In this informative podcast episode, Craig, Hussam & Guillaume delve into the world of electronic payment systems, focusing on their use in corporate treasury.
The conversation covers various payment mechanisms, including ACH, wire transfers, RTPs, and the upcoming FedNow system, set to launch in July 2023.
The episode provides valuable insights into the complex world of payment processing, highlighting the role of banks and integrated receivables providers in streamlining the reconciliation process.
Keep reading for the key takeaways from the episode or listen to the full podcast here.
If you’d like to hear more from Corporate Treasury 101, please visit their website here or find them on any of your favorite podcast apps.
Real-Time Payments (RTP) and The Clearing House (TCH)
RTP is an innovative and faster payment scheme managed by The Clearing House. Designed to revolutionize the world of financial transactions, it enables instant payment processing 24/7, providing a more efficient, secure, and cost-effective method for transferring money between accounts, even across different financial institutions.
The Clearing House (TCH) is a highly regarded organization with a long-standing history, responsible for processing and settling transactions between banks in the United States.
TCH offers a range of financial services and operates critical payment systems, providing a reliable and trusted alternative to using the Federal Reserve's services for payment processing. By facilitating seamless communication and settlement between banks, TCH plays a vital role in the smooth functioning of the nation's financial system.
The Core Concept of Electronic Payments
Electronic payments are value-transfer instructions that begin and end electronically. They involve no physical aspect and rely on digital instructions to handle transactions. These transactions pass through various institutions and networks before settling and transferring the value to the recipient's account.
An example of this is when you pay using an ACH payment. The ACH payment process is a widely-used, secure, and efficient way of transferring money within the United States. When you send an ACH payment to someone in the US, the payment follows a series of steps involving multiple parties:
- Originating Depository Financial Institution (your bank)
- ACH Network (managed by NACHA)
- Receiving Depository Financial Institution (the recipient's bank)
The Role of Central Banks and Private Networks
Central banks like the Federal Reserve manage payment settlement rails, such as the FedWire system. However, private networks like The Clearing House (TCH) also exist as an alternative for payment processing. In the US, banks can choose between using the central bank's services or private networks for settling transactions.
ACH settlement can be done through the Federal Reserve's ACH Network or The Clearing House's private network. The choice between the two is often determined by the bank, but sometimes users can specify the payment network they prefer.
Similarly, wire transfers can be settled through the Federal Reserve's FedWire system or the private Clearing House Interbank Payments System (CHIPS). Banks can choose between these two methods for processing wire transfers.
ACH and Clearing House Options
Both ACH Network and The Clearing House follow the same rules and formats. The ACH Network is managed by the Federal Reserve, while The Clearing House is a private institution owned by banks. Banks can choose between these two options for processing ACH transactions.
Similar to ACH transactions, wire transfers can also be processed through the Federal Reserve's FedWire system or the private Clearing House Interbank Payments System (CHIPS).
The Historical Context of Availability Schedules
In the past, checks were not instant, and money transfers would take one to three days to move across the country. The Federal Reserve provided availability schedules for funds based on the check's origin, assuming normal operating conditions.
In extraordinary situations, such as the aftermath of 9/11, the Federal Reserve had to honor the availability schedules for clearing checks despite the inability to physically deliver them to their intended destinations.
The Rationale Behind Secondary Systems
Secondary systems like The Clearing House are owned by banks and can often process transactions more efficiently and at a lower cost than the Federal Reserve. This is particularly true for larger banks that clear significant volumes of transactions among themselves.
Secondary systems also serve as a failsafe in case the primary system managed by the Federal Reserve experiences disruptions or inefficiencies.
The Purpose of Clearing Houses
Clearing houses act as intermediaries between banks, streamlining the process of transferring funds. Instead of each bank maintaining individual balances with every other bank, they can use their accounts at the central bank (e.g., the Federal Reserve) to settle transactions.
When banks send money to each other, they send instructions indicating changes in the balances they owe or are owed. Clearing houses facilitate these changes and ensure that the process is more efficient and manageable.
