Transcript Banking and Foreign Exchange 2004

Electronic Payment Systems
20-763
Lecture 2:
Banking and Foreign Exchange
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Lecture Outline
•
•
•
•
•
World banking system
Central banks
Money supply measures
What banks do
Foreign exchange
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
World Banking System
WORLD BANK
UNITED NATIONS AGENCY
(DEVELOPMENT LENDER)
184 MEMBERS
ASSETS: $230B
WASHINGTON, DC
BANK FOR
INTERNATIONAL SETTLEMENTS
(A BANK FOR 45 CENTRAL BANKS, $130B)
BASEL, SWITZERLAND
INTERNATIONAL
MONETARY FUND
(PUBLIC POLICY LENDER $300B)
182 MEMBER COUNTRIES
WASHINGTON, DC
PRIVATELY OWNED
CENTRAL BANKS
MIXED-OWNERSHIP
CENTRAL BANKS
GOVERNMENT-OWNED
CENTRAL BANKS
U.S. FEDERAL RESERVE
DEUTSCHE BUNDESBANK
SWISS NATIONAL BANK
S. AFRICAN RESERVE BANK
BELGIUM
BANK OF JAPAN
HONG KONG HKMA
BANQUE DE FRANCE
BANK OF ENGLAND
PEOPLE’S BANK OF CHINA
CENTRAL BANK OF INDIA
PRIVATE BANKS AND
CREDIT INSTITUTIONS
PRIVATE BANKS AND
CREDIT INSTITUTIONS
PRIVATE BANKS AND
CREDIT INSTITUTIONS
SOURCE: TRANSACTION.NET
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Central Banks
• Legal tender (“real money”) is issued by central
banks (and banks operating under their authority)
– U.S.: Federal Reserve Bank
• Non-central banks cannot hold legal tender (except in
cash form). Why? (What form would it take?)
• How do banks pay each other?
– Through accounts in the central bank (directly or
indirectly)
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Payment System Layers
VALUE TRANSFERRED FROM
BANK TO BANK ON BOOKS
OF CENTRAL BANK
Securities
Financial markets
CENTRAL BANK
FINAL SETTLEMENT
INTERBANK SYSTEMS
Transportation/Exchanges
CLEARING
Risk/Credit
Management
Head Office BANK B
Head Office BANK A
BANKS
Branch A1
3
2
2
Branch A2
3 2 1
Client A Client A1
Client A2
3
Branch B1
Branch B2
SETTLEMENT BETWEEN
BRANCHES AND
CUSTOMERS’ ACCOUNTS
Client B Client B1
Client B2
SOURCE: WORLD BANK
Cash Transaction
1. CENTRAL BANK ISSUES
FIDUCIARY MONEY
(ANTI-FORGERY) +
(SERIAL NUMBERS)
CENTRAL
BANK
2. CENTRAL BANK SELLS
CASH TO BUYER’S BANK
BUYER’S
BANK
7. SELLER’S BANK
SENDS CASH TO
CENTRAL BANK
6. SELLER’S BANK
CREDITS SELLER’S
BANK ACCOUNT
SELLER’S
BANK
5. SELLER DEPOSITS
CASH IN SELLER’S
BANK ACCOUNT
3. BUYER’S BANK ALLOWS
BUYER TO DRAW CASH
FROM BUYER’S ACCOUNT
BUYER
SELLER
4. BUYER PHYSICALLY
GIVES CASH TO SELLER
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Money Supply
• Money supply (US, November 2003, in USD)
– M0 (currency = coins & notes) 661B
– M1 (spendable now) 1281B (liquid = M0 + noninterest deposits + travelers checks)
M1 IS MONEY AVAILABLE FOR PAYMENTS
– M2 (M1+ time deposits + bank CDs) 6.07T
– M3 (M2 + large time deposits + institutional money
funds) 8.86T
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
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The U.S. Money Supply
In billion USD
Nov. 30, 2003
Currency
661
Non-bank travelers cheques
7
Demand deposits
306
Other checkable deposits
307
M1 Total
Savings
3155
Small time deposits <100K
810
Retail money market funds 825
M2 Total
Large time deposits >100K
876
Institutional money funds
1129
Bank agreements
502
Eurodollars
282
M3 Total
• .
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
(2/3 outside the U.S.)
.
1281 USD
.
6071 USD
.
