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7. Bank Accounts: reconciling accounts & Electronic Funds Transfer (EFT)

Tuesday, May 30, 2017 - 2:00pm - 4:00pm

Banking relations have changed considerably, largely with the growth of online banking capabilities. This session will explore management of banking functions from setting up the accounts to reconciling the accounts and discuss the issues that surround Electronic Funds. Banking Session

• Bank reconciliation

• Electronic Funds Transfer

2 “Reconciling the bank statement is a crucial step. It's very unlikely that someone is going to steal from you and run away forever. Reconciling the bank statement means that embezzlement can't go on for very long.

Ideally someone other than the bookkeeper (or whoever handles the money) reconciles the bank account from an unopened statement. That's a strong check on the person who handles the money. But in a small nonprofit there may not be a bookkeeper, and there may be only one person who does everything. In these instances someone else, such as a board member, should receive the unopened bank statement, and look it over before giving it to the bookkeeper or the sole staff person.”

Carl Ho, CPA January 6, 2010 at Blue Avocado

3 Bank Reconciliation

• What is a Bank Reconciliation?

• Who does it, and why?

• What does it look like?

• What does it have to do with Internal Financial Controls?

• Best Practices for the board of a nonprofit organization ....

4 What is a Bank Reconciliation?

• An internal control on your revenues and expenditures

• A comparison of your accounting records with the records of your bank

• One way to check on how much cash is flowing through your organization

5 Who does it and why?

• Usually your bookkeeper, but rightly, a person who can knowledgeably check on the book

keeper’s work

• Often the treasurer

• Occasionally, an auditor, if you have one

• To look for errors, omissions or fraud

6 What does it look like?

Example Bank Reconciliation March 31, 2011

Balance per bank statement $ 4,672.98 Deposits in Transit • Short, or long, the bank Date Amount reconciliation is a ‘tally’ 3/30 $ 500.25 3/31 $ 1,890.33 $ 2,390.58 and should balance at the Subtotal $ 7,063.56 bottom of the sheet Outstanding Cheques

Cheque Number Amount 1656 $ 22.50 1693 $ 150.00 • Verify balances and 1696 $ 32.00 1697 $ 1,902.00 explain discrepancies 1698 $ 1,105.80 $ 3,212.30 Balance per books $ 3,851.26

7 8 Step 1. Balance per Bank Statement on Aug. 31, 2010 $ 3,490

Adjustments:

Deposits in transit + 1,450

Outstanding cheques – 3,221

Bank errors 0

Adjusted/Corrected Balance per Bank $ 1,719

Step 2. Balance per Books on Aug. 31, 2010 $ 967

Adjustments:

Bank service charges – 35

NSF cheques & fees – 110

Cheque printing charges – 80

Interest earned + 8

Note Receivable collected by bank + 960

Errors in company's Cash account + 9

Adjusted/Corrected Balance per Books $ 1,719

9 What does it have to do with Internal Financial Controls? • Preparation of bank reconciliation helps in the identification of errors in the accounting records of the company or the bank. • Cash is the most vulnerable asset of an entity. Bank reconciliations provide the necessary control mechanism to help protect the valuable resource through uncovering irregularities such as unauthorized bank withdrawals. • If the bank balance appearing in the accounting records can be confirmed to be correct by comparing it with the bank statement balance, it provides added comfort that the bank transactions have been recorded correctly in the company records.

10 Why Hassle With Bank Reconciliation?

• Without bank reconciliation, you may not have a clear idea of how much cash is available in your account.

• You might bounce cheques and incur overdraft charges. With electronic cheque clearing, you don’t have much time to get funds into your account when you write cheques.

• Reconciling your account ensures you the opportunity to spot inappropriate cheques, withdrawals or transfers that are unsupported by authorization.

11 Best Practices for the board of a nonprofit organization

• Have accounting procedures which require a monthly bank reconciliation on your account(s). (i.e., do on a timely basis) • Spot check bank ‘recs’ if you cannot always segregate this job from regular bookkeeping. (i.e., segregate the duties) • Do bank recs more often if you are handling large sums of cash, such as proceeds from fundraising events or ticket sales. • Keep bank ‘recs’ on file for review purposes. • Always attach source documentation for occasional reviews.

