Financial Technology

Topic 8

Introduction
• Banks provide valuable services to customers
• Play an important role in society, providing an important source of
capital
• Pooling depositors’ funds
• Making them available to companies and individuals
• Facilitate payments and settlements
• Competition from Fintech have had a major impact on banks’
business and IT strategies
Customer Segmentation
• The size of the banking institution will partially determine the types of customers and
business it serves
• Small banks may
• Focus on only a single line of business
• E.g. deposit taking and lending or credit card issuance
• Primarily serve only one subgroup of customers
• E.g. nonaffluent retail customers
• Medium-sized banks
• Typically have multiple lines of business
• Serve a broader range of customers,
• E.g. consumers and corporations
• Large banks
• Provide almost all categories of banking services
• E.g. FX dealing and investment banking
• Cater to almost all customer segments

Customer Segmentation
• Differences between servicing retail and corporate customers
• Number of customers
• Assets per customer
• Customer information availability
• Customer revenue diversification
• Number and types of products and services required
Customer Segmentation
• Consumer banking customers

Customer Segmentation
• Consumer banking customers
• Nonaffluent
• Largest segment in terms of numbers of customers
• Limited deposits
• Provide significant lending opportunities
• Mass affluent
• Deposits provide a low-cost source of funding
• Loans present less risk
• Diverse banking needs
• High net worth
• Relationship driven
• Wealth preservation and growth of funds are key concerns
• Taxes, estate planning, and privacy are also considerations
Customer Segmentation
• Private banking and wealth management
• Relatively small number of customers
• Often catered to by specialized institutions
• Private banks
• Account management may extend beyond an individual
• Business structures
• Familial structures
• Require integrated access to a wide range of investment products

Customer Segmentation
• Corporate and institutional banking customers
Customer Segmentation
• Corporate customers
• Small businesses
• Many and diverse in their nature
• Have relatively few banking options
• Some have large volumes of cash transactions
• Medium-sized enterprises
• Have more diverse banking needs
• May have international dealings, requiring FX and trade finance services
• May outsource some finance activities – e.g. payroll processing

Customer Segmentation
• Corporate customers
• Large corporations
• Fewer but high transaction volumes
• May require banks to integrate with their business processes and IT systems
• Often have relationships with multiple banks
• MNCs commonly have
• Complex corporate structures
• Large in-house treasuries that manage
• Corporate liquidity
• Foreign exchange risk
• Return on liquid capital
Customer Segmentation
• Institutional banking customers
• Financial firms and large MNCs
• Typical needs
• Investment, financing, remittances, risk management
• Expect lower costs for products and services and higher levels of service
• Have less regulatory protection
• Investment banking customers
• Typical needs
• Security underwriting
• Brokerage
• Merger and acquisition advisory

Opportunities
• Transition from being bank-centric to being customer-centric
• Improve customer relationship management
• See chapter 14 for further discussion
• Expansion into new markets
• Addressing the needs of underserved market segments
• The unbanked and underbanked
• Specific geographic regions
Opportunities
• Consumers somewhat or highly likely to make a mobile payment to
another person in the next six months

Challenges
• Tightening regulation
• Higher capital requirements
• Restrictions on trading activities
• Competition from non-financial institutions
• E.g. Walmart and Google
• Public and private firm discontent with the financial services industry
• US mortgage foreclosure scandal
• Product mis-selling
Transaction and Service Lifecycle
• A framework for examining the start-to-finish
activities involved in transactions
• Often individuals and IT systems only address a small
part of the lifecycle
• All parts are important, interrelated

Transaction and Service Lifecycle

• Design and setup
• Construction of banking products and processes
• Setup and configuration of supporting IT systems
• Engage customer
• Marketing and selling products and services to customers
Transaction and Service Lifecycle
• Capture order
• Acquisition of customer order details
• Agreement to legally execute the transaction
• Fulfill transaction
• Transaction confirmation, accounting, disbursement, and
remittance

Transaction and Service Lifecycle

• Maintain transaction
• Activities that support long-lived products and services –
e.g. mortgages
• Review
• Evaluate the effectiveness and profitability of products and
services
• Feeds back into the design and setup stage
Lifecycle Focus: Design and Setup
• Segment-related considerations drive IT solutions’ design

Lifecycle Focus: Design and Setup

• Reference data is an integral part of solutions
• Example: settlement holiday calendars
Solution Considerations
Financial Product Advice
• Business context
• Providing financial product advice to customers provides a major opportunity
• Can improve customer relationship and loyalty
• Bank can serve as a trusted third party
• Leverages banks’ specialized knowledge
• Leads to more responsibility though
• Providing appropriate advice to customers
• Fully understanding customers’ needs, capabilities, and risk preferences

Solution Considerations
Financial Product Advice
• Business context
• The risk that customers may receive bad advice is a major concern
• Relationship managers may have
• Poorly designed incentives that lead them to recommend inappropriate products
• Inadequate knowledge of the products offered
• Inadequate knowledge of the customer needs and preferences
• Many law suits and regulatory fines have resulted
• Hence, need for effective controls in those business processes
Solution Considerations
Financial Product Advice
• Key stakeholder needs
• Customer
• Receive objective and accurate advice
• Financial consultant
• Establish a long-term relationship with the customer
• May be rewarded for promoting specific products
• Bank management
• Sell financial products
• Avoid risks associated with providing inaccurate advice
• Leverage information related to customers’ financial needs, financial condition, and risk
preferences
• Regulator
• Ensure that customers are treated fairly and are not taken advantage of

