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«July 2012 THE WORLD BANK Acknowledgements The preparation of this paper was led by the Financial Inclusion Practice of the World Bank. Lead author is ...»

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Clearing and Settlement for Payment Cards For a typical payment card transaction, be it a credit card or debit card—for example the purchase of goods and services at a merchant location equipped with a POS terminal— once the card is swiped or the chip is read, the card‘s data is transmitted through the payments network‘s electronic network (called a payment cards switch) to the card issuer for authorization. If approved, the merchant receives the authorization to capture funds, and the cardholder accepts liability by signing the credit voucher (can be paper or electronic). The merchant receives payment, net of fees, by submitting captured payment card transactions to its financial institution in batches at the end of the day. The merchant‘s card acquirer forwards the sales draft data to the payment network, which The ECC process mentioned earlier is a particular case in which the cheque given by the payee serves the same purposes as the mandate.

The settlement agent is also in most cases the central bank. According to the Global Payment Systems Survey 2010, 97 percent of ACHs reported settling their transactions in central bank money.

forwards the data to the card issuer. Once again, the rest of the clearing and settlement cycle is similar to that of cheques and EFT-based products.35 Signature-debit transactions are cleared and settled in the same way as credit card transactions. For an online, PIN-based, debit card transaction at a merchant POS, the cardholder enters a PIN to authorize the transaction. For all prepaid cards, whether they are branded prepaid card or affinity, closed loop prepaid cards, a financial intermediary—typically a commercial bank or another third-party payment service provider eligible to issue prepaid cards36—holds the funds in a pooled account. Each pooled account has various sub-accounts, depending upon the characteristics of cardholders and the program to which the cardholders belong. An issuer or its third-party payments processor maintains a system of record, keeping a record of all transactions belonging to each sub-account. When a consumer uses a prepaid card, the merchant sends a message to the recordkeeping entity to determine whether the balance is sufficient to cover the transaction. In the case of branded prepaid cards, the authorization, clearing, and settlement works similar to a traditional debit card.

Processing of Transactions in Agent-based Mobile Payment Services Typically, these schemes rely on the payer and payee exchanging payment instructions through either custom applications loaded onto their mobile phones or through standard mobile phone messaging services like short messaging service (SMS). In general industry terminology these are referred to as ―mobile payments.‖ These payment services are typically used for person-to-person payments. However, in some country environments mobile payment services are also being considered or used for various types of bill payments, government payments, and collections as well as for cross-border remittances.

There are two predominant models in the delivery of agent-based mobile payment services. In the first model, a commercial bank holds funds and maintains the customer accounts. It may outsource the management of the agent network and transaction processing to a third-party payments processor or a mobile network operator (MNO). In the second model, a non-bank payment service provider, typically an MNO leads the effort, including customer management and ownership of accounts. In this scenario, it may partner with a bank to hold funds on its behalf. Consumers typically buy (cash-in) emoney credit from the network of agents, who in turn buy e-money credit in bulk from the MNO or the bank. The consumer then uses the mobile phone interface to generate a payment instruction to another individual or business, which then obtains funds (cashout) from the network of agents. There is typically a one-to-one relationship between the e-money credit a consumer holds and the real money that is held in their sub-account at the bank. This is illustrated in Figure 3.

Of the 165 payment card switches reported as part of the Global Payment Systems Survey 2010, around 67 percent of the switches were reported to be settling in central bank money and around 31 percent in commercial bank money.

These may include non-financial institutions.

Figure 3: Clearing and Settlement for Mobile Money Schemes In large scale agent networks like that used by FINO in India and M-Pesa37 in Kenya, additional entities are involved to provide cash management services to the agents;

these are often referred to as super-agents. The super-agents typically hold the accounts of the agents and facilitate conversion of the agents e-money balance to cash balance in their regular bank accounts and also in certain cases provide overdraft facilities to the agents.

There are also a few other mobile payment models where a separate entity operates the mobile payment platform integrating with a set of institutions or even in some cases with a payment card switch.38 These models mirror the clearing and settlement arrangement of payment cards. In these models, the mobile phone is used as a channel to send the payment instruction instead of a card being swiped at a POS terminal, with the payment instruction being handed off to the merchant‘s acquiring bank. From there on the process remains the same as for payment cards. The transaction confirmation is received on either a standard POS terminal or perhaps at the mobile device of the merchant.

For details on M-Pesa please refer Annex 8.

These models have been created by existing payment networks in some countries (e.g. Dominican Republic), by the existing global payment networks Visa and Master Card, and also by independent entities like Obopay, Yellow Pepper, and others.

The above model also applies to agent-based payment services using other mechanisms for transaction initiation, such as the payer using a smartcard at the agent‘s POS terminal to initiate a range of transactions including remittances, cash deposits, and cash withdrawals.

II.5 Different Roles within Retail Payment Systems The Role of Central Bank Central banks typically seek efficiency and safety in payment systems as well as stable financial markets. More recently, in addition to safety and efficiency, accessibility and the existence of a competitive environment are also being considered important objectives.

Safety implies that the system functions smoothly and securely, which is important for the trust in currency/fiat money. Efficiency implies that the costs39 within the retail payments value chain are as low as possible, and depends upon factors such as technology, innovation, and the level of cooperation and competition within the retail payments market. To fulfill these goals, a central bank typically plays three different roles: a) an operational role; b) facilitator, acting as the catalyst in provision of retail payment services; and c) overseer and/or regulator of retail payment systems and services.

