CHAPTER 5

ELECTRONIC BANKING
LEARNING OBJECTIVES

• Explain how electronic banking and electronic

funds transfer system have evolved
• Describe processes for transferring funds
electronically
• Describe electronic banking services commonly
used by consumers
• Identify electronic banking services used by
businesses
• Explain provisions of the laws and regulations
that affect electronic banking services
 50 years history

Introduction 1969: ATMs

1990s:
Development of the
Internet
 The
Development • Magnetic Ink Character Recognition
of Electronic Code (MICR Code) is a character-recognition
technology used mainly by the banking
banking industry
• The MICR encoding, called the MICR line, is at
the bottom of cheques and other vouchers
and typically includes the document-type
indicator, bank code, bank account number,
cheque number, cheque amount, and a
control indicator.
THE
DEVELOPMENT
OF ELECTRONIC
BANKING
THE
DEVELOPMENT
OF ELECTRONIC
BANKING
The Development
of Electronic
Banking
 • Virtual banks
• Only operate online
• No physical branches
TRENDS IN • First began in 1995
ELECTRONIC • Aka direct banks, cyber banks and Internet banks
• Make deposits through direct deposit and
BANKING automatic transfers from accounts at other
financial institutions
• Withdrawal are made online by telephone
transfer or by card
• Operating expense are lower → higher deposit
interest rate and lower borrowing interest rate
• Virtual currency
• Intangible currency
• Function like currency as a medium of exchange
• Exist only in the electronic world
 • Mobile banking
• Banking done through the Internet a
TRENDS IN wireless device such as smart phone
ELECTRONIC or tablet
BANKING • Web server
• Text messaging
• Mobile apps
• Offer interactive benefits as
information notification and alerts
prompting the customer to view
balances
• Security and privacy issues
• Devices are easily stolen
 • Electronic fund transfer (EFT):
A transfer of money from one bank
account to another that is initiated
PROCESSING through an electronic terminal, telephone,
ELECTRONIC computer or magnetic tape.
BANKING Services include ATM transfers, direct fund
deposits or withdrawals, point-of-sale
(POS) terminals, debit cards and electronic
check transactions
• Automated Clearing House (ACH)
An electronic network for financial
transactions in the United States. ACH
processes large volumes of credit and
debit transactions in batches. ACH credit
transfers include direct deposit, payroll
and vendor payments.
PROCESSING
ELECTRONIC
BANKING

• RDFI: Receiving
Depository Financial
Institution's
• ODFI: Originating
Depository Financial
Institution
PROCESSING
ELECTRONIC
BANKING
Processing
Electronic • Fedwire
Federal Reserve Wire Network, Fedwire is
Banking a real-time gross settlement funds transfer
system operated by the United States
Federal Reserve Banks that enables
financial institutions to electronically
transfer funds between its more than
9,289 participants
 • CHIPS
Clearing House Interbank Payments
PROCESSING system is a United States private clearing
house for large-value transactions. By
ELECTRONIC 2010 it settling well over US$1 trillion a
BANKING day in around 250,000 interbank
payments.
Together with the Fedwire Funds Service
(which is operated by the Federal Reserve
Banks), CHIPS forms the primary U.S.
network for large-value domestic and
international USD payments (where it has
a market share of around 96%). CHIPS
transfers are governed by Article 4A of
Uniform Commercial Code.
 • SWIFT
The Society for Worldwide Interbank
PROCESSING Financial Telecommunication (SWIFT)
ELECTRONIC provides a network that enables financial
BANKING institutions worldwide to send and receive
information about financial transactions in
a secure, standardized and reliable
environment.
SWIFT also sells software and services to
financial institutions, much of it for use on
the SWIFTNet Network, and ISO 9362.
Business Identifier Codes (BICs, previously
Bank Identifier Codes) are popularly
known as "SWIFT codes".
 • A SWIFT code is an international bank code that
identifies particular banks worldwide. It’s also known
as a Bank Identifier Code (BIC). CommBank uses
SWIFT codes to send money to overseas banks.
• A SWIFT code consists of 8 or 11 characters.

