The Payment System and Financial Institution Relationships

 Types  The Ledger balance  The Collected balance

 Checks - a written order for a bank to pay a specified amount from deposited funds  Drafts - a written order to make a payment to a third party, in which the entity ordered to pay the draft is usually a bank – It is an order to pay that involves three parties

 Not necessarily drawn on a bank  Are not always payable on demand ⁻ Sight draft ⁻ Time draft  Purposes for which drafts are written are different

 Payable through draft (PTD)  Payable through draft (PTD)- gives the payor 24 hours to decide whether to honor or refuse payment  Government warrant  Government warrant- A PTD issued by Government agency  Pre-authorized draft  Pre-authorized draft- initiated by payee, who has been authorized to draw against payor’s account

 All credits and debits posted to an account  May not be all spendable

 Adjusted ledger  Also termed as available balance  May be less than ledger balance due to the availability delay applied to the checks by the bank

writes check 1. Customer (Payor) writes check 2. Supplier (payee) receives check 3. Supplier deposits Check (collecting) 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’s Bank (drawee) 7. Check is presented for payment to customer’s Bank (drawee) 4. Check forwarded 5. Supplier’s bank is credited Check Check- a written order for a bank to pay a specified amount from deposited funds

 House/On-us checks  Local items  Transit items

 Payee deposits check in the bank on which it is drawn  Bank credit depositor’s (payee’s) account  Bank debits Payor's account

 Checks may be sent by courier to be swapped for checks drawn on itself at another bank  Checks may be processed through correspondent bank relationship  Local clearing house may be used

 Also called “Out-of-Town” checks  Direct presentment (hand carried checks via courier)  Correspondent bank located near the drawee bank  Fed Reserve

 Wire transfers  Automated clearinghouses  Point-Of-Sale debit cards

 Bookkeeping entry that simultaneously debit the payor’s account and credits the payee’s account.  The only thing that is wired is the encoded message requesting the transfer.  Value is transferred immediately.

Advantages Advantages  Completed in matter of minutes  Best method for transferring large amount of money quickly.  Immediate final transfer of value Disadvantages Disadvantages  Most expensive on a per transaction basis  Minimize the disbursement float

Mechanics of Wire Transfer

Fastrelativelyroutine Fast and relatively inexpensive means of processing large numbers of routine transactions

 Reduced cost for banking, reconciliation and cash application and handling return items.  Ensure faster inflows  More reliability  Greater security  More accurate forecasting of funds availability

 Disbursement float are reduced for the payor  Upfront system cost may be very high for a small bank or originator

Transaction is processed through an online hookup to local banks or offline through ACH system and the amount is immediately subtracted from customer’s checking account

 Objective To ensure that all the company’s banking services are provided reliably at a reasonable cost

 Collections  Payments  Information  Credit  Investments

 Account Analysis Statement, Ex 8-14  Required Compensating Balance Calculation: SC RCMP = ecr (------)n 365  Balances vs. Fees Bank’s view: Advantages of Balances Corp View: Disadvantages of balances Here, SC= Service Charge ECR= Earnings Credit Rate N= Number of days in Month

 Effect of increasing deposits for the bank  Balances can be lent  Form a cushion in case of loan default

 Fees are tax deductible  Fees offer tangible expense that can be monitored  Fees are generally fixed and thus comparable, ECR floats