8860 USD
SOURCE: FEDERAL RESERVE
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Function of Banks
• Central banks:
– Issue fiduciary money (both token and notational)
• All other (non-central) banks:
– Issue notational scriptural money (bank accounts)
• Not fiduciary (“real money”), not token
• Non-central banks
– Move notational money
– Accept deposits (loans from depositors)
– Loan deposits to others (borrowers)
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
What is a Bank Account?
• Notational representation of a loan to the bank from a
depositor
• Once the depositor puts money in his account, it
becomes the bank’s money, not the depositor’s
• When the bank deposits its money in the central
bank, it becomes fiduciary (real) money
• The bank then owes the depositor real money
• Effect of deposit: bank ends up with more real money
I HAVE
$1000
MY ASSETS:
$1000 CASH
I DEPOSIT
$200 IN THE
BANK
I HAVE $800.
BANK OWES
ME $200 (MY
“ACCOUNT”)
MY ASSETS:
$800 CASH
+$200 OWED BY BANK
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
BANK DEPOSITS $200
IN CENTRAL BANK
BANK HAS
$200 MORE
MONEY NOW
BANK’S ASSETS:
+$200 REAL MONEY
- $200 DEBT
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Benefit of a Bank Deposit
• Bank can
– loan the money (more than was deposited!)
– invest the money
– move the money, e.g. make payments
– buy foreign currency with the money
• Reserve ratio
– Fraction of deposits the bank must keep in the
central bank
– If the reserve ratio is 25%, then for a $1000
deposit, the bank can lend out $3000
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Foreign Exchange
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Currency = token fiduciary money of a central bank
Every bank account is denominated in one currency
Most banks allow accounts in only one currency
All currencies have three-letter ISO currency codes:
– USD (U.S. dollar)
– GBP (Great Britain pound)
– HKD (Hong Kong dollar)
JPY (Japan yen)
CHF (Swiss franc)
EUR (Euro)
• Usually, the first two letters indicate the country; third
letter is the first letter of the currency name
• Foreign exchange is a barter transaction
– To buy GBP for USD, buyer has to find someone with GBP
who wants USD
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Foreign Exchange
• Every bank must have an account at the central bank
(or with another bank that has a central account)
• The account is (usually) denominated in that
country’s currency and is used to settle obligations in
that currency
– Hong Kong is an exception. It has systems for
transacting in HKD, USD and EUR.
• A foreign exchange transaction requires two
settlements, one in each currency
• Therefore, two countries’ central banks (or settlement
systems) are involved (except in HK)
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Foreign Exchange Example
• Buyer in the US wants to pay an invoice in GBP from
Seller in the UK
• Buyer needs GBP. Where does he get them?
Where does he put them? This is done through banks.
• Bank B (buyer) in the U.S. buys 1 million GBP for
1.78 million USD from Bank S (seller) in the UK
• Bank B must have an account denominated in GBP
somewhere, probably at Bank C in the UK
• Bank S must have an account denominated in USD
somewhere, probably at Bank T in the US
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Foreign Exchange Example
US BANKS
BANK B (US)
WANTS TO BUY
1 MILLION GBP
FOR USD
BANK T (US)
(NOSTRO ACCOUNT)
BANK S
USD ACCOUNT
BANK C (UK)
BANK B
GBP ACCOUNT
(NOSTRO ACCOUNT)
BANK S (UK)
WILLING TO SELL
1 MILLION GBP
FOR USD
UK BANKS
US FEDERAL
RESERVE BANK
THE BANK
OF ENGLAND
BANK B USD ACCOUNT
BANK S GBP ACCOUNT
BANK T USD ACCOUNT
BANK C GBP ACCOUNT
SETTLEMENT ONE:
BANK B PAYS 1.78
MILLION USD TO BANK T
CENTRAL
BANKS
SELLER S NOW HAS 1.78
MILLION USD IN BANK T
ELECTRONIC PAYMENT SYSTEMS 20-763
SETTLEMENT TWO:
BANK S TRANSFERS
1 MILLION GBP TO BANK C
BUYER B NOW HAS 1
MILLION GBP IN BANK C
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Clearance v. Settlement
• Messaging
– Transmission of payment orders
• Clearance
– Determining the net effect of multiple payment orders
– How much does each party owe or is owed?
