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National payment systems (NPS) are the conduits through which buyers and sellers of financial products and services make transactions and are an important component of a country's financial system. Global financial liberalization and advancements in information technology have enabled significant updates to the architecture of large-value, retail, and securities payment systems, as well as the processes and procedures carried out by operators, administrators, regulators, and users of the systems.
In a large number of countries, a significant measure of responsibility for the integrity of the national payment system exists within the central bank. This article will provide an overview of financial payment systems and the role they play in the modern global financial system.
A national payment system is a configuration of institutions supported by an infrastructure of technology-driven processes and practices to facilitate commercial and financial transfers between buyers and sellers. A country's payment system reflects its banking and financial history and the development of supporting communications and technology platforms.
The market for payment system services operates according to supply and demand as with any market. On the demand side, users seek easy availability of payment instruments and services to meet their various financial transactions, from large-scale bank transfers to point-of-purchase transactions with retail credit instruments, such as credit and debit cards.
Users favor low transaction costs, interoperability between different systems, security, privacy, and legal protection. On the supply side, payment services provide a source of revenue for banks and other financial organizations and open up markets for providers of technology and communications products and services.
A typical national payment system includes the following institutions and infrastructure:
Banks and other depository institutions communicate with each other through a messaging and routing system. If you have a checking account with a U.S. bank, you are probably familiar with the nine-digit number on the bottom left-hand side of your checks: this is the American Bankers Association (ABA) routing transit number (RTN), which is used to identify the financial institution on which the check is written.
If your U.S. employer pays your salary via direct deposit, the transfer instructions (the messaging) are going to your bank via the automated clearinghouse (ACH), a system administered by the nonprofit National Automated Clearinghouse Association (NACHA) and operated by the U.S. Federal Reserve System (FRS) and Electronic Payments Network (EPN), a private-sector payment network.
As of September 2023, the U.S. government has spent $5.3 trillion in 2023.
The regulatory framework for the U.S. national payment system involves many government agencies and bodies at both the federal and state levels. Here are some of the key players of this framework.
The U.S. Federal Reserve plays a central role in overseeing and regulating the national payment system. It operates the payment and settlement systems that facilitate the clearing and settlement of interbank transactions. The Federal Reserve also sets monetary policy which can indirectly influence payment system operations.
The CFPB, established under the Dodd-Frank Wall Street Reform and Consumer Protection Act, has the authority to regulate and enforce consumer protection laws related to financial products and services. This may include aspects of the payment system that impact consumers. This may also include regulations governing payment cards, remittances, and electronic fund transfers.
The OCC oversees and regulates national banks and federal savings associations, including those that participate in the payment system. It ensures that these institutions adhere to relevant banking and payment regulations.
The FDIC provides deposit insurance to banks, including those involved in the payment system. While its primary focus is on ensuring the safety and soundness of banks, it also contributes to maintaining confidence in the payment system. This coverage is passed along to consumers based on their deposits.
FinCEN, a bureau of the U.S. Department of the Treasury, focuses on anti-money laundering (AML) and counter-terrorism financing (CTF) efforts. It sets AML and CTF regulations that apply to financial institutions, including those involved in the payment system.
If you happened to work for an employer in Europe but still wanted your salary paid to your U.S. bank account, the process would be similar to that described above, but rather than routing through the U.S. ACH system, the deposit message would most likely post through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, a Belgium-based cooperative society linking financial institutions in more than 200 countries.
The SWIFT code is similar to the ABA RTN number as a means to identify the bank initiating the transfer as well as the correspondent banks with which the bank has pre-existing agreements to facilitate international transfer and settlement of funds. The SWIFT platform is used by all central banks that are part of the Eurosystem, the monetary authority for the 19 European Union countries that are part of the Eurozone, including Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain.
The concept behind cryptocurrency is to overtake national payment systems. For those not wanting their payments or currency tied to a specific country, decentralized payment systems are a solution.
