1. CHAPTER THREE MONEY TRANSFERS 1

2. 3. MONEY TRANSFERS 3.1 Overview When a person or a business in one country wants to make a payment to someone in another country commercial banks provide this service. Central banks depend on commercial banking system to record thousands of daily transactions that constitute a nation’s balance of payment. 2

3. When people need to use the international service of a bank, it is usually for transferring money from one country to another. For example, for children studying abroad, for relatives living abroad, for merchandise that is to be shipped, for settling trades in foreign exchanges etc. Banks wishing to clear their checks internationally utilize their correspondent banks. At home interbank settlements (clearing checks, payments, credit card transactions etc.) are made through the FED (central bank). 3

4. Transferring funds, financing international trade, extending credit etc. are made through correspondent banks. They are active customers of one another. This is called correspondent banking. Any payment does two things: It sends a message to pay someone (how much, when and what currency) and makes the actual transfer of money to settle or reimburse the payment. 4

5. 3.2 Correspondent Banking Today, most of the international activities in banking are made through correspondent banks. Not even biggest banks can afford to have branches in all countries where their customers do business. For example, only 1 % of US banks have branches in other countries. Major banks and small banks become correspondents of each other to provide services to their customers. Larger banks gain access to regional markets and small banks obtain services in a large market and also obtain specialized assistance including lines of credit to support their operations. 5

6. At the initiation of a relationship, the two banks will exchange information (terms and conditions) on the services they can perform for each other and the fees for those services. The banks also exchange signature books and confidential telegraphic test keys. 6

7. 3.3 Accounts in an International Department Global payment rests on banks in one country maintain deposits accounts with banks in other countries to serve the needs of the customers of both banks. When funds are debited from or credit to such accounts, money is said to move from one country to another. Global payments are made through changes in bank accounts balances. Physical movements of currencies are rare. 7

8. 3.3.1 Due to Accounts A demand account maintained by a foreign bank in an US bank is referred to as a Due To or Vostro (meaning your account with us) account. The account is denominated in US dollars. This account enables foreign banks to make payment to other countries, handle collections and settle drafts under letter of credits. They provide deposits for those banks that are opened. Banks, regularly send each other statements showing the balances of the accounts. 8

9. 3.3.2 Due from Accounts An account maintained by US banks in a foreign bank is referred to by the US bank as a Due From or Nostro (our account with you) account. It is denominated in the currency of the foreign country. This account is under the control of the foreign exchange traders and it is kept in both foreign currency and US dollar equivalent. Therefore, it is called a dual currency account. 9

10. 3.3.3 Using the Account The establishment of only one account between two banks is sufficient for the conduct of all their business, for transfer of funds from one country to the other, for payments to be made in either country in either currency or to a third country in that country’s currency, for payment of traveler’s checks and foreign deposits etc. 10

11. 3.4 Basic Instruments The basic means, by which banks transfer funds upon request of a client, is through the network of correspondent bank accounts. Instructions are given by remittance orders or foreign drafts. An essential part of this instruction is settlement (debiting and credting accounts). Banks transfer funds by instructing each other either by an air mail or teletransmission. 11

12. 3.4.1 Remittance by Airmail This is an airmail letter sent from one bank to another foreign bank specifying; the amount, the name, and address of the beneficiary and the sender with authorized signatures. Banks gets the money, plus its commission and other expenses, along payment instructions from the customer. 12

13. 3.4.2Remittance by Teletransmission It is exactly the same as a remittance by airmail, except that the message is sent by means of a telegraphic or electronic communication system. Speed is important. Today online computer system is the most used method for sending payment messages. A test key or a code should be used for verification since there is no signature. 13

14. Test keys generally consist of a group of tables of numbers, perhaps one for the day, one for the month, one for the year, one for the currency, one for the amount etc. and only known by the lending and receiving banks. See figure 3.1 Telegraphic Test key 14

15. Payment orders sent by data teletransmission usually use the services provided by Society for Worldwide Interbank Financial Services (SWIFT). It is organized as a cooperative to provide member banks with standardized message formats in place of unstructured messages or incompatible message systems. This facilitates processing and transmissions. They have more than 120 types of messages for transmission. 15

16. SWIFT have more than 2800 member banks around the world. SWIFT is a communication system which is linked directly with member banks. Sometimes, SWIFT use regional payment such as Chips. The messages sent by SWIFT have also security features (authentication and verification). 16

17. 3.4.2 Foreign Draft A foreign draft (figure 5.2) is a negotiable instrument drawn by a bank on a foreign correspondent bank. It can be issued in any currency and it is given to the client. The client sends it directly to the beneficiary. A foreign draft must be received by the beneficiary in order for that person to receive payment. In remittance order makes the two banks responsible for the payment. It can be attached to invoices. 17

