CHAPTER 2

THE PAYMENTS SYSTEM

Topics
2.1 Overview
2.2

The retail payments system

2.3

The wholesale payments system

2.4

Management of ES funds by ADIs and the RBA

LEARNING OBJECTIVES
Present an overview of Australias payment
system
Describe the main retail payment
instruments and explain the deferred net
settlement system and the proposals for
replacing it with faster settlement
arrangements
Describe real-time gross settlement of
wholesale payments and explain how its
liquidity pressures are overcome
Explain the management of exchange
settlement funds by ADIs and the RBA

INTRODUCTION
The payments system performs the
settlement function
Without a payments system we would rely on
barter to trade
A payments system settles transactions using
money - money can be:
cash which remains the most commonly
used payment instrument, albeit for small
transactions
payments orders are more important
when measured by the total value of the
payments

2.1 OVERVIEW
A transaction is an agreement between a
buyer and seller to exchange an item (or
service) for payment
Most consumer transactions are settled
immediately
Whereas transactions in the financial
settlement occurs
markets
an agreement
are made
is in two stages:
a specified number
made between the
buyer and seller
that specifies the
terms of the trade

a specified number
of days later when
payment is made
and ownership of
the asset transferred

PAYMENT ORDERS

Most transactions are between households

and businesses, or between businesses, and
many are settled with payment orders

Payment orders are instructions to an ADI

to pay the stated amount to the
nominated party
Where the drawer and recipient of a
payment order use different ADIs, a system
is required for the drawers ADI to pay the
funds to the recipients ADI

EXCHANGE
SETTLEMENT ACCOUNTS
ESAs are funds that financial institutions
hold with the RBA to settle the payments
they make to each other and with the RBA
The benefits of ESAs are:
1. they enable ADIs to provide payment
services to their customers
2. they are safe
3. the RBA pays interest on the end-of-day
balance
. but the accounts cannot be overdrawn

INTERBANK
PAYMENT ORDERS
Interbank payment orders require:
Clearing where the ADIs agree on their
payment obligations to be settled using ES
funds

Settlement the actual transfer of ES funds

from the paying to the receiving ADI
(by the Reserve Bankss Information and Transfer
System) (RITS)

SETTLEMENT SYSTEMS
The two long-standing settlement systems have
been:
1.

The wholesale system which uses realtime gross settlement

the individual settlement of payments
immediately upon clearing
instructions are received from the debt
markets clearinghouse (Austraclear) and
FX market (SWIFT)

2.

The retail system which uses deferred

net settlement
retail payment orders are net cleared and
settled as a batch at 9am next business

THE PAYMENT SETTLEMENT SYSTEM

The batch
feeder facility
net clears
specific groups
of payments
(such as share
transactions)
and then settles
real-time

RETAIL AND WHOLESALE

PAYMENTS

THE PAYMENTS SYSTEM BOARD

Through this board the RBA is responsible
for:
controlli
ng risk

promotin
g
efficienc
y

promoting
competitio
n

within the
payment
system

The PSB is fulfilling its responsibilities by

pursuing reforms to reduce risk and
improve the competitiveness and efficiency
of the payments system

2.2 THE RETAIL PAYMENTS SYSTEM

The main retail payment orders are:
direct entries
chequ
debit and
(credits and
es
credit cards
debits)
Each must be
authorised by the payer (by signature or
PIN) , and
verified to reduce the incidence of
fraudulent payment orders (by PIN or
inspection of signature)
ADIs charge fees for providing payment
services, usually payable by both depositors
and merchants

2.2.1 DEFERRED NET SETTLEMENT

Inter-ADI retail payment orders are:
i. cleared after hours when each ADI is able
to tally the amounts deposited during the
day, and calculate the net transfers
required to settle the days payment orders
the RBA is then advised of the cleared
net obligations
ii. settled at 9am on the next business day
(that is, settlement is deferred) by the
transfer of the net amounts of ES funds

EXAMPLE OF NET SETTLEMENT

Assume the days deposits require:
Alpha to settle payments worth $70 to Beta and
$50 to Delta,
Beta is required to pay $60 to Alpha and $45 to
Delta, and
Delta is required to pay $40 to Alpha and $60 to
Beta