Processing
Electronic
Banking
 Fedwire
• Real-time gross settlement system of the Federal Reserve
• Used by any institution that has an account at the Federal Reserve
• Used mainly for large transfers (average: $3.5M)
• On-line connection (7800 institutions, 99% of transfers)
• Direct connection
• Computer dialup
• Off-line connection (1700 institutions, 1% of transfers)
• Telephone instructions with codeword
• FedLine access from PCs
• Some services over the Web (not funds transfer yet)
 • Depository institutions
Fedwire • Agencies and branches of foreign banks
Participants • Member banks of the Federal Reserve
System
• U.S. Treasury and authorized agencies
• Foreign central banks, foreign monetary
authorities, foreign governments, and
certain international organizations; and
• Any other entities authorized by a
Reserve Bank

SOURCE: FED
 Federal Reserve System

Interdistrict Settlement Fund

(Washington DC)

+ branches (Cleveland Fed has a branch in Pittsburgh) SOURCE: FED

How Fedwire Works
EVERGEEN BANK PNC WANTS TO TRANSFER PNC BANK
(SEATTLE) $1M TO EVERGREEN BANK (PITTSBURGH)

9. SEATTLE BRANCH NOTIFIES 1. PNC SENDS TRANSFER ORDER

EVERGREEN. PAYMENT IS TO PITTSBURGH BRANCH OF
NOW IRREVOCABLE. CLEVELAND FED
SAN FRANCISCO FED CLEVELAND FED
(SEATTLE BRANCH) (PITTSBURGH BRANCH)

8. SF FED NOTIFIES 2. PITTSBURGH BRANCH SENDS

SEATTLE BRANCH ORDER TO CLEVELAND FED
INTERDISTRICT
SETTLEMENT FUND

SAN FRANCISCO FED 6. ISF NOTIFIES ATLANTA FED CLEVELAND FED

4. CLEVELAND
SF FED BOSTON FED
EVERGREEN BANK SENDS ORDER DOLLAR BANK
CLEVELAND FED
...
TO ISF MELLON BANK
...
WELLS FARGO ...
WESTERN BANK SAN FRANCISCO FED PNC BANK

7. SF FED ADDS $1M TO 5. ISF SUBTRACTS $1M FROM 3. CLEVELAND FED

EVERGEEN ACCOUNT CLEVELAND, ADDS $1M TO SF SUBTRACTS
$1M FROM PNC
ACCOUNT
 • In 2000,
• 108 million Fedwire transfers
• Value $380T (11 times the World
Economic Product)
Fedwire • New York Fed: 40 million transfers, $209T
• “Instantaneous” (within minutes) irrevocable
settlement
• Payment guaranteed by Fed
• Operates 18 hours/day on business days
• No minimum dollar amount
• Daylight overdrafts permitted (intraday peak:
$70B)
• Fee charged if not collateralized ($6.94
per million)
Fedwire Fees

SOURCE: FEDERAL
RESERVE
 Payment Orders (Checks)
CHECK
DATE NUMBER
MAKER (DRAWER)

PAYEE
AMOUNT

CURRENCY

DRAWEE
BANK

DRAWEE BANK
ACCOUNT NUMBER AUTHORIZED
NUMBER
SIGNATURE OF
MAKER’S AGENT
THIS CHECK IS AN ORDER TO MELLON BANK TO
PAY $100 TO PAYEE OR HIS TRANSFEREE FROM
THE CARNEGIE MELLON UNIVERSITY ACCOUNT
 Clearing Payment Orders (Check)
1. CMU SENDS CHECK TO SHAMOS
CUSTOMER CMU CUSTOMER SHAMOS
OF MELLON BANK “PAY SHAMOS $100” OF CITIBANK
9. MELLON SENDS 2. SHAMOS DEPOSITS
CHECK BACK TO CMU CHECK AT CITI

