If you have shopped online on international portals or have received payments from abroad, you would have wondered about how the payments flow across the world and which banks and financial institutions underpin global commerce and trade.
Further, if you work in a corporate that has global supply chains with international suppliers and customers, you would be again dealing with a complex network of institutions and banks that route the payments from one end of the supply chain or the value chain to the other.
In addition, when nations trade with each other and when central banks transact with each other as well as banks in different countries deal with each other, then they are all participating in the international payment system that is the bedrock of global payment flows.
Components and Constituents of the International Payment System
So, who and what are the constituents and components of the international payment system? To start with, banks and financial institutions form the first layer of the international payment wherein they hold accounts of other global banks who in turn hold accounts of the former. This enables the banks to send and receive payments from each other as they can simply debit their accounts and credit the other bank’s account with them and this in turn leads to payments flowing to the recipient bank that debit the sending bank and credit their account.
Indeed, it can be said that banks such as Citibank which is part of the international financial conglomerate, Citigroup, Standard Chartered, HSBC, and Barclays form the lifeline of the international payment system by routing the money from the senders to the recipients anywhere in the world, anytime of the year, and any place that they are located in.
The SWIFT Protocol
However, it is not enough for banks and other financial institutions to simply transfer money to each other without having a common protocol and standard by which they can communicate with each other. In other words, they need to “talk to each other” in a “language” that is understood by them.
Hence, there is indeed a common protocol that forms the basis for such communication, this is the SWIFT standard wherein the acronym stands for Society for Worldwide International Funds Transfer wherein this payment standard prescribes the rules and regulations that all participants in the international payment network must abide with to ensure that there is a common standard of messaging and communication between the banks and other financial institutions.
For instance, the sender, the recipient, the intermediary, and the address and other details are to be captured in a specific format that is standard across banks so that each participant in the payment value chain knows exactly what is contained in the payment message.
An Example of How International Payments Work
To take an example, if you are located in the United States and want to send a funds transfer to India, you must first setup the beneficiary and then transfer funds from your account to the beneficiary. While this completes your end of the value chain, the next step is when your bank in the United States debits your account and credits its account with the funds. After this, it transfers the money to its partner bank in India or if it does not have any dealings with Indian banks, it contacts a bank in the United States that has such dealings and in both these cases; the funds are then transferred from the banks in the United States to the bank in India.
Once the banks in India receive the funds, they must then send it to the ultimate beneficiary wherein the funds are debited from its account and credited to the recipient. Again, this step might be a single or two step processes depending on the recipient holding an account with the concerned bank that receives the funds.
Automation and Digitalization of the International Payment System
As you can see from the above example, international payments involve a complex chain of transactions and payment routes that entail cooperation and coordination between multiple banks and financial institutions. All these flows are made possible by automated payment systems that use the SWIFT standard which as explained earlier enables and ensures that the payments flow smoothly throughout the value chain.
Further, in recent years, there has been so much automation and digitalization of the payment systems that funds from one country to the other are flowing in an almost real time manner with just minor delays because of the clearing houses in between.
Clearing houses are financial institutions such as the Reserve Bank of India in India and the United States Federal Reserve in the US which function as the node for the payments between domestic banks and international banks. Clearing houses are also places where traditionally there have been like the village markets where at the end of the day, the various merchants gather to settle their accounts and square the debts and the credits.
As can be seen from the points raised so far, international payment flows go smoothly as long as all participants in the value chain do their part in addition to adhering to the SWIFT protocol. Further, the global payment value chain is efficient mainly because globalization has led to liberalization of the banking rules and regulations that have enabled banks anywhere to deal with other banks everywhere and anytime and every time.
Finally, the next time you send or receive an international payment, just think about what it takes to enable your payment and imagine bits and bytes of data and information streaming across the world so that your payment is processed smoothly and successfully.
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