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Roger Clarke's 'Business Payment Processing'

How Business Payments Get Processed in Australia

Version of 17 August 2010

Roger Clarke **

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During 2008, I was asked to provide expert evidence in a N.S.W. court case, to explain how a particular payment from one company to another was processed through the banking system. This document contains an edited version of the general description with which I began my evidence.

Payment Instructions

In order to effect a payment to a payee, a payer composes and communicates a 'payment instruction' to a financial services provider with which they have an account. Financial service providers include banks, building societies and credit unions. For brevity, the remainder of this document uses the term 'bank'.

A payment instruction is generally of the following form:

	PAY 		<amount>
	FROM 		<payer-account-identifier>
	TO 		<payee>
	AT 		<payee-account-identifier> 
	HELD AT 	<financial-services-provider-identifier>

The payment instruction can be communicated from the payer to their bank in a variety of ways, including the following:

It is normal for large organisations to adopt the last of these alternatives, 'direct entry'. This is because the data needs to be captured into the organisation's own computer systems for both operational and accounting purposes, and this approach minimises the overall cost of the process, and maximises the convenience.

Processing a Direct Entry Payment Instruction

After receiving the payer's payment instruction, the payer's bank executes it. This involves transferring to the payee's bank:

The Transfer of the Funds

There is a variety of ways of achieving the transfer of funds from one bank to another. For example, it can be done by passing banknotes.

Generally, however, interbank transactions are conducted by means of an intermediary banker with which both banks have an account. If banks were to use another for-profit, commercial bank for this purpose, both banks would be exposing data about their business to a competitor, and would be financially exposed in the event that the competitor became insolvent. It is therefore common for the country's central bank to operate such a service.

In Australia, such interbank payments are effected through entries against accounts each bank holds with the Reserve Bank of Australia (RBA), called 'Exchange Settlement (ES) Accounts'. This is described in a 1999 RBA document (mirrored here, because web-masters are so unreliable).

For very large transactions, it is normal to execute the instruction promptly and individually. In this context, 'very large' means tens of millions of dollars, rather than normal business transactions of only up to 7-figure sums.

There are very big volumes of payment transactions ranging from, say $50 to $5 million dollars each. It would be very expensive for banks to issue an instruction to the RBA for each such instruction that they received from each of their customers.

It is more efficient for each bank to combine all of the instructions of this kind that they receive during a business day, and issue a single instruction to the RBA to transfer a total amount from the paying bank to each of the receiving banks. This is referred to as 'deferred net settlement'.

It is 'net' in the sense of being a single bulk or summary transaction for each bank, rather than a large number of detailed transactions. It is 'deferred' in that it does not occur progressively during a business day, but just once, at the end of each business day.

This effects the transfer of the funds to the payee's bank. But the crediting of the amount to the right payee account depends on further information reaching the payee's bank.

The Transfer of Details of the Transaction

In order for the funds to be credited to the payee's account with their bank, the data in the payment instruction also has to be transferred to the payee's bank. This is achieved by means of what is generically referred to as a 'clearing scheme'.

Since 1992, clearing schemes have been operated by an entity called Australian Payments Clearing Association (APCA). APCA is a company owned by participants in the financial services sector. APCA operates five clearing systems, each of which is designed to support a particular category or categories of payment instruction. This is described in a 2002 APCA document (mirrored here, in case the web-page disappears). The five systems are:

None of the above short descriptions mention the mainstream 'direct entry' scheme whereby large companies generally submit their payment instructions. However, a more detailed description of the BECS system says that it "currently covers direct entry payments ... [because] it provides a framework to encompass large volumes of individual payments which are batched for delivery between financial institutions". The quotation is from a separate 2002 APCA document (mirrored here, in case the web-page disappears).

I was unable to find information on the APCA site about the frequency with which batches are transferred. However, the following was provided by a bank as sworn evidence: "Banks may exchange data for BECS instructions on 5 occasions throughout the day 10am, 1pm, 4pm, 6.30pm and 8.15pm. Exchange of data must be complete by 8.30pm".

Completion of the Transaction

After the payee's bank has received both the funds (by means of net settlement through the ES account with the RBA) and the payment instruction (by means of the relevant APCA clearing system, in the case of direct entry transactions, BECS), the payee's bank effects the final part of the instruction by crediting <amount> to <payee-account-identifier>.

Banks generally effect the credit of payee accounts in one or more batches each `business day' (i.e. each calendar day on which the bank is open for business).

The batch processing may be undertaken both during the `working day' (i.e. 9-5 weekdays except public holidays) and overnight, after the end of the working day during which the direct entry payment instructions were received.

Batch processing is adopted because it is much less expensive to process transactions in batch runs and at a time of the organisation's choosing, rather than individually and at a time driven by the arrival of information from outside the organisation.

However, all banking works 'on daily rests'. That is to say that banks do not regard funds as arriving in an account at a particular time within a business day, but only on a particular business day. (Consistently with that approach, interest accrues per business day, not per hour).

A corollary of that rule is that all processing is regarded as having occurred 'as-at close of business' on a particular business day. It is not relevant whether the processing actually takes place during working hours, or at some time overnight (although it does need to have been completed prior to the beginning of the following working day).

The customer cannot reliably know what transactions have been reflected in the processing for a particular business day until the commencement of the following working day. That is a longstanding practical arrangement, such that banks have from approximately 8:30pm in the evening until 8:30am the following morning to complete the previous business day's processing.

Banks make available to their clients 'bank statements', which show the transactions processed in date order, and the balance in their account at the end of each business day. This is a slow process, because it involves printing and mailing of a hard-copy document.

During recent years, it has become more common for payees to have more timely access to information, by means of online displays of data equivalent to a 'bank statement'. These generally display transactions recorded up to the end of the preceding business day.

Author Affiliations

Roger Clarke is Principal of Xamax Consultancy Pty Ltd, Canberra. He is also a Visiting Professor in the Cyberspace Law & Policy Centre at the University of N.S.W., and a Visiting Professor in the Department of Computer Science at the Australian National University.

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Created: 17 August 2010 - Last Amended: 17 August 2010 by Roger Clarke - Site Last Verified: 15 February 2009
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