MELLON BANK 8. CLEARING HOUSE CITIBANK

SENDS CHECK TO
4. CITI SENDS CHECK
MELLON
TO CLEARING HOUSE
CUSTOMER A CUSTOMER A
CUSTOMER CMU -100 CLEARING HOUSE CUSTOMER B
... (FEDERAL RESERVE) ...
CUSTOMER Y SHAMOS +100
MELLON -100
CUSTOMER Z CUSTOMER Z
BANK A
7. MELLON 6. CLEARING ... 3. CITIBANK CREDITS
DEDUCTS $100 HOUSE SENDS SHAMOS WITH $100
FROM CMU
BANK Z
MELLON
ACCOUNT DEBIT INFO CITIBANK +100

5. CLEARING HOUSE ADDS $100 TO CITI,

SUBTRACTS $100 FROM MELLON
 Electronic Clearing
MAKER (DRAWER) DATE CHEQUE The paper cheque is just
NUMBER
PAYEE
a carrier of information.
AMOUNT
Electronic transmission is
CURRENCY
DRAWEE better.
BANK
AUTHORIZED
DRAWEE BANK SIGNATURE OF We dematerialize the cheque
DRAWER MAKER’S AGENT
NUMBER
ACCOUNT
(remove the paper).
NUMBER

06130018184310143700000000010000USD065200356425020010130
DRAWEE DRAWER CHEQUE AMOUNT CURRENCY PAYEE PAYEE DATE
BANK ACCOUNT NUMBER BANK ACCOUNT
NUMBER NUMBER NUMBER NUMBER

Only the information is sent to the clearing house

Federal
• 46 regional check processing centers
Reserve • Interdistrict Transportation System (ITS)
Check • an airline for physical movement of
Processing checks
• ACH charges (Oct. 1, 2001):
• $5.00 per computer file
• $0.004 - $0.0055 per item (about 1/2
cent)
 • Nationwide wholesale electronic payments
system
Automated • Transactions not processed individually
Clearing • Banks send transactions to ACH operators
House • Batch processing store-and-forward
(ACH) • Sorted and retransmitted within hours
• Banks
• Originating Depository Financial
Institutions (ODFIs)
• Receiving Depository Financial Institutions
(RDFIs)
• Daily settlement by Fedwire
• Posted to receiver’s account within 1-2
business days
 • Processes dematerialized checks (digital
data only)
Automated • Both debits and credits allowed
Clearing • ACH processors:
House • American Clearing House Association
(American)
• Federal Reserve System
• New York Automated Clearing House
(NYACH)
• VISANet ACH
• 1998: 5.3B transactions, $16.4T
• ACH cost: less than 1 cent per transaction
 ACH Credit Transaction
1. BUYER SENDS
AN ORDER TO
BUYER’S BANK TO BUYER
CREDIT $X TO SELLER
SELLER’S ACCOUNT
6. SELLER’S BANK
IN SELLER’S BANK
CREDITS SELLER’S
2. BUYER’S BANK ACCOUNT WITH $X
SENDS TRANSACTION
TO AUTOMATED
BUYER’S CLEARINGHOUSE SELLER’S
BANK BANK

4. BUYER’S BANK
PAYS $X TO
SETTLEMENT BANK

SETTLEMENT CLEARINGHOUSE
BANK
3. CLEARINGHOUSE DETERMINES THAT
5. SETTLEMENT BANK
BUYER’S BANK OWES SELLER’S BANK $Y
PAYS $X TO
(ALL TRANSACTIONS ARE NETTED)
SELLER’S BANK
 ACH Debit Transaction
1. BUYER AUTHORIZES 2. SELLER ASKS HIS BANK
SELLER TO DRAW $X TO SEND TRANSACTION
FROM BUYER’S BUYER TO AUTOMATED
ACCOUNT IN BUYER’S SELLER CLEARINGHOUSE
BANK
7. SELLER’S BANK
CREDITS SELLER’S
8. BUYER’S BANK ACCOUNT WITH $X
ADVISES BUYER
OF PAYMENT
BUYER’S SELLER’S
BANK BANK

