A payment system is a set of instruments, procedures, rules, and technology that allow for the transfer of funds between businesses, consumers, governments, and other entities. These funds are usually held in an account at a financial institution and require the use of a payment instrument — such as cash, checks, or electronic funds transfers — to transfer from one financial institution to another.
The World Bank defines payment systems as the “mechanisms established to facilitate the clearing and settlement of monetary and other financial transactions.” A payment system offers a common platform for centralizing financial transfers between entities. Every payment system has its own procedures and protocols, and while some are country- or product-specific, others operate on a global scale.
How do banking payment systems work?
Banking payment systems provide financial institutions a common way to transfer funds safely and securely. Today’s payment transfers between parties can be quite complex and can involve different players. Here’s an overview of the major components that comprise most payment systems and the functions they serve.
Payment Instruments
These are the methods or tools used to initiate and process transactions. They serve as the interface between the payer and the payee, enabling the transfer of funds. Common payment instruments include:
These are digital portals that facilitate online transactions between merchants and customers. They serve as intermediaries, authorizing and processing payments made via credit cards, debit cards, or other digital payment methods. Essential functions of payment gateways include:
Integration
The gateway connects with e-commerce platforms and point-of-sale systems to streamline the payment process.
Authorization
The gateway verifies the validity of the payment method and checks for sufficient funds.
Encryption
Data is encrypted to ensure sensitive payment information is securely transmitted between parties.
Financial Institutions (FIs)
Banks and credit unions play a central role in the payment system by offering accounts and processing transactions. When using credit cards or digital payments, a financial institution will operate as either the issuing bank or the acquiring bank in the transaction.
Issuing Bank
These are FIs that provide payment cards (credit, debit, or prepaid) to consumers and businesses. They are responsible for extending credit, managing cardholder accounts, and handling the billing and payment processes associated with card transactions.
Distributes payment cards to eligible customers
Extends credit limits, assesses creditworthiness, and monitors spending
Sends monthly statements, processes payments, and manages collections
Resolves card-related inquiries, disputes, and account management updates
Acquiring Bank
Also known as merchant banks or acquirers, these FIs work with businesses (merchants) to process card payments. They facilitate the acceptance of card transactions by providing the necessary infrastructure and services to merchants.
Sets up and maintains accounts that allow businesses to accept card payments
Handles the authorization, clearing, and settlement of card transactions
Provides online merchants with payment gateway solutions to process e-commerce transactions
Transfers the proceeds from card transactions to the merchant’s account after deducting fees
Payment Service Providers (PSPs)
PSPs are companies that offer businesses and individuals the technology and services to accept electronic payments. They act as intermediaries between merchants and financial institutions, enabling merchants to accept card payments by setting up merchant accounts. They handle the authorization, clearing, and settlement of transactions during payment processing.
Clearing Houses
These are entities that facilitate the exchange and settlement of transactions between financial institutions. They ensure that transactions are accurately processed and funds are correctly transferred.
Payment Networks and Schemes
Payment networks and payment schemes are the infrastructure and set of rules that govern the processing of payment transactions. Their functions include:
Directing payment requests between acquiring banks and issuing banks.
Establishing uniform standards and protocols for transaction processing.
Ensuring compatibility between different payment instruments and systems across borders.
Examples include Visa, MasterCard, PayPal, Alipay, and the Automated Clearing House.
Regulatory Agencies
These are the agencies responsible for overseeing payment systems to ensure their integrity, security, and efficiency. They establish and enforce rules and guidelines that govern the operations of all components within the payment system.
Type of Regulatory Agency
Role
Example
Central Banks
Oversee the national monetary policy, regulate the money supply, and ensure the stability of the financial system
The US Federal Reserve System
Financial Conduct Authorities
Protect consumers and maintain market integrity by enforcing compliance with financial regulations
The Financial Conduct Authority (FCA) in the UK
International Organizations
Set global standards and promote best practices in payment systems
Bank for International Settlements (BIS)
Regulatory agencies ensure that payment systems and services are secure, stable, affordable, and accessible for merchants and consumers. They also aim to promote growth and development and expand financial inclusion.
What is the difference between a payment network and a scheme?
