the economy. A core task for payment systems is to facilitate the settlement of monetary liabilities arising from the business activities of entities in markets for goods and in financial markets. Users of payment systems expect their payments to be carried out securely, quickly and efficiently, allowing debtors to settle their liabilities to creditors via the systems.

There are several definitions of payment systems. According to the Bank for International Settlements’ glossary, payments systems consist of a series of instruments, banking processes and interbank payment systems that allow money to circulate. In the widest sense, payment systems consist of the institutions, rules, procedures, instruments and technology that facilitate the transfer of money to the widest range of users. The main elements within this are the banking services and the infrastructure of the banking system – the commercial banks, the central bank and the links between them.

Particularly important are payment instruments that allow users to transfer money or to settle liabilities. Technological advances have helped in the creation of new, advanced ways of settling monetary liabilities that guarantee users greater security and speed of payments. Payment instruments are based on technical standards and contractual rules that define the mutual rights and obligations between the issuer of the payment instrument and holders in respect of the way in which the payment instrument may be used and the use of technical equipment that allows direct or indirect access to money in a transaction account.

The Slovenian Payment Transactions Act gives a narrower definition of a payment system, i.e. as a legal relationship between three or more payment system members in connection with the mutual settlement of monetary liabilities, regulated by system rules (an interbank payment system). In the narrower sense, payment systems involve the exchange of information about payments (clearing) and the transfer of money arising from payments (settlement) between banks as payment services providers that are required in the case when the payer and the recipient are not customers of the same bank (or in the case of payments between banks).

In general there are two models of systems for interbank payments. In the first model, each payment order is settled immediately upon its entry into the system in its entire (gross) amount, known as real-time gross settlement. These systems are normally operated by central banks, with the commercial banks holding settlement accounts at the central banks. A payment order sent by the first bank to debit its account is processed immediately, and provided that it has sufficient funds in its account at the central bank its account is debited to credit the account of the second bank. This procedure is applied to each individual payment.

The second model works on the principle of netting, which means that payment orders debiting the accounts of participants are collected for a certain time period, and then at the end of that time the net position is calculated for each participant on the basis of the payment orders sent and received. Netting thus entails the conversion of claims and liabilities arising from mutual payments between participants in the system into a single net claim or liability (multilateral netting) or several net claims and liabilities (bilateral netting), which is/are then received or paid by a participant. The multilateral net position or individual bilateral net positions between participants are then usually settled by transferring money via accounts at the central bank.

From the point of view of banks, the main advantage of net settlement systems (in respect of gross settlement systems) is the lower liquidity requirement that they need in order to settle payments of a specific value (only the difference between the value of an individual bank’s incoming and outgoing payments is settled by transferring funds).

This is an attractive property given the lower liquidity requirement in accounts at the central bank for settling the same amount of payments.

At the same time netting systems are more efficient from the point of view of the communications and processing capacity employed, which has an impact on the price of transactions. However, these systems expose participants to a settlement risk, as they are implicitly giving each other unsecured credit on the basis of payments that are not immediately settled in final terms. This credit is based on the participants’ readiness to participate in the system (to receive and to send payments), naturally on condition that net debtors cover their net liabilities upon settlement.

Domestic payment systems allow the exchange of payments and their settlement between banks as payment services providers within a single country. Given the increasing integration of markets for goods and financial services, there is increasing focus on the provision of interbank payment systems for cross-border payments, i.e. those where the payment services providers for the creditor and for the debtor are not from the same country. Cross-border interbank payment systems allow payment services providers from different countries to participate, allowing for the clearing and settlement of payments between them, and thus making a significant contribution to the integration of markets.