5. BUYER’S BANK 3. SELLER’S BANK

PAYS $X TO SENDS TRANSACTION
SETTLEMENT BANK TO AUTOMATED
CLEARINGHOUSE

SETTLEMENT CLEARINGHOUSE
BANK
4. CLEARINGHOUSE DETERMINES THAT
6. SETTLEMENT BANK
BUYER’S BANK OWES SELLER’S BANK $X
PAYS $X TO
(ALL TRANSACTIONS ARE NETTED)
SELLER’S BANK
 • High-volume, small value payment orders
between financial institutions
Automated • largely recurring payments: payroll,
mortgage, car loan, Social Security
Clearing
• U.S. Treasury Financial Management
House Service: cost to send gov’t check:
$0.42. Cost of epayment: $0.02.
• Automated Teller Machines (ATM)
• Debit-card point-of-sale payments
• Telephones or PC bill payments.
• Direct deposit (e.g. payroll)
• Electronic benefits transfer
 • TARGET (European Central Bank)
• 1T Euros/day, average transaction $6.7M
• CHIPS (Clearing House Interbank Payments
Other System)
• Private, owned by NY Clearing House
Wholesale Association
Payments • U.S. dollar leg of foreign exchange (90%
share)
• 128 banks, 29 countries
• Continuous multilateral netting
• Each bank’s position v. every other bank
constantly recalculated
• Irrevocable transactions, end-of-day
settlement
• $1.44T per day, average transaction $6.6M
• Cost per transaction: $0.13 - $0.40
 • SWIFT (Society for Worldwide Interbank
Financial Telecommunications) Messaging
System
• Instructions between financial institutions
Wholesale • 137 countries
Payments • $2T per day, average transaction $1M
• Other foreign exchange
• $1.2T per day ($1T in U.S. dollars)
• 2/3 are banks trading for their own
accounts
• Settled through transfers in respective
currencies (must have accounts in both
currencies)
• Herstatt risk (pay out one currency before
receiving the other -- cascading effect)
 • London Bank L has an account in a NY Bank A
• Wants to transfer $1M to the account of
Bank J in NY Bank B (A and B are on CHIPS)
CHIPS • Bank L sends Bank A a SWIFT message
Operation • Bank A verifies the message, enters it into
CHIPS (Bank A has the $1M; doesn’t rely on
L’s credit)
• CHIPS verifies that the transaction is within
A’s debit limit and the B-A bilateral limit;
otherwise rejects
• CHIPS notifies Bank B that $1M is being
deposited from Bank L through Bank A for
Bank J
• Bank B notifies Bank J that $1M has been
added to its account
 • CHIPS closes at 4:30 p.m. NY time
• Each settling bank gets a settlement
report showing net amount owed or
CHIPS owing
• Settling banks have until 5:30 to
Operation challenge the total or must pay into the
CHIPS account at the NY Federal Reserve
by Fedwire (US RTGS)
• Banks with net credit positions are paid
by 5:45
• All payment orders are final and
irrevocable
• Fedwire is a payment system
• CHIPS is a clearing system
• SWIFT is a messaging system
 CHIPS Operation
LONDON BANK L JACKSONVILLE BANK J
S
1. BANK L TELLS BANK A W S
TO PAY $1M TO J’s I 2. BANK A VERIFIES W
F 9. CHIPS ADVISES B I 10. B CREDITS J
ACCOUNT IN BANK B FUNDS, ENTERS CHIPS
T OF CREDIT AMT F WITH $1M
TRANSACTION T
NEW YORK BANK A CHIPS CHIPS
NEW YORK BANK B
(L’S CORRESPONDENT) (J’S CORRESPONDENT)
3. CHIPS VERIFIES
F CHIPS CREDIT LIMITS,
E CHIPS
D ADJUSTS ACCTS
W 4. AT 4:30, CHIPS TELLS A’S ACCOUNT INTERNALLY
I BANK A HOW MUCH
R
B’S ACCOUNT
TO PAY VIA FEDWIRE
E
7. BY 5:45, CHIPS MAKES PAYMENT TO B