12 Electronic Funds Transfer (EFT)

• Electronic banking, also known as electronic fund transfer (EFT), uses computer and electronic technology as a substitute for cheques and other paper transactions. • EFTs simplify the payment process to vendors, etc. • Benefits include increased efficiency and security, and immediate access and availability of funds to vendors • Two types of EFT payments: bank-to-bank wire transfers and direct deposits • Wire transfers are for domestic or international transactions where no cash or cheque exchange is involved

13 Internal Control and EFT

• Separate individuals are authorized to perform the incompatible duties of initiating and reviewing/approving wire transfers. • Bank account reconciliations selected for review: were completed timely and reviewed and approved by an appropriate level of management. • Wire transfer application security measures employ not only physical and user access controls but also digital certificates installed on computer equipment used by authorized employees. • Preventing fraud or unauthorized activity requires cautious management of physical and logical security components of the computing equipment and operating systems, network, and banking application used for wire transfers.

14 Internal Control and EFT (cont’d)

• Internal control is a process designed to provide reasonable, but not absolute, assurance regarding the achievement of objectives in the following categories: – effectiveness and efficiency of operations – reliability of financial reporting – compliance with applicable laws and regulations • Must have well documented and understood Policies and Procedures • Transaction amount limits and appropriate management approval requirements are implemented in accordance with policy and procedures

15 Example of use

• Direct deposits are the electronic transfers of funds to payees through the ACH Network (a highly reliable and efficient nationwide batch-oriented electronic funds transfer system) • Compared to wire transfers, ACH payments are typically for smaller dollar amounts, payee-payment records are sent in batches, and settlements do not occur until the next business day. • Direct deposits usually set up to pay salaries, expense reimbursements, etc.; not used to pay vendors.

16 Some final thoughts

• Online banking access for some volunteers, should be restricted to “read-only” • Emails from your bank confirming transactions should be directed to someone other than the initiator of a payment

17 Session Handouts

• Payments Canada Overview of Canadian Payment System

• Accounting Coach – Bank Rec. Example

18 Bank Reconciliation (Explanation) Introduction to Bank Reconciliation

A company's general ledger account Cash contains a record of the transactions (checks written, receipts from customers, etc.) that involve its checking account. The bank also creates a record of the company's checking account when it processes the company's checks, deposits, service charges, and other items. Soon after each month ends the bank usually mails a bank statement to the company. The bank statement lists the activity in the bank account during the recent month as well as the balance in the bank account.

When the company receives its bank statement, the company should verify that the amounts on the bank statement are consistent or compatible with the amounts in the company's Cash account in its general ledger and vice versa. This process of confirming the amounts is referred to as reconciling the bank statement, bank statement reconciliation, bank reconciliation, or doing a "bank rec." The benefit of reconciling the bank statement is knowing that the amount of Cash reported by the company (company's books) is consistent with the amount of cash shown in the bank's records.

Because most companies write hundreds of checks each month and make many deposits, reconciling the amounts on the company's books with the amounts on the bank statement can be time consuming. The process is complicated because some items appear in the company's Cash account in one month, but appear on the bank statement in a different month. For example, checks written near the end of August are deducted immediately on the company's books, but those checks will likely clear the bank account in early September. Sometimes the bank decreases the company's bank account without informing the company of the amount. For example, a bank service charge might be deducted on the bank statement on August 31, but the company will not learn of the amount until the company receives the bank statement in early September. From these two examples, you can understand why there will likely be a difference in the balance on the bank statement vs. the balance in the Cash account on the company's books. It is also possible (perhaps likely) that neither balance is the true balance. Both balances may need adjustment in order to report the true amount of cash.

After you adjust the balance per bank to be the true balance and after you adjust the balance per books to also be the same true balance, you have reconciled the bank statement. Most accountants would simply say that you have done the bank reconciliation or the bank rec.

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Bank Reconciliation Process

Step 1. Adjusting the Balance per Bank

We will demonstrate the bank reconciliation process in several steps. The first step is to adjust the balance on the bank statement to the true, adjusted, or corrected balance. The items necessary for this step are listed in the following schedule:

Deposits in transit are amounts already received and recorded by the company, but are not yet recorded by the bank. For example, a retail store deposits its cash receipts of August 31 into the bank's night depository at 10:00 p.m. on August 31. The bank will process this deposit on the morning of September 1. As of August 31 (the bank statement date) this is a deposit in transit.