18. When a foreign draft is presented to the bank, signatures are verified and usually advice is waited from the issuing bank before payment. When a foreign draft is lost, a duplicate may be issued after a stop payment order has been placed on the original. 18

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20. Exhibit 3.2 Summary of Transfer Method Method Advantages Disadvantages Foreign Draft 1. Can be attached to invoices and bills for ease in paying small amounts. 1. Must be received by beneficiary. Customer is responsible for mailing. 2. Stop payments on lost drafts are time consuming. Remittances by airmail 1. Bank-to-bank instructions with banks responsible for making payments. 1. Beneficiary must await notification from bank. 2. Depends on international airmail services. Remittance by teletransmission 1. Fastest way to transfer funds. 2. Bank-to-bank instructions with banks responsible for making payments. 1.Expensive 2. Beneficiary must await notification from bank. 20

21. 3.5 Traveler’s Checks Probably the most widely used negotiable instrument in international banking is the Traveler’s Check, which is also used domestically. That bank Issues traveler checks after arranges for the design and printing (in $10, $20, $50, $100, $500, $1000) distributes them to banks and travel agents around the world to be available for sale. When the traveler’s checks are sold, the money is received by the issuer and when the check is cashed the issuer must pay out the amount to the bank where it was deposited. Records of these checks are strictly kept. The issuer must be prepared to replace lost or stolen checks. 21

22. 3.6 Settlement Settlement is the process of actually moving the funds from the seller to the recipient to complete the money transfer, by moving balances in bank accounts. This can be made; By crediting the paying bank’s Due To Account, Authorizing the paying bank to debit the Due From Account, Transferring the Funds through CHIPS and Fedwire. 22

23. 3.6.1 Other Money Transfer Instruments Payment instruments that have been created for use within the country are sometimes used for payments between countries. These are usually for small value amounts. Personal or business checks present difficulties when send to foreign countries (time consuming and verification problems). 23

24. The Giro system is widely used in the European countries for small payments. Giro is an automated interbank system in which the payers instruct their bank or post office in UK for example, to debit their account and credit the account of recipient. Recently credit cards have expanded as a means of payment to replace traveler’s checks. Travelers also benefited from ATM’s which permit them to withdraw cash from their accounts in a foreign currency. 24

25. 3.7 Large Value Settlement Banks usually keep only working balances in their accounts, sufficient funds to cover normal day-to- day transactions as these accounts do not earn interest. For large amounts in USA two systems are used. Fedwire and CHIPS. Fedwire payments are related to domestic and CHIPS payments are related to foreign transactions. 25

26. 3.7.1 Fedwire This is a message and payment system of the Federal Reserve System for transfers within the USA. All banks in the US including branches of foreign banks are required to maintain reserves (federal reserves). The accounts are available for making payments. Under Fedwire a payment is made as soon as a transaction is completed. When a bank transfer funds over the system to another bank, the account of originator bank is immediately debited. There is no “netting out” of claims (Real Time Gross Settlement “RTGS”). The average size of a transfer is about $ 3 million. Treasury securities are also transferred. 26

27. 3.7.2 CHIPS The Clearing House Interbank Payments System is a private computerized on-line real-time large-dollar transfers that is owned and operated by the New York Clearing House Association. During the day each transaction considered irrevocable, but actual settlement done at the end of the day based on each participant’s net position. That is if a bank sending payment orders of $10 million and receiving order for $ 9 million would make one transfer of $ 1 million at the end of the day (end of the day net settlement). This is in contrast to Fedwire which settles each transfer individually. In E.U. Trans European Automated Real Time Gross Settlement Express Transfer is used. 27

28. 3.8 Risk Management When more money is paid out of an account than in that account, an overdraft is created. At the end of the day an interest will be assessed by the bank over the overdraft. Banks routinely have to temporarily overdraw accounts on their books during the day. They do so with the expectation that over covering funds will come in later in the day so that no day-end over draft will remain. These are referred to as Daylight overdrafts. If the crediting funds did not appear, this is a very serious problem (Demirbank case). To avoid this situation CHIPS requires each participants to establish a credit limit for each other. These predetermined limits on the amount of daylight overdraft should not be exceeded. Payment orders exceeding these limits is held until sufficient funds come in to account during the day. 28

29. 3.9 Accounting Due to Accounts are listed as liabilities and Due From accounts are listed as assets. Due to accounts of foreign banks as well as domestic banks require reserves to be kept in FED 29