Payment systems Essay Example | Topics and Well Written Essays - 1000 words

Payment systems - Essay Example An important factor that influences the choice of payment system lies in the value of the transaction. The most efficient and fair payment system in terms of the risk tradeoff for transactions of $100 may not be the same as it is for transactions of $1,000,000. So alternative payment systems often distinguishes between a large-value transfer system (LVTS) and a small-value transfer system (SVTS).2 The following stages are involved in Payment System development: Transitional economies started their payment system development from stage 2, a cash circuit for consumers and a paper-based noncash circuit for enterprises in which all transactions were gross but with long lags between payment instruction and receipt of payment. The prototype DNS system of stage 3 was a simple clearinghouse in London where banks exchanged cheques at the end of each business day. In this system, there were no credit limits between banks, in part because banks did not provide unconditional funds against deposited cheques. Such deposits became unconditional only after clearing and the confirmation that sufficient funds were available in the payer's account. In the case of credit transfers, however, the credit risk is more likely to fall on the receiving bank. With a credit transfer, customers and their receiving banks know that the payer had sufficient funds when making the transfer. So the receiving bank makes funds available to its clients and bears the risk that the payer's bank may fail in the interval between sending the credit transfer information and settling that payment in the end-of-day netting. Stage 4: Most industrial countries had reached stage 4, predominantly with DNS systems, by the 1970s or 1980s. In such unprotected DNS systems, commercial banks provided free, unlimited, uncollateralised intraday credit. 3 As risks in both net and gross systems were recognized, central banks required collateral or charged for intraday credit. With limited intraday liquidity, both DNS and RTGS systems have adopted prioritization arrangements, while some DNS systems have increased the frequency of batch settlements during the day. Stage 5: Automation increased speed and reduced costs, both followed by the dramatic increases in transaction values in both domestic and international financial liberalization that took place during these two decades. The traditional DNS systems of stages 3 and 4 involved unlimited implicit credit granted to the paying bank by the receiving bank from the time a payment instruction was received until the time of final settlement after clearing. Risks In Payment Systems Legal risks are one aspect of the need for certainty about how the system operates. Participants need to know what happens in different circumstances. If a participant defaults, for example, what will be the impact on other participants Operational risk is