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Copyright 2005 by Thomson Learning, Inc.

Chapter 8
The Payment System and Financial
I nstitution Relationships

Copyright 2005 by Thomson Learning, Inc.
The Cash Flow Timeline



Order Order Sale Payment Sent Cash
Placed Received Received
Accounts Collection
< Inventory > < Receivable > < Float >


Time ==>
Accounts Disbursement
< Payable > < Float >

Invoice Received Payment Sent Cash Disbursed
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Learning Objectives
+ Explain, understand, and calculate float.
+ Explain the roles of the two major components of
the payment system.
+ Describe the major paper-based and electronic-
based payment systems.
+ Understand the ACH and how its fits with the EDI.
+ Use an availability schedule.
+ Explain the uses of an account analysis statement.
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Value of Float
+ The delay in value transfer from the time a check is
written until it finally is charged to the payors
account.
+ Value of float is based on differences in present
value based on time delay.
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U.S. Payment System
+ Banking system
+ Payment mechanisms
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Financial I nstitutions
+ Product differences, Ex 8.1
+ Geographical restrictions
+ Safety considerations
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Federal Reserve System
+ Organization, Ex 8.2, 8-3
+ Feds involvement in payment system
+ Check clearing
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Organization, Ex 8.2
+ Board of Governors
+ FOMC
+ Federal Advisory Council
+ District banks, Fig 8.2
+ Member banks
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Feds Involvement
+ Circulate new money
+ Check processing, 16.5 billion checks/yr
+ Check settlement
+ ACH
+ FedWire
+ Regulate availability schedules
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Check Clearing
+ MICR line, Exhibit 8.5
+ Clearing process, Exhibit 8.4
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MI CR Line, Exhibit 8.5
+ 2 digit Fed Bank Code
+ 2 digit Fed Office Code
+ 4 digit ABA Code
+ 1 digit verification code
+ Account number
+ Sequence number
+ Encoded amount
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MI CR CODE
Account Number
ABA Bank#
Check Digit
Fed District Code
Fed Bank Code
$
Pay to the
Order of
Dollars
Encoded Field

.. ..:l. :l
. ll
Chk Sequence #
..
xxxxxxxx7.75
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The Clearing Process, Exhibit 8.4
writes check
1. Customer
sends check
2. Supplier (payee) receives
check
3. Supplier
deposits
check
6. Suppliers
account is
credited
Clearing agent:
on-us, or Fed,
or correspondent,
or clearinghouse.
8. Customers
bank account is
debited
7. Check is
presented for
payment to
customers
bank
4. Check
forwarded
5. Suppliers bank is
credited
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Clearing Mechanisms
+ House/On-us checks
+ Local items
+ Transit items
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On-us Items
+ Payee deposits check in the bank on which it is
drawn
+ Bank credit depositors account
+ Bank debits payors account
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Local I tems
+ 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
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Transit I tems
+ Direct send
+ Correspondent bank
+ Fed Reserve
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Concept of Float
+ Types of float
+ Components of float
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Types of Float
+ Collection float
+ Disbursement float
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Components of Float
+ Mail float
+ Processing float
+ Clearing float
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Fed Float
+ 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.
+ Methods used to reduce float
check truncation
high-dollar group sort
inter-district transportation system
later presentment and deposit deadlines
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Paper-Based Payments
+ Types
+ Ledger balance
+ Collected balance
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Types
+ Checks
+ Drafts
+ DTCs
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Ledger Balance
+ All credits and debits
+ Not all spendable
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Collected Balance
+ Adjusted ledger
+ Reg CC, (2 and 5 days)
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Electronic-Based Payments
+ Wire transfers
+ Automated clearinghouses
+ POS debit cards
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I nternational Payment Systems
+ Paper-based systems
Giro systems
Value dating
+ Electronic payments
Clearing House Interbank Payment System, CHIPS
Society for Worldwide Interbank Financial
Telecommunications, SWIFT
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Managing the Bank Relationship
+ Objective

to ensure that all the companys banking services
are provided reliably at a reasonable cost
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Managing the Bank Relationship
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Services Provided
+ Collections

+ Payments

+ Information

+ Credit

+ Investments
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Collections
+ Coin & currency

+ Standard check processing

+ Lockbox services

+ Electronic collections

+ Deposit reporting service
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Payments
+ Demand deposit accounts

+ Zero balance accounts

+ Controlled disbursements

+ Payroll
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I nformation
+ Balance reporting services

+ Account reconciliation

+ Electronic delivery systems

+ Advisory or consulting services
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Credit
+ Shifting from a direct financing role

+ Moving toward role of risk-sharing or guarantor
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I nvestments
+ Repurchase agreements

+ CDs

+ Commercial paper

+ Corporate agency services

+ Trends
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Bank Selection and Relationship
Management

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Bank Selection
+ Location
+ Bank/Company Fit
+ Service Quality and Breadth
+ Bank Creditworthiness
+ Bank Specialties
+ Price
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Managing the Relationship
+ Account Analysis Statement, Ex 8-14
+ Required Compensating Balance Calculation
SC
RCMP = -----------------
ecr
(1-rr)(------)n
365
+ Balances vs. Fees
Banks view: Advantages of Balances
Corp View: Disadvantages of balances
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Banks View: Advantages of
Balances
+ Effect of increasing deposits for the bank

+ Balances can be lent

+ Form a cushion in case of loan default
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Corp View: Disadvantages of
Balances
+ ECR is < investment rate

+ Fees are tax deductible

+ Fees offer tangible expense that can be monitored

+ Fees are generally fixed and thus comparable, ECR
floats
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Daylight Overdrafts and the
Availability Schedule
+ Define: when a banks Federal Reserve account
book balance is negative during the day
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Optimizing the Banking Network
+ Check list
what is banks 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?
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NonBank Service Providers
+ Pepsicos loan to Marriot

+ Almost half of all consumer and business loans
held by nonbank companies

+ Third-party vendors of information between banks
and companies
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Financial System Trends
+ Nationwide banking in the US
+ Economic unification of Europe
+ Both of these will be catalysts for an ongoing drift
toward concentration and globalization in the
banking industry.
+ Imaging
+ Information services
+ Banking on the Internet
+ International aspects of banking relationships
+ Global bank consolidation
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Summary
+ We developed the uniqueness of the US payment
system and its major components.
+ We discussed the role the Federal Reserve plays.
+ We discussed the payment system using paper-
based and electronic-based methods.
+ We discussed bank selection and relationship
management.
+ We concluded with financial system trends.