Payments are financial instruments that people and businesses around the world use to transfer funds and this makes them one of the most important parts of a company’s financial operations. The subject can become complex because there are often many different payment systems in a given country-and most countries have their own unique currency.
For the purposes of this paper we will deal with one method of payment using wire transfers.
Wire transfer is an electronic payment service and is considered the fastest and safest method to move and exchange funds nationally and internationally. The essence of this electronic payment is to use a cash substitute (electronic messages) to create a debit or credit that transfer’s value. The value that is being transferred is typically stored in depository accounts at banks or other types of financial institutions. The banks, in turn, are connected to a set of payment systems that they use to process payments on behalf of their customers or depositors.
In the simplest case involving the traditional banking system, payments involve four participants:
The payer: Makes the payment and has its bank account debited for the value of the transaction.
The payer’s financial institution: Processes the transaction on the payer’s behalf.
The payee’s financial institution: Processes the transaction on behalf of the payee and holds the value in an account.
The payee: Receives value of the payment by credit to its account.
In the real world the funds transfers tend to be more complex involving a network that includes central banks such as the Fed (US Federal Reserve), ECB (European Central Bank) and The Bank of England. Clearinghouses such as CHIPS (Clearing House for Interbank Payments), information transmission mechanisms such as SWIFT (Society for Worldwide Interbank Financial Telecommunications), and payment systems such as Fedwire and BojNet , both of which include information transmissions systems.
The actual exchange of data and funds necessary to complete a funds transfer transaction relies upon electronic processing, settlement, and communication systems. While the various payment and messaging systems offer differing levels of functionality, the instruction messages underlying all of these functions are primary.
In the following paragraphs we will review three important payment or messaging systems in operation in the United States. They are Fedwire, Chips and SWIFT
The Federal Reserve provides the Fedwire Funds Service which serves as the primary domestic electronic funds transfer system in the United States. The Fedwire system handles both the transmission of funds transfer instruction messages among financial institutions, as well as the settlement of payment. As a real-time gross settlement system (RTGS) it enables participants to initiate funds transfer that are immediate, final, and irrevocable once processed. Depository institutions and certain other financial institutions that hold an account with a Federal Reserve Bank are eligible to participate in the Fedwire Funds Services. The Fedwire Funds Service is generally used to make large-value, time-critical payments.
The Fedwire system is available only to U.S. financial institutions and does not permit a participating U.S. financial institution to transmit instructions or transfer funds directly to a non-U.S. financial institution.
Like Fedwire, the Clearing House Interbank Payment System (CHIPS) handles both transmission of funds transfer instruction messages among financial institutions, as well as the settlement of payment between the institutions. CHIPS is the United States main electronic funds-transfer system for processing international U. S. dollar funds transfers made among international banks. Like Fedwire, CHIPS is a real-time final settlement system.
CHIPS claims to handle 90% of all U.S. dollar- based funds trasfers moving between countries around the world.
Access to the CHIPS payment system is conditional upon a financial institution’s U.S. presence. The financial institutions using CHIPS must operate a U.S. branch office for use of the system. It is important to note that a CHIPS instruction may serve as one segment of a cross –border transfer.
The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides secure electronic financial messaging services to financial institutions. SWIFT is a cooperative society owned by its member banks and is a unified international financial transaction messaging service. SWIFT represents an extensive telecommunications network by which a financial institution in one country can communicate with its branches or correspondent institutions anywhere in the world. In contrast to Fedwire and CHIPS, SWIFT is a messaging system for funds transfer instructions, rather than a financial settlement system.
In contrast to Fedwire and CHIPS, a SWIFT message may travel directly from a U.S. financial institution to a foreign institution or vice versa. In practice SWIFT is the primary method for international funds transfer messages.
Funds transfers often involve a combination of SWIFT and Fedwire messages or SWIFT and CHIPS or other messages in the same transaction. For example, a U.S. institution may receive a SWIFT message from a foreign institution and map the message into a Fedwire or CHIPS message before passing it along to the additional U.S. financial institutions serving as correspondents.
When a funds transfer requires multiple correspondents’ participation and involvers more than one message system, one or more of the institutions translates or “maps over” the data from one message format to another. A large portion of the traffic on the CHIPS system originates from SWIFT message traffic.
Domestic bank to bank fund transfers are conducted through the Fedwire System which uses the Federal Reserve and its assignment of routing transit numbers which uniquely identify each bank (ABA number). This code serves as the banks address, so to speak, allowing funds to move to and from the banks location and individual accounts within the bank. The term ABA is used because the American Banking Association assigns these location numbers to the banks.
Most international fund transfers are executed through SWIFT. Each financial institution is provided a Bank Identifier Code (BIC) or Swift Code. SWIFT handles the registration of these codes. With the BIC/SWIFT code banks can be identified and international funds transfers processed.
As Europe is moving to the Single Euro Payments Area (SEPA), the European Union-as well as Norway, Iceland, Liechtenstein, and Switzerland-have made a series of regulatory changes designed to improve straight-through processing of payments and reduce costs. A key element was the introduction of the International Bank Account Number (IBAN). IBAN’s are assigned by the European banks to their customers. The IBAN contains information to identify the country, the account holding bank, the counterparty’s account number and check digit verification. With the SEPA, transactions will require IBAN and SWIFT-BIC identification.
Bank wire transfers are immediate transfers from one bank to another. Bank wire transfers are fast as transferred funds are considered “cleared” immediately when received.
The bank wire transfer system is reliable. There are many redundancies built in to reduce the impact of failures. To take advantage of this method of moving funds, it behooves one to understand the systems in place and the functions used in operating the systems.
Akirix, with their expertise and robust web site, is the ideal partner in providing safe and fast movement of your funds from place to place while you are conducting your ‘business transaction on a global scale.
US Department of the Treasury: “Fundamentals of the Fund Transfer Process”
Treasury Alliance Group: White Paper “Fundamentals of payment services”
International Resource Center, TD Bank
European Consumer Centre France: Banking
Board of Governors of the Federal Reserve System: “Fedwire Funds Services”