Solution Considerations
Financial Product Advice
• Business processes
• What are some of the weaknesses and limitations of this
elementary process?
Solution Considerations
Financial Product Advice
• Business processes
• Potential improvements
• Capture more information about the customer and his/her interactions with the bank
• Utilize that information in a more structured way to provide advice that is
• More process driven, less dependent on individuals
• More consistent, producing repeatable results
• Create a separate compliance function
• To ensure the financial advisory process is executed as intended

Solution Considerations
Financial Product Advice
Solution Considerations
Financial Product Advice
• Solution implementation options
1. Paper driven approach
• Not practical for the improved process
2. Use central database for information storage
• Helps facilitate information sharing
3. Use business process management system to semi-
automate the process
• Helps ensure the correct process steps are followed
• Provides an audit trail of the steps that were taken

DEPOSITS
Introduction
• Deposits are the foundation of banks’ products and services.
• The majority of funds that banks use to lend comes from customer
deposits
• Cash management facilitates the movement of funds between
accounts and investment vehicles.
• Cash management helps corporate customers manage their liquidity
• Digital currencies are a new store of value that can deposited and
managed

Deposit Taking
• An important banking activity
• Customer deposits provide banks with cheap and “sticky” funding
• Usually requires multichannel access to accounts
• ATMs
• Internet banking / online payment facilities
• Branches
• Some banks have limited deposit taking capabilities and rely on other
sources of funding
• E.g. bonds and commercial paper
Cash Management for Corporate Banking
• Account management and access facilities
• Customers need to review their financial position
• Requires access to bank account balance information
• See current (real-time) account balances
• Monitor cash movements
• Retrieve historical transaction information
• Check the status of outstanding payments
• See mark-to-market valuation of foreign currency holdings in terms of the customer’s
base currency
• Make interaccount fund transfers

Cash Management for Corporate Banking

• Receivables management
• Automate collection of retail bill payments
• Use domestic electronic payment network
• For example, giro or ACH network transfers
• End customer authorizes the bank to withdraw from their account
• Lockbox services
• Bank provides post office boxes for corporate customers
• Specified as the destinations for cheque payments
• Bank opens the mail that is received for customer
• Processes any cheques received
• Deposits cheques and generates reports
Cash Management for Corporate Banking
• Liquidity management
• Cash sweeping
• Move end-of-day balances from subaccounts to a single interest bearing master account
• Eliminates issues of surpluses in some accounts and shortfalls in others
• Cash pooling
• Same as sweeping but notional consolidation of balances without the physical
movement of funds between accounts
• May extend across subsidiary’s accounts
• No accounting entries required

Cash Management for Corporate Banking

• Liquidity management
• Netting of cash settlements
• Net corporate intracompany payment obligations
• May include third parties, such as suppliers
• Eliminates the need for gross settlement
• Reducing fund movements and funds-transfer costs
• Reduces amount of FX conversions required for cross-currency payments
Cash Management for Retail Banking
• Integrated retail accounts often provide
• Cheque and electronic payment
• Interest bearing and overdraft facilities
• Online bill payment and cash withdrawal capabilities
• Cross-border
• Payments
• Money transfers
• Cash withdrawals
• Online personal financial management tools have
become increasingly important

Business Opportunities
• Banks to help their customers save more, especially Millennials
• Creating savings products that are easy to understand, both risks and
rewards
• Tailoring savings products and services for specific customer
segments
Business Challenges
• Price competition and profitability of products
• Processing efficiency
• Cost per transaction
• Processing delay
• Operational risk
• Anti-money laundering (AML) compliance
• Lost and duplicated payments
• System downtime
• Fraudulent deposits

Architecture Considerations:
Core Banking Systems
• Provide transaction processing and account management functions
• Current and savings accounts
• Basic loan products
• Payments processing
• May also support
• Basic treasury products
• Multichannel connectivity – e.g. branch, ATM, internet-banking
• Customer relationship management facilities
Architecture Considerations:
Core Banking Systems
• Primarily provide functions for
• Capturing order
• Fulfillment
• Transaction maintenance
• Additional IT systems are usually required to support activities related
to
• Engaging the customer
• Transaction maintenance activities
• E.g. collections

Architecture Considerations:
Core Banking Systems
Architecture Considerations: Resilience
• Resilience concerns
• System level failures, may fail over to
• Another system
• A manual process
• Site level failures
• Business continuity planning
• Recovery of business processes
• Disaster recovery
• Availability of IT systems and services

Architecture Considerations: Resilience

• Resilience patterns
• Active-active
• Load balancing between servers or sites
• When one instance fails the remaining instances make up lost capacity
• Active-passive
• Hot standby
• Passive service runs in parallel with the active service
• Often implemented using software-level failover
• Warm standby
• The passive service does not begin running until the active service fails
• Hardware clustering is often used to implement
• Cold standby
• May be substantial delay (e.g. hours) after active service fails before passive service is available to
continue processing
• Common for disaster recovery setups
Cash Notes
• Governments’ success in phasing out physical payment instruments
has been mixed
• Electronic payments trump cash payments in terms of convenience,
cost, and security
• Cash notes provide anonymity
• Electronic payments are vulnerable to major catastrophes, telecom,
and power failures
• Cash usage varies significantly by country

Cash Notes
• Cash payments as share of transaction volume
Digital Currencies
• Motivations
• Ideological factors
• Eliminate dependencies on traditional financial institutions
• Circumvent centralized control and restrictions
• Improved transaction processing
• Faster transactions
• Low transaction fees
• Not linked to the users’ geographical location
• Financial benefits for the inventors