Because deposits in transit are already included in the company's Cash account, there is no need to adjust the company's records. However, deposits in transit are not yet on the bank statement. Therefore, they need to be listed on the bank reconciliation as an increase to the balance per bank in order to report the true amount of cash.

 A helpful rule of thumb is "put it where it isn't." A deposit in transit is on the company's books, but it isn't on the bank statement. Put it where it isn't: as an adjustment to the balance on the bank statement.

Outstanding checks are checks that have been written and recorded in the company's Cash account, but have not yet cleared the bank account. Checks written during the last few days of the month plus a few older checks are likely to be among the outstanding checks.

Because all checks that have been written are immediately recorded in the company's Cash account, there is no need to adjust the company's records for the outstanding checks. However, the outstanding checks have not yet reached the bank and the bank statement. Therefore, outstanding checks are listed on the bank reconciliation as a decrease in the balance per bank.

 Recall the helpful tip "put it where it isn't." An outstanding check is on the company's books, but it isn't on the bank statement. Put it where it isn't: as an adjustment to the balance on the bank statement.

Bank errors are mistakes made by the bank. Bank errors could include the bank recording an incorrect amount, entering an amount that does not belong on a company's bank statement, or omitting an amount from a company's bank statement. The company should notify the bank of its errors. Depending on the error, the correction could increase or decrease the balance shown on the bank statement. (Since the company did not make the error, the company's records are not changed.)

Step 2. Adjusting the Balance per Books

The second step of the bank reconciliation is to adjust the balance in the company's Cash account so that it is the true, adjusted, or corrected balance. Examples of the items involved are shown in the following schedule:

Bank service charges are fees deducted from the bank statement for the bank's processing of the checking account activity (accepting deposits, posting checks, mailing the bank statement, etc.) Other types of bank service charges include the fee charged when a company overdraws its checking account and the bank fee for processing a stop payment order on a company's check. The bank might deduct these charges or fees on the bank statement without notifying the company. When that occurs the company usually learns of the amounts only after receiving its bank statement.

Because the bank service charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the service charges will have to be entered as an adjustment to the company's books. The company's Cash account will need to be decreased by the amount of the service charges.

 Recall the helpful tip "put it where it isn't." A bank service charge is already listed on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

An NSF check is a check that was not honored by the bank of the person or company writing the check because that account did not have a sufficient balance. As a result, the check is returned without being honored or paid. (NSF is the acronym for not sufficient funds. Often the bank describes the returned check as a return item. Others refer to the NSF check as a "rubber check" because the check "bounced" back from the bank on which it was written.) When the NSF check comes back to the bank in which it was deposited, the bank will decrease the checking account of the company that had deposited the check. The amount charged will be the amount of the check plus a bank fee.

Because the NSF check and the related bank fee have already been deducted on the bank statement, there is no need to adjust the balance per the bank. However, if the company has not yet decreased its Cash account balance for the returned check and the bank fee, the company must decrease the balance per books in order to reconcile.

Check printing charges occur when a company arranges for its bank to handle the reordering of its checks. The cost of the printed checks will automatically be deducted from the company's checking account.

Because the check printing charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the check printing charges need to be an adjustment on the company's books. They will be a deduction to the company's Cash account.

 Recall the general rule, "put it where it isn't." A check printing charge is on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

Interest earned will appear on the bank statement when a bank gives a company interest on its account balances. The amount is added to the checking account balance and is automatically on the bank statement. Hence there is no need to adjust the balance per the bank statement. However, the amount of interest earned will increase the balance in the company's Cash account on its books.

 Recall "put it where it isn't." Interest received from the bank is on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

Notes Receivable are assets of a company. When notes come due, the company might ask its bank to collect the notes receivable. For this service the bank will charge a fee. The bank will increase the company's checking account for the amount it collected (principal and interest) and will decrease the account by the collection fee it charges.Since these amounts are already on the bank statement, the company must be certain that the amounts appear on the company's books in its Cash account.

 Recall the tip "put it where it isn't." The amounts collected by the bank and the bank's fees are on the bank statement, but they are not on the company's books. Put them where they aren't: as adjustments to the Cash account on the company's books.

