presented by: the northern trust company dan carey

© 2012 Northern Trust Corporation

Presented by: The Northern Trust CompanyDan Carey

Windy City Summit CTP Review

Chapters 10

Service Expertise Integrity

IntegrityExpertiseService2 Windy City Summit CTP Review

Chapter 10

Payment Systems, Collections and Disbursements

Dan Carey


Overview of Payment Methods

Payment Systems Payment Instrument/Method+Clearing Channel Settlement Mechanism that transfers money Payment System

Cash- coin and currency Paper- checks, draftsElectronic-

Business Electronic Payment Systems- wire, ACH Consumer Electronic Payment Systems- ACH or giros

Payment Card- debit and credit cards, smart cards


Payment Systems

Key Participants in the Payments Clearing ProcessPaying Bank- payor’s bankReceiving Bank- payee’s bankCorrespondent Bank- “partner” bankCentral Bank or Monetary/Banking Authority- runs

clearing systemBanking Clearinghouse- groups of banks agreeing to

exchange paymensThird-Party Clearing Entity- third-party that handles

clearing, but not settlement, process (CHIPS and credit card networks)


Overview of Payment Systems

SettlementSettlement occurs when depository bank account is credited and

drawee bank account is debitedPayee’s and payor’s account credited and debitedProvisional credit: credit may be reversedReal- time settlement: transaction processed when initiated;

settlement may be transaction by transaction (gross), intraday, or netSettlement is final when payment unconditional and irrevocable-

returns not accepted

Settlement MethodsExchange of value between banksCorresponding bank accountsReserve accounts at banking authority (Fed accounts)


Common Payment Practices and Issues

Society for Worldwide Interbank Financial Telecommunication (SWIFT)Interbank network that allows banks to send electronic

payment-related information in standard formats

Cash PaymentsSecurity and integrity issues and costly

Paper-Based International PaymentsSlow, complicated and expensive

Industry-Based Net Settlement SystemsAirlines, oil and gas, telecommunications and securities

Electronic Payment SecurityEncryption, Authentication, Security Tokens


Global Banking Systems and Practices

Identification of Bank Accounts Bank Identification Code (BIC): international standard for

identifying banks International Bank Account Number (IBAN): international

standard for identifying bank accounts European Payment Systems

Economic and Monetary Union (EMU): to integrate the economies of all them members

European Central Bank (ECB): sets policy for EU members that have accepted the euro as their currency (in “euro zone”)

Advantages of euro include elimination of exchange rate risk, lower transaction costs, consolidation of banks and simplification of treasury management techniques



Settlement MechanismsTARGET2Correspondent BankingInternal Networks and Local Clearing ChannelsEuro Bankers Association (EBA)

Single Euro Payments Area (SEPA)Straight-thru electronic payment system that allows cashless

transactions be made in euro zone using only one bank and one set of instructions



Bank of Canada is the central bank 5 major banks and 60 other smaller financial institutionsAutomated Clearing Settlement System (ACSS)The Large Value Transfer System (LVTS)

Banco de Mexico (Banxico) is central bank Two major clearing/settlement channels

Sistema de Pagos Electronicos Interbancarios (SPEI)Sistema de Camara (SICAM)



Anti-money laundering (AML):legal constraints requiring financial institutions to prevent or report suspected money laundering activities

Financial Action Task Force (FAFT): set policies aimed at combating money laundering and terrorist funding (travel rule)

Office of Foreign Assets and Control (OFAC): U.S. office that administers and enforces economic and trade sanctions (provides list of specially designated individuals)

Continuous Linked Settlement (CLS): a simultaneous exchange of both sides of financial transactions eliminating settlement risk

Straight-Thru Processing (STP): allows for information that is electronically entered in the settlement process to be processed without manual intervention.

International Organization for Standardization (ISO) 20222 Global Standards: global messaging standard related to SEPA and is the next generation of SWIFT messaging


Paper-based Payments

Check/IRD Clearing Process

Deposit of check at Bank of First Deposit (Payee Bank)

Bank encodes amount then runs checks on a reader/sorter which captures images (IRD) and processes physical checks based on MICR line information

Checks/Images are sorted based on clearing channel, cash letters /image files are prepared and sent to the clearing system for presentment to the paying bank


Check Clearing Process

Check 21:Created Image Replacement Document (IRD) allowing banks

to exchange images rather than paper documentsAllowed for the introduction of Remote Deposit Capture (RDC)

Return deadlines Clearing Channels

On-Us vs Transit Check ClearingEndpoints: location of the paying bankDeposit Deadlines and Timing

Ledger cut-off: time a check must be received in order for it to be posted for ledger (provisional) credit that day

Deposit deadline: time it must be received to qualify for availability stated in availability schedule


