Funds Transfer System

A funds transfer system is an arrangement, made up of common rules, technical infrastructure and participating institutions, that allows money to be moved from one account to another. Participants, usually banks and sometimes other licensed payment firms, send payment instructions into the system, which processes them, determines what each participant owes and arranges settlement. The term is widely used by central banks, standard-setters and in law, often interchangeably with payment system, although some definitions limit it to systems that move funds rather than card or securities systems.

Funds transfer systems range from large-value systems that settle interbank payments one by one in central bank money, such as Fedwire and T2, to retail systems that handle high volumes of smaller payments, such as automated clearing houses and instant payment systems. International principles for their safety, set out in the CPMI-IOSCO Principles for Financial Market Infrastructures, apply to systemically important systems.

• Rules and agreements. A rulebook binds participants, setting out membership criteria, message formats, timings, rights and obligations, and what happens if a participant fails.
• Operator. A payment system operator, often a central bank or a company owned by banks, runs the system.
• Participants. Direct participants connect to the system and settle in it; indirect participants reach it through a direct participant.
• Messaging and processing. Infrastructure for receiving, validating and routing instructions, increasingly using ISO 20022 messages.
• Settlement arrangements. Accounts in which obligations are settled, typically at the central bank.

Real-time gross settlement (RTGS). Each payment is settled individually and immediately, providing final settlement in central bank money. Used for high-value and time-critical payments. See real-time gross settlement.

Deferred net settlement. Payments are collected over a period, offset against each other and settled as net positions at set times, reducing the amount of liquidity needed. Many automated clearing house systems work this way.

Hybrid systems. Systems such as CHIPS combine continuous netting and settlement to save liquidity while settling payments quickly.

Instant payment systems. Systems such as FedNow and Faster Payments credit the payee within seconds, at any time, with settlement between participants either in real time or in frequent cycles backed by prefunding or collateral.

Because funds transfer systems are central to the economy, central banks oversee them and, in many countries, have legal powers to designate and regulate them. Oversight covers legal soundness, governance, credit and liquidity risk management, settlement finality, operational resilience, access criteria and transparency. In the EU, the Settlement Finality Directive protects designated systems by ensuring that payments entered into them remain valid if a participant becomes insolvent. In the United States, Article 4A of the Uniform Commercial Code governs the rights and obligations of parties to funds transfers, and the Federal Reserve oversees systemically important systems. Regulators also apply anti-money laundering rules to transfers, such as recordkeeping and the travel rule.

Funds transfer systems face several key risks. Credit risk arises when participants are exposed to one another before settlement. Liquidity risk arises if participants lack funds to settle on time, which can cause gridlock. Operational risk includes cyber attacks and outages, which can disrupt large parts of the economy. Legal risk arises if rules are unclear or unenforceable. Systems manage these with collateral, liquidity-saving mechanisms, loss-sharing arrangements, business continuity plans and robust legal frameworks.

Funds transfer systems differ from card networks, which route card authorisations and clear card transactions under their own scheme rules before settling net positions through banks, and from securities settlement systems, which transfer ownership of securities, often against payment. They also differ from internal book transfers, where a single bank moves money between two of its own customers without using any external system. In practice these systems are linked: card networks and securities systems settle their cash legs through funds transfer systems, and many funds transfer systems settle in the central bank's RTGS system. Messaging networks such as SWIFT carry instructions between banks but do not themselves settle funds, so they are not funds transfer systems in the strict sense.

Access to funds transfer systems has become an important policy issue. Traditionally, only banks could participate directly, so non-bank payment providers relied on banks for access. Several central banks, including the Bank of England, have opened settlement accounts to eligible non-bank payment firms, and others are considering similar changes. New technologies, including distributed ledgers and tokenised money, are being tested to see whether they can improve how funds transfer systems clear and settle payments, particularly across borders.

• Committee on Payments and Market Infrastructures