Chapter 163 Settlement Business

"In terms of clearing, we have the Georgia Clearing House operated by the Georgia Bankers Association. Clearing takes place every 20 days, followed by ten days for settlement."

"However, most of our settlement amounts here are not high, so we rarely use the Fed's settlement services."

"Wait a minute, Goodman, are you saying that we, not being members of the Fed's system, can still use the Fed's settlement services? Like, we've used them before?"

Rarely using and not being able to use are completely different matters! Upon hearing the implication in Goodman's statement, Carter quickly raised his hand to inquire.

"We can't use them directly, but we can indirectly. Abrams Bank in Macon is a member bank of the Fed system. When we need large settlements, we request their assistance."

Dry language is never as straightforward as a simple, intuitive image. Goodman obviously understands this point well. As he spoke, he took a pen and paper from the table, starting to draw a logic diagram for Carter.

"Let's assume a scenario. We have a customer who has deposited $1 million in our bank, and now he wants to transfer this money to any bank, let's say Bank X in Maryland. At this point, neither our bank nor Bank X is a member bank of the Fed's system. So what do we do? Hire an armored car and directly transport the $1 million over there? By the time we arrive, the customer would have been twiddling their thumbs in Maryland."

Goodman drew two boxes representing the two banks on the paper and continued:

"We can't do that, so what do we usually do? We first send a $1 million transaction request to Abrams Bank. At this point, the money is still in our bank."

Another box representing Abrams Bank was added next to the box representing Blake Bank, with a line connecting them:

"Abrams Bank, upon receiving our transaction request and knowing where we want the money to ultimately go (Bank X), will also send a $1 million transaction request through the Fed's Large-Value Transfer System, Fedwire, to a Fed member bank near Bank X, let's call it Bank Z."

At this point, a large circle representing Fedwire appeared between the four boxes.

"Do you know that member banks of the Fed system have reserve accounts in the Fed? If Abrams Bank's reserve account has a balance of $1 million or close to it, this transaction will be completed. The Fedwire system will instantly transfer the $1 million from Abrams Bank's reserve account to Bank Z and then Bank Z will transfer the money to Bank X's account."

"In this process, we are the sending bank, meaning we initiate the transaction. Bank X is the receiving bank, as they are the final recipient of the $1 million. Abrams Bank and Bank Z act as intermediary banks, responsible for transferring the funds for us. And the Fed is the biggest clearing institution, helping both parties to complete the clearing and settlement."

"But that's not all. The $1 million is still in our bank at this point. However, Abrams Bank has effectively reduced its balance by $1 million, so now we owe Abrams Bank $1 million."

"This debt will be settled on clearing day by the Georgia Bankers Association Clearing House, overseeing the settlement. On this day, we need to confirm the debt and transfer $1 million from our bank to Abrams Bank, completing the entire fund transfer process."

"I understand, so if we can use the NSS service provided by the Fed, we can greatly simplify these intermediary processes and save on fees, right?"

Having understood this operational process, Carter immediately grasped the convenience of this regulation.

A single transfer involves two intermediary banks, three clearing institutions (the Fed, the clearinghouses of the sending and receiving banks), and seven fees! Plus, the fees for the sending and receiving banks, seven fees in total, leaving maybe $990,000 out of $1 million.

Not only is it frustrating for customers, but it's also troublesome for banks. Especially for the sending and receiving banks, they don't actually receive much of the fees; most go to the main intermediary bank, like Abrams Bank in the previous example. Because they're the ones actually providing the funds, even if they're not actually lending money to you.

"If we can use the NSS service, it will indeed be much more convenient. But the fixed operating costs of the bank will increase. Look at these charges, the annual fee... To be honest, it's a bit high. Abrams Bank hardly pays anything for using the Fedwire system, or pays very little."

"That's easy. We'll just pay for our bank's use. We'll skip Forest Bank's charges. If necessary, they can go through us for accounting. They're all my banks, so there's no need to bother with clearinghouses then, and you and Mr. Williams can handle settlements yourselves, saving us one clearing fee. So, by spending a dollar, I get back two benefits."

After comparing the Fed's fixed fees with previous transaction fees, Carter realized that, even then, they weren't really making much profit. After all, for small local banks like theirs, the need for large fund transfers isn't frequent. If they don't have a large amount of demand to pay fees, then paying the fixed annual fee is actually a loss.

This change is somewhat akin to moving from underwriting to subscription. Previously, it was pay-per-use, then transfer the money, with a high one-time fee, but no fixed expenses. Now, it's a fixed expense every year, and then whatever transaction fees you collect are your profit. As for how many transaction fees you can collect and whether you can recoup the costs with those fees, that's up to each bank.

"By the way, if we need to settle between Blake Bank and Forest Bank, do we need a third party? Like, should we establish a separate settlement institution? The law allows private institutions to engage in settlement services, right?"

"Not really necessary. I'll directly coordinate settlements with Manager Williams. Although they're two separate institutions, Forest Bank is more like our branch. So, in this case, it's internal settlement within the bank, and we don't need to set up an additional settlement institution. However, in the future, if you have more banks under your umbrella, we could establish a dedicated settlement center internally to handle these transactions."