While the terms payment network and payment scheme are sometimes used interchangeably, there is an important distinction. Both provide connectivity between the acquiring and issuing banks. However, where a payment network can be just a directory of participants and relevant payment information, payment schemes are networks that ensure that transactions are conducted consistently and in compliance with established standards.
A payment network is an electronic or physical framework that enables transactions to occur and is responsible for routing transaction data, authorizing transactions, and ensuring that funds are transferred accurately and securely.
Payment schemes will set the governing rules, price structure, and clearing and settlement guidelines on how card transactions should be conducted. They will also determine how fees are calculated, how disputes are resolved, and the roles and responsibilities of each participant in the payment process. Schemes can be open networks (Visa, Mastercard) that encourage banks to issue and accept transactions, closed networks (Amex) where the card brand acts as the issuer and acquirer, and hybrid models (Discover) where the card brand can issue the card directly and allow other FIs to act as acquirers.
Payment Network
Integrated with bank systems and do not rely on any other settlement mechanisms to execute payments
Direct payment requests from the point of initiation to the appropriate parties for authorization and settlement
Ensure compatibility between different devices, software, and financial institutions
Implement measures to protect transaction data and prevent fraud
Visa Net
Mastercard Network
SWIFT (Society for Worldwide Interbank Financial Telecommunication)
Real-time gross settlement (RTGS)
Payment Scheme
Set guidelines on how transactions should be processed, including authorization, clearing, and settlement procedures.
Some may manage their own rules and standards without maintaining a directory of participants
Establish frameworks for determining the costs associated with processing transactions, including interchange fees and service charges
Has clear definitions of the roles and responsibilities of issuers, acquirers, merchants, and consumers within the payment process
Visa
Mastercard
Amex
China UnionPay
Zelle
Wise
Hybrid Schemes
Integrate the infrastructure of payment networks with the regulatory and procedural frameworks of payment schemes
Ensure compatibility across different payment methods, devices, and financial institutions, promoting seamless transactions
Create a common set of guidelines that adhere to regulatory requirements and industry standards
ACH
PayPal
Alipay
WeChat Pay
TWINT
What are some common examples of banking payment systems?
When considering examples of banking payment systems, it can be helpful to distinguish between traditional and modern payment systems.
Traditional banking payment systems — such as check clearing, ACH, wire transfers, card-based systems, and direct debits/standing orders — rely on physical infrastructure and centralized networks and offer reliability and security. However, they often involve longer processing times and less flexibility compared to modern digital payment systems.
Traditional Payment System
Key Features
Typical Use Cases
Examples
Check Clearing Systems
• Requires physical checks • Manual verification and processing
• Personal and business payments
• Local clearing houses • U.S Federal Reserve Bank
ACH
• Transactions collected and processed in batches • Direct transfers between banks in 1-2 business days
• Payroll • Direct deposits • Recurring payments
• NACHA • Electronic Payments Network (EPN)
Wire Transfers
• Provides immediate transfer • Stringent verification and security
• High-value transactions • Urgent payments
• SWIFT • Clearing House Interbank Payments System (CHIPS)
Modern banking payment systems — including real-time payment systems, mobile payment platforms, digital wallets, cryptocurrency payment systems, online payment gateways, and P2P payment systems — have features and functions driven by digital innovation. They offer increased speed, convenience, accessibility, and security compared to traditional payment systems.
• Seamless integration with eCommerce platforms and websites • Supports multiple payment methods
• E-commerce • Online services
• ACI Worldwide • Square • Authorize.Net
P2P Payment Systems
• Simple interfaces provide ease of use • Lower fees than other payment systems
• Personal transfers • Splitting bills
• Zelle • Cash App • Revolut
What is payments modernization?
Payments modernization refers to the process of updating and enhancing payment systems to meet current technological, regulatory, and user demands. FIs are under increasing pressure to respond to:
Technological advancements — Innovations in digital technology, such as blockchain, artificial intelligence, and cloud computing, have introduced more sophisticated and complex payment systems, all with their own set of benefits and features that challenge traditional systems.
Rising consumer expectations — As fintechs and other banking disruptors develop and popularize digital applications, more consumers expect payment experiences that are fast, seamless, convenient, and always available across various channels and devices.
Increased security threats — Just as technology has become more sophisticated, so have the threats against payments security. FIs need to employ modern solutions to fight the increasing risk of fraud, cyberattacks, and data breaches.
