Chapter 12.

Understanding Interbank Real-

Time Retail Payment Systems
Handbook of Blockchain, Digital Finance,
and Inclusion
12.2.1 Wholesale Payment Systems
• Wholesale payment (also known as large-value
payment systems) are usually operated by a country’s
central bank for the transfer of high-value funds
between banks and large corporations.
• There are generally two types of wholesale payment
systems:
– A Real-Time Gross Settlement (RTGS) system is used
for settling funds between accounts on a per
transaction basis in real-time.
– A Deferred Net Settlement system is used for settling
funds between accounts at designated times of the day
on a net basis.
12.2.1 Wholesale Payment Systems
• Due to the sheer scale in the total value of funds
transferred, such systems are classified as Systemically
Important Payment Systems (SIPS) which can impact the
entire financial well-being of a country in the event of a
failure.
– UK’s RTGS called CHAPS processed 3.3 million
payments worth 6.6 trillion GBP over 22 settlement
processing days in September 2016.
12.2.2 Retail Payment Systems
• The retail payment (also known as a low-value
payment system) is used for processing non-urgent,
low-value transactions such as consumer payments and
is typically conducted in huge volumes.
• Retail payment systems can exist in two forms:
– A closed-loop system requires both payer and payee
to be on the same platform, therefore it is also
known as a “three-party” payment system.
– An open-loop system is used to facilitate the
transfer of funds between a payer and payee
belonging to different banks.
12.2.2 Retail Payment Systems
12.2.2 Retail Payment Systems
12.2.3 Closed-Loop Payment Systems
• Closed-loop system is a single vendor system that
requires customers to deposit funds as a pre-payment
for the goods and services offered by the vendor.
• The funds that are deposited money usually exist in the
form of electronic that cannot be withdrawn as cash but
usually can be transferred to customers of the same
vendor.
• Because transactions are controlled by the same vendor,
therefore transfers can happen very quickly with low
overhead and therefore reduced cost.
12.2.3 Closed-Loop Payment Systems
• There are some well-known success stories that have
demonstrated the successful use of closed-loop
systems, but these are usually the exceptions rather
than the norm.
– Octopus card in Hong Kong was originally created in
1997 for public transportation use and has since been
evolved from a single-purpose card into multi-purpose
cash card with 24 million in circulation that can be
used in convenient stores, restaurants and
supermarkets supporting over 13 million transactions
per day.
12.2.4 Card Payment Networks
• A card payment network, for example VISA and
Master, is an open-loop payment system that is
commonly used for electronic fund transfer point-of-
sale systems (EFTPOS) internationally.
• The merchant (accepting party) holds an account with
its bank (acquirer) for receiving payments.
• The consumer (cardholder) holds a credit or debit card
account with its bank (issuer) for making card
payments.
12.2.4 Card Payment Networks
• This is originally designed for point-of-sale scenarios
whereby the merchant and consumer that are in close
physical proximity during the transaction and card
signature can be visually verified or a card-based
terminal is available for PIN verification.
• However, card payment can also be used in “card not
present” situations such as online e-commerce, but they
are not originally designed for such use cases and can
be costly to maintain and difficult to use.
• The settlement of card payment involves three distinct
steps – authorization, clearing and settlement.
12.2.4 Card Payment Networks
• Card Payment Authorization
– Card Payment Authorization is the process whereby
merchant is authorized by the card’s issuing bank to
accept payment using the card presented by consumer.
– This happens at the point of purchasing when the
cardholder’s card is swiped.
– Upon authorization approval, the payment amount is
deducted from the card’s credit limit (or bank account
funds put on hold in debit card transaction) until
clearing happens.
– This process may give the impression of payment
being immediate, but fund is not transferred to the
merchant yet.
12.2.4 Card Payment Networks
• Card Payment Authorization
12.2.4 Card Payment Networks
• Card Clearing
– Card Clearing is the process by which acquiring bank
and issuing bank exchange transaction information but
funds are not actually transferred yet.
• Card Settlement
– Card Settlement is the process by which funds are
actually transferred from the card issuing bank to the
acquiring bank based on the net settlement position
advised by the credit card network.
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
• An automated clearing house payment network is
another open-loop retail payment system besides card
payment that facilitates domestic fund transfer directly
between banks (known as Account-to-Account or A2A
transfer).
• The original purpose of clearing houses is to provide
clearing services for paper checks between banks.
