The Reserve Bank of India has taken several steps to ensure that the country’s payment systems are secure, safe, stable, economical, efficient, and authorized. The Payment and Settlement Systems Act (PSS Act), established in 2007, passed into law in December 2007 and governs India’s payment and settlement systems. Since then, the Reserve Bank has authorised the operators of payment systems for prepaid payment instruments, card programs, cross-border inbound money transfers, ATM networks, and centralised clearing arrangements.
What Is the Clearing and Settlement Process?
There are certain steps involved in the clearing and settlement process. The steps are as follows:
Settlement and Netting for Payment Transactions
The entire payment chain is a series of accounting transactions that transfer debt from one party to the next. The payment system influences payments between the payer and the end beneficiary. The participant in the payment service could be a process provider for all, some, or any of the payment system’s processes, such as clearance, payment, or settlement. Generally speaking, the term “payment” refers to a fund transfer.
Clearing Process
Before performing a settlement transaction in the payment system, clearing must be completed. It transfers money from the beneficiary’s account to the payee’s account. All payment instructions from the payee must undergo a clearing process to verify the existence of the necessary funds and transaction records. Pre-settlement is when a payment participant authorises the payment transaction to go forward.�
The clearing facility is now provided by a central processing site (the clearing house) by authorising or approving the check. The Clearing House performs a netting function without settling each check and simplifies cheque payments between member banks. Similarly, electronic payments also require the clearing procedure because they use an automated clearing house to support debit and credit transactions.
Settlement Process
The post-clearing procedure, known as settlement, entails transferring money from the payer to the payee. A settlement is the discharge of a financial obligation related to the underlying transaction. The post-clearing procedure, known as settlement, entails transferring money from the payer to the payee. A settlement is the discharge of a financial obligation related to the underlying transaction.
A bank or other organization participating in a payment system, such as a system provider, is referred to as a “system participant. So, a client and a payment participant or two settlement participants could complete the settlement transaction. In a settlement transaction, commitments between or among participants in the payment system are offset.
Paper-based Payments
Nearly 60% of all national non-cash payments are made using paper-based instruments (such as checks, drafts and similar items). The share is currently around 11% in value terms. The Reserve Bank of India made concerted efforts to promote electronic payment solutions as an alternative to cash and checks, so as a result, this percentage has been slowly declining over time.
The Reserve Bank established Magnetic Ink Character Recognition (MICR) technology to speed up and increase efficiency in the processing of checks because paper-based payments play a significant role in the nation.
Electronic Payments
The initiatives taken by the RBI in the middle of the 1980s and the beginning of the 1990s were centred on technology-based solutions for enhancing the infrastructure of the payment and settlement systems, along with implementing new payment products by utilising technological developments in banks. A cost-effective alternative method was required because the volume of checks continued to rise, putting more strain on the current setup.
The Mechanism for Clearing and Settlement (CSM)
Using correspondent banks to handle payments would be efficient, given that there are around 30,000 banks worldwide. Furthermore, it has been demonstrated ever since the Lehman crisis how rapidly this system can halt if a participant fails.
To adequately address these issues, so-called CSMs were developed. In this case, banks collaborate to create a centralized accounting system and can transact with each other within it. Typically, a CSM operates on a credit system, meaning that no one person may yank the others down into the depths.
What is the Distinction Between Clearing and Settlement?
There are fundamental differences between clearing and settlement, which are listed further in this section.�
Typically, a financial transaction involves these two steps:
Clearing
The receiving bank, or CSM, ensures it will be processed by accepting the transaction.
Settlement
It signifies that the funds are genuinely placed at the recipient’s disposal, allowing him to�keep using the user pleases.
Both stages would happen at the exact time in online processing, but this remains the exception in the finance industry.
Real Time Gross Settlement (RTGS) and the Clearing and Settlement Mechanism
The RTGS principle, “Real Time Gross Settlement,” governs how the more recent CSM systems operate. Banks frequently have a nearly equal flow of payments with other banks, or “roughly as much comes in as flows out.” It is an effort to trigger your departing payments as late as possible to protect your liquidity.�
There are various procedures at the CSMs to prevent participants from acquiring an unfair advantage. The TARGET2 system of the EU’s CSM ensures that payments are made as soon as possible. However, if there is no cover, the system will only hold off once payments are made. In this sense, “Real Time” in CSM systems should be relative. Gross settlement is the settlement of sales without any fee deductions; therefore, fees are computed independently.
Blockchain and Clearing and Settlement Mechanism (Distributed Ledger Technology � DLT)
There are many initiatives worldwide to introduce ‘cryptocurrency’ in addition to one’s own money. The transfer of this cryptocurrency becomes more like cash than fiat money as soon as a state tokenizes its currency. The DLT system has replaced the National Bank’s central database. However, banks are no longer in charge of regulating the money supply; instead, it now more or less belongs to the currency itself.�
A regular account is optional for cryptocurrency. In the context of cryptocurrency, the function of a bank changes radically. So, even a CSM would only be allowed to exist to exchange money. With the help of cryptocurrency, clearing and settlement combine into one stage.
Oversight of Payment and Settlement Systems
The central bank’s monitoring of the settlement and payment systems promotes efficiency and safety by monitoring planned and current systems, evaluating them against these goals, and enforcing change. Central banks support the maintenance of systemic stability, the reduction of systemic risk, and the preservation of public trust in settlement and payment systems.
FAQs
Below are five questions that will help you learn more about the clearing and settlement mechanisms.�
Q1. How does the system of payment and settlement operate?
Payment transactions are settled in “real-time,” which means there is no waiting period. Gross settlement refers to the one-to-one settlement of the transaction, which excludes bunching or netting associated with any other payment. Payments are final and irreversible once they’ve been processed.
Q2. Who is in charge of settlement and clearing?
One of the key players in the clearing and settlement process in the stock market is the clearing corporation.
Q3. Which form of payment is most popular in India?
In India, credit and debit cards are frequently used for online transactions.
Q4. In India, who are clearing members?
Clearing members who are not trading members are known as Professional Clearing Members (PCM).
Q5. What function does the payment system serve?
Systems for payments and settlement were developed to make it easier to clear and settle financial transactions involving money and other assets.
Payment, clearing and settlement systems, commonly referred to as financial market utilities, offer payment and settlement services to financial institutions and are a crucial component of the global financial system. Depending on the model employed by the specific system, participants in quicker payment systems may settle interbank obligations in various ways. Participants from financial institutions should be aware of how different, faster and instant payment networks reduce risk based on the settlement structure of the network.