Errors in the company's Cash account result from the company entering an incorrect amount, entering a transaction that does not belong in the account, or omitting a transaction that should be in the account. Since the company made these errors, the correction of the error will be either an increase or a decrease to the balance in the Cash account on the company's books. Step 3. Comparing the Adjusted Balances

After adjusting the balance per bank (Step 1) and after adjusting the balance per books (Step 2), the two adjusted amounts should be equal. If they are not equal, you must repeat the process until the balances are identical. The balances should be the true, correct amount of cash as of the date of the bank reconciliation.

Step 4. Preparing Journal Entries

Journal entries must be prepared for the adjustments to the balance per books (Step 2). Adjustments to increase the cash balance will require a journal entry that debits Cash and credits another account. Adjustments to decrease the cash balance will require a credit to Cash and a debit to another account. Bank Reconciliation (Explanation) Sample Bank Reconciliation with Amounts

In this part we will provide you with a sample bank reconciliation including the required journal entries. We will assume that a company has the following items:

Item #1. The bank statement for August 2016 shows an ending balance of $3,490.

Item On August 31 the bank statement shows charges of $35 for the service charge for #2. maintaining the checking account.

Item On August 28 the bank statement shows a return item of $100 plus a related bank fee of #3. $10. The return item is a customer's check that was returned because of insufficient funds. The check was also marked "do not redeposit." Item #4. The bank statement shows a charge of $80 for check printing on August 20.

Item The bank statement shows that $8 was added to the checking account on August 31 for #5. interest earned by the company during the month of August.

Item The bank statement shows that a note receivable of $1,000 was collected by the bank on #6. August 29 and was deposited into the company's account. On the same day, the bank withdrew $40 from the company's account as a fee for collecting the note receivable. Item #7. The company's Cash account at the end of August shows a balance of $967.

Item During the month of August the company wrote checks totaling more than $50,000. As of #8. August 31 $3,021 of the checks written in August had not yet cleared the bank and $200 of checks written in June had not yet cleared the bank. Item The $1,450 of cash received by the company on August 31 was recorded on the company's #9. books as of August 31. However, the $1,450 of cash receipts was deposited at the bank on the morning of September 1. Item On August 29 the company's Cash account shows cash sales of $145. The bank statement #10. shows the amount deposited was actually $154. The company reviewed the transactions and found that $154 was the correct amount.

Before we begin our sample bank reconciliation, learn the following bank reconciliation tip.

Put it where it isn't.

If an item appears on the bank statement but not on the company's books, the item is probably going to be an adjustment to the Cash balance on (per) the company's books.

If an item is already in the company's Cash account, but has not yet appeared on the bank statement, the item is probably an adjustment to the balance per the bank statement.

Our approach to the bank reconciliation is to prepare two schedules. The first schedule begins with the ending balance on the bank statement. We refer to this schedule as Step 1. The second schedule begins with the ending Cash account balance in the general ledger. We call this schedule Step 2.

Items 1 through 10 above have been sorted into the following schedules labeled Step 1 and Step 2. The item number is shown in the far right column of each schedule.

Step 1 Amounts

Let's review the schedule for Step 1. In all likelihood the balance shown on the bank statement is not the true balance to be reported on the company's balance sheet. The bank reconciliation process is to list the items that will adjust the bank statement balance to become the true cash balance. As the schedule for Step 1 indicates, the amount of deposits in transit must be added to the bank statement's balance. Also, the amount of checks that have been written, but not yet appearing on a bank statement, must be subtracted from the bank statement's balance. Next any bank errors should be listed and should be reported to the bank for correction. (The company does not report deposits in transit and/or outstanding checks to the bank.)

Step 2 Amounts and Required Journal Entries

Step 2 begins with the balance in the company's Cash account found in its general ledger. The bank reconciliation process includes listing the items that will adjust the Cash account balance to become the true cash balance. We will review each item appearing in Step 2 and the related journal entry that is required. Remember that any adjustment to the company's Cash account requires a journal entry. Generally, the adjustments to the books are the result of items found on the bank statement but have not yet been entered in the company's Cash account.

Item #2 Bank service charges. Since the bank deducted $35 from the company's checking account, but the company has not yet deducted this from its Cash account, the following journal entry needs to be made.

(If the annual amount of service charges is small, debit Miscellaneous Expense.)

