Money – as a payment mean
Payments instruments
Payments are made either in cash (banknotes and coins) or by cashless payment instruments. While the relative importance of cash payments is decreasing, the absolute value of the outstanding stock of cash is expected to continue to grow.
The transfer of funds can be made by payment service providers (credit institutions, payment institutions and other institutions), based on a payment instruction sent via payment instruments.Payment instruments allow the end-users of payment systems to transfer funds between accounts at banks or other financial institutions.
Payment instruments are an essential part of payment systems, and they can be:
- credit transfer;
- direct debit;
- payment card;
- cheque;
- bill of exchange;
- promissory note.
Based on the instrument type, the payment instruction may be initiated by:
the debtor (e.g. in the case of the credit transfer);
the beneficiary (e.g. in the case of direct debiting).
The most frequently used cashless payment instruments in the euro area are:
-credit transfers;
-direct debits;
-payment cards;
-cheques.
Usage of the first three instruments is increasing, while that of cheques is declining. E-money payments have remained of marginal importance. National preferences vary widely as regards the use of the various instruments in cashless retail payments
- Credit transfers
Credit transfers are instructions sent by a payer to its bank requesting that a defined amount of funds be transferred to the account of a payee. A credit transfer is a payment initiated by the payer. The payer sends a payment instruction to his/her payment service provider (PSP), e.g. a bank. The payer’s PSP moves the funds to the payee’s PSP. This can be carried out via several intermediaries.
Around one-third of all non-cash payments are effected as credit transfers.
- Direct debits
Direct debits are pre-authorised payments (debits) on the payer’s bank account that are initiated by the beneficiary/payee,under which an account holder authorizes its bank to pay variable amounts of money (such as bills or invoices) directly to the supplier or utility company, at regular (usually monthly) intervals. So, they are often used for recurrent payments (such as utility payments, utility bills).
Around one-third of all non-cash payments are effected as direct debits.
- Payment cards
A payment card is a card backed by an account holding funds belonging to the cardholder, or offering credit to the cardholder. It can be used by a cardholder to:
-make payments to merchants that accept cardsor payments of some other obligations;
-withdraw money from ATM (Automated Teller Machine)[1];
-to transfer funds between accounts.
Payment cards (debit or credit cards) are cards issued by a credit institution or card company. They indicate that the holder of the card may charge its account at the bank (debit card) or draw on a line of credit up to an authorised limit (credit card).
Debit cards allow the cardholder to charge purchases directly to its bank account. Credit cards provide the cardholder with a certain credit limit, within which he/she can make purchases. The credit card holder must pay off the balance in full by the end of a specified period. Alternatively, he/she can pay off part of the balance. The remaining balance is taken as extended credit on which the cardholder must pay interest.
Card payments have been supported by the existence of cheap and efficient national card schemes, complemented by international card schemes. Acceptance of national cards for transactions outside the home country is typically achieved by means of co-branding with one of the international card schemes.
Cards account for more than one-third of non-cash euro payments.
There are many types of cards, which can be classified depending on some criteria:
a.Depending on their functions:
Credit card – allows drawing of funds up to an approved credit limit; there are two main types of credit card:
Charge card – is a means of obtaining a very short term (usually around 1 month) loan; it is similar to a credit card, except that the contract with the card issuer requires that the cardholder must each month pay charges made to it in full – there is no “minimum payment” other than the full balance.
Credit card– is a revolving credit instrument which does not need to be paid off in full each month; credit card can have a grace period, when the customer has to pay only the interest.
Debit card – allows drawing of funds up to the available balance in cardholder’s account; if the available funds are insufficient, the transaction is not completed.
Debit card with an overdraft – can allow an overdraft, which occurs when withdrawals from a card account exceed the available balance(which gives the account a negative balance).
Cash card – allows the customer only to draw money from Automated Teller Machines (ATMs or cash machines).
Card for cheque guarantee – is used to back up any cheque writen by customer, usually up to a specified value.
Multifunctional (combined) card – is a cash, debit and cheque guarantee card rolled into one.
b.Depending on the issuer:
Bank card – is issued by the banks and other financial institutions; banks were the first issuers of payment card.
Store card – is issued by the merchants and other retailers usually offering to the clients a discount on shopping, but shoppers often end up paying extra through high interest charges; despite the discounts and convenience they offer, store cards usually have a higher interest rate than the credit cards; but nowadays the “buy now, pay later” mentality is widespread and considered acceptable.
Co-branded card – is issued by a bank in partnership with a merchant; usually, it offer to client discounts on shopping to the merchant; the bank and the merchant can agree to divide the income coming from their partnership.
c.Depending on the technology:
Card with a magnetic stripe – is the first type of card issued by financial institutions.
