Question

PAYMENTS IN A NEW DEMOCRACY

A country in Africa has recently undergone a revolution and is now governed by a popular democracy. In the past, all economic activity was undertaken by the autocratic leadership and their facilities, which no longer exist. The population of the country only survived in the past via various forms of barter, but now have to understand and establish modern functioning payment facilities. Start the process of understanding by describing some of the basics of payment in a letter to the revolutionary council.

Include:

Define (briefly) payment, clearing and settlement networks and summarise how they work together to effect payment between parties;( 1 typed page)

Answer 1

There are three parts involved and coordinating together to effect a systemized payment from one party to another – Payment network, clearing house and settlement. Please note here that when we are discussing payments, we are including traditional payments in the form of negotiable instruments such as checks and bills and also security documents exchanging hands.

A payment system consists of a set of instruments, banking procedures and interbank funds transfer systems that ensure the circulation of money. The same is carried out by a payment order or payment instruction sent by the payee. The payment is processed through the clearing house which checks for availability of funds and if everything is in place, it clears the transaction and settles it.

Part two of the transaction chain is the payment system. Clearing denotes all activities from the time a commitment is made for a transaction until it is settled. It is the process of transmitting, reconciling and confirming payment orders or security transfer instructions prior to settlement. Clearing is carried out by specialized institutions called clearing houses which transmit information and funds through payment system networks. The institutions settle for items exchanged at a designated time based on the rules and procedures of the clearing. This system consists of a set of procedures whereby financial institutions present and exchange data and/or documents relating to funds or securities transfers to other financial institutions at a single location.

Settlement refers to an act that discharges obligations in respect of funds or securities transfers between two or more parties. It is basically the completion of a transaction, wherein the seller transfers securities or financial instruments to the buyer and the buyer transfers money to the seller. It is managed by a settlement agent. Very often, the clearing and settlement agents are the same. If all documentation and other checks are clean, the clearing houre or settlement agent, completes the payment transaction by settling the deal.