• With the increasing use of paperless transactions,
clearing houses have taken on the role of processing
electronic payment instruments in general hence the
term “automated.”
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
• Credit Transfer
– A payment service that is originated by the payer of
one bank to send money to a payee of a different bank.
• Direct Debit
– A payment service that is originated by the payee of
one bank to collect money from a payer of another
bank.
• ACH Clearing
– ACH batch payment systems operate only during
normal working day.
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
• Consumers would like payment services to be timely,
accessible, easy to use and easy to integrate into
existing processes and systems.
• Modern day payment systems must be able to support
low value fund transfer securely and the service must
be available anytime, anywhere, at a low cost.
• The systems described earlier have their limitations and
are usually not fit for purpose in fulfilling these needs:
– Wholesale systems, although can operate in real-time,
are not accessible and are too expensive for low value
payments.
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
– Card payment networks, although they operate in real-
time and are designed for retail purposes, are expensive
to the merchant and are best suited for use when both
payer and payee are in close proximity during the
transaction. It can take days for funds to be made
available to merchant accounts.
– Closed-loop systems, although the most cost-effective
and efficient, are ubiquitous in most countries. It requires
a brand that is more trusted than the bank, card and
government institutions. It must be dominant in their
market and reach the critical mass to be adopted by both
payers and payees.
12.2.5 Automated Clearing Houses (ACH)
Payment Networks
– ACH payment networks are ubiquitous and lower in cost
than card payment networks. They facilitate account-to-
account transfers but can only support batch processing
and operate only during working days.
– Cash is still the best way to make low-cost payment such
as bill splitting or thrift stores in face-to-face situations
but is not efficient in other cases.
• Due to these limitations, Real-Time Payment Systems can
be seen as the modernization of ACH network’s batch
payment systems in addressing new payment needs that
cannot be readily addressed by existing systems.
12.3 The Case for Real-Time Retail Payment
Systems
12.3.1 Reasons for Real-Time Retail Payment
Systems
• Banking industry in general does not find RTPS (Real
Time Retail Payment Systems) a compelling business
case especially with its potential to compete with their
existing revenue stream such as card and float revenue.
• Benefits to RTPS are for serving a public good in
fostering a better risk control, promoting efficiency and
competition.
12.3.1 Reasons for Real-Time Retail Payment
Systems
• The following points illustrate some of the motivations
in implementing RTPS:
• Regulator’s Perspective
– Adherence to their mandates
• It is in the central banks’ interest to foster payment
innovation and competition in payment sector to
improve overall payment effectiveness.
– Financial Inclusion
• Improve the financial inclusion situation through the
use of RTPS.
12.3.1 Reasons for Real-Time Retail Payment
Systems
• Regulator’s Perspective
– Controlling high-inflation rate
• Implementing a real-time payment system is for the
purpose of enabling payment as soon as possible
avoiding the use of the slow paper check payment
instrument to counter the effect of its sliding currency
value.
– Improving Economy
• Faster payments can speed up cash conversion cycle,
generate working capital, reduce short-term interest
rate expenses.
12.3.1 Reasons for Real-Time Retail Payment
Systems
• Consumer’s Perspective
– Availability of fund
• RTPS is available around the clock and can address
urgency payment very well such as late payment of
bills.
– Proximity Person-to-Person payment
• There is no easier way to make payment to someone
face-to-face apart from the use of cash. This problem
can be solved electronically in consumer-to-business
transactions through the use of EFTPOS.
– Instant confirmation
• When a payment is made, payer will usually want to
know if the payment is transferred successfully
12.3.1 Reasons for Real-Time Retail Payment
Systems
• Merchant’s Perspective
– Card is expensive
• The biggest issue with card payment is the card
charges that merchants have to pay
– Availability of fund
• Being able to receive payment faster can improve the
cash position
– Ability to support more payment information
• the ability to carry additional payment information
12.3.1 Reasons Against Real-Time Retail Payment
Systems
• Reasons Against Real-Time Retail Payment Systems
– High Implementation and Support Cost
• In developed markets, banks have lesser motivation to
change.
• In emerging markets, banks may be more receptive to
change.
• There will be substantial upfront cost involved for the
implementation of RTPS and it will not be economically
viable without sufficient banks’ participation.
• There will be ongoing support cost and enhancement
investments that are critical to ensure no down-time to
RTPS operations in a 24/7/365 setup.
• The following slides
are for Week 4
tutorial discussion.
