Q. How can banks make their clearing and settlement more efficient?
David Medeiros, TowerGroup: Clearing and settlement is an interbank process, the rules of which are dictated by banking laws and regulations, and whose operational efficiency is determined by the policies and systems of the utilities that operate the networks and clearinghouses through which payments are cleared and settled. Banks can indirectly and collectively push for greater efficiency through membership in industry trade associations, standards organizations and political lobbying groups, but other than ensuring that their own payments are posted correctly and on time, their options are limited.
Paul Harris, Fundtech: Banks are realizing significant and tangible benefits by installing systems that automate the process of matching and settling FX trades. Real-time information and systems is another enhancement that banks are using to gain competitive edge. One new program in particular, the Real Time Nostro system led by Cable & Wireless, has the potential to improve the overall efficiency and profitability of FX transactions.
George Thomas, The Clearing House: There are three significant areas that can be improved to make clearing and the settlement of payments more efficient. First, consumers should be able to perform electronic transfers and payments from multiple payment initiation platforms, using a credit push model that allows money to be moved from the consumer's account to another account. Banks should provide this capability through their home banking products as the primary payment initiation platform and use telephone and ATM banking as secondary solutions.
Second, there is an opportunity to convert to electronic payments approximately 4 billion business-to-business check payments that are produced annually. Eighty percent of all business-to-business payments are made by check. Third, Check 21 creates an opportunity to transition the physical paper check clearing and settlement process into the world of electronic clearing and settlement. Image enablement by financial institutions and the electronic exchange and settlement of images will eventually eliminate much of the paper check clearing costs that exist today.
Q. How involved are corporate customers in clearing and settlement?
Medeiros, TowerGroup: Corporations are only as involved in the clearing and settlement process as they are allowed to be by the banks that provide them with payment services; this involvement is generally limited to payment initiation on the front end of the transaction, and customer service and reporting on the back end of the transaction. It is essential to remember that the banking industry depends, due to its unique demands for the highest levels of security and reliability, upon its own systems of closed, proprietary, industry-owned and -operated networks, where user access and authentication are strictly controlled, particularly for bank-to-bank processes like payment clearing and settlement.
Harris, Fundtech: There has been a slow uptake from the corporate sector with CLS, although a handful of the largest are testing the waters. Many are currently buffered by their financial services providers, which perform some of the settlement functions on their behalf, so they do not have the same incentive as the money center and regional banks. There are also technology issues involved with the integration of legacy systems and the newer CLS applications that hamper the adoption of the new CLS processing. Aside from reduced settlement risk, those that do participate in CLS benefit from faster processing and settlement of FX trades.
Q. How does the U.S. clearing and settlement system compare with other regions' systems in terms of technology and efficiency? Is there a market that is leading the way?
Medeiros, TowerGroup: While the U.S. compares favorably to other countries in terms of security and technology, it is certainly lagging other countries in terms of the displacement of paper-based payments (checks) by electronic payments (due to historic dependence on the check in the U.S. as a payment mechanism). However, multiple initiatives, including truncation and/or conversion of checks at the lockbox and point-of-sale; interbank check image interchange for forward presentment; and electronic bill and invoice presentment and payment are spurring greater migration of payments toward electronic clearing and settlement.
Harris, Fundtech: The U.S. clearing and settlement systems do an adequate job - but the real action in terms of innovation is in the major European money centers. Because international trade and finance is more critical to this economic bloc, greater emphasis has been placed on the systems that support this activity. In addition, there are new regulations that require banks to rethink and reengineer their settlement systems to operate profitably while conforming to those regulations.
Thomas, The Clearing House: Sweden and Finland are very advanced in their consumer-to-business and business-to-business payment processes. The vast majority of the payments (90 percent plus) are cleared electronically over the Internet by businesses and consumers using online banking and cash management tools. The use of mandatory reference numbers to identify the payments creates a highly sophisticated, straight-through process that makes clearing and settling electronic payments very efficient.
Lester J. Owens, Deutsche Bank: An excellent international example is the euro settlement system, RTGS+. It requires full STP for every payment it makes or the system rejects it back to the member bank. Therefore, the member banks have learned to correct these payments before sending them, hopefully educating their customers about STP processing in the process. The result is an ever-increasing cycle of end-to-end STP, making for an extremely efficient payment network.
Q. To what degree have new technologies and processes mitigated settlement risk? What are the key technologies in this regard?
Medeiros, TowerGroup: Settlement risk is actually an amalgamation of multiple types of payment risk, including operational risk, fraud risk, and compliance and regulatory risk. These risks exist in varying degrees for different types of payment mechanisms, but in general, they can be mitigated, procedurally or technologically, with attention paid to standards and user authentication, systems oversight and management, and adherence to payment processing-related guidelines.
Thomas, The Clearing House: Technology has been a great tool to mitigate and monitor settlement risk. We are leveraging technology to detect fraud and abusive practices on the ACH network through the use of rules-based scoring systems to identify suspect transactions. We were able to eliminate settlement risk in the Clearing House Interbank Payment System ($1.4 trillion in payments daily) by using a patented algorithm. Settlement risk in some of the other payment systems is still a concern. However, in all of our clearing and settlement systems, we use credit evaluations and limits on the gross amount of payments that an institution can submit to the system based on its credit rating and a percentage of capital. The use of technology allows us to monitor the financial institutions in real-time.
Owens, Deutsche Bank: Clearing systems around the world, but most notably in the U.S. and Europe, have virtually eliminated settlement risk in their high-value payments networks. This has been accomplished utilizing sophisticated, multilateral netting algorithms running on state-of-the-art processing systems. These algorithms take into account a member bank's position with all the other banks, the number and amount of the payments it currently has pending, and the receiving bank's position. Based on this data, it helps to regulate the efficient flow of payments. Additionally, in 2002, continuous linked settlement was introduced into the marketplace, drastically reducing foreign exchange settlement risk by netting member banks' foreign exchange trades.
David Medeiros, Director, Global Payments practice, TowerGroup (Needham, Mass.)
Paul Harris, VP and GM, Fundtech's CLS business unit (Jersey City, N.J.)
George Thomas, EVP, Payments Services, The Clearing House (New York)
Lester J. Owens, Global Head, Pmts. Ops., Grp. Tech & Ops., Deutsche Bank (New York)