Cheques Clearing

Also called bank clearing is the process of moving cash or cash equivalence from the bank on
which it was drawn to the bank in which it was deposited. Cheques could either be deposited
by physical or electronic transfer of the cheque from the issuing bank to the deposit bank. A
beneficiary is only due payment after a cheque has been cleared.
 The clearing process results in a credit to the account at the bank of deposit and an
equivalent debit to the account at the bank on which it was drawn, leading to inter-
bank adjustments of accounts.
The first organization for clearing cheque was the” Bankers’ clearing house” but
todays it is done by banks reconciling on the net amounts for transactions with other
banks.
Electronic Money (e-money)
This money that exist only in the electronic form and can be used to make purchases
online. Banks now provide a facility in which you just need to make a few clicks to
transfer money electronically during payments. Electronic payments technology now
substitutes not only cheque but cash as well and includes; Debit cards, Digital cash, e-
wallet, smart cards, credit cards etc.
Considering the ease and convenience of electronic money system one might think
that there is a drive towards a cashless society. However, they are hampered by the
following reasons;
 They are expensive to set up.
 They require constant telecommunication network.
 They raise a lot of security concern.
 They require constant energy supply which is inadequate particularly in third world
countries.

The financial system and money market

A) Financial systems
The efficient management of every economy requires the availability of financial
capital. The accumulation of financial capital of an economy depends on the capacity
of the financial system of that economy.
Financial system is an aggregation of legislations, laws, rules and regulations as well
as financial agreements, markets, institutions, instruments and agents that interact with
each other and with the rest of the world (international sector). An aggregation of
financial markets makes up the financial system and includes; money market where
the process of money creation takes place with banks being unique in money creation,
stock exchange market etc.
Fig1: Financial System

The society at any time will be composed of two groups of individuals; Those whose
income exceeds their expenditures (surplus economic unit or Ultimate Lenders) and
those whose expenditure exceeds their income (Deficit economic unit or the Ultimate
Borrowers). The deficit economic units are those that have to borrow to meet up with
their expenditure financing. While the surplus economic units are those with idle cash
resources and are ready to give them out. The movement of funds from the surplus
unit to the deficit unit takes place principally through two channels. As illustrated on
the figure above, funds can either flow from the surplus economic units to the deficit
economic units through;
1) Direct Financing: Through this channel, borrower acquire funds directly from
lenders in the financial markets by issuing securities and there is a direct contact
between the lender and the borrower. The securities could either be marketable e.g
treasury bills or non-marketable securities e.g shares in limited partnership.
2) Indirect Financing: Being at the center of the Ultimate Lender and the Ultimate
borrowers, financial intermediaries guarantee indirect financing. Through this
channel the process of lending and borrowing takes place in a condition in which
the borrowers do not know whose money they are borrowing. This implies that
through this channel, fund leave lenders to borrower only through financial
intermediaries.
 Despite the fact that lending and borrowing can take place through the direct
channel, the presence of financial intermediaries is so instrumental as they go a
long way to eliminate the challenges abound in direct borrowing.
Borrowing direct or indirect requires the issuance of debt-evidence (security) by
the Ultimate borrower to the Ultimate lender. It should be noted that these two
types of lending are not mutually exclusive in any one society also, there is no
guarantee that surplus funds from the Ultimate lender will be lent to the Ultimate
borrower with or without a system of financial intermediaries however, the
presence of financial intermediaries as a middle man between the Ultimate lenders
and the Ultimate borrowers makes it more like that such funds do not lie idle
because financial intermediaries are so important in solving some fundamental
challenges inherent in the direct channel.