Clearing houses play a crucial role in simplifying electronic payment transactions and maintaining efficiency in the financial system. Secondary systems like The Clearing House offer banks an alternative to the Federal Reserve for processing transactions, which can provide cost savings and improved efficiency. Understanding these systems and their roles helps us appreciate the complexity of electronic payments and the mechanisms in place to ensure their smooth operation.
SWIFT’s Role in Electronic Payments
SWIFT is a standard-setting body for formats and methods of communication. It is also a messaging network that supports non-repudiation, ensuring parties cannot deny sending or receiving messages.
SWIFT serves as a communication hub for banks and corporations, delivering messages required for settling transactions but not directly handling the settlement process.
When a party is cut out of SWIFT due to sanctions, they lose the ability to communicate about transactions. While this doesn't directly stop the settlement process, it hinders the ability to conduct global transactions.
ACH vs. Wire Transfer
One significant difference between ACH and wire transfers lies in their reversibility. ACH transfers have a revocable period, allowing customers to reverse transactions due to errors or fraud within a limited time frame. On the other hand, wire transfers are irrevocable once approved, which means they cannot be reversed or canceled, providing a higher level of finality.
Another key distinction between ACH and wire transfers is the cost associated with each method. Wire transfers are generally more expensive than ACH transfers, with costs ranging from 10 to 25 dollars, depending on the volume and the financial institution involved. ACH transfers, being a more cost-effective option, are often favored for routine transactions, such as bill payments and payroll processing.
ACH transactions are processed in batches, typically taking place overnight or on the next banking day. However, same-day ACH transactions are available within specific processing windows, allowing for quicker transfer times when needed. This batch processing system contributes to the lower cost of ACH transfers compared to wire transfers.
In contrast, wire transfers are processed individually and are essentially immediate once approved by the bank. This faster processing time makes wire transfers a preferred choice for urgent or high-value transactions, despite the higher cost.
Real-Time Payments (RTP)
Real-Time Payments (RTP) is an innovative payment system that provides instantaneous delivery, rapid settlement, and the ability to include more detailed information about the payment. Launched in 2017 by The Clearing House, RTP has become a reliable and efficient payment solution for businesses and individuals, offering a competitive cost of about a nickel (4.5 cents) per transaction, similar to ACH transfers depending on volume and the financial institution.
Aside from its speed and cost efficiency, RTP offers several other benefits such as better communication between parties due to the transmission of more comprehensive payment information, streamlining the reconciliation process and reducing manual intervention. With 24/7/365 availability, RTP ensures payments can be sent and received anytime, providing flexibility and convenience to both businesses and consumers, making it an attractive choice for various payment scenarios.
What is FedNow?
FedNow, a highly anticipated electronic payment system, is slated for launch in July 2023. With a default limit of $100,000 per transaction and a physical limit of $1,500,000, the system is poised to handle large transfers. However, each transfer will cost 45 cents, making it a more expensive option compared to ACH, wire, and RTP transactions.
Corporate Treasury Payment Considerations: Key Factors to Evaluate
When evaluating payment mechanisms, corporate treasurers must consider factors such as revokeability and the overall cost of the process, including communication with trading partners and other associated expenses.
The quality and comprehensiveness of information accompanying a payment play a crucial role in ensuring proper execution, settlement, and allocation of funds to the correct accounts and invoices.
To optimize payment processing, companies must assess whether their treasury, payables, and admin systems are capable of supporting various payment types and formats.
In conclusion, the rapidly evolving landscape of electronic payment systems presents corporate treasurers with a range of options, each with its own unique features and considerations.
From traditional ACH and wire transfers to newer payment mechanisms like RTP and the upcoming FedNow system, companies must carefully evaluate the cost, revokeability, information richness, and compatibility of each method in order to optimize their payment processing and reconciliation efforts.
As technology continues to advance, businesses must stay informed and adapt to new payment systems that can improve efficiency and streamline their financial operations, ultimately leading to more effective treasury management and enhanced financial performance.
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