Regulatory changes — As the industry evolves, so do the rules and guidelines set by governments and regulatory bodies. FIs need to be able to comply with the regulations and security requirements intended to protect consumers and promote competition in the payments industry.
Globalization — With increased global trade and the growing popularity of eCommerce, there’s more of a need than ever for efficient, cross-border payment solutions. FIs need to have an answer for merchants who are looking to expand into new markets and to global competitors offering innovative payment solutions.
Payments modernization means meeting these challenges to offer more efficient, secure, and user-friendly payment solutions.
What are the benefits to implementing a modern banking payments system?
FIs that utilize modern banking payment systems benefit from:
Offering a frictionless customer experience — By providing seamless, intuitive, and convenient payment options, modern systems enable customers to complete transactions quickly and effortlessly.
Providing faster, more efficient transactions — Modern payment systems are designed to process transactions in real-time, significantly reducing the time it takes for payments to be completed and funds to be available.
Reduced settlement times — Faster settlement times reduce the delay between the initiation and completion of transactions, improving liquidity for businesses and ensuring quicker access to funds for consumers.
Greater operational efficiency — The automation of payment processes reduces manual intervention, minimizing errors and freeing up staff to focus on higher-value tasks. Automated systems also streamline operations, from transaction processing to reconciliation, resulting in cost savings and improved efficiency.
Enhanced cross-border capabilities — Improved interoperability and real-time processing reduces the complexity and delays traditionally associated with international payments, benefiting global businesses and customers with easier and more cost-effective cross-border transactions.
Access to robust risk management and fraud prevention tools — Advanced security features such as tokenization, encryption, biometrics, and real-time fraud detection algorithms enhance an FI’s ability to detect and prevent fraudulent activities, protecting them and their customers.
Easier regulatory compliance — Modern payment systems are designed to comply with current regulatory requirements, providing built-in features for reporting and compliance. This ensures that financial institutions can more easily meet legal obligations, avoid penalties, and maintain trust with regulators and customers.
Data-driven insights about customers — Modern payment systems generate and capture valuable data on customer behavior. Analyzing this data helps in understanding spending patterns, preferences, and customer trends, enabling more personalized and targeted services.
More opportunities for value-added services — Payments modernization enables financial institutions to offer additional services that can improve customer engagement and satisfaction, such as personalized financial advice, loyalty programs, and integrated financial management tools.
The ability to reach unbanked or underbanked populations — Payments modernization expands financial inclusion by providing access to different digital payment solutions — such as mobile payment platforms and digital wallets — for unbanked or underbanked populations, offering them secure and convenient financial services.
The agility to adapt to new and emerging industry trends — Modern payment systems are flexible and scalable, allowing financial institutions to quickly adapt to new technologies, market trends, and customer demands.
How can banks set up a modern payments infrastructure?
FIs interested in setting up an infrastructure to support modern payment systems should take the following steps:
Assess current payment systems and identify gaps — Start by understanding current strengths and weaknesses, such as gaps in capabilities, performance, and security.
Develop a comprehensive strategy — Create a detailed roadmap for modernizing your payments infrastructure that aligns with established business objectives and customer needs.
Set a budget and timeline — Establish a realistic budget and timeline for implementation, considering the costs of new technology, training, and potential disruptions during the transition.
Strategize on how to meet compliance and regulatory requirements — Ensure that all payments infrastructure and processes will comply with current regulations and industry standards, as well as any future updates to relevant regulations such as PSD3, SCA, and anti-money laundering compliance.
Establish staff training and development programs — Ensure that staff is well-equipped to manage and operate the new payments infrastructure and have programs in place, so they’re always updated on the latest trends and best practices in payments modernization.
Partner with professionals who are experienced in modernizing payment systems — Don’t try to reinvent the wheel. Work with experienced professionals and leverage their innovative solutions to ensure that payment modernization is as efficient, comprehensive, and cost-effective as possible.
As the payments partner of choice for countless global organizations, ACI Worldwide specializes in delivering software that enables banks, merchants, and billers to bring new payment types to market at speed, adapt to shifting and regulatory mandates, and rapidly launch new value-added services according to consumer demand.
To learn more about how ACI Worldwide can help your organization realize the benefits of a modern banking payments system, contact us today.
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