Smart card – is a card with embedded microprocessor chip, that stores and transact data:
a smart card contains more information than a magnetic stripe card and it can be programmed for different applications;
this type of card is replacing today more and more the usual card with magnetic stripe;
first introduced in Europe nearly three decades ago, smart cards debuted as a stored value tool for payphones to reduce theft;
as smart cards and other chip-based cards advanced, people found new ways to use them, including charge cards for credit purchases and for record keeping in place of paper;
is used in fields like banking, healthcare, entertainment, and transportation;
is much more popular in Europe than in the United States.
Dual card –is a card incorporating both magnetic stripe and microprocessor chip.
d.Depending on the settlement date:
“Pay now” system – is applied to debit cards.
“Pay before” system – refers to the prepaid cards:
the card-holder spends money which has been “stored” via a prior deposit by the card-holder;
can be a pre-paid phone card, a prepaid gift card or a prepaid sim card allowing users to ‘top up’ the card with cash from another account.
“Pay later” system– is applied to credit cards.
e.Depending on the circulation area
Domestic card – is issued in domestic currency and used only in the domestic territory.
International cards – can be used everywhere in the world no matter in which currency it is issued.
- Cheques
A cheque is a written order from one party (the drawer) to another (the drawee, normally a bank), requiring the drawee to pay the indicated sum on demand to the drawer or to a third party specified by the drawer.
Cheques are still common in a few countries but usage is diminishing. In most euro area countries cheques are practically non-existent.
Graph nr. 1 -Non-cash payment instruments in the euro area
(millions of transactions)
Source: ECB
Graph no. 2 – Growth in payment instruments per capita per year in the EU
Source: ECB
- Bill of exchange
Bill of exchange is the document through which a person, the drawer or the issuer, gives an order to another person, the drawee, to pay at maturity, an amount of money to a third person, the payee, or upon his order.
- Promissory note
Promissory note is a document through which the issuer undertakes to pay to the payee, or upon his order, an amount of money, at maturity, in a certain place; thus, the promissory note intervenes between two and not three persons, as is the case of the bill of exchange; it does not contain the payment order addressed to another person, but only the recognition of issuer’s own payment obligation.
- Electronic money
Electronic money (e-money) is a monetary value (claim on the issuer) which is stored in an electronic device (e.g. a card or computer) and accepted as means of payment by undertakings other than the issuer.
Payment methods
Payment methodsrefer to the assurance in advance or not of the necessary funds for payment settlement. There are two main methods of payment use in both domestic and international transactions:
1. Methods which assure necessary funds for payment, most important being:
Letter of credit
Bank letter of guarantee
2. Acceptance
It does not assure the payment in advance.
It requires the consent of the payer regarding the payment given either through the acceptance of some payment instruments issued by the beneficiary or through the issuing from its own initiative of the payment instruments.
The first methods are preponderant in international commercial transactions and the second in the domestic transactions.
a)Letter of credit
A letter of credit is a contractual agreement between a bank, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. It makes a commitment to honor drawings made under the credit. It’s liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. The beneficiary is normally the provider of goods and/or services, being entitled to payment as long as he can provide the documentary evidence required by the letter of credit. An advising bank, usually a foreign correspondent bank of the issuing bank, will advise the beneficiary. The confirming bank (the correspondent bank) may confirm the letter of credit for the beneficiary.
Letter of credit is defined by the following elements:
A payment undertaking given by a bank (issuing bank)
On behalf of a buyer (applicant)
To pay a seller (beneficiary) for a given amount of money
On presentation of specified documents representing the supply of goods
Within specified time limits.
Documents must conform to terms and conditions set out in the letter of credit.
Documents to be presented at a specified place.
b)Bank letter of guarantee
Abank letter of guarantee is a guarantee made by a bank on behalf of a customer (usually anestablished corporatecustomer),shouldthe customer fail to deliver the payment, essentially making the bank a co-signer for one of its customer’s purchases. Should the bank accept thatits customer has sufficient funds or credit to authorize the guarantee, it will approve it. A guarantee is a written contract stating that in the event ofthe borrowerbeing unable or unwilling to pay the debt with a merchant, the bank will act as a guarantor and payits client’s debt to the merchant. The initialclaim is still settled primarily against the bank’s client, and not the bank itself. Should the client default, then the bank agrees in the bank guarantee to pay for its client’s debts. This is a type of contingent guarantee.
Bank letter of guarantee vs. bank letter of credit
Letters of credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if the transaction doesn't go as planned.