Item #3 NSF checks and fees. Since the bank deducted these legitimate amounts from the company's bank account, the company will need to deduct these amounts from its Cash account. As mentioned, the NSF check of $100 was from a customer. Therefore, the company will likely undo the reduction to Accounts Receivable that took place when the company originally processed the $100 check. If the company wishes to recover the bank fee of $10 from the customer, it should add the $10 fee to the amount that the customer owes the company. The journal entry might look like this:

(If the amount cannot be recovered from the customer, charge an expense.)

Item #4 Check printing charges. Because this expense is not yet entered on the company's books, but the amount has been deducted from its bank account, the company will make the following journal entry.

Item #5 Interest earned. The bank increased the checking account balance by $8 on August 31. Since the bank did not notify the company previously, the company must now increase the balance in its Cash account.

Item #6 Notes receivable collected. The bank increased the company's checking account when it collected a note for the company on August 29. It was determined that the company had not yet made an entry to its Cash account for this transaction. As a result the following journal entry is needed.

Item #10 Company error. The company had entered $145 in its Cash account on August 29, but the bank statement showed the correct amount: $154. The transaction involved the cash sales for the day. As a result the company's Cash account will have to be increased by $9 as follows:

Step 3 Comparing the Adjusted Balances

In the above schedules the adjusted balance for Step 1 is $1,719 and the adjusted balance for Step 2 is $1,719. The company believes that all items involving cash have been included in the schedules. As a result the company has successfully completed its bank reconciliation as of the August 31, 2016.

Canada's Major Payments Systems

Learn what a payments system is and how payments are processed through Canada’s Large Value Transfer System (LVTS) and the Automated Clearing Settlement System (ACSS). Both of these systems are owned and operated by Payments Canada. Read about the Bank’s functions in payments systems. Payments systems explained

Canadians use various “payment instruments” to purchase goods and services, to make financial investments, and to transfer funds from one person to another. These instruments include cash, cheques, debit and credit cards, and e-money. Except for cash, payment instruments involve a claim on a financial institution, such as a bank, credit union or caisse populaire. Financial institutions therefore need arrangements to transfer funds among themselves, either on their own behalf or on behalf of their customers. A payments system is the set of instruments, technical arrangements, procedures and rules used to transfer these funds. How payments are processed

Payments go through two steps:

1. Clearing - the process of transmitting, reconciling and, in some cases, confirming payment orders prior to settlement. This process can include netting of payments and the establishment of final positions for settlement. 2. Settlement - the release of payment obligations between two or more parties by transferring funds between them.

There are two payments systems in Canada:

 Large Value Transfer System (LVTS)  Automated Clearing Settlement System (ACSS)

Payments systems also play a role in clearing and settlement transactions involving assets such as securities, derivatives and foreign exchange. For example, CDSX, operated by the Canadian Depository for Securities Limited, clears and settles trades in Canadian-dollar-denominated debt and equity securities. The LVTS is used to settle end-of-day net payment obligations among CDSX participants.

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The Large Value Transfer System (LVTS)

The LVTS is a real-time, electronic wire transfer system that processes large-value, time-critical payments quickly and continuously throughout the day. Owned and operated by Payments Canada, the LVTS was launched on 4 February 1999. The system provides participants and their customers with the certainty that, once a payment message has passed the system’s risk-control tests, it is final and irrevocable in real time. These transactions will settle on the books of the Bank of Canada at the end of the day.

Payments Canada sets the requirements that financial institutions must meet to be direct participants in the LVTS. An institution must:

 be a member of Payments Canada  use the SWIFT telecommunications network  have adequate backup capability for its LVTS operations  have a settlement account at the Bank of Canada  enter into agreements relating to taking loans from the central bank and to pledging eligible collateral

LVTS participants provide their customers, which include other financial institutions, as well as commercial and government entities, with indirect access to the system.

Risk-control mechanisms

The LVTS forms the core of Canada's national payments system. Because the LVTS is designated as systemically important, it is expected to meet the Principles for Financial Market Infrastructures (PFMIs). The smooth functioning of the LVTS substantially reduces systemic risk and allows Canada to meet best international practices for processing large-value payments. The risk-control structure of the LVTS is composed of the following elements:

 Individual payment messages are subject to risk-control tests in real time.  The net amount that each participating financial institution is permitted to owe is subject to bilateral and multilateral limits.  Participants pledge to the Bank of Canada eligible collateral with a value that is sufficient to cover, at a minimum, the largest permitted net debit position of a single participant. This provides sufficient collateral to make available the necessary funds to settle the system even if one of the participants defaults.  The Bank of Canada guarantees settlement of the system in the extremely unlikely circumstance of more than one participant defaulting on the same day. The guarantee will be called on only in the event of a failure of more than one participant on the same day during LVTS operating hours, with the failing participants in a net owing position vis-à- vis the system, and if the amount owed by the defaulters exceeds the value of the collateral pledged to the Bank of Canada.