Digital Currencies
• Digital currency timeline
Digital Currencies
• Characteristics
• Use digital ledger technologies
• Use cryptography to validate transaction
• Enable pseudonymous payments
• Transactions are irrevocable

Digital Currencies
• Participants
• Users
• Wallet providers
• Exchanges
• Miners
• Others – inventors, ATM providers, etc.
Digital Currencies
• Risks
• Technical
• Design flaws and backdoors
• Depended on availability of power and networks
• Cybersecurity: an open target for hackers
• Financial: price volatility
• Legal and regulatory
• Unclear how they will be treated in the future

Digital Currencies
• Banks’ positioning
• Wary of potential risks and uncertainty
• Performing limited tests to better understand technology
• Revamping interbank payments could be the most immediate opportunity for
banks
Digital Currencies
• Evolution
• Open-source projects makes it easy for new digital currencies to propagate
• Hundreds of “alt-coins” have been developed
• Success of new digital currencies depends on achieving a sufficient level of
use
• The greater the number of digital currencies that compete with one another,
the fewer (in total percentage) that are likely to succeed

Digital Currencies
• Potential
• Thousands of businesses across the world accept Bitcoin for payment
• Overall, a very small proportion of businesses accept digital currencies
• For payments, the network effect is critical
• Digital currencies’ broader uptake hinges on their ability to fill an unmet
market need
• Widespread adoption may require institutional support – governments,
regulators, and banks
LOANS

Introduction
• There is a long history behind lending
• Capital provided by bank loans have changed the course of history
• Banks bear loan repayment risk and charge interest rates and fees to
compensate
• The law of large numbers helps limit aggregate losses on loan
portfolios
• Fintech marketplace lenders have encroached on this core business
for banks
Lending
• Corporate banking context
• Corporate loans are typically customized products
• Significant time required to initiate a corporate loan transaction
• Negotiation of rates, fees, and covenants
• Understand business purpose and repayment means
• Fulfillment and maintenance requirements may be complicated
and long-lived
• E.g. verifying that covenants are being met
• Due diligence processes are often difficult to automate
• E.g. reviewing financial statements
• Anti-money laundering checks are also required

Lending
• Corporate banking context
• Common loan attributes
• Loan type
• Tenure
• Secured versus unsecured
• Covenants
• Amount/credit limit
• Repayment schedule
• Rates and fees
• Penalty clauses
• Property, equipment or receivables can be used as
collateral to secure loans
Lending
• Corporate banking context
• Understanding and tracking loan risk correlation
• Loans to the same corporation represent correlated risk
• So do loans to different subsidiaries of the same parent
corporation
• Corporate holding structures need to be taken into account
for counterparty limits

Lending
• Retail banking context
• Unsecured credit
• Major area of growth
• Individual credit exposures are small
• Relatively high delinquency and charge-off rates
• Interest rates and fees are high to offset losses due to defaults
• Collections is an important part of the business
• Credit bureaus often used to help gauge applicants creditworthiness
• A highly regulated business in many markets
Lending
• Retail banking context
• Mortgages and other secured credit
• Fixed rate term loans
• Floating rate term loans
• Hybrid fixed then floating
• Loan refinancing is an important business where fixed rate mortgages are
used
• Property usually serves as security collateral
• Important that collateral is valued conservatively
• Many banks had inadequate security for loans made on mortgages in U.S.
• Home prices dropped precipitously, reducing collateral value

Lending
• Retail banking context
• Complications in the lending process
• Loan origination may be performed by brokers or auto dealers
• Third party appraisers may be used for
• Assessment of the property/collateral value
• Periodic inspections
• Insurance verification
• Collections
• Loans may ultimately be bundled into securities and sold to investors
Opportunities
• Increasing size and diversity of loan portfolio to reduce relative risk
• Taking advantage of institution-specific characteristics
• Geographical location
• Partnerships
• Industry expertise
• Specialized analytics
• Customizing rates and fees to take into account customer profitability
• Automating frequent, simple decisions

Challenges
• Managing complexity
• Variable attributes
• Multiple interest rate calculations
• Varying repayment schedules
• Variable approval structures
• Multiple manager approvals for
• Large loan amounts
• Special loan conditions
• Integration with external parties
• E.g. external ratings agencies, appraisers, and insurers
• May be provided electronically or as paper documents
Challenges
• Varying lending practices by country
• Availability of customer credit history information
• Effectiveness of legal system in some countries
• For dealing with recovery in the case of default
• Competition from marketplace lenders
• Offer cost-effective services via web and mobile phone channels
• enable individual investors to loan funds
• only act as intermediaries
• financing activity does not hit their balance sheets

Managing Counterparty Credit Risk

• Forms of counterparty credit risk
• Sources of risk
• Outstanding loans
• Foreign exchange transactions
• Derivative contracts
• Payment guarantees
• In some cases, the amount of risk will be the same as the notional amount of the
transaction
• E.g. loans
• In other cases, the risk is the change in value based on current market conditions
• E.g. an interest rate swap
• Usually the risk is a small fraction of the notional amount
Managing Counterparty Credit Risk
• Approaches to counterparty credit risk management
• Limits are defined for all counterparties prior to transacting
• Limits are reviewed and adjusted on a regular basis
• Presettlement credit limits
• Based on the expected risk of transactions over the lifetime of the contract
• Settlement credit limits
• Difference between gross outbound and inbound payments
• With a given counterparty
• During the settlement cycle
• Usually between one and a few days
• Transactions must not exceed either limit