A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. A bank guarantee guarantees a sum of money to a beneficiary, that is only paid if the opposing party does not fulfill the stipulated obligations under the contract.
For example a letter of credit could be used in the delivery of goods or the completion of a service. The seller may request that the buyer obtain a letter of credit before the transaction occurs. The buyer would purchase this letter of credit from a bank and forward it to the seller's bank. A bank guarantee might be used when a buyer obtains goods from a seller then runs into financial difficulties and can't pay the seller. The bank guarantee would pay an agreed-upon sum to the seller.
Payment system
Apayment systemis a set of instruments, procedures and rules for the transfer of funds amongparticipants in the system (credit institutions or financial institutions). The system relies on an agreement between the participants in the system and the system operator, and the funds transfer is performed via an agreed upon technical infrastructure[2].
Payment and settlement systems have been growing in importance over the past two decades in the majority of the countries. This is a result of an increase in both the volume and the value of transactions resulted from money and foreign exchange markets and from financial markets in general.
A payment system usually comprises the following components:
Real Time Gross Settlement(RTGS)system settles the large-value payments on one to one basis:
RTGS system is a funds transfer mechanism where transfer of money takes place from one bank to another on a “real time” and “gross” basis.
This is the fastest possible money transfer system through the banking channel.
Settlement in “real time” means payment transaction is not subjected to any waiting period. The transactions are settled as soon as they are processed.
“Gross settlement” means the transaction is settled on one to one basis without bunching with any other transaction.
The RTGS system is primarily for large-value transactions and minimum amount stipulation varies from country to country.
Automated Clearing House (ACH) settles low-value and large volume (retail) payments through clearing system on a net basis:
Netting avoids the gross settlement and, thus, allows reducing of the transfer of funds between subsidiaries to a net amount.
The choice of netting can vary considerably:
- Bilateral:
-Two banks, one centre, one currency
-Two banks, one centre, more than one currency
-Two banks, one currency, more than one centre
- Multilateral: clearing house
Rather than physically make hundreds of payments to each other every day, the net position (funds receivable against funds payable) is calculated for each bank with each other member and each bank would then either receive or make only payment to every other member of the clearing.
Each country has its own local payment clearing system and its own rules and regulations devised to ensure fair and efficient running.
In the USA the clearing system is called Clearing House Interbank Payment System (CHIPS).
In the UK the clearing system is called Clearing House Automated Payment System (CHAPS).
Securities settlement system(SSS) settles transactions with securities:
Securities settlement system is a system which permits the holding and transfer of securities, either free of payment or against payment (delivery versus payment) or against another asset (delivery versus delivery).
It comprises all the institutional and technical arrangements required for the settlement of securities trades and the safekeeping of securities.
The system can operate on a real-time gross settlement, gross settlement or net settlement basis.
A settlement system allows for the calculation (clearing) of the obligations of participants.
The Central Bank also uses the settlement system in its own transactions with securities, which makes it an important tool in monetary policy implementation.
The securities settlement system plays a key role for the domestic securities market, financial system and financial stability.
Payment systems in euro zone
The euro area needs a financial market infrastructure which enables the safe and efficient flow of payments and financial instruments. The Eurosystem has unique responsibilities with regard to the market infrastructure for the euro. The Eurosystem’s keen interest in a safe and efficient infrastructure is closely interlinked with its responsibilities in the fields of monetary policy and financial stability.
Financial integration, globalisation and the launch of the euro in 1999 have led to a reshaping and harmonisation of the infrastructure for euro payments and for the trading, clearing and settlement of financial instruments. The greatest progression in terms of reshaping and consolidating the infrastructure has been in large-value payments, whereas post-trading services for financial instruments and retail payment services are still largely fragmented. Projects are, however, underway with a view to further enhancing integration in the latter two segments.
Payment systems are classified into two main categories, depending on the types of payments they transmit and settle:
-large-value payment systems
-retail payment systems
- Large-value payment systems
Large-value payment systems typically process a relatively small number of high-value and time-critical payments.
These systems are essential to the proper functioning of the financial system. A failure could trigger disruptions in the markets or transmit shocks, both at the local and at the cross-border level. Therefore, large-value payment systems in the euro area are always classified as systemically important.
- TARGET2
TARGET2 is the real-time gross settlement (RTGS) system owned and operated by the Eurosystem. TARGET stands for Trans-European Automated Real-time Gross settlement Express Transfer system. It is the second generation of TARGET, replacing in 2007 the TARGET1 (which was launched on 4th January 1999, at the same time as the start of Monetary Union).