Market plumbing checkpoint
Check that you can reason about the wholesale plumbing behind payments: how a cheque clears once the paper is truncated, why payment-versus-payment settlement removes Herstatt risk, how treasury pools and virtual accounts organise liquidity, and how large-value net systems such as EURO1 and name checks such as Confirmation of Payee fit in.
QUESTIONS AS TEXT
Q1. What does it mean to truncate a cheque?
Answer: A: The paper cheque is stopped early in the chain and an electronic image and data are cleared in its place.
Cheque truncation halts the paper at or near the collecting bank and clears a digital image plus the key data fields through an image-based system. The paper no longer moves between banks, which cuts transport time and cost while keeping a recognised record.
Q2. In cheque clearing, which bank decides whether the payee ultimately keeps the money?
Answer: A: The drawee bank, when the cheque is presented to it and it chooses to pay or return.
The drawee bank holds the cheque writer's account. On presentment it validates the drawer's funds and signature and either pays or returns the cheque. Any earlier credit to the payee is provisional until the drawee has had its say and the return window has passed.
Q3. What exposure does Herstatt risk describe?
Answer: A: You pay away the currency you owe and then the counterparty fails before you receive the currency you are owed.
Herstatt risk is the principal risk in foreign-exchange settlement: one leg is paid before the other is received, so a counterparty failure in between loses the whole amount. It comes from settling the two legs separately and at different times.
Q4. How does payment-versus-payment settlement remove principal risk on an eligible foreign-exchange trade?
Answer: A: It links the two currency legs so one is released only if the other is, meaning neither party can pay without being paid.
Payment-versus-payment binds the two legs so that one is discharged if, and only if, the other is. If a leg cannot be funded, the linked pair does not settle and the funded side is not paid away, so no one is left exposed.
Q5. A member of a payment-versus-payment settlement service funds its pay-in schedule but a counterparty on one trade misses its pay-in. What happens to that trade?
Answer: A: The linked pair does not settle; the funded side is not paid away, so neither leg moves.
Because the two legs are linked, an unfunded leg means the pair does not settle and the funded side is not released. This is why funding the pay-in schedule on time is its own discipline even though principal risk on settled trades is removed.
Q6. What is the key difference between physical and notional cash pooling?
Answer: A: Physical pooling actually moves balances into a header account; notional pooling offsets balances for interest without moving money.
Physical pooling concentrates liquidity by transferring balances into a header account, creating intercompany loans that must be tracked. Notional pooling offsets credit and debit balances for interest while each account keeps its own balance, subject to the bank being able to offset them.
Q7. A corporate gives each customer its own virtual IBAN over a single real account. What does this achieve?
Answer: A: Incoming payments identify themselves by the IBAN they were sent to, so reconciliation can attribute each one automatically.
A virtual IBAN is an addressable alias that routes payments to one underlying real account. Giving each payer its own virtual IBAN means an incoming credit transfer identifies whom it is from, which makes reconciliation automatic without opening many real accounts.
Q8. How does a large-value net system such as EURO1 settle the payments exchanged during the day?
Answer: A: It records the running obligations between participants and settles the net balances at the end of the cycle.
EURO1, operated by EBA CLEARING, processes high-value interbank euro payments by tracking participants' running obligations and settling only the net balances at the end of the cycle in central bank money. Netting reduces the liquidity needed compared with settling every payment gross.
Q9. What is the trade-off that deferred net settlement makes compared with settling each payment gross in real time?
Answer: A: It needs far less liquidity because flows are netted, but participants carry exposure to one another until the cycle settles.
Deferred net settlement collects payments over a cycle and settles only each participant's net position at the end. Offsetting flows sharply cut the funds needed, but the gap between exchange and settlement creates interim exposure, so the system relies on limits, collateral, or loss-sharing.
Q10. What does a Confirmation of Payee check tell a payer, and when?
Answer: A: Whether the account name they entered matches the destination account, before the payment is authorised.
Confirmation of Payee, used in the United Kingdom, checks the name a payer enters against the name on the destination account before authorisation, returning a full, close, or no match. The aim is to catch mistyped details and disrupt authorised push payment fraud at the moment the payer can still stop.