Managing Counterparty Credit Risk

• Distributed credit limit allocation approach
• Delegates limit management to downstream systems
• Total limit amount is divided across business systems
• Then divided across business units within each system
• Simple from an integration standpoint
• Push start of day limit files to each system
• Downside
• Limits will never be optimally distributed
• Some lines of business/countries will have customer transactions that hit their counterparty
limits
• Others will have surplus limit allocations that are not utilized
Managing Counterparty Credit Risk

Managing Counterparty Credit Risk

• Centralized credit limit allocations approach
• Implement limit-checking functions as part of a central
limits management system
• Enables better limit utilization
• Simplifies operational processes
• Eliminates the need for operational staff to manage limits
differently in multiple systems
• Technically difficult to implement a fully centralized limits
system
• Business applications must be able to
• Bypass their own internal credit limit checking mechanisms
• Call out to an external system for real-time limit availability checks
Managing Counterparty Credit Risk

Secured Lending Lifecycle

• Design and setup
• Population of data records and templates in the core
banking system
• Customer information
• Product information
• Limit information
• Fee information
• Product attributes
Secured Lending Lifecycle
• Engage customer
• Advertize products
• Understand purpose of loan
• Determine means of repayment
• Identify and value collateral available for security

Secured Lending Lifecycle

• Capture order
• Credit evaluation and verification
• Qualitative review
• Understanding the company’s business and the trends of its business
environment
• Quantitative review
• Analysis of its financial statements
• Negotiations of payment terms, fees, and covenants
• Preparation of the contractual documentation
Secured Lending Lifecycle
• Fulfill transaction
• Verification of signatures
• Sending transaction advice to the customer
• Generation of account entries
• Disbursement of funds
• Where collateral is involved, may require
• Physical handover
• Legal transfer of ownership
• Registration of a lien

Lifecycle Focus: Credit Evaluation

• Maintain transaction
• Repayment processing
• Including early repayments
• Apply fees for late payments
• Collections and loan foreclosure processing
• Legal recovery actions in case of default
• Corporate customers
• Ensure that loan covenants are not broken
• Review financial statements
• Cancel or amend the credit agreement, as necessary
Lifecycle Focus: Credit Evaluation
• Review
• Customers corporate activities
• E.g. mergers and acquisitions
• Customers’ risk profiles and behavioral patterns
• E.g. ability to repay other creditors
• General economic conditions
• Customer industry-specific conditions

Lifecycle Focus: Credit Evaluation

• Relationship banking services
• Close connection between the bank and the customer
• Requires collection of more qualitative information about customers
• Management capabilities
• Financial condition
• Practical for customers performing large value transactions
• E.g. wealth management and corporate lending
Lifecycle Focus: Credit Evaluation

Lifecycle Focus: Credit Evaluation

• Transactional banking services
• Sell high volumes of standardized product
• Use quantitative measures that can be
• Assessed quickly
• With minimal effort
• Using automated processes
• Best for high-volume, low value transactions
• E.g. Unsecured consumer lending – credit cards
Lifecycle Focus: Credit Evaluation

Architecture Considerations:
Debt Collection Technology
• Business Context
• The collections process is triggered when a customer fails to make an agreed
payment
• Banks will attempt to rehabilitate the account for up to 180 days past due
• The longer the account has been delinquent, the more difficult it is to recover
funds
• After 180 days of delinquency, banks are required to charge off the debt
Architecture Considerations:
Debt Collection Technology
• Recovery approaches
• In house collection
• Outsourced collection
• Sell off debt for third-party collection
• Current contact information is essential for collections
communication
• Debt payments may be restructured
• Consumer protection regulations restrict debt collection practices

Architecture Considerations:
Debt Collection Technology
• Debt collection complaints by type of issue
Architecture Considerations:
Debt Collection Technology
• Technology support for collection management functions
• Monitoring and managing the status of delinquent accounts
• Tracking interactions with customers
• Maintaining customer contact information
• Calculating customer-specific payment options
• Recording and tracking customers’ promises to pay on future dates
• Generating reports that can be used for financial, audit, and compliance purposes

Architecture Considerations:
Debt Collection Technology
• Other areas that technology supports
• Payments
• Customer communication channels
• Predictive dialing
• Call recording and monitoring
Solution Considerations
• Multistage loan approval
• Loans usually require one or more managers’ approval
• Who approves transactions is determined by set of business rules based on
• Loan amount
• Interest rate offered
• Fees applied or waived
• Unusual terms in loan agreement
• For example
• US$100,000 loan may only require a one managers approval
• US$1 million may also require a senior manager’s approval
• US$10 million loan may require a senior manager’s and division director’s approval

Solution Considerations
• Multistage loan approval
• Business rules for approval are institution-specific
• Easy to cater to arbitrary and ad hoc approval structures when paper is used
• More difficult when rules are embedded in software
• Core banking systems may have some predefined approval structures
• Business process management systems (BPMS) can be used to implement
more flexible structures
Solution Considerations
• Loan application processing and monitoring
• Originally, applications and supporting documents were paper stacks moved
between desks
• In some cases, they still are
• Concerns
• Paper gets lost
• Difficult to determine what stage of processing a particular application is at
• Hard to track whether processing time service level agreements (SLA) for individual
applications will be met prior to the completion of the process