• Settlement
– Actual payment, often involving a central bank
• Foreign exchange requires two settlements
– Exchange HKD (HK dollars) to JPY (Japanese ¥) requires
settlement in both HKD and JPY
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Gross v. Net Settlement Systems
• Gross settlement system: every transaction is
processed separately (usually immediately)
Example: cash purchase, large-value bank transfers
• Problem: transaction overhead, network load
• Net settlement system: transactions are batched
Example: credit cards
– Merchant is paid once per day, not for each sale
– Customer is billed once per month
• Problem: delay. Time is the enemy of money.
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Payment Graphs
B
23
31
8
F
7
C
9
15
10
49
A
31
B
16
14
D
44
E
17
B
“A OWES B $31”
16
A
31
A
31
G
“A HAS $49; B HAS $16;
A OWES B $31”
55
12
H
13
96
49 (+15)
A
31
16 (-12)
B
I
“A HAS $49; B HAS $16;
A OWES B $31;
A IS OWED NET $15;
B OWES NET $12”
WITH N PARTIES, NUMBER OF
POSSIBLE DEBTS IS N(N-1)/2
10,000 BANKS, 50 MILLION PAYMENTS
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Gross Settlement
B
23
31
16
A
8
F
7
C
9
D
14
44
E
17
15
10
31
G
55
12
H
13
96
I
ELECTRONIC PAYMENT SYSTEMS 20-763
• Each debt is settled
individually
• # of payments = # of debts
• Here, 16 payments
required
• Collection is a problem
(failure to pay)
• RTGS = “real-time gross
settlement,” immediate
payment
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Net Settlement
(+24)
B
23
31
(-23)
A
16
(-46) 7
8
(+15)
F
C
9
(+52)
D
14
44
(+90)
31
G
55
12
H
(-85)
(+68)
E
17
15
10
13
96
I
(-95)
ELECTRONIC PAYMENT SYSTEMS 20-763
• Compute net amount owed
or owing for each party
• Net debtors make one
payment to the “clearing
house”
• Net creditors receive one
payment from the clearing
house
• # of payments = # of parties
• 10,000 banks = 10,000
payments, not 50 million
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Net Settlement
(+24)
(+24)
B
B
23
31
(-23)
A
16
(-46) 7
8
(+15)
(-23)
(+15)
A
F
(-46)
C
C
9
(+52)
D
10
(+68)
(+90)
31
E
G
(+90)
G
55
12
H
(-85)
(+52)
D
(+68)
E
17
15
14
44
F
13
H
96
(-85)
I
I
46
(-95)
23
(-95)
85
95
NET CREDITOR
CLEARING HOUSE
NET DEBTOR
ELECTRONIC PAYMENT SYSTEMS 20-763
+249
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Net Settlement
(+24)
(+24)
B
B
23
31
(-23)
A
16
(-46) 7
8
(+15)
(+15)
(-23)
A
F
C
C
9
(+52)
D
10
(+68)
(+90)
31
E
G
(+90)
G
55
12
H
(-85)
(+52)
D
(+68)
E
17
15
14
44
F
(-46)
13
H
96
(-85)
I
I
(-95)
(-95)
52
24
68
NET CREDITOR
15
90
CLEARING HOUSE
NET DEBTOR
ELECTRONIC PAYMENT SYSTEMS 20-763
+249-249 = 0
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Net v. Gross Settlement
• Net settlement requires “clearing”
– Determining the net amounts owed or owing
• Need a separate clearing house
• Introduces delay (for clearing)
• Reduces counterparty risk
• Used for large numbers of small payments, e.g.
