1. Copyright  2005 by Thomson Learning, Inc. Chapter 8 The Payment System and Financial Institution Relationships

2. Copyright  2005 by Thomson Learning, Inc. The Cash Flow Timeline Order Order Sale Payment Sent Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Received Payment Sent Cash Disbursed Invoice Received Payment Sent Cash Disbursed Order Order Sale Payment Sent Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Received Payment Sent Cash Disbursed Invoice Received Payment Sent Cash Disbursed

3. Copyright  2005 by Thomson Learning, Inc. Learning Objectives v Explain, understand, and calculate float. v Explain the roles of the two major components of the payment system. v Describe the major paper-based and electronic- based payment systems. v Understand the ACH and how its fits with the EDI. v Use an availability schedule. v Explain the uses of an account analysis statement.

4. Copyright  2005 by Thomson Learning, Inc. Value of Float v The delay in value transfer from the time a check is written until it finally is charged to the payor’s account. v Value of float is based on differences in present value based on time delay.

5. Copyright  2005 by Thomson Learning, Inc. U.S. Payment System v Banking system v Payment mechanisms

6. Copyright  2005 by Thomson Learning, Inc. Financial Institutions v Product differences, Ex 8.1 v Geographical restrictions v Safety considerations

7. Copyright  2005 by Thomson Learning, Inc. Federal Reserve System v Organization, Ex 8.2, 8-3 v Fed’s involvement in payment system v Check clearing

8. Copyright  2005 by Thomson Learning, Inc. Organization, Ex 8.2 v Board of Governors v FOMC v Federal Advisory Council v District banks, Fig 8.2 v Member banks

9. Copyright  2005 by Thomson Learning, Inc. Fed’s Involvement v Circulate new money v Check processing, 16.5 billion checks/yr v Check settlement v ACH v FedWire v Regulate availability schedules

10. Copyright  2005 by Thomson Learning, Inc. Check Clearing v MICR line, Exhibit 8.5 v Clearing process, Exhibit 8.4

11. Copyright  2005 by Thomson Learning, Inc. MICR Line, Exhibit 8.5 v 2 digit Fed Bank Code v 2 digit Fed Office Code v 4 digit ABA Code v 1 digit verification code v Account number v Sequence number v Encoded amount

12. Copyright  2005 by Thomson Learning, Inc. MICR CODE Account Number ABA Bank# Check Digit Fed District Code Fed Bank Code $ Pay to the Order of Dollars Encoded Field   Chk Sequence #  xxxxxxxx7.75

13. Copyright  2005 by Thomson Learning, Inc. The Clearing Process, Exhibit 8.4 writes check 1. Customer sends check 2. Supplier (payee) receives check 3. Supplier depositscheck 6. Supplier’s account is credited Clearing agent: “on-us”, or Fed, or correspondent, or clearinghouse. 8. Customer’s bank account is debited 7. Check is presented for payment to customer’sbank 7. Check is presented for payment to customer’sbank 4. Check forwarded 5. Supplier’s bank is credited

14. Copyright  2005 by Thomson Learning, Inc. Clearing Mechanisms v House/On-us checks v Local items v Transit items

15. Copyright  2005 by Thomson Learning, Inc. “On-us” Items v Payee deposits check in the bank on which it is drawn v Bank credit depositor’s account v Bank debits payor’s account

16. Copyright  2005 by Thomson Learning, Inc. Local Items v Checks may be sent by courier to be swapped for checks drawn on itself at another bank v Checks may be processed through correspondent bank relationship v Local clearing house may be used

17. Copyright  2005 by Thomson Learning, Inc. Transit Items v Direct send v Correspondent bank v Fed Reserve

18. Copyright  2005 by Thomson Learning, Inc. Concept of Float v Types of float v Components of float

19. Copyright  2005 by Thomson Learning, Inc. Types of Float v Collection float v Disbursement float

20. Copyright  2005 by Thomson Learning, Inc. Components of Float v Mail float v Processing float v Clearing float

21. Copyright  2005 by Thomson Learning, Inc. Fed Float v When the Fed grants the depositing bank credit according to a preset availability schedule, but is not always able to present the check to the drawee bank for payment within the same period. v Methods used to reduce float –check truncation –high-dollar group sort –inter-district transportation system –later presentment and deposit deadlines