These four elements provide the participants with certainty of settlement. In turn, this certainty permits institutions to offer their customers intraday finality of payment.

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Two types of payments - Tranche 1 and Tranche 2

When sending an LVTS payment, the sending participant can choose between two types of payment: Tranche 1 and Tranche 2. Each tranche has a corresponding risk-control limit and collateral requirements.

Tranche 1 payment

A participant can send a Tranche 1 payment as long as its net owing position (as a result of all its Tranche 1 payments sent and received) is no greater than the collateral that the institution has pledged to the Bank of Canada for Tranche 1 activity. If the participant should default on its final LVTS settlement obligation, this collateral would be used to cover any net negative position in this tranche of payment. For this reason, Tranche 1 payments are known as “defaulter pays.”

Tranche 2 payment

Under Tranche 2, each participating institution begins the day by granting a bilateral line of credit to every other institution (which can be zero), i.e., the largest net exposure that it is prepared to accept vis-à-vis that institution on that day. In addition, each participant (as a sender) has a multilateral net debit cap, calculated as the sum of all bilateral lines extended to it, multiplied by a specified percentage set by Payments Canada. Each participating financial institution pledges to the Bank of Canada collateral equal to the largest bilateral line of credit it has extended to any other institution multiplied by the specified percentage. If a participant defaults on its final LVTS settlement obligation, in addition to seizing the collateral pledged to Tranche 1, the Bank of Canada seizes the defaulter’s Tranche 2 collateral. If the defaulter’s Tranche 2 collateral is not sufficient to cover their amount owing, the loss-allocation procedures pro-rate any remaining amounts to surviving participants on the basis of the bilateral lines of credit established by survivors vis-à-vis the defaulter. The collateral pledged by the participants will always be sufficient to cover the default of the institution with the largest possible amount owing to the system, i.e., the institution participant with the largest sender net debit cap. This part of the system has been described as “survivor pays,” since surviving financial institutions absorb any losses associated with a default (after the defaulter’s collateral is seized and used to meet its obligations). Tranche 2 payments make up the great majority of the volume and value of payment transfers in the LVTS, principally because of savings in collateral relative to Tranche 1 operations.

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LVTS daily operating schedule - phases of the LVTS cycle

00:00 (ET) - Commencement and Start of Initialization Period

Participants wishing to send payments will sign on, pledge collateral, apportion collateral, confirm participant profile information and set bilateral limits. The Bank of Canada will evaluate all participants’ collateral.

00:30-06:00 (ET) - Start of Payment Message Exchange Period

The LVTS is open for exchanging payments. During this period, participants exchange payments to settle CLS transactions. CLS is a foreign exchange settlement system, operated by the CLS Bank. All Canadian-dollar CLS transactions settle in the LVTS. There must be bilateral agreement between sending and receiving participants to send non-CLS-related payments prior to 06:00.

06:00-08:00 (ET)

The LVTS is open for payment exchange between active participants for all payments (MT 103 and MT 205), both customer and inter-participant.

07:00-08:00 (ET)

Participants not already active will sign on, pledge collateral, apportion collateral, confirm participant profile information and set bilateral limits.

08:00-18:00 (ET)

Payment exchange

18:00 (ET) - End of Payment Message Exchange Period/Start of Pre-Settlement

(Start of Inter-Participant Payment Message Exchange Period)

The LVTS is open for inter-participant payments (MT 205 only). This period is to be used by the participants to bring their multilateral net positions closer to zero.

18:30 (ET) - End of Pre-Settlement

No further payment messages may be exchanged through the LVTS.

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By 19:30 (ET) - Settlement

The Bank of Canada will settle all participants’ multilateral net positions simultaneously. All participants’ multilateral net positions are settled simultaneously.