Solution Considerations
• Loan application processing and monitoring
• Using scanned images combined with BPMS can help alleviate these problems
• After scanning, no papers to lose/misplace
• Easy to determine at what stage of processing an application is at with process
monitoring
• Can estimate which applications are likely to miss their SLA based on their current state
and expedite processing
Solution Considerations
• Internal and external data integration
• Many potential sources of data used for evaluating loan applications
• Customer, credit bureaus, insurance companies, etc.
• Ideally, all data sources would be integrated to have straight-through
processing
• Reduces manual effort and risk of mistakes in capturing the information
• It may not always be practical though, since some information may not
• Be available via electronic interfaces
• Be used often enough to make it worthwhile to automate
• Have transmission (entry) errors of significant concern
• Provide supplemental value, such as for MIS reporting

PAYMENTS
Introduction
• Electronic payments have transformed banking
• Domestic payment systems are shifting from batch to real-time
processing
• Fintech companies are using technology to drive change in the
payments industry
• Digital currencies enable faster funds transfers and at lower costs

Concepts
• Main activities involved in payment processing
• Payment instruction generation
• Specification of the fund transfer details by the payer
• E.g. the amount, payee, and payee’s account information
• Clearing
• Process of providing payment instruction information to a clearing house
• The clearing house matches, reconciles, and sometimes nets the payment instructions
• Settlement
• The transfer of cash or securities so that the transfer is final from a legal standpoint
Concepts
• Settlement
• Banks may participate in many different types of settlement activities
• Interbank same-currency settlement
• Multicurrency foreign exchange settlement
• Securities settlement, e.g. stocks and bonds
• Focus of the discussion here is on interbank same-currency settlement

Concepts
• Settlement
• Multiple payment systems may function in the same country
• Provide different services
• For large and small value payments
• With different settlement cycles
• Example: in the United Kingdom
• Bacs
• Faster Payments Service
• Cheque & Credit Clearing Company
• CHAPS
• LINK
Concepts
• Settlement
• Clearing members of a national payments system settle directly with other
clearing members
• Smaller financial institutions and foreign banks
• May not qualify to be clearing members
• May not be financially practical to be clearing members
• In either case, they will need to use another financial institution that is a clearing
member as their settlement agent

Concepts
• Settlement
• Settlement lag is the delay between the acceptance of the payment instruction and its
final settlement
• Payment systems have different settlement lags
• Settlement may occur
• Within some specified number of hours or minutes
• At the end of the day
• The next day (T+1)
• Some number of days later (T+n)
Concepts
• Settlement risk
• Is a result of settlement lag, caused by
• Time zone differences
• Clearing and confirmation delays
• During settlement lag, settlement obligations accumulate
• Increases the amount due to be settled at the end of the settlement cycle
• The risk is that when the time comes to settle, a bank’s counterparty may fail
to meet its settlement obligation
• Banks use counterparty settlement limits to manage settlement risk

Concepts
• Netting
• Alternative to gross settlement
• Enables banks to offset their obligations to one another
• Periodically calculate the net settlement positions for a series of payments or trades
• Reduces the number of cash flows and their amount
Concepts
• Netting
• Bilateral netting nets positions between pairs of individual
counterparties

Concepts
• Netting
• Multilateral netting nets positions across all counterparties
Concepts
• Real-time gross settlement (RTGS)
• Avoids settlement lag inherent with netting
• Often net settlement is implemented at after the close of the business day
• Improves liquidity, because it makes funds available more quickly
• National payment systems manage RTGS across multiple banks’ accounts
• E.g. FedWire in the US and CHAPS in the UK

Payment Technologies
• Automated clearing house transactions
• In the US, the National Automated Clearing House Association (NACHA) sets
and enforce rules for ACH payments
• ACH participants
• Originator
• Originating Depository Financial Institution (ODFI)
• ACH Operator
• Receiving Depository Financial Institution (RDFI)
• Receiver
Payment Technologies
• Automated clearing house transactions
• US ACH is a store and forward payment system
• ACH files are created by the originator are received by the ODFI and then
forwarded to the ACH operator
• The operator
• Verifies that the formatting is correct and sets the settlement date value
• Extracts entries from the ODFI files, sorts, and groups according to the destination RDFI
• Generates RDFI-specific ACH files and makes them available for download by the RDFI
• Historically has been next-day payments, but moving to same-day and,
ultimately, immediate payments

Payment Technologies
• International payment messaging
• The SWIFT network is run by a cooperative of over 200 banks from 15
countries
• Communicates payment information across international borders
• Based on a standard set of message types and business identifier codes (BICs)
• SWIFT is a messaging platform, not a clearing or settlement system
Payment Technologies
• Major SWIFT message series categories

Payment Technologies
• Payment cards
• Payment card transactions represent a major portion of consumer payments
in many countries
• The card payment ecosystem is complex
• The number of participants involved
• Card associations, card issuers, transaction acquirers, merchants, and payment processors
• The variety of technologies that are used
• Magnetic stripe, EMV, contactless
Payment Technologies
• Payment cards
• Payment card share of consumer transactions, by transaction value

80%

70%

4%
60%

50% 41%

3%
40% 18% 28%

Credit
7%
30% 60% Debit
5%

43%
20%
32% 30%
28% 27%
25%
10%

0%
s ce y ria lia S da
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m
Au st an
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Payment Technologies
• Payment cards
• Common types of payment cards
• Credit cards
• A revolving credit facility
• Charge cards
• A credit facility that must be settled on a monthly basis
• Debit cards
• Funds held in a bank demand draft accounts
• Prepaid (stored value) cards
• Funds loaded by the customer held in an account maintained by the
card issuer
• Gift cards
• Typically non-reloadable prepaid cards that are purchased via
merchants
Payment Technologies
• Payment cards
• Magnetic stripe
• Information stored in a static form on the card
• Advantages
• Inexpensive to produce
• Enables transactions to be processed quickly
• Is able to be read ubiquitously by POS terminals
• Weaknesses
• Easily read by skimming devices
• Easily copied onto counterfeit cards