Check Settlement and Funds Availability

Availability SchedulesStates, by endpoint, when the bank grants available

credit for collected items (generally 0-2 days)

Balances and FloatLedger Balances: reflect all entries, available or notAvailable Balances: funds available for withdrawalCollected Balances: Average ledger – deposit float

used to determine earnings credit

Other Factors Influencing AvailabilityPre-encoding/RDC/Image CaptureReject ItemsAs-of Adjustments


Other Paper-Based Instruments

Payable Thru Drafts (PTD)

Pre-Authorized Draft

Remotely Created Check (RCC)

Money Order

Traveler’s Check

Sight and Time Draft

Cashier’s Check/Certified Check

State Warrants


U.S. Payment Systems and Instruments

Check Conversion: converts MICR line into electronic debit transactionPoint-of-Purchase (POP) Check Conversion: information

captured and check returned to customer at time of purchaseAccounts Receivable Conversion (ARC): Lockbox checks

converted, with prior authorizationBack Office Conversion (BOC): conversion after sale if

stated on the receipt

Ineligible for Check ConversionGreater than $25,000If Aux on-us field (business checks)Third-party checks, credit card checks, money orders,

traveler’s checks, cashiers checks


Electronic Funds Transfers (EFT)

The Automated Clearing House (ACH)Clearinghouse for high-volume, low-dollar electronic transactions

NACHA establishes and administers rules and standards, UCC Article 4A covers credit transactions and Reg E governs consumer debit entries

Parties involved in ACH entries include: the originator, receiver, originating depository financial institution (ODFI) and the receiving depository financial institution (RDFI) and the operator (Fed or EPN)

ACH credits: instruct the ODFI to move funds from the originators account to the receiver’s account with the RDFI (e.g. direct deposit of payroll, benefit payments, tax and vendor payments)

ACH debits: instruct the ODFI to take funds from the receivers account at the RDFI and deposit them into the originator’s account at the ODFI (e.g. mortgage payments, insurance premiums, check conversions)



ACH Transaction ProcessingBatch, store and forward systemTransactions are value dated (settlement dates)Simultaneous settlement between originator and recieverMemo posting commonRisk associated with the ODFI’s obligation to settle credits once credit

file is released, regardless of originator’s account statusReturns allowed (unauthorized vs. authorized)Same-day settlement of on-us and possibly other entriesStandard ACH formats (by SEC code) including addenda record

formatsPrenotes optional but recommendedAuthorization required for certain transactions (usually consumer)


Payment Format

SEC Code

Payment Type

Definition Examples Addenda included?

Prearranged Payment and Deposit

PPD Consumer Consumers authorize a company/bank to credit/debit for recurring payments in fixed amounts

Credit: direct deposit of payroll, tax refundsDebit: membership dues, utility payments

No

Corporate Credit or Debit/CCD Plus Addendum

CCD, CCD+

Corporate Concentration or disbursement of funds between companies

Vendor payments; CCD+ for tax payments

CCD: NoCCD+: Yes,

one

Corporate Trade Exchange

CTX Corporate For payments with a lot of invoice detail

List bill payment Yes, up to 9,999 records

Represented Check Entry

RCK Consumer Used to collect for checks returned NSF or uncollected

Must be under $2,500 and with permission

No

International ACH Transaction

IAT Business/ Consumer

Debit/credit entry that is part of an int’l transaction

U.S. Company paying payroll to employee living abroad

Yes- mandatory




Payment Format

SEC Code

Payment Type

Definition Examples Addenda included?

Check conversion formats

ARC, BOC, POP

Consumer Conversion of paper check entries to electronic payments

MICR line extracted at grocery store- check returned to consumer

No

Customer-Initiated Entry

CIE Consumer Pre-authorized payments initiated via telephone bill paying services

Telephone investments, redemptions

No

Telephone-Initiated Entry

TEL Consumer Payments initiated via phone, approved over the phone vs. pre-authorized

Ticket sales No

Internet-Initiated Entry

WEB Consumer Single or recurring entries initiated via Internet, that are not. pre-authorized, and provide debit authorization

On-line purchase No

Destroyed Check Entry

XCK Consumer Used to settle checks lost or destroyed due to catastrophe

Check destroyed in flood, fire…

No



IATs: any transaction that is sent to, or received from, a foreign source and includes domestic transactions funded internationallyMust include mandatory addenda records to comply with OFAC

Fed Global ACH Payments:Credit payments 35 countries, debits to CanadaAccount to account or Account to ReceiverFixed to variable: U.S. dollar to destination currencyFixed to fixed: U.S. dollar to U.S. dollar or foreign currency to

foreign currencies



FedwireFedwire transfers settle individually and continuously –gross

settlementLarge dollar and/or urgent transactionsFederal Reserve guarantees finality of paymentFunds and information transferred togetherExpanded Fedwire format aligns with CHIPS, SWIFT and

combats money launderingRelatively expensiveRegulated by Federal Reserve Regulation J and UCC4A