22. Copyright  2005 by Thomson Learning, Inc. Paper-Based Payments v Types v Ledger balance v Collected balance

23. Copyright  2005 by Thomson Learning, Inc. Types v Checks v Drafts v DTCs

24. Copyright  2005 by Thomson Learning, Inc. Ledger Balance v All credits and debits v Not all spendable

25. Copyright  2005 by Thomson Learning, Inc. Collected Balance v Adjusted ledger v Reg CC, (2 and 5 days)

26. Copyright  2005 by Thomson Learning, Inc. Electronic-Based Payments v Wire transfers v Automated clearinghouses v POS debit cards

27. Copyright  2005 by Thomson Learning, Inc. International Payment Systems v Paper-based systems –Giro systems –Value dating v Electronic payments –Clearing House Interbank Payment System, CHIPS –Society for Worldwide Interbank Financial Telecommunications, SWIFT

28. Copyright  2005 by Thomson Learning, Inc. Managing the Bank Relationship v Objective to ensure that all the company’s banking services are provided reliably at a reasonable cost

29. Copyright  2005 by Thomson Learning, Inc. Managing the Bank Relationship

30. Copyright  2005 by Thomson Learning, Inc. Services Provided v Collections v Payments v Information v Credit v Investments

31. Copyright  2005 by Thomson Learning, Inc. Collections v Coin & currency v Standard check processing v Lockbox services v Electronic collections v Deposit reporting service

32. Copyright  2005 by Thomson Learning, Inc. Payments v Demand deposit accounts v Zero balance accounts v Controlled disbursements v Payroll

33. Copyright  2005 by Thomson Learning, Inc. Information v Balance reporting services v Account reconciliation v Electronic delivery systems v Advisory or consulting services

34. Copyright  2005 by Thomson Learning, Inc. Credit v Shifting from a direct financing role v Moving toward role of risk-sharing or guarantor

35. Copyright  2005 by Thomson Learning, Inc. Investments v Repurchase agreements v CDs v Commercial paper v Corporate agency services v Trends

36. Copyright  2005 by Thomson Learning, Inc. Bank Selection and Relationship Management

37. Copyright  2005 by Thomson Learning, Inc. Bank Selection v Location v Bank/Company Fit v Service Quality and Breadth v Bank Creditworthiness v Bank Specialties v Price

38. Copyright  2005 by Thomson Learning, Inc. Managing the Relationship v Account Analysis Statement, Ex 8-14 v Required Compensating Balance Calculation SC RCMP = ----------------- ecr (1-rr)(------)n 365 v Balances vs. Fees –Bank’s view: Advantages of Balances –Corp View: Disadvantages of balances

39. Copyright  2005 by Thomson Learning, Inc. Bank’s View: Advantages of Balances v Effect of increasing deposits for the bank v Balances can be lent v Form a cushion in case of loan default

40. Copyright  2005 by Thomson Learning, Inc. Corp View: Disadvantages of Balances v ECR is < investment rate v Fees are tax deductible v Fees offer tangible expense that can be monitored v Fees are generally fixed and thus comparable, ECR floats

41. Copyright  2005 by Thomson Learning, Inc. Daylight Overdrafts and the Availability Schedule v Define: when a bank’s Federal Reserve account book balance is negative during the day

42. Copyright  2005 by Thomson Learning, Inc. Optimizing the Banking Network v Check list –what is bank’s compensation rate and how will it be paid, fees or balances, etc.? –if balances, over what time period? –multiyear agreement available with capped price increases? –compare a proforma account analysis statement –who is the account officer? –who is the customer service rep? –how will float be computed? –what performance guarantees are offered? –penalties for customer overdrafts?

43. Copyright  2005 by Thomson Learning, Inc. NonBank Service Providers v Pepsico’s loan to Marriot v Almost half of all consumer and business loans held by nonbank companies v Third-party vendors of information between banks and companies

44. Copyright  2005 by Thomson Learning, Inc. Financial System Trends v Nationwide banking in the US v Economic unification of Europe v Both of these will be catalysts for an ongoing drift toward concentration and globalization in the banking industry. v Imaging v Information services v Banking on the Internet v International aspects of banking relationships v Global bank consolidation

45. Copyright  2005 by Thomson Learning, Inc. Summary v We developed the uniqueness of the US payment system and its major components. v We discussed the role the Federal Reserve plays. v We discussed the payment system using paper- based and electronic-based methods. v We discussed bank selection and relationship management. v We concluded with financial system trends.