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).
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”, mobile payments 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, or casually use you smartphone give a thought to the process that you are initiating in a complex structure that we take so for granted - the payment system.