Provisioning in Financial Systems: An Analysis
Why security is important?
Today’s world is cyber world and brings so much speed, everything is happening so quickly. But with this speed, everything becomes vulnerable and put all actions in a danger; just like speeding with a car on highway, as much as you accelerated you taking more risk. At this point ‘security’ comes to the stage and being most important topic. Speed must be supported with security at all areas.
One of these areas is financial systems. Almost all people is in touch with this system one way or another by purchasing something and making payment as 1.86 billion payment is happening per day globally based on 2022 records. Since money is the main actor here, security is way more important here compared to other systems. Security is happening in different ways for payment systems. As combination of various security ways and speed; provisioning is the most known one.
What is provisioning?
Provisioning is the process of ensuring that sufficient funds or securities are available to settle a payment or a trade. Provisioning is essential for the smooth functioning of payment systems, as it reduces the risk of settlement failures and enhances the efficiency of liquidity management. Provisioning can be done in different ways, depending on the design and features of the payment system.
Provisioning methods in payment systems?
One way of provisioning is to use pre-funded accounts, where participants deposit funds or securities in advance to cover their payment obligations. This method is commonly used in retail payment systems, such as card networks, mobile money platforms, and fast payment systems. Pre-funded accounts provide certainty of settlement, as payments are processed only if there are enough funds or securities in the account. However, pre-funded accounts also entail opportunity costs, as participants have to lock up their funds or securities and forego any potential returns from other uses.
Another way of provisioning is to use netting arrangements, where participants offset their payment obligations with their payment claims and settle only the net amount at the end of a predefined period. This method is typically used in deferred net settlement (DNS) systems, central counterparties (CCPs), and payment versus payment (PvP) systems. Netting arrangements reduce the liquidity needs of participants, as they can settle multiple transactions with a single payment. However, netting arrangements also increase the settlement risk, as participants may face delays or failures in receiving their net claims if one or more participants fail to pay their net obligations.
A third way of provisioning and most known one is to use credit cards, where participants borrow funds or securities from a lender, such as a central bank, a commercial bank, or another participant, to settle their payment obligations. This method is often used in large-value payment systems, such as real-time gross settlement (RTGS) systems, securities settlement systems, and foreign exchange settlement systems. Credit cards provide flexibility of settlement, as participants can access funds or securities on demand and optimize their liquidity usage. However, credit cards also involve credit risk, as participants may default on their repayment obligations and expose the lender to losses.
Conclusion
The choice of provisioning method depends on various factors, such as the size and frequency of payments, the availability and cost of liquidity, the legal and regulatory framework, and the risk appetite and preferences of participants. There is no one-size-fits-all solution for provisioning in payment systems, as each method has its own advantages and disadvantages. Therefore, it is important for payment system operators and regulators to carefully assess the trade-offs between different provisioning methods and design payment systems that best suit the needs and characteristics of their markets.
