How Do Interbank Settlement Networks Work?

Every day, banks around the world send and receive wire transfers. Coordination between several payment systems—divided into clearing networks and settlement networks—is necessary for the rapid clearing and settling of these transactions. Using these secure systems, banks can send wire transfer payment instructions to other institutions within minutes.

For transactions in the US, there are two networks that manage transfers: the Clearing House Interbank Payments Systems (CHIPS), a clearing system run by The Clearing House (TCH), and Fedwire Funds Services or simply Fedwire, a clearing system and the real-time gross settlement system (RTGS) for USD run by the Federal Reserve Board. For international wire transfers, the Society for World Interbank Transactions (SWIFT) delivers payment instructions which a clearing or settlement system then settles. Together, CHIPS and Fedwire handle the approving and settling of wire transfers in US dollars.

Why Interbank Settlement Networks Are Used

Interbank clearing and settlement networks allow banks to settle USD payments within a day and international payments within two days. Wire transfers cost between $25 and $50 per individual transaction, which is more expensive than ACH payments, but wire transfers also make it through interbank clearing and settlement networks faster, second to Real-Time Payments (RTP) payments between banks in the US.

The importance of increased speed in international and domestic money movement is hard to overestimate. In addition to boosting efficiency, intraday settlements bolster security by eliminating the risk of waiting over the weekend or night to process time-sensitive transactions. As most networks require identity verification and are all monitored for fraud, interbank clearing and settlement networks offer a safe and reliable way to move money.

How Do Interbank Settlement Networks Process Transactions?

Interbank clearing networks send secure payment instructions so banks can receive funds. This process begins when an individual or business initiates a payment by providing instructions to their bank. Their bank then sends information about the transaction—the wire amount, receiving bank routing number and the account number—to an interbank clearing network: Fedwire if they have a Federal Reserve Bank account, CHIPS if they do not or if they want to avoid Fedwire’s high fees, or SWIFT for transactions in any currency.

The clearing network will then pass the wire information to the recipient institution. The receiving bank uses reserve funds, or funds set aside for future costs or financial responsibilities, to deposit the wire amount into the designated account. The sending bank removes money from the sender’s bank account, clearing the transaction. It’s not until after the receiving bank puts forth the funds, both institutions settle the payment, and the banks exchange capital that the process ends. This settlement process can occur right after clearing the transaction or later.

This process differs for one of the interbank clearing networks, CHIPS. The CHIPS process includes another step called netting. This entails aggregating payments between the same parties to prevent the depletion of reserves. Though this additional step extends the clearing time, most CHIPS payments still settle within a day. Banks using CHIPS only have to send or receive a single wire at the end of the day, which goes to Fedwire to be cleared.

All payments cleared and settled through interbank clearing networks are final, so there is no possibility of the sender revoking their money after they pay the recipient.

What Happens to Transactions at Cutoff Hours or if There Is a System Outage?

When they operate as planned, interbank clearing and settlement networks provide a secure, efficient, and scalable method for bank-to-bank payments. However, there are a few variables that can impede the process.

First, because interbank clearing and settlement networks cannot process wire transfers 24/7, activities are limited to specific hours. Payments made through SWIFT must work around the cutoff times of domestic and international banks. Wire transfers made in USD through CHIPS or Fedwire, on the other hand, benefit from overlapping cut-off hours which facilitate intraday settlements. Specifically, CHIPS operates from 9 a.m. to 6 p.m. Eastern Time and Fedwire operates 22 hours a day, from 9 p.m. to 7 p.m. Eastern Time. If there are still unmatched or unresolved payments in CHIPS at the end of the day, it will release, net, and send after hours payments to Fedwire to settle.

Interbank clearing and settlement networks rely on sophisticated software to facilitate digital cash flow. Still, networks are vulnerable to outages due to human error or technical glitches. On Feb. 24, 2021, the Fedwire Funds Services was unavailable for around four hours due to a human error, resulting in backlogged information and payment failures. Transactions yet to be settled in the system at the time of the outage had to be resubmitted when it came back online. Fedwire is regularly tested to prevent shutdowns.

At the End of the Day

Today, interbank clearing and settlement networks streamline the movement of significant volumes of cash. Due to their high transaction limits and swift delivery, CHIPS, Fedwire, and SWIFT make it possible for individuals, businesses, and banks to send and receive money around the world.

Given the efficiency and availability of this payment method, many organizations can benefit from a scalable tool to help them manage their wire transfers and interactions with interbank clearing and settlement networks.

Reach Out

Modern Treasury's API facilitates wire transfers and provides a consolidated system for tracking your payments. To learn more about how Modern Treasury’s API can streamline interactions with interbank clearing and settlement networks, sign up for a sandbox, or reach out to one of our payments advisors.