12.3.1 Reasons Against Real-Time Retail Payment
Systems
• Reasons Against Real-Time Retail Payment Systems
– Unclear Revenue Potential
• Larger banks especially those that have achieved a
dominant position in the markets have more to lose in
implementing RTPS.
• Cannibalization of card revenue.
• RTPS will remove the time for cash to be outside of
consumers’ bank accounts and reduce revenue
opportunities of float from the banks.
• Making transactions faster and irrevocable also means
making it harder to manage fraud.
12.3.1 Reasons Against Real-Time Retail Payment
Systems
• Project Implementation Risks
– Implementations of RTPS are often plagued with delays
– the cost for operating the central infrastructure is high and
investment will need to be maximized involving as many
banks as possible to share the cost.
• This explains why take-up rate of RTPS in developing
countries is not high since RTPS technologies are too costly for
them to implement and developing countries stand the most to
lose from the inability to unlock the economic potential from
the rise in digitalization.
• Banks in developed countries are not motivated to change due
to lack of compelling business case and seemingly incremental
benefit can only be materialized in longer terms.
12.4 The Characteristics of Real-Time Retail
Payment Systems
• There is no standard definition to the term RTPS. To
observe what sets various implementations of RTPS
apart, it is important to understand the characteristics
that are generally expected in new generations of such
systems.
• For the purpose of this writing, a real-time retail
payment system is defined to be a domestic interbank
payment system that is used for the transfer of funds
from a payer’s bank account to a payee’s bank account
of a different bank with near instant confirmation and
availability of funds. Settlement of transferred funds
between the payer’s and payee’s bank need not be real-
time.
12.4 The Characteristics of Real-Time Retail
Payment Systems
• Timeliness
– A real-time payment transaction can involve
processing for clearing, posting and settlement. For
real-time to take place, posting and clearing must at
least be able to operate in real-time.
– Availability
• Most systems operate 24/7/365.
– Universal Financial Messaging Standards
• The financial messaging standards should be:
Interoperable, Can carry richer information, Ease of
Straight-Through-Processing (STP) Integration.
12.4.4 Overlay Services
• Banks and payment service providers will develop new
and innovative services that overlay on the platform
that provides new value-adds to the consumers.
• One of the most common overlay services that is
implemented together with RTPS is known as the
addressing service.
– It is the ability to allow payer to make payments to a
payee using an alternative form of identification
without the need to use bank account numbers.
12.4.4 Overlay Services
– For instance, instead of sending money to a bank
account, payer can send money to the payee’s phone
number instead.
– From a payees’ perspective, they may not be
comfortable with sharing their bank account details
to payer to receive payment due to fear of fraud and
scams.
– From a payer’s perspective, it is more convenient to
send using the payee’s phone number and is less
likely to make a mistake in sending funds.
– It makes the payment experience simpler and much
like a check where the sender is only required to
know the addressee but up to the receiver to bank
into their own account.
12.5.3 Risk Management Principles
• Because funds are cleared between banks in real-time
but settled later, payer bank is exposed to
counterparty risk between time of clearing and time
of settlement.
• One of the ways to mitigate this risk is to increase the
frequencies of settlement, for instance Singapore’s
FAST payment network is settled twice a day, UK’s
Faster Payment settles three times a day whereas
Australia’s NPP is designed to cater for 24/7 real-
time settlement.
12.5.3 Risk Management Principles
• Besides increasing settlement frequencies, the
network can also adopt certain risk management
measures.
– Collateral Posting
• Banks are required to create special collateral
accounts for holding funds that can be used for
settlement of real-time payments. The disadvantage
is that this can lock in the bank’s funds in a reserve
and limiting the bank’s liquidity.
12.5.3 Risk Management Principles
– Imposing a Daily Debit Cap
• Banks can be imposed with a cap that limits the net
debit settlement position. Sending of funds cannot
take place until either the bank receives incoming
payments to reduce its net debit position or after
settlement cutover takes place.
– Imposing a Daily Maximum Account Transfer Limit
• A daily limit can be imposed by a bank to control
the maximum value of funds that can be sent by an
individual account for a single day to limit the
bank’s credit exposure.
12.5.3 Risk Management Principles
– Loss Sharing
• In the event of member’s default, the collateral put
up by the defaulted member will be disbursed to
the remaining members on the network. In return,
all other members on the network will be obligated
to provide liquidity to fund the shortfall due to the
member’s default.