Fedwire TypesRepetitive transfers (pre-defined debit and credit

parties)Semi-Repetitive transfers (adds description)Non-Repetitive transfers (free-form)Drawdown (Used for concentration)Standing (Used for concentration)



Clearing House Interbank Payments System (CHIPS)Operated by The Clearing House AssociationFor international transactions, letter of credit and documentary

collections payments and third-party transferClears over 95% of international payments made in U.S. dollarsSpecific CHIPS format accommodates extensive informationReal-time intraday net settlement systemSettles in U.S. dollars via Fedwire

Alternative Payment InstrumentsMoney transfer via Check cashing storeOn-linePaypal



Credit CardsTwo primary bank-issued cards are VISA and MasterCard

(AMEX main non-bank card)Three main steps in the credit card transaction: authorization,

clearing and settlementMerchant charged fees from issuing bank (IRF fees) and

network either during settlement process or separately which are set by the network

Fees tied to the swiping of a card at POS are cheaper than internet or phoned in (MOTO) transactions



Debit cards - direct access to cardholder accountSignature or PIN based

Purchasing cardsTravel cardsGhost CardDepartmental (Un-named) cardsSingle-Use cardsStored Value cards (SVC)Smart cards



Collection Float Components Mail Float Processing Float Availability Float

Measurement Float is measured in dollar-days Float is a function of the transaction’s dollar amount and

the number of days delay



Company Processing CenterPrimary advantages: control of operation, cost savingsPrimary disadvantage: increased float

Lockbox Advantages: reduced float, scalability, efficient processingDisadvantage: loss of control

Wholesale• Small volume, large dollar corporate to corporate

payments with non-standard remittance data Retail

• Large volume, small-dollar consumer-to-corporate payments with standard return document (ICR,OCR,MICR)

Hybrid



Cost Benefit Analysis: Reduced Float vs. Incremental CostsNet Benefit Calculation:

Reduction in Float Opportunity Cost

+ Reduction in Internal Processing Cost

- Lockbox Processing CostsFloat Opportunity Cost is a function of

the dollar amount of collected itemstotal collection time for the itemscompany’s current investment or borrowing rate



Electronic Payment Methods – Three Benefits:Predictability of settlement improves cash forecastingDirect payments to any account or financial institution Ease of transmitting customer remittance information

Check 21Enhances collection efficiency

Conversion of checks to ACH debits – POS, ARCWeb based – integrated billing and payment

EBPP (Electronic Bill Presentment and Payment) - ConsumerEIPP (Electronic Invoice Presentment and Payment) -

Corporate


Disbursements

GoalsDisburse funds to payees in timely and accurate mannerCommunicate information to cash manager for cash

forecasting and position management

Disbursement ProductsControlled disbursement – same-day notification of check

clearingsPrograms impacting controlled disbursements

Payor Bank Services – electronic notification High Dollar Group Sort – second presentment to banks

with more than $ 10 million in daily presentments Same Day Presentment – by 8:00 am


Disbursement Products

Payable Through Drafts (PTD)Drawn against payor, not bankUsed by insurance companies

Positive PayPayee matchReverse positive pay

Multiple Drawee Check/Payable-If-Desired (PID)Imprest or Petty Cash AccountAccount reconciliation services

Full or partial reconciliationStop payments and high-order prefix

Image-based Services


Electronic Disbursement Methods

Direct DepositPurchasing/Procurement Cards (P/Cards)

Issued to designated employeesAuthorized for pre-specified types of purchasesCost savings:

Reduce check volumes Negotiated terms with major suppliers Rebates from card providers

Electronic Benefit Transfers and Payroll CardsTax Payments (TXP) Format


Questions for Chapter 10

1. What is the Automated Clearing House(ACH) system?2. Discuss the obligations of the originating depository financial institution and the

receiving depository financial institution regarding ACH settlement and returns.3. What is same-day ACH? 4. What are prenotes and why are they used?5. What is the Fedwire? What Federal Reserve regulation governs Fedwire transfers?

How does Fedwire clear and settle funds transfers?6. What are the three steps(and substeps) in the credit card transaction process?7. How long do consumers have to dispute a credit card transaction and what can a

merchant do to respond to this chargeback?8. What is a lockbox processing system? What is the primary advantage of an

lockbox? What is the major advantage of a traditional check/mail-based lockbox system over a company processing center?

9. Define dollar-days. How are dollar-days relevant when deciding whether to switch from in-house processing to the use of a lockbox system?

10. What is the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and what does it do?

presented by: the northern trust company dan carey

Documents

payment unconditional

drawee bank account

depository bank account

money payment systemcash

international standard

credit cards

payors account

channel settlement mechanism