5. BANK A MUST
FEDERAL RESERVE
8. FED DEBITS CHIPS
PAY BY 5:30 A’s ACCOUNT ACCOUNT; CREDITS
B’s ACCOUNT B’S ACCOUNT

6. FED MOVES $$ CHIPS SETTLEMENT ACCOUNT

INTO CHIPS ACCT
 • Society for Worldwide Interbank
Financial Telecommunication (non-profit,
Brussels)
• Financial messaging system, not a
S.W.I.F.T. payment system
• Settlement must occur separately
• 7125 institutions, 193 countries
• 1.27 billion messages per year: $5 trillion
per day
• Cost ~ $0.20 per message
• X.25 packet protocol
• CCITT X.400 store-and-forward standard
• Moving to full IP network in 2002
• swiftML
• interoperable with ebXML
SOURCE: SWIFT
SWIFT Message Types

SOURCE: SECURITIES OPERATIONS FORUM

Foreign Exchange Example
BANK T (US)
US BANKS (NOSTRO ACCOUNT)
BANK S (UK)
BANK S WILLING TO SELL
BANK B (US) USD ACCOUNT BANK C (UK) 1 MILLION GBP
WANTS TO BUY FOR USD
1 MILLION GBP (NOSTRO ACCOUNT) BANK B
FOR USD GBP ACCOUNT
UK BANKS

US FEDERAL THE BANK

RESERVE BANK OF ENGLAND
BANK B USD ACCOUNT BANK S GBP ACCOUNT
BANK T USD ACCOUNT BANK C GBP ACCOUNT

SETTLEMENT ONE: SETTLEMENT TWO:

BANK B TRANSFERS BANK S TRANSFERS
1.44 MILLION USD TO 1 MILLION GBP TO BANK
BANK T BY FEDWIRE C BY CHAPS (BOE RTGS)

SELLER S NOW HAS 1.44 BUYER B NOW HAS 1

MILLION USD IN BANK T MILLION GBP IN BANK C
INTERNET BANKING
SERVICES

• Internet banking account

management
• Order checks, view their deposit history,
make transfer between accounts and
pay bills
• View up-to-minute account balance
information, interim statements
showing current activities and previous
issued statements
• Internet bill payment
• Pay recurring bills over their computer
or mobile devices
INTERNET BANKING
SERVICES
• Internet loans
• Apply for loans on their websites or mobile app
• Standard loan applications for both personal
and mortgage loans
• After being processed, a customer service
representative will follow up by calling
customers
• Internet investment
• Research investment options by accessing real-
time price quotes, market news, educational
material, financial calculators and other tools
• Purchase and sell investment by transferring
funds between checking and investment
accounts
• View accounts balance, holdings, asset
allocation, and losses and gains
• Receive electronic versions of documents,
including trade confirmations and tax
documents
• Download account information to financial and
tax preparation software
CARD ACCESS TO FUNDS
• ATM cards
• A plastic access card
• Getting quick cash or making a deposit
• Buying stamps or cash checks
• Paying utility bills and buying concert tickets
• Debit cards
• A check card – quickly replacing the ATM card
• Paying for purchases or services directly from their checking
account
• Embossed with either VISA or Mastercard logo
• Used at POS terminal
• Credit cards
• Access to funds in their credit card account at a bank
• Used at ATMs to get cash advances or in retail establishment
to make purchases
• Stored-valued cards
• A prepaid card
• Contactless payment cards
• Use radio frequency identification (RFID) technology to
transmit information to the card reader
• Wave the card in front of the device
 Descriptive Bill or
Customer Statement
Debit card Point-of-sale Transactions

Debit PIN/ Receipt

card Signature

Merchant’s
terminal

Debit
Notification Authorization
Card Data

Switching and
Processing data

Tape of daily
transaction

Automated
Merchant’s bank Customer’s Bank
Clearing House

Payment
LAW AND REGULATIONS

• Binding under:
• Circular 19/2016/TT-NHNN – On bank card operations
• Decree 35/2007/NĐ-CP – On banking e-transactions