cheques, credit cards
• Gross settlement can be instantaneous (< 1 minute)
• Gross settlement involves a large number of
payments; used for large transactions, e.g. interbank
transfers
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Clearing and Settlement
Low value payments
Large value payments
National Clearing Centres
Real Time Gross Settlement System RTGS
Settlement accounts
Electronic
End of day
Cards
Net balances
Securities
Balances
Central Bank
Electronic
transactions
Net
systems
interfaces
Queuing mechanism
Exchange interface
CB Interfaces
Liquidity
G/L
Monitoring
Real Time Commercial Bank Interface
HQ commercial banks
Regional offices
Regional clearing
paper
Local offices
Local clearing
paper
Commercial banks
ATM, POS, PHONE, INTERNET, E-COMMERCE
Clients
SOURCE: WORLD BANK
Clients
Clients
Payment Orders (Checks)
CHECK
NUMBER
DATE
MAKER (DRAWER)
PAYEE
AMOUNT
CURRENCY
DRAWEE
BANK
DRAWEE BANK
NUMBER
ACCOUNT NUMBER
THIS CHECK IS AN ORDER TO MELLON BANK TO
PAY $100 TO PAYEE OR HIS TRANSFEREE FROM
THE CARNEGIE MELLON UNIVERSITY ACCOUNT
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
AUTHORIZED
SIGNATURE OF
MAKER’S AGENT
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Check Processing
“On-Us”
Check
Deposit
Ticket
Encode
Sort/Balance
Check
Deposit
Ticket
BANK A’S
DEPOSITS
Clearing
House
Check
Cash
Letter
“Clearing
House”
OTHER BANKS
Check
Cash
Letter
“Direct
Sends”
BANK B
SOURCE: PNCBANK
U.S. Cheque Clearing
~40 billion checks
transported
26 billion checks
transported
2.1 billion checks
returned
SOURCE: CELENT
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Clearing Payment Orders (Check)
CUSTOMER CMU
OF MELLON BANK
1. CMU SENDS CHECK TO SHAMOS
“PAY SHAMOS $100”
9. MELLON SENDS
CHECK BACK TO CMU
MELLON BANK
7. MELLON
DEDUCTS $100
FROM CMU
ACCOUNT
2. SHAMOS DEPOSITS
CHECK AT CITI
8. CLEARING HOUSE
SENDS CHECK TO
MELLON
CUSTOMER A
CUSTOMER CMU -100
...
CUSTOMER Y
CUSTOMER Z
CITIBANK
4. CITI SENDS CHECK
TO CLEARING HOUSE
CUSTOMER A
CUSTOMER B
...
SHAMOS
CUSTOMER Z
CLEARING HOUSE
(FEDERAL RESERVE)
6. CLEARING
HOUSE SENDS
MELLON
DEBIT INFO
CUSTOMER SHAMOS
OF CITIBANK
MELLON
BANK A
...
BANK Z
CITIBANK
-100
+100
3. CITIBANK CREDITS
SHAMOS WITH $100
+100
5. CLEARING HOUSE ADDS $100 TO CITI,
SUBTRACTS $100 FROM MELLON
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Settling Payment Orders (Checks)
1. AT END OF DAY, EACH
BANK HAS A NET POSITIVE
OR NEGATIVE CLEARING
HOUSE BALANCE
6. CLEARING HOUSE PAYS
MELLON $34,299,321
MELLON BANK
CUSTOMER A -15085
CUSTOMER CMU +3167
...
CUSTOMER Y +728103
CUSTOMER Z +35529
5. CLEARING HOUSE ADVISES
MELLON IT WILL
RECEIVE $34,299,321
REAL-TIME GROSS
SETTLEMENT SYSTEM
(FEDWIRE)
MELLON
+34,299,321
BANK A
...
BANK Z
CITIBANK
-107,071,775
CLEARING
+107,071,775
HOUSE
CLEARING HOUSE
(FEDERAL RESERVE)
MELLON
BANK A
...
BANK Z
CITIBANK
ELECTRONIC PAYMENT SYSTEMS 20-763
+34,299,321
2. BANKS WITH NEGATIVE
BALANCES MUST PAY;
THOSE WITH POSITIVE
BALANCES RECEIVE
MONEY
4. CITI PAYS THE CLEARING
HOUSE THROUGH RTGS
CITIBANK
+2786
CUSTOMER A
CUSTOMER B -988713
...
SHAMOS
+100
CUSTOMER Z -31872
3. CLEARING HOUSE INFORMS
CITI IT MUST PAY $107,071,775
-107,071,775
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Checks
•
•
•
•
U.S. -- 63 billion checks per year, average $1100
80% of noncash payments made by check
“On-Us” (payor and payee in same bank -- 30%)
Interbank (payor and payee in different banks) -requires settlement
– Direct presentment (“direct sends”)
– Correspondent banks
– Clearing house associations (150)
– Federal Reserve system (15 billion checks/year,
27%)
• Complex laws re bank liability in check processing
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Major Ideas
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•
•
•
•
Central banks play a central role in money movement
Payment requires M1
Foreign exchange requires two settlements
Gross v. net settlement
Check processing is cumbersome: requires clearing
and settlement.
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS
Q&A
ELECTRONIC PAYMENT SYSTEMS 20-763
SPRING 2004
COPYRIGHT © 2004 MICHAEL I. SHAMOS