Clearing and settlement
In banking and finance, clearing denotes all activities from the time a commitment for a transaction is made until it is settled. Clearing is necessary because the speed of trade is much faster than the cycle time for completing the transaction. In its widest sense, clearing ensures that trades are settled in accordance with market rules, even if a buyer or seller should become insolvent prior to settlement.
A key requirement for successful payment completion is sufficient liquidity on two levels: the payer and the payer’s bank. In payment processing, the term liquidity refers to the availability of funds for making the transfer. In order to reduce credit risks, real-time liquidity checks are becoming the norm at both levels. Banks’ liquidity positions depend on the outflow and inflow of payments. As online processing has increased, especially for large-value payments, banks are obliged to move to continuous settlement of their interbank positions. In real-time gross settlement (RTGS), this is done by immediate bookings on the settlement accounts. If there are not enough funds for bookings, the transactions are queued or discarded.
After the trade and before settlement, the rights of the purchaser are contractual and therefore personal. Because of this, the purchaser’s rights are at risk if the vendor becomes insolvent. After settlement, the purchaser owns securities and their rights are proprietary. Settlement is the delivery of securities to complete trades. It involves upgrading personal rights to property rights and thus protects market participants from the risk of the default of their counterparts.
Implementation guidance
In order for payments to be made between payer’s and payee’s accounts, these both need to have their own unique address. Each infrastructure needs addressing systems that identify both the institution and the account. The traditional account identifiers for payments are the account number and the card (i.e., credit or debit) number. Card numbers have a very straightforward design based on international standards from ISO. The first six numbers constitute the institution identifier, or Bank Identification Number (BIN). This is followed by the customer account identification number, unique within an institution, and the card number concludes with a cheque digit. Bank account number standards are more complex, as they are based partly on different national numbering systems that have been embedded in an international account numbering scheme called IBAN (International Bank Account Number). In international payments, a separate institution identifier called BIC (Bank Identification Code) is generally used.