DNS AND RISK

The main benefits of DNS are:
it handles the very large number of
payment orders that are deposited each
day
by net clearing, the amount of funds that
has to be transferred between ADIs is
greatly reduced
Its main disadvantage is deferred settlement
poses settlement risk because ADIs are
owed net payments
this is the risk of default by the banks of
their DNS net cleared obligations

2.2.2 PAYMENT ORDERS

(a) DIRECT DEBITS AND CREDITS
Direct entries allow businesses and other
organisations to make payments to, and
receive payments from large groups
(through arrangements made with their ADI)
Direct credits are payments to an account
holder, such as salary payments
Direct debits are payments from an
account, such as loan payment deductions
They are pre-authorised and verified
electronic payment orders that are highly
efficient, reliable and low cost

2.2.2 (b) CHEQUES

Cheques are a dated, paper-based
instruction to the drawers ADI to pay the
stated party the stated sum from the
drawers ADI account
They are cleared and settled (via DNS) prior
to their verification
funds are credited once deposited, but
access to funds is delayed until verification
the depositor faces the risk that a cheque
fails verification and deposit is reversed

CHEQUES continued

Cheques are expensive to process and

so have largely been replaced with direct
debits and credits, particularly for regular
payments

2.2.2(c) DEBIT, CREDIT AND

CHARGE CARDS
Debit cards are issued by ADIs to their
depositors to enable them to access funds in
their deposit account

Debit cards can be used to access funds and

settle transactions via ATMs, EFTPOS
terminals and ADI branches

Banks usually charge customers an annual

fee for their debit cards and may charge a
small transaction fee, depending on the
cardholders account

CREDIT CARDS
Credit cards are used to make payments,
initially from the credit card companys
account (Visa or MasterCard) with the option
of borrowing funds to cover the unpaid balance
on the due date
Credit card
used for
payment

deposited by
merchant

customer
billed
monthly

customer
pays bill

merchant paid by
card companys
bank next day
(DNS)
or pays interest
on unpaid
amount

CHARGE CARDS
Cards issued by a company for use in settling
transactions on the condition that the full
amount owing is paid on the monthly billing
date
These are American Express and Diners
Club
not part of the DNS system - the
merchant submits the payment
instruction to the card company
the card company will deposit the funds
in the merchants ADI account in due
course
the cardholder receives interest free

2.2.3 THE USAGE PATTERN OF

RETAIL PAYMENT ORDERS

TRENDS IN THE USAGE OF RETAIL

PAYMENT ORDERS

Debit cards are the most commonly used

payment order followed by credit cards
but the average amount of card payments
is small and represent only 2.8% by value
PSB reforms have rationalised card fees
and this has contributed to the growth of
debit over credit cards

Direct debits and credits dominant in

terms of the value of payment orders
largely replaced cheques because of their
lower cost and convenience

2.1 INDUSTRY INSIGHT

PLANNED REFORMS TO THE RETAIL
PAYMENTS SYSTEM
The PSB has proposed:
Direct entries be settled
The system develop
in cleared batched
the capacity for the
throughout the day
real time gross
mostly on the same day
settlement of other
as deposit
payment orders on a
this was meet in late
24/7 basis
2013
More efficient
The ability to send more
cheque
remittance information with
settlement
payments

2.3 THE WHOLESALE PAYMENTS

SYSTEM
Payments for:
1.

Financial markets transactions, with

payment instructions from
SWIFT regarding FX trades
Austraclear for debt market
transactions

2.

Transfers among ADIs

including DNS transfers

3.

Transfers between ADIs and the RBA

REAL-TIME GROSS SETTLEMENT

Payment instructions are placed in a queue

and RTGS settles each payment
individually one after the other during the
day by
1.

clearing checking the paying bank

has sufficient ES funds and if so the
instruction is

RTGS
strengthens
the stability
the financial
2. settled
immediately
by aoftransfer
of ES
system
because it eliminates settlement
funds
risk because settlement is immediate once a
payment is cleared

2.3.1 RTGS OPERATING DAY

Session
Early morning
session
(7.30 to 8.45 am)

9 am
Business day
End-of-day
After-hours

Activity
Banks increase their ESA
balances by
making interbank ES
transfers
selling securities to the RBA
DNS net payments settled
Payments queued and
processed individually
Overnight ESA balances
established
AUD settlement leg of FX
trades simultaneously with
euro or GBP leg

