Payments at Glacial Speed
A Little Bit of Money
Thought Experiments on Cross-Border Payments - Of Couriers, Bankers, and Bitcoiners
Series 23: The Never-Ending Story: Payments at Glacial Speed
The Black Hole of the Banking Galaxy and Other Horrors
Once a wire payment is sent off, it disappears into the black hole of the banking galaxy, and somehow miraculously pops back up a few days later. Where have all the funds gone in the meantime? The answer to this publicly unresolved riddle is hidden in the phrase “clearing and settlement.” Clearing and settlement happen in the background. The payments desk in the cash management department of the bank handles this nebulous money. This process takes time because it is done through the back office, involving various manual procedures performed by bank officers and their computing machines.
The Drawbacks of Traditional Wire Transfers
The drawbacks of traditional wire transfers utilizing the age-old Nostro-Vostro clearing and settlement procedure are apparent – it is both time consuming and costly. To send a typical $5,000 payment from one country to another, bank customers in most countries - whether they are developed or developing - must pay up to $50 in fees, plus a percentage of the amount paid if the transaction also includes a currency exchange. Even in the age of instant gratification, wire payments take a few days to reach their destination. The payee is not given any estimated time of receipt or any tracking information showing the whereabouts of the money, or the potential obstacles preventing the payment from reaching its destination.
Clearing and Settlement – The Fraternal Twins
Clearing and settlement are fraternal twins, even though the terms are often used interchangeably. Clearing, by definition, is the process that happens after payment authorization. It is the entry booking – the “departure” so to speak – followed by another booking once funds are settled, which is the “arrival”. Hence, a settlement is the process of balancing the accounts, or the actual movement of the funds.
A Distinction Between Clearing and Settlement
Transparency is lacking when funds are in movement because the small difference between clearing and settlement cannot be verified; it is an internal process. Therefore, normal banking processes are hardly comprehensible, as clearing and settlement are separate. For cross-border payments at least, the possibility of a real-time transfer or tracking payments has so far been a utopian dream. But don't shut out the banking business.
Instant Bank Transfers Challenging the Economics of Banks
As for domestic transactions, the US is the frontrunner in this realm. NACHA, their national automated clearinghouse is finally moving toward same-day ACH processing in September 2016. With regards to cross-border payments, Europe is on topic. Banks are discussing SEPA instant transfers, but so far, no financial institution has jumped on the bandwagon because there is no money to earn. European customers expect immediate and free payments as part of their regular banking services.
To be continued. Further Reading:
D. Broom. "Cross-border payments systems: Regulation, innovation and the impact of new entrants." Journal of Payments Strategy & Systems 9.2 (2015): 156-163.
Euro Retail Payments Board (ERPB). Statement following the second meeting of the ERPB held on 1 December 2014, published at www.ecb.int.
Summers, Bruce J., Wells, Kirstin E. “Emergence of immediate funds transfer as a general purpose means of payment”, Economic Perspectives, Federal Reserve Bank of Chicago, Q3 2011.