The LVTS - Canada's Large-Value Transfer System

The LVTS is an electronic network for sending and receiving large-value payments. It is expected to become operational in the first half of 1999. Major chartered banks and other large deposit-taking institutions will provide access to the system for their clients in the financial, corporate, and government sectors. Canada’s LVTS exceeds world standards for risk control in large-value systems. The author explains how this is achieved through the netting, bilateral and multilateral credit limits, collateral, and loss-sharing procedures used in the event of a default, and, as a last resort, a guarantee by the Bank of Canada. The LVTS gives participating institutions certainty of settlement for their LVTS positions every day, even if one or more participants default. This greatly reduces systemic risk in the financial system. Moreover, the LVTS supports finality of payment; that is, it makes funds unconditionally and irrevocably available to the receiver. Finality is highly desirable when the amount of the payment is substantial, or when exact timing is critical. Since the LVTS will carry the great majority of the value of all payments in Canada, it should be considered the core of the national payments system.

A Primer on Canada’s Large Value Transfer System

This paper provides a comprehensive overview of Canada’s Large Value Transfer System (LVTS). The LVTS is a real-time electronic system for handling large-value payments and is an integral component of the country’s financial system. Each day, approximately Can$140 billion in payments is sent through the LVTS, including payments used to settle other important clearing and settlement systems in Canada. The Automated Clearing Settlement System (ACSS)

The Automated Clearing Settlement System (ACSS) is owned and operated by Payments Canada. The ACSS is a deferred net settlement system that clears retail payments, including paper-based payment items (mostly cheques), pre-authorized debits and credits, as well as small- value electronic payment items, such as point-of-sale debit card or automated banking machine transactions. Payment obligations cleared in the ACSS are settled in the LVTS.

In 2013, the ACSS handled an average of 26.8 million payment items per day, with an average daily value of $24 billion. Paper items accounted for 11 per cent of the volume and 49 per cent of the value , while electronic items made up about 89 per cent of the volume and 51 per cent of the value.

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Direct and indirect clearers

Members of Payments Canada may be either direct or indirect clearers in the ACSS. Eligibility criteria for being a direct clearer include being a Payments Canada member and maintaining a settlement account and loan facility at the Bank of Canada. The entity must also account for at least one-half of 1 per cent of the total volume of ACSS clearings. An indirect clearer is a member of Payments Canada that does not maintain a settlement account or loan facility at the Bank of Canada and has a direct clearer acting as its agent in the ACSS clearing and settlement process.

ACSS clearing and settlement cycle

In the ACSS, payment items that are exchanged among ACSS direct and indirect participants throughout the day are cleared overnight and are settled with interest compensation on the next business day across the settlement accounts of the Bank of Canada. The specifics of the exchange and clearing of the items vary, depending on the item (e.g., whether the payment item is paper based or is sent as an electronic data transmission). But all items follow a similar path.

Clearing for paper transactions is handled through six regional settlement points across the country, and the specifics differ according to the type of payment item. Generally, items collected by Payments Canada members throughout the value day (T) are forwarded to a local data centre operated, or contracted, by a direct clearer. Payment items are sorted at the data centre by high-speed computerized readers/sorters, according to the institutions on which they are drawn. Items drawn on other institutions are then delivered to the data centres of the appropriate direct clearer in the same regional clearing area. The delivering direct clearer enters the information regarding the exchanged items, including the volume and value of various types of payment items, into its ACSS terminal. This information can be checked at the receiving direct clearer's data centre and adjusted if necessary. The next day, the cheques are returned to the branches of the institutions on which they are drawn.

This process of exchanging items, entering information into ACSS terminals and, potentially, adjusting entries continues on the value day until the final closing time, which is 11 a.m. ET on the settlement day (T+1) for all regional settlement points. The ACSS calculates the net position across all types of payment items for each direct clearer. By 8 a.m. on T+1, the financial institutions have typically finished making adjustments to their clients' accounts, debiting payors' accounts, and crediting payees' accounts. At approximately 9:30 a.m., initial net balances are available to all the direct clearers, and bilateral reopenings of the clearing may occur to correct errors, if both parties agree. By 11 a.m., the final multilateral positions of the direct clearers are calculated and made known to the Bank of Canada.

