Bank Settlement Process

A typical Payment Settlement Process
Bob
Jake
Bob wants to send money $100 to Jake and uses (for example) a Mobile to Mobile (P2P) payment solution to send money instantly. ! Both are using two different banks. How does this work?
Faisal Khan (Payments Consultant) http://about.me/faisal.khan
(c) Copyright 2013-2014. Faisal Khan & Company. All Rights Reserved.
Bob
Jake
Lets use the example above, Bob wants to send his friend Jake money. Assuming they are using some real-time mobile solution that sends money across instantly. ! Both Bob & Jake are using two different banks. So the question usually asked is how is the money instantly transferred across? ! In Bob's bank? how does the core banking software move money and how is this money, suddenly posted in Jake's bank account, which might be using a different core banking software?
Faisal Khan (Payments Consultant) http://about.me/faisal.khan (c) Copyright 2013-2014. Faisal Khan & Company. All Rights Reserved.
SWITCH
X Bank Used by Bob
Y Bank Used by Jake
Settlement Bank Z for the P2P System (Switch)
In most cases, a settlement bank is used. The settlement bank will usually settle all the net transactions at the end of the day (at a particular anointed time and will settle the net funds for all the participating member banks). In this example, let us consider three banks:
!
X-Bank (which is the bank Bob uses) Y-Bank (which is the bank Jake uses) Bank Z - which is the settlement bank for all these participating banks using the switch.
SWITCH
-$100
+$100
X Bank Settlement Bank Z for the P2P System (Switch)
Y Bank
At a particular time, (lets take this clock for example), when Bob sends money across to Jake, at 9:40:00 AM, a message is generated on a switch (think of a switch as a nancial router/ authority that both the banks agree-to/listen-to). This message (and lets not get into the technical details of the message) simply says, in a secure, irrevocable manner that: ! "Y-Bank, please pay Jake US$ 100, as I have already taken US$ 100 from Bob, from his X-Bank". ! ! Remember, nothing more than a message is sent across. No money actually moves. Just an "instruction" (or message).
SWITCH
-$100
+$100
X Bank
Y Bank
Bob Bank Account: Debit US$ 100 Bank-X Settlement Account: Credit US$ 100
Jake Bank Account: CREDIT US$ 100 Bank-Y Settlement Account: DEBIT US$ 100

Here is where the magic that seemed so confusing, actually happens - how does the money move? ! The short answer is - its doesn't move (yet!) ! X-Bank will deduct money from Bob's account (US$ 100) and credit this money in its own bank Settlement Account. Think of this settlement account as an SWITCH IOU Account, or a safekeeping account. ! Y-Bank will take money from its own Settlement Account or Switch IOU Account, and credit the money to Jake's account. ! The assumption here was, that when both these banks decided to do business with the switch and each other, they decided they would need a Settlement Account and this account will be funded by the bank's own money, which would be used to fund the transfers, pending the actual net settlement of funds.

In simple words, we will loan the money to whomsoever needs it immediately, because I have already been assured by the switch that the money is available, and you will settle with me later on.
! ! !
If you assume that both X-Bank and Y-Bank started the day with US$ 1,000 in their settlement accounts, then this is how the ledger would reect as the transaction was done: Before Transaction: X-Bank Settlement Account: US$ 1,000.00 Bob's Bank Account: US$ 100.00 Y-Bank Settlement Account: US$ 1,000.00 Jake's Bank Account: US$ 0.00
! ! ! !
(Lets assume Bob has US$ 100 only and Jake has zero money, at the start of the transaction). After the transaction is done, this is how the accounts will look like: X-Bank Settlement Account: US$ 1,100.00 Bob's Bank Account: US$ 0.00 Y-Bank Settlement Account: US$ 900.00 Jake's Bank Account: US$ 100.00
SWITCH
X Bank Used by Bob
Y Bank Used by Jake
Settlement Bank Z for the P2P System (Switch)