In an operational role, the central bank typically provides settlement services for some or all retail payment systems in a country. The settlement is done on the books of the central bank and is common for paper-based systems (usually cheques), EFT-based systems, and some debit card and ATM systems. In some countries, central banks also play a more direct operational role by provide direct clearing services to various retail payment systems; for example, central banks in countries like Saudi Arabia, Kazakhstan, Kyrgyz Republic, Germany, Italy and Belgium provide cheque, EFT, and payment card clearing services. In some other countries the central banks also operate some retail payment systems. The responses received for the World Bank Global Payment Systems Survey-2010 show that central banks operate approximately 55 percent of the check clearing houses; 35 percent of ACH systems; and, 12 percent of the payment card switches.

As a facilitator of retail payment services, most central banks maintain close relationships with commercial banks and other retail payment service providers in order to discuss priorities for payment system development within the country and to promote these to materialize. Through these relationships, central banks also pursue development of strategic initiatives aimed at benefiting all participants uniformly (e.g., implementation of payment systems standards). In many countries, as part of their public Cost is used here broadly and is used to refer to both direct costs like transaction fees and also indirect fees like costs of access to the system/instrument.

policy objectives, central banks also pursue important research agendas that benefit the wider payments industry in an impartial way.

As an overseer and/or regulator of retail payment systems: the scope of oversight function varies across central banks, and in some cases depends upon whether retail payment systems are considered systemically important or not.40 In the responses to the World Bank Global Payments Survey 2010, 64 percent of the central banks surveyed responded that their oversight powers extended to all payment systems operational in the country. However, 48 percent responded that they actually exercise oversight powers only over systemically important payment systems. In only a few countries some retail payment systems are considered to be systemically important, while in many others retail systems are considered to play a role of ―prominent‖ importance, since their failure can have major economic effects and may undermine the confidence of the public in the payment systems and in the national currency. Central banks typically exercise their oversight powers by monitoring, assessing, and inducing change, if necessary, through the issuance of formal regulations.

The Role of Payment Institutions For all EFT and most card-based payment instruments, banks41 have the direct relationship with customers and hold funds on their behalf (depending on the type of payment product) and are issuers of the relevant payment instruments and operators of the underlying current account. In the case of credit and debit transfers, they also provide the transaction channels (e.g. online banking platforms) through which the payment instructions are received and processed.

For some innovative payment services, some non-bank institutions are playing one or more of these roles.

In card systems, an additional role is that played by the so-called acquirers. These institutions maintain the relationship with the merchant, provide the infrastructure needed for accepting a card payment (e.g. access to the POS terminal or the payment services supporting an e-commerce website) and normally operate the current account in which the proceeds of the sale transaction are deposited.

Clearing and Settlement Arrangements In cases where the payer and payee maintain a relationship with the same payment institution, then that institution will normally perform all clearing and settlement functions associated with the transactions between those parties. Likewise, in closed-loop, proprietary payment mechanisms, the payee and payer institutions are by definition the same since one institution manages the entire payment process.

Bank of Japan and Bank of Sweden, for instance consider at least one or more retail payment systems as systemically important.

Throughout this document, the term banks refers to all deposit taking institutions.

In payment mechanisms where the payment institution of the payer and that of the payee are different, an inter-institution network that facilitates authorization routing, clearing, and settlement of transactions is necessary. The payment card networks, clearinghouses and clearing associations, play this role.42 Payment card networks play an important role in facilitation of payment card transactions, including payment authorization and clearing and settlement services for member institutions. To perform these services efficiently, reliably and securely, the payment card networks define and enforce highly standardized operating procedures and policies, and controls for payment card issuance, acquiring, and settlement activities.

In some cases, some or all of such services are provided directly by or in close association with the international card networks Visa and MasterCard, which typically also own the trademarks/logo and grant membership to eligible financial institutions that use the logo and services to facilitate issuance and acquiring/acceptance. Visa and MasterCard, normally in conjunction with member institutions, also set and enforce the interchange fees that are normally incorporated into the fees charged to merchants or cardholders for point of sale transactions.

Clearinghouses and clearing associations43 facilitate both electronic (EFT) and cheque clearing and settlement services. Clearinghouses that facilitate EFT-based transactions and other electronic instructions like the ones arising from electronic processing of cheques in an automated manner are also referred to as ACHs. Cheque clearinghouses play a similar role and act as a network for exchange of payment instructions for cheques. Financial institutions or third-party service providers typically send payment instructions for credits or debits in batches for processing one or two days before the settlement date, however there are several ACHs with same-day settlement.44 Both ACHs and clearing associations set standardized schedules, along with rules and procedures for payment submission, formatting, messaging, and processing that members are required to follow.

The Role of Third-Party Payment Service Providers The role of third-party payment service providers has become more prominent in recent years due to growth and increasing sophistication and specialization of retail payment systems. Recent technological innovations have further influenced the growth of such specialized services.

For details refer to CPSS, ―Clearing and settlement arrangements for retail payments in selected countries‖, BIS, 2000.

The difference between a Clearinghouse and Clearing Association is that the former does multilateral clearing and settlement, whereas the latter is a combination of bilateral clearing and a combination of bilateral and multi-lateral netting for settlement.

Examples include the Faster Payments Service in the UK and the NEFT system in India, among others.

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