Basics of Payment Systems

Definition of Settlement

“Settlement” is defined as “an act that discharges obligations in respect of funds between two or more parties” (BIS, 2001). More plainly, settlement is an act to make payments in compensation for purchases of goods or services, and complete the business process.

Any economic activities, including the mail-order, B2B transactions, internet auctions, trading of equities and government bonds, and foreign exchange trading, ultimately require a settlement. In other words, settlement is indispensable to credit-based business transactions in the modern world.

Definition of Payment System

“Payment System” is a mechanism that enables such kind of settlement or funds transfer smoothly between the buyer and seller, and/or between the banks. According to the definition of the Bank for International Settlements (BIS), “a payment system consists of a set of instruments, banking procedures and, typically, interbank funds transfer systems that ensure the circulation of money” (BIS, 2001).

Payment System as an Infrastructure

A payment system plays a pivotal role in circulating funds all over the economy. If some malfunctions were to happen to a payment system and hinder the flow of funds, the impact would be extraordinary and disruptive. The economic activities and functions of financial markets would become completely paralyzed. You can easily imagine such a disastrous situation where no one can make payments and no one can receive money from others, and that all the flow of funds between banks stopped dead.

Therefore, we can conclude that payment systems are social infrastructures that support all economic activities, including the commercial activities and transactions in financial markets. A safe and efficient payment system is an important mechanism that props up the functions of financial markets and the financial system.