What is a payment system? I am reminded of lengthy debates around the office on just this question - and the heated and, at times, passionate discussion that ensued. My antagonist, who is also my partner, took one view and I took the other. The thrust and parry of the dialogue ebbed and flowed … long into the night over innumerable cups of coffee.
The Bank for International Settlements (BIS) definition of a payment system states; “A payment system consists of a set of instruments, banking procedures and, typically, interbank funds transfer systems that ensure the circulation of money”. (From “A glossary of terms used in payments and settlement systems”, Committee on Payment & Settlement Systems. BIS, Basel, Switzerland. March 2003 (Revised Edition)).
Armed with this definition we can examine the components that make up what we so glibly refer to as a “payment system”. This examination will help us see what a payment system really is.
The BIS definition focuses on “. . .instruments, banking procedures … interbank funds transfer systems”. Let us examine each in a little more detail.
The key word in the definition is “set” - for all these components have to be combined to make up a complete unit which achieves the desired outcome – just like a tea set with its cups, saucers, tea-pot, strainer (or perhaps a tea-bag holder), milk jug and sugar bowl are just the thing for carrying out correct ritual for brewing and serving tea.
Sure, one can have tea without all this but it’s not really the same.
The analogy, while useful as a description ends here - in a payment system the missing components give rise to a serious problem – Risk.
Risk takes on many forms; credit risk, liquidity risk, legal risk, operational risk, settlement risk, systemic risk and put the whole fabric of the payment system in danger.
Despite this we often associate the word “system” with only the technology; the bits and bites, the hardware and the software. We tend to forget that there is a lot more that goes into making up a payment system.
So the next time that you write out a check or take that credit card from your wallet, give a thought to the process that you are initiating in a complex structure that we take so for granted - the payment system.
Stanley Epstein is a Principal Associate and Director of Citadel Advantage Ltd. , a consultancy dealing in bank operations and specializing in Operations Risk and Payment Systems. Further information and details can be found at http://www.citadeladvantage.com