Direct clearers’ net positions are settled by adjustments to their settlement accounts at the Bank of Canada. This is typically completed by 12noon ET on the settlement day (T+1), with interest compensation calculated on positions at the Bank Rate minus one-quarter of 1 per cent (25 basis points), the Bank's target for the overnight interest rate. For settlement, direct clearers in a net

Page 6 of 8 debit position make an LVTS payment to their settlement account at the Bank to cover their ACSS position plus calculated interest compensation. Similarly, direct clearers in a net credit position have the funds plus interest compensation credited to their account, and value is returned to them through an LVTS payment. Note that although the exchange process begins on day T, settlement is completed the next business day for value T+1; hence, the interest compensation component. Payments Canada

Payments Canada is a not-for-profit organization created by an Act of Parliament in 1980 under the Canadian Payments Association Act. The Act was replaced in 2001 by the Canadian Payments Act (the CP Act). The CP Act underwent significant amendments in 2014 to update the Governance and Accountability frameworks of Payments Canada.

The mandate of Payments Canada is to:

 establish and operate national systems for the clearing and settlement of payments and other arrangements for the making or exchange of payments;  facilitate the interaction of its clearing and settlement systems and related arrangements with other systems or arrangements involved in the exchange, clearing, or settlement of payments; and  facilitate the development of new payment methods and technologies.

In fulfilling its mandate, Payments Canada has the public policy objective to “promote the efficiency, safety and soundness of its clearing and settlement systems and take into account the interests of users.” Payments Canada owns and operates the two national payments systems in Canada ─ the Automated Clearing Settlement System (ACSS) and the Large Value Transfer System (LVTS). Payments Canada sets bylaws, rules and standards that govern members’ participation in these systems and outlines operational procedures.

Membership and governance

Membership in Payments Canada includes the Bank of Canada, domestic banks, and authorized foreign banks. Other deposit-taking institutions (credit union centrals, trust and loan companies, and provincial savings offices) have been eligible for membership since 1980. The amendments to the CP Act in 2001 opened membership to life insurance companies, securities dealers, and money market mutual funds.

Following amendments in 2014, and taking effect in July 2015, Payments Canada will be governed by a 13-person Board of Directors, composed of 7 independent directors, 3 directors from Payments Canada members who are direct participants in Payments Canada systems, 2 directors from other Payments Canada members, and the President of Payments Canada. The Chair of the Board is one of the independent directors. Also contributing to the work of Payments Canada is the Stakeholder Advisory Council (SAC) and the Member Advisory Council, which provide advice and expertise to the Board on payment, clearing, and settlement issues.

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All Payments Canada bylaws are approved by the Governor in Council, i.e., the federal government Cabinet. The Bank’s functions in payments systems

Beyond its oversight responsibilities under the Payment Clearing and Settlement Act, the Bank of Canada has two other roles in Canada's payments systems:

 The first is settling the positions among the participants in the LVTS and the ACSS. There are about a dozen financial institutions in these systems that have “settlement accounts” with the Bank. At the daily settlement times, the systems calculate the net amounts owing among the institutions, and those amounts are settled via entries to the institutions' accounts at the Bank. In the case of the ACSS, participants that have net funds owing fund their ACSS settlement account with an LVTS payment.  Another important function of the Bank is to lend funds overnight to any institution that is a direct participant in the LVTS and has net funds owing in the LVTS at settlement time. This is referred to as “providing liquidity.”

Unlike central banks in many other countries, the Bank of Canada neither owns nor operates any of Canada's major payments systems. However, the Bank of Canada has a keen interest and involvement in these systems, for several reasons:

 The safety and stability of payments systems contribute to the Bank’s broader objective of promoting a safe and sound financial system in Canada.  Unsafe or unsound payments systems could impair the Bank’s ability to implement monetary policy effectively.  As the ultimate source of liquidity to the financial system, the Bank is naturally concerned about the safety and soundness of Canada’s systems. Poorly designed systems could generate significant liquidity and credit risks for their participants.  Final settlement of payment obligations among the participants in the systems takes place through the transfer of funds held in their settlement accounts at the Bank.  The Bank is a participant in the LVTS and the ACSS, settling amounts owing to or from itself and to or from the Government of Canada.  The Bank has strong links to the Canadian Payments Association, which operates Canada's national payments systems.  The Bank participates in international groups - particularly the Bank for International Settlements Committee on Payment and Market Infrastructures - that set risk- management principles for payment, clearing and settlement systems.

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