End of Day Settlement Time (Batch Processing)
During the day, a lot many transactions can happen, back and forth for different accounts between each participating member bank. As a switch operator or payment system operator, they too will have a Settlement Bank to use.
!
Participating banks appoint a time when they will do net settlements (transfers In/ Out) with the Settlement Bank of the Switch Operator. This is usually done during banking hours for RTGS type of a transfer.
Settlement Bank Z! for the P2P System (Switch)
X Bank! Used by Bob
Y Bank! Used by Jake
Bank-X Settlement Account: Debit US$ 100 - 1 Transaction bank-z settlement Account: CREDIT US$ 100 - 1 TRANSACTION
Bank-Y Settlement Account: credit US$ 100 - 1 Transaction bank-z settlement account: debit US$ 100 - 1 TRANSACTION

So, the nal ledger of accounts would looks something like this:
!
Before Transaction:
!
X-Bank Settlement Account: US$ 1,000.00 Bob's Bank Account: US$ 100.00 Y-Bank Settlement Account: US$ 1,000.00 Jake's Bank Account: US$ 0.00 Bank-Z: Settlement Account for X-Bank: US$ 0.00 Bank-Z: Settlement Account for Y-Bank: US$ 0.00
!
After the transaction is done, this is how the accounts will look like:
!
X-Bank Settlement Account: US$ 1,100.00 Bob's Bank Account: US$ 0.00 Y-Bank Settlement Account: US$ 900.00 Jake's Bank Account: US$ 100.00 Bank-Z: Settlement Account for X-Bank: US$ 0.00 Bank-Z: Settlement Account for Y-Bank: US$ 0.00

and the end of the batch process day, this is how the ledges would look like (expanding it to show how the transfer are made)
X-Bank Settlement Account: US$ 1,00.00 Bob's Bank Account: US$ 0.00 Y-Bank Settlement Account: US$ 900.00 Jake's Bank Account: US$ 100.00 Bank-Z: Settlement Account for X-Bank: US$ 100.00 Bank-Z: Settlement Account for Y-Bank: US$ 0.00
! !
and transfer to the nal Bank (Y-Bank): X-Bank Settlement Account: US$ 1,00.00 Bob's Bank Account: US$ 0.00 Y-Bank Settlement Account: US$ 900.00 Jake's Bank Account: US$ 100.00 Bank-Z: Settlement Account for X-Bank: US$ 0.00 Bank-Z: Settlement Account for Y-Bank: US$ 100.00
! !
Final transfer to Y-Bank X-Bank Settlement Account: US$ 1,00.00 Bob's Bank Account: US$ 0.00 Y-Bank Settlement Account: US$ 1000.00 Jake's Bank Account: US$ 100.00 Bank-Z: Settlement Account for X-Bank: US$ 0.00 Bank-Z: Settlement Account for Y-Bank: US$ 0.00
Now you will notice...

!
X-Bank's Settlement Account and Y-Bank's Settlement Account have both been topped up back to their initial investment of US$ 1,000
!
Bob's Bank Account is US$ 0.00 Jake's Bank Account is US$ 100.00
!
and the Settlement accounts at Bank-Z for X-Bank and Y-Bank are US$ 0.00 each as all has been settled.

Bank Settlement Process

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Bank Settlement Process

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A typical Payment Settlement Process

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

A typical Payment Settlement Process

X Bank Used by Bob

Y Bank Used by Jake

Settlement Bank Z for the P2P System (Switch)

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

A typical Payment Settlement Process

X Bank Settlement Bank Z for the P2P System (Switch)

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

A typical Payment Settlement Process

A typical Payment Settlement Process

A typical Payment Settlement Process

X Bank Used by Bob

Y Bank Used by Jake

Settlement Bank Z for the P2P System (Switch)

A typical Payment Settlement Process

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

Settlement Bank Z! for the P2P System (Switch)

X Bank! Used by Bob

Y Bank! Used by Jake

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

A typical Payment Settlement Process

A typical Payment Settlement Process

Now you will notice...

Faisal Khan (Payments Consultant) http://about.me/faisal.khan

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