The importance of financial intermediaries in the Financial system

 Reduction in Cost of Borrowing: Financial intermediaries attract a large pool of

financial resources therefore they have the capacity to increase the supply of loanable
funds. Interest rate which is the cost of borrowing reduces as supply of loanable funds
increases.
 Risk Reduction: Lenders are confronted with principally two types of risks that is; the
default risk and illiquidity of assets acquired. Financial intermediaries are capable of
reducing the risks involved in the lending process.
Through loans diversification, default risk of the ultimate lender is reduced since
sectoral down turn in economic activities will more likely cause a default. Because
different activities have different default risk, giving loans to different individuals
whose activities are not related to the business cycle in the same way serves to reduce
the overall risk of default.
Also, the presence of financial intermediaries reduces the liquidity risk. It is well
known that the rate of interest depends on the liquidity of the asset acquired by the
ultimate lenders in exchange for their surplus funds. In the case of financial
intermediaries, the deposit claims against financial intermediaries given to the ultimate
lender is highly liquid. In the case of checking deposits, claims on financial
institutions are money itself and payments can be made through it. Although certain
classes of time deposits have fixed time to maturity, and can only be converted into a
means of payment when they are due, the certificates of deposits received by the
lenders are negotiable and can be traded for immediate cash in an organized money
market. Therefore, the availability of deposit claims issued by financial intermediaries
to the lenders ought to reduce the liquidity risk in the lending process.
Types of financial intermediaries
1) Commercial Banks: They are financial intermediaries that attract surplus funds
and idle resources from the general public, safeguard them and make them
available to the owners upon request. The origin of their name was the granting of
commercial loan to businesses at an interest. They are also called retail or clearing
banks by virtue of their participation in the bank clearing system. They can either
be organized as unit banking or branch banking.
Functions of Commercial Banks
The traditional functions of commercial banks include the following;
A) Accepting and Safeguarding Deposits: This is the oldest function of commercial
banks, they attract and safeguard idle cash from the general public. Deposits can
be done as either Current account deposits, Time deposits or saving deposits
accounts.
 Current Account Deposits: Deposits with this account can be paid in and
withdrawn as often as the customer finds convenient. Since deposits on
current account are payable upon demand they are regarded as Demand
deposit accounts. Deposits proof is the paying-in-slip and withdrawals are
done by the use of cheques. This account does not earn an interest instead
the customer is charged some fee for the current account holding.
Current account holders benefit commercial bank services such as;
- Regular Statement of account
- Standing Orders
- Credit transfer
- Overdraft
- Prerogative to use cheques
 Time Deposits or Term Deposits: Deposits with this account have a fixed
term to maturity, prior to the maturity, the depositors have no access to
their deposits. Holders of this account earn an interest on their deposits
which could be paid up-front. Holders of this account are issued a
Certificate of Deposit. Upon maturity of the deposits, the bank should be
notified 7 days in advance before withdrawal can be made.
 Saving Accounts: This account is intended for small savers and offer easy
way for people to keep their money safe while also growing it earnings
from the modest interest rate. They are similar to time deposits but are
more accessible and cannot be accessed by the use of cheques that is they
operate on cash basis.
B) Lending to Customers: This is the second key and the most profitable function
of the commercial banks. Banks, from the deposits they receive also lend to
customers of the deficit economic units who can provide a collateral security. The
 profit banks make comes as a result of paying lower interest rates on deposit and
charging higher interest rates on loans. Lending to customers could be in the form
of loans or Overdraft.
 Loans: This is a specified sum of money lent by a bank to a customer to
which interest is calculated on the full amount, repayment is predetermined
upon inception and in most cases require some form of collateral security.
A collateral security is an asset required from a borrower before granting a loan.
The lender can dispose of the asset in the event of a default of the borrower.
Therefore, a collateral security should worth the value of the loan and should be
easily converted in to cash.

 Overdrafts: This is a facility granted a customer that allows the customer to

withdraw an amount greater than what they have in their account up to the
approved limit. The customer pays interest only on the amount by which their
account has been overdrawn. It should be noted that the negative cash balance
can be drawn on current, saving or salary account. When drawn on a salary
account, no form of collateral is required. Time deposits account although
eligible are rarely applicable for overdraft facility in most banks.
C) Payment Mechanism: Commercial banks act as agents of payments and this
could be in the following ways;
 Credit Transfer or Bank Giro Systems: This function enables customers to
make payments from their account by credit transfer to the accounts of
beneficiaries. Through this systems, banks pay money directly in to the bank
account of the Payee from the customers’ account. This function is highly
utilized in the payment of salaries of workers. The procedure is simply to
present to the bank a list of workers, their bank accounts and the amount of
money due each person. The bank will simply transfer to the credit of the
employees account from a debit of the employers’ account.
 Standing Orders: Customers of a bank making regular payments to a
particular individual can give their bank a standing order in writing to effect
such payments as at when due and to debit the amount from their account. This
is a convenient way to settle reoccurring payments for example; utility bills,
insurance premiums
 Direct Debit: This is an instruction to a bank by a customer to accept a request
for payment from a particular individual. It is different from a standing order
method of payment in that payment here is not requested by the drawer but by
the payee. It could be used for varied amounts at regular intervals as well as
fixed amounts at irregular intervals.
 Cheques: See above.