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But first a quick review - last post I gave an overview of Exchange Settlement Accounts (ESAs), held by the RBA, and showed how a bank's "money" is split between cash and it's ESA balance. All the "money" in Australia always exists in one of three forms. It can be

1. 'Circulating' as cash (in your wallet, down the back of the sofa, tucked in to a stripper's g-string), OR
2. A deposit held by a bank as cash, OR
3. A deposit held in a bank's ESA.

If I go to a store and pay by cash, then everything is simple - notes come out out of my wallet, and go in to the till at the hardware store. But what if I succumb to the temptations of eBay, and then the seller wants me to pay by direct deposit? This is what happens.

First, I need to tell the bank that I want to make a transfer from my savings account to the sellers account. I tell this to the bank by using an application they have provided ('back in the day', this would be using desktop application, such as Westpac's DeskBank product, and a dialup modem connection to the bank, now it's most likely done through the banks website). When I lodge the request, I specify the amount to transfer, the account (owned by me) that I want to transfer money out of, and the account (owned by somebody else) that I want to transfer money to. In Australia, the bank account is specified in 2 parts. First, there is a 'BSB' number, and then there is an account number. BSB stands for 'Bank/State/Branch'and it's a 6 digit number. The first 2 digits uniquely specify the bank as a whole, the remaining 4 digits specify the branch within that bank. (originally, the 3 digit specified the State the branch was in, i.e. xx2xxx was NSW,xx3xxx was VIC etc but that appears to no longer be enforced). The list of BSB numbers is maintained by APCA. The BSB is to a bank account number what an area code is to a phone number.

As soon as I send the transfer request to my bank, the bank will debit my account, and transfer that money to another internal holding account within the same bank. Then overnight, each bank gathers up all of the days direct debit & direct deposit requests, and groups them by the destination bank (i.e. by the first 2 digits of the BSB).All the banks then exchange files with each other, i.e. CBA will send to Westpac a file containing all the transfers initiated by Westpac customers to CBA accounts, CBA will send another file to Westpac with all the transfers initiated from CBA accounts to Westpac, etc. Each bank needs to set up it's own transfer arrangement with every other bank[1]. Originally these exchanges would involve representatives from all the banks getting together and swapping magnetic tapes - nowadays the files will be transmitted using FTP or equivalent . The files are formatted according to a specification put out by the Australian Payments Clearing Association. The spec itself is 'confidential' but it's obviously a COBOL era design - there's a footer and trailer record, each record starts with a 2 digit 'record type', has fixed width fields and ends with a line break.

After the banks have exchanged the files containing the individual transfers, each bank calculates it's 'Net Position' with each other bank. This is the net movement of money between those 2 banks. i.e. if Westpac customers have transferred a total of $500,000 to CBA customers, and CBA customers have transferred a total of $650,000 to Westpac customers, then the 'Net Position' between CBA and Westpac is that CBA owes Westpac $150,000. This position needs to be settled before any of the individual transfers can be applied to individual bank accounts. This settlement happens by both banks telling the RBA what the movement of money should be, and if both banks tell the RBA the same thing, then the RBA will debit CBA's ESA balance by $150,000, and credit Westpac's ESA with $150,000. Once all these adjustments have been made, each bank can then apply the transactions specified in the files they have received, and credit their individual account holders.

This type of system, where there is a single daily movement of money to settle a whole bunch of individual transactions is called a Deferred Net Settlement (DNS) system. i.e. Settlement of transactions is done seperately from communicating details of the transaction, and the settlement is done on a net basis.

In the next post, I'll talk about the other type of settlement systems, called Real Time Gross Settlement (RTGS) system, and show how the final settlement under a DNS system ends up being a single RTGS transaction.

Footnotes

• [1] I'm only talking about the 'top tier' banks here, e.g. Westpac/NAB/ANZ/CBA/St George. I'll talk about how the other banks & building societies do things in another post