Payment Technologies
• Payment cards
• EMV
• Information accessed via a microprocessor on the card
• Advantages
• Information cannot be easily copied off of the card
• Prevent the use of counterfeit cards by using public-key encryption
techniques to verify the card’s authenticity
• Can store the card PIN information to provide two-factor
authentication
• Disadvantages
• Requires POS and IT system upgrades to support EMV
• Slower transaction processing times
Payment Technologies
• Payment cards
• Tokenization
• Addresses issue of compromised card information due to security
breaches of merchants’ IT systems
• POS software sends the cardholder account information to a token
vault
• Token vault provides a proxy account identifier, a.k.a. the token
• The merchant uses token, instead of the real account information,
to process the transaction
• The merchant does not directly handle or store the card account
information

Payment Technologies
• Payment cards
• Contactless payments
• Proximity cards use electromagnetic induction to transfer
electrical power from the POS device
• Can communicate at distances of up to several centimeters.
• Use near field communication (NFC) protocols
• Faster than having to dip an EMV card into a POS terminal and
wait for the transaction to be authorized
• Mobile phone payments also use NFC technology
Corporate Banking Context
• Payments are necessary for companies’ ongoing
business operations
• Core bank payment services
• Paper cheque processing
• Interbank fund transfers
• Domestic electronic payments
• Telegraphic transfers (TTs)
• Other payment-related services
• Standing instruction
• Bulk-payment facilities

Retail Banking Context

• Common retail payment services
• Domestic ACH and GIRO payments
• Online bill payment
• International wire payments (TTs)
• Fintech companies have been driving real-time, peer-to-peer
payments
• Banks have launched their own initiatives to counter this competition
• Payments are continuing to evolve, e.g.
• Payments via social media
• Mobile phone ATM withdrawals
Business Opportunities
• Fee-based revenue
• Example: telegraphic transfer fees
• Handling fee
• Wire transfer charge
• Foreign currency handling charges
• Standing instruction sign-up fee
• Standing instruction amendment fee
• Shifting customers from paper-based to electronic
• Addressing the unique needs of emerging markets, e.g. Africa

Business Challenges
• Price competition and economies of scale
• Regulator-driven payment system changes
• Operational risk
• Anti-money laundering (AML) compliance
• Lost and duplicated payments
• System downtime
• Fraud
Business Challenges
• Common fraud schemes involving customer payments

Telegraphic-Transfer Service Lifecycle

• Design and setup
• Specification of service’s terms and conditions
• E.g. customer is responsible for loss due to incorrect payment
details
• Create fee structure
• Specify languages supported for payment instructions
Telegraphic-Transfer Service Lifecycle
• Engage customer
• Marketing
• Letters, emails, Internet banking “splash” screen
• Fee waivers
• Train branch and call center staff
• To instruct customers on how to complete the forms
• Logistical considerations
• Distribution and storage of paper forms
• Online access
• Develop and deploy web pages to support transaction capture

Telegraphic-Transfer Service Lifecycle

• Capture order
• Information validation
• Transaction details
• AML checks
• Signature verification – for paper forms
• Original signature check at point of receipt
• Authenticity of signature checked later during fulfillment
• Timestamp the payment instruction
• Used for cutoff time and SLA tracking
Telegraphic-Transfer Service Lifecycle
• Fulfill service
• Check if if multiple signatories are required
• Under what conditions
• E.g. if the transaction is over a certain dollar amount
• Enter transaction into the core banking system
• Generate accounting entries
• Clear and settle transaction
• Deal with exceptions
• E.g. payment is rejected by a correspondent bank
• Calculate fees
• Include correspondent bank charges, as necessary

Telegraphic-Transfer Service Lifecycle

• Maintain service
• Daily reconciliation between payment gateways and the core banking system.
• Keep static data up to to date
• Fees structures
• Payment network destinations
• Upgrade interfaces to support changes to payment networks
Telegraphic-Transfer Service Lifecycle
• Review
• Profitability and SLA fulfillment
• Improving process efficiency

© DBS Bank.
Reprinted with
permission.

Lifecycle Focus: Order Validation

• Missing information on a TT application can cause a processing
exception
• Best to perform completeness checks as early as possible
• E.g. if the paper form is submitted at a branch, the teller who receives it can
verify that all fields have been completed
• If the instruction is entered online, the webpage can verify that all required
fields have plausible values
Lifecycle Focus: Order Validation
• Payment instructions may be received from customers by letter
• Require the payment processing staff to manually extract relevant payment
information
• One letter may contain multiple payment instructions
• Complex and error prone activity

Lifecycle Focus: Order Validation

• Some exceptions may only become apparent at later stages of
processing
• E.g. exceptions generated by correspondent banks
• Account details may be contained in “special instructions” field
• Free form text information
• Many different ways that account information may be encoded in it
Solution Considerations
• Real-time versus batch processing
• Batch processing
• Many types of transactions are recorded electronically during the day
• Processing is not completed until the batch run is performed after hours
• Requires a cutoff time for entering transactions
• Transactions entered after cutoff will
• Not be processed as part of the batch
• Be included on the following business day’s run