Clearing refers to the transmission and reconciliation of payment orders and the establishment of the final positions to be settled. Settlement is the event that actually carries out the obligations — the respective debiting and crediting of the accounts of the parties to the transaction. The integrity of the global financial system relies on the proper accounting for each transaction that takes place in the system; therefore, stability depends on the reliability and accuracy of the clearing and settlement systems.
There are three main types of clearing and settlement systems.
Clearing and settlement systems may settle on a gross or a netting basis. Gross settlement is when the settlement of funds or securities takes place individually, one transaction at a time. Netting is when large numbers of individual positions (both credits and debits) are netted together into smaller batches for processing so that settlement takes place at specified times during the business day rather than on a continual basis.
Some payment systems may operate more than one clearing and settlement platform, incorporating both netting and gross settlement. Real-time gross settlement (RTGS) has become the most widely adopted method for large value systems. Real-time in this context means that transmission, processing, and settlement of a transaction takes place as soon as it is initiated.
The U.S. Fedwire system, the primary large value component of the U.S. national payment system, settles on a real-time gross basis, as does the TARGET (TARGET2) system, which is the main large value platform for the European Central Bank and its networks of Eurozone national central banks, such as the Banque de France and the German Deutsche Bundesbank.
One of the major risks in a clearing and settlement environment is that one of the parties may default. If settlement takes place on a real-time gross basis, then the effect of a default is limited to the single transaction being processed. However, if the default takes place in a netting arrangement, then all of the parties in that arrangement—potentially hundreds or thousands—may also be at risk, and thus so may their counterparties in other transactions taking place at the same time and so on throughout the system.
This is an example of systematic risk—the risk that a failure in one part of the system will spread like a contagion throughout the system. Technology has facilitated the ability to process trillions of dollars every day through the global financial architecture. Yet each country has only a small number of individual systems, and these systems interact with each other around the world, so the ramifications of a systemic failure are dramatic.
One institution responsible for the study and development of guidelines for financial system risk management is the Bank for International Settlements (BIS), a Geneva-based institution that acts as a bank for central banks and uses various initiatives to promote cooperation between international financial and monetary systems.
In 2001, the BIS Committee for Payment and Settlement Systems (CPSS) introduced a set of guidelines for high-importance payment systems called Core Principles for Systemically Important Payment Systems. This sets out 10 principles for the prudent operation and risk mitigation for those systems—in particular, the large value clearing and settlement systems described above—where a failure in one part of the system could spread rapidly.
The Core Principles also set out recommendations for the particular responsibilities of the national central banks in operating, supervising, and using the critical systems in their jurisdictions. The sound operation of national payment systems is often explicitly set forth in the organizational mandate of a central bank. For example, the organizational mandate of the U.S. Federal Reserve System consists of five activities:
National payment systems are crucial for the functioning of an economy. They facilitate commerce, enable financial inclusion, promote economic stability, and enhance the overall efficiency of financial transactions within a country.
National payment systems support various transactions, including everyday retail payments (e.g., buying groceries), salary payments, bill payments, interbank transfers, and government disbursements like tax refunds and social benefits.
Payment service providers, such as banks and fintech companies, are essential participants in national payment systems. They offer various payment channels, develop innovative payment solutions, and connect consumers and businesses to the payment infrastructure.
National payment systems have a significant impact on the economy by reducing transaction costs, enabling efficient capital allocation, and fostering economic growth. They also help stabilize the financial sector and support the central bank's monetary policy objectives.
National payment systems are vital to the integrity of the global financial system. Technology and globalization have facilitated the rapid growth of systems for processing noncash electronic transfers between parties located anywhere in the world.
The payment system in any country will consist of a small number of retail, large value, and securities settlement systems that link into the systems of other countries through various linkage platforms and correspondent relationships. The actualization of risk, such as a party defaulting on a large value transaction, has the potential to spread throughout and thus imperil the system's integrity, making the payment system a major priority for central banks and other key institutions in the financial community.
