Payment System is about how participants from individuals to banks, governments and international participants exchange monetary value within an economy and across national borders. It is the framework of laws, regulations, mechanisms, systems, procedures and agreements that governs payments. Payment systems are like the circulatory system in the human body when it functions well it contributes to the health of the whole economy but when it fails there may be serious implications for the financial system. Therefore, safety and efficiency are the most common public policy objectives for regulators around the globe.
Payments are classified into wholesale and retail transactions keeping in view the value of transaction and the type of party that initiates the transaction. Wholesale payments are generally large value payments made by financial institutions whereas retail payments are executed by individuals and are relatively of low value. Whole sale payments are considered to be Systemically Important Payment Systems (SIPS) due to the fact that it processes large values and it can create systemic risk in the financial system. This risk can be mitigated by implementing a Real Time Gross Settlement System thereby allowing financial institutions to settle their obligations on real time or near real time securely and irrevocably. In contrast, retail payment systems are considered to be socially important due to its widespread use in an economy.
A payment system is all about the use of payment instruments on various payment channels. There are five main categories of payment instruments:
- Cash – notes and coins
- Cheques/demand drafts/other negotiable instruments
- Payment cards
- Credit transfers
- Direct debits
Cash and cheques/other negotiable instruments are usually called paper-based instruments whereas payment cards, credit transfers and debit transfers are electronic because an electronic message is used to authorize and complete the payments. Further, the categories of electronic payment instruments vary depending upon their initiation, authorization and authentication mechanism added by distinct roles and responsibilities and the types of risks associated etc. Payment cards include the debit, credit and prepaid cards which are presented by the cardholder on a merchants’ location and cardholder authorizes the merchant’s bank to pull the funds from payer’s account. Credit transfers are also called ‘Push’ payments since the transaction is initiated and authorized by payer to debit his account and credit the payees account. Whereas direct debits are called ‘Pull’ payments as they are initiated by the payee but pre-authorized by the payer thus pulling the funds from the payer.