Solution Considerations
• Real-time versus batch processing
• Batch processing “window” is allocated
• E.g. between 1:00 am to 4:00 am
• Different batch activities run may be dependent on one another
• Each batch must complete within its own specific time window
• Increases in transaction volume cause longer batch processing times
• Can lead to scalability concerns when total batch processing time exceeds the allocated
window
• Batch processing contributes to payment settlement lag
• Many payment systems designed to support settlement using end of day
batch processing
Solution Considerations
• Real-time versus batch processing
• Real-time processing
• Preferable from a delay and scalability standpoint
• Requires substantial parts of the processing chain to support real time processing
• Major IT retrofit required for banks that do not currently have real-time processing
capabilities
• Requires business processes be redesigned to support short turnaround times for
processing exceptions and making fraud decisions

TRADE SERVICES
Introduction
• Banks have provided trade services and finance for centuries
• Trade-related banking transactions still are largely driven by paper
documents
• Attempts to dematerialize trade documentation have had limited
success
• Still very much driven by manual processes
• New technologies (i.e. blockchain) have renewed interest in
leveraging technology to improve the trade finance

Introduction
• Extent to which banks’ trade finance transaction processes are digitized

Great extent Source: Duran, R. E.,

7% Financial Services Technology,
Cengage Learning Asia, 2018

Not at all
22%

Somewhat
28%

Very little
43%
Corporate Banking Context
• International trade interactions
• Primary participants and flows for simple trade payment
scenarios
Payment
Importer's Exporter's
Bank Bank

Payment Payment

Importer Exporter
Trade
Documents

Goods Goods
Source: Duran, R. E.,
Carrier Financial Services Technology,
Cengage Learning Asia, 2018

Corporate Banking Context

• International trade interactions
• Common trade-related documents that banks must handle
• Commercial invoice
• Packing list
• Certificate of inspection
• Certificate of origin
• Insurance certificate/policy
• Bill of lading
• Airway bill
• Rail consignment note
• Bill of exchange
• Promissory note
Corporate Banking Context
• Banking customer needs
• Buyer/importer risks loss if the goods purchased are
• Not delivered
• Not delivered on schedule
• Of inferior quality
• Seller/exporter faces the risk of loss if the importer
• Does not pay for the goods as promised
• Delays payment
• Both face risks related to the damage or loss of goods in transit

Banking Trade Services

• Importers and exporters’ have several options for
delivery and payment
Banking Trade Services
• Payment services
• Are the primary service used for cash-in-advance and open account
arrangements
• Invoices and bills of exchange presented by the exporter and accepted by the
importer initiate the payment process
• Telegraphic transfers are the primary means of effecting international
payments

Banking Trade Services

• Collection services – documentary collections
Payment Payment
Importer's Collecting Exporter's
Bank Bank Bank
Trade
Documents

Payment
Payment
Obligation Trade
Documents Trade
Payment Documents

Importer Exporter
Trade
Trade
Documents
Documents

Goods
Goods

Source: Duran, R. E.,

Carrier Financial Services Technology,
Cengage Learning Asia, 2018
Banking Trade Services
• Collection services
• Documentary collections
• Benefits
• Exporter
• Retains control over the goods up to the point when the importer agrees to payment
• Reduces counterparty payment risk
• Importer
• Able to examine the trade documents in advance of payment

Banking Trade Services

• Collection services
• Documentary collections
• Concerns
• Exporter
• Importer may refuse to pay when presented with the trade documents
• Importer
• Goods may not be delivered as expected after the payment obligation has been made
Banking Trade Services
• Trade finance services – letters of credit
Letter of Credit
Payment
Importer's Exporter's
Bank Bank
Trade Letter of Credit
Request for
Documents
Letter of Credit
Pay- Pay-
Trade ment
ment Trade
Documents
Documents

Importer Exporter
Trade Trade
Documents Documents

Goods Goods

Source: Duran, R. E.,

Carrier Financial Services Technology,
Cengage Learning Asia, 2018

Banking Trade Services

Source: Duran, R. E.,

Financial Services Technology,
Cengage Learning Asia, 2018
Banking Trade Services
• Trade finance services
• Irrevocable documentary credits
• A.k.a. irrevocable letters of credit (L/Cs)
• Benefits
• Exporter
• Provides a bank guarantee that the exporter will be paid
• As long as the requirements stipulated in the L/C are met
• L/C can be used to secure preshipment finance
• Importer
• Provides a fixed date by which the exporter must ship to comply with the terms of the L/C
• Can be used to secure longer terms of credit for a term bill of exchange

Banking Trade Services

• Trade finance services – letters of credit
• Concerns
• Payment of the L/C is linked only to the presentation of the required documentation
• It is not dependent on the delivery of the goods or their condition when delivered
• Third-party inspection can be required as a condition of the L/C to help mitigate this concern
• To obtain an L/C, the importer must have a line of credit with its bank
• Or sufficient funds deposited as security for the L/C
• Cost of an L/C is higher than documentary collections
• Cost depends on the importers credit rating
Banking Trade Services
• Trade finance
• Finance of working capital
• Supports the purchase, production, and delivery of good
• Usually dependent on proof of the customer’s need for trade-related financing
• Commonly used in conjunction with cash-in-advance or open account payment
arrangements
• Provided as
• Short-term loans
• Revolving credit lines
• For security, liens may be placed on customers’
• Equipment
• Raw materials
• Inventory
• Accounts receivable

Banking Trade Services

• Trade finance
• Term bill discounting
• A term bill is bill of exchange that is payable only after a fixed period of time
• Represents a security that can be sold at a discount to raise funds immediately
• Payment of term bills can be linked to L/Cs
• Drawn against the exporter’s bank, rather than the exporter
• Carry considerably less credit risk
• Attractive for third parties to purchase as money market instruments
Banking Trade Services
• Trade finance
• Term bill discounting
• An attractive option for exporters who would like to offer trade credit to their customers
but have difficulty in obtaining bank loans
• Importer benefit
• Receives a period of trade credit
• Exporter benefit
• Receives immediate payment
• Drawbacks
• Discounting diminishes the profitability of the trade transaction