INTRADAY LIQUIDITY PRESSURES

Each day banks must have sufficient ES funds
to cover their overall daily RTGS payment
obligations
From their trading records, they know
payments to be paid and received, but do not
know in what order they will occur in the
queue
If they have to make a series of payments
before collecting receipts, they could suffer a
shortage of ES funds
these liquidity problems could cause
gridlock in RTGS

2.3.2 INTRADAY LIQUIDITY

MANAGEMENT
The RBA provides two mechanisms to assist
ADIs manage intraday illiquidity:
Intra-day repos
Payment queue
An interest-free loan
adjustments
of ES funds where
Payments that are
the RBA purchases
uncleared remain in
eligible securities
the queue for later
from an ADI on the
retesting, the
basis there will be a
system also looks for
reversing
offsetting payments
transaction later
between banks
that day

USE OF INTRADAY REPOS

2.4 MANAGEMENT OF ES FUNDS BY

ADIS AND THE RBA
ADIs manage their ESA balances by:
1.

Using the interbank overnight market

a market where banks lend to and
borrow from each other on a daily basis
ES funds earn the cash rate minus 25
bps whereas ADIs earn the cash rate in
the interbank market
funds can be transferred between the
interbank market and ESAs and so ADIs
hold most of their liquid reserves in this
market

ADI MANAGEMENT OF ES FUNDS

continued
2.

If an ADI can not repay their intra-day

repos, they can borrow overnight from the
RBA at the cash rate plus 25bps (but rarely
do so)

3.

ADIs hold money and bond securities

that can be sold to raise ES funds or used in
repurchase agreements

When retail payments are settled 24/7, the

RBA intends to introduce open repos to
help ADIs manage the additional liquidity
pressures

2.4.1 THE RBAS MAINTENANCE

OF ES BALANCES
Transfers between ADIs do not change the total
amount of ES funds
But
payments to
or from the
RBA change
the amount of
ES funds ADIs
have

and cause ADIs to

adjust their ES
funds by moving
money into or out
or the interbank
overnight market,

making
the
cash
rate
change

MARKET OPERATIONS

Each day the RBA estimates the increase or

decrease in ES funds caused by the
payments it will make that day on behalf of
the government

At 9.30 am each day the RBA conducts

market operations (MO) to prevent
unintentional changes to the cash rate

It does this by buying or selling

securities
on days when the RBA makes net payments
to ADIs it will sell securities to offset the
impact
and buy securities on days it receives funds

AN EXAMPLE OF DAILY MARKET

OPERATIONS

REVIEW OF LEARNING OBJECTIVES

Present an overview of Australias
payment system
Transactions are settled in cash or with
payment orders
Payment orders are instructions from buyers
to ADIs to transfer funds to the sellers ADI
Retail payments dominate by number and
are settled using DNS, though this is
scheduled to be replaced with a faster
system
Wholesale payments dominate by value and
are settled using RTGS

REVIEW OF LEARNING OBJECTIVES

Describe the main retail payment
instruments and explain the deferred net
settlement system and the proposals for
replacing it with faster settlement
arrangements
Main payment orders are direct entries, debit
and credit cards and cheques
Net clearing occurs at the end of each business
day, with settlement at 9am next business day
known as deferred net settlement
DNS poses settlement risk and the risk of
contagion
Planned reforms will speed up settlement and
reduce risks

REVIEW OF LEARNING OBJECTIVES

Describe real-time gross settlement of
wholesale payments and explain how its
liquidity pressures are overcome
Wholesale payments are financial markets
payments, transfers between ADIs and
ADI/RBA transactions
Real-time gross settlement settles payments
individually throughout the day
It avoids settlement risk but requires liquidity
arrangements which are provided by the RBA
as intra-day repos and payment queue
adjustments

REVIEW OF LEARNING OBJECTIVES

Explain the management of exchange
settlement funds by ADIs and the RBA
ADIs hold reserves in the inter-bank overnight
market where they earn the cash rate (which is
25bps higher than the rate earned on ESAs)
these funds can be easily moved into and out-of
ESAs
ADIs also hold securities and can borrow from the
RBA overnight (as a last resort)
RBA payments/receipts alter aggregate ES
balances and the cash rate
The RBA prevent unintentional cash rate changes
daily using market operations