Banking Trade Services

• Trade finance
• Export factoring
• Used by exporters who have difficulty securing bank lines of credit
• E.g. small and medium enterprises
• Factor pays cash for the exporters’ future invoice payments or accounts receivable
• If “without recourse”, the factor assumes the risk that the importer does not pay
• Reduces exporter’s counterparty credit risk
• Avoids adding debt (i.e. trade credit) to the exporter’s balance sheet
Business Opportunities
• Standardization
• Trade finance rules are standardized, trade documents are not
• Differences in legal frameworks from country to country have made
standardization efforts difficult
• Use of SWIFT messaging has helped
• Transition to open account arrangements
• Avoid costs and overheads of issuing L/Cs
• Good for large corporations that import from a large number of suppliers
• White-labeling trade services to other banking institutions

Business Challenges
• Processing L/Cs is often still very manual
• Requires specialized skills and expertise
• Potential for mistakes that lead to losses
• Many of the terms may be maintained in free-form text fields in
electronic messages
• Must be parsed and interpreted by people
• Paper copies of trade documents must still be maintained
• Some countries’ do not legally recognize electronic transactions
Business Challenges
• Importer’s bank must continually monitor and assess the importer’s
ability to make payment
• In the case of nonpayment
• Importer’s bank retains goods and must try to sell them to recover funds
• Recovery rates vary based on type of goods
• Avoiding fraud
• Many scams related to forged L/Cs
• Banks may require questionable importers to deposit funds rather than
providing credit

Letter of Credit Lifecycle

• Design and Setup
• Define the types of L/Cs that will be offered
• Variations that will be supported within each type
• Create fee structures
• Align with cost of channel operation
• Link delivery channels with trade finance IT systems
Letter of Credit Lifecycle
• Engage Customer
• Perform antimoney laundering (AML) checks
• Know your customer (KYC) checks
• Vet the correspondent bank
• Not associated with political corruption or illicit activities
• Applicants for L/Cs are usually already the bank’s customers
• Banks may issue one-time L/Cs on behalf of importers who are not regular
customers
• Deposits provide security in lieu of a credit line

Letter of Credit Lifecycle

• Capture Order
• Details to be captured:
• Beneficiary name and address
• Applicant name and address
• Currency and amount
• Expiry date
• Delivery mode: registered mail, courier, or SWIFT/Telex
• Payable on sight or for term and term length
• Documents required, for example, commercial invoice, clean bill of lading made out in
importer bank’s name, insurance policy
• Delivery location
• Discharge port
• Latest shipment or delivery date
• Verify port of delivery and the transit ports are not in countries that have been blacklisted for
AML
Letter of Credit Lifecycle

• Fulfill transaction
• Amendments may be made to
• Extend the expiry or latest shipping date
• Adjust the amount of the L/C
• Modify the trade documentation requirements
• Change the beneficiary’s details
• Acceptance of trade documents trigger the importer’s bank
to distribute payments according to L/C instructions

Letter of Credit Lifecycle

• Maintain transaction
• Review customers’ credit lines
• Annually for stable customers
• More frequently for those under financial stress
Letter of Credit Lifecycle
• Review
• Determine the product and customer profitability
• Evaluate which customers will benefit from other trade services
• E.g. working capital financing

Lifecycle Focus: Transaction Fulfillment

• Effective verification of L/C trade documentation is crucial
• Erroneously delaying payment to the exporter may lead to a penalty interest
claim by the beneficiary
• Erroneously making payment before all the terms of the L/C have been
fulfilled may lead to non-fulfillment of the goods delivery
• Processing mistakes may also cause reputational damage and loss of business
Lifecycle Focus: Transaction Fulfillment
• Must ensure that L/C includes reference and is compliant with
relevant UCP
• Other typical documentation checks for
L/Cs
• Documents presented relate to the L/C
• Documentation is presented before expiry date
• Original L/C and amendment documents are presented
• Endorsements, transfers, or assignments are presented
• Documents in compliance with accepted amendments

Architecture Considerations:
Geographic Distribution
• Centralized processing is
• More efficient in terms of resources
• Complicates document management logistics
• Transportation of physical documents to remote processing centers can cause
delays
• Using scanned images with BPM can help accelerate remote
processing
• Enables processing to begin before documents arrive
Architecture Considerations:
Geographic Distribution
• Dedicated trade finance IT systems are used by larger
banks
• Requires integration with many other IT systems
Electronic Imaging and Customer
Banking Workflow Information
Channels System (CIF)

FX Rates MIS

Global Trade Finance System

Compliance
Credit
/ OFAC
Limits

Source: Duran, R. E.,

Financial Services Technology,
Core Cengage Learning Asia, 2018
SWIFT General
Banking Gateway Ledger
System

Architecture Considerations:
Geographic Distribution
• Trade finance IT systems may also be geographically centralized or
distributed, logically and physically
• Common configurations
• Fully centralized
• A single trade finance IT system instance processes the trade finance
transactions for all of the bank’s international operations.
• Centralized multi-instance
• Multiple instances of the trade finance IT system are run in parallel, one
for each country served. All of the application instances are run in one
physical location.
• Distributed multi-instance
• Multiple instances of the trade finance IT system are run in parallel, and
each instance is physically located within the country that it serves.
 26/6/2022

Thank you

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