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credit) from its customer and performs certain basic functions, regardless of the type of payment. The bank must verify the customer's and the item's authenticity, post the transaction to the customer's account (debit the customer's account for a credit item, credit for a debit item) and set up the appropriate offsetting accounting entry to the counterpart bank or clearing agent. The bank must sort the item by clearing agent and transport the item to the clearinghouse. The transpiortation can be physical for paper payments or telecommunications for electronic items. If items are sent in batches, a covering paper or electronic transmittal register provides control totals and listings for account reconciliation. With electronic items, security precautions must be taken to prevent access or alteration of the data. The originating bank must also establish archival records of the transactions for account reconciliation.

Clearing. Clearing includes the physical exchange of payinent instruments between the payer's bank and the payee's bank (or their agents). Clearing process can be centralized in a clearinghouse (participants exchange payment instruments among themselves on a multilateral basis). Alternatively, the clearing can be distributed (the originating and receiving banks deal directly with each other on a pair wise basis (bilateral clearing).

Clearinghouses simplify the exchange process.6 For paper payments (checks) there may be multiple clearinghouses, one in each major city within the country to minimize the document shipping time and costs. Electronic payments may be subject to a single nationwide clearinghouse or many geographic or competitive clearinghouses. Because payments (consumer payments) occur within narrow geographic areas, paper items are often processed locally or regionally to avoid lengthy transportation delays to and from a central point, or to reduce message traffic and telecommunications costs for electronic payments. Settlement. The setlement process transfers the transaction value between the originating and the receiving banks. To settle payment transactions, the two participating banks must have account relationships with each other, or each must have accounts with a comnon third party. Transaction accounts at banks on behalf of banks are called correspondent accounts or clearing accounts. If Bank A presents $100 in debit payment items to Bank B, and Bank A holds an account with Bank B, Bank B would credit A's account for $100 to setfle the item.

Pair wise settlement is cumbersome and can lead to systemic risk in the country's banking system. For example, if a country has 10 banks, and each bank holds a correspondent account with the other banks, a minimmn of 45 account relationships would be required.<sup>2</sup> ' This distributed settlement is operationally inefficient, requires large balances to be held until settlenent and can lead to systemic risk if a principal correspondent bank fails and cannot repay correspondent balances to the other banks.

Centralized settlement is often used for all or part of a country's payment settlements.

- _a A clearinghouse is an institaion established by a group of banlcs (with or. without the central bank's participation) to settle obligations. Each bank settles its obligations by paying the clearinghouse for the net amount owed to the rest of the members._

- _" To calcuate the number of permutions (P) of r objectsfrom a collecion of size n, denoted as P (r,n)_ = _[n! / (n-rJI!, where nI denotes a factorial fnr'= n. (n-I). (n-2) .... 2.11. Ifte order of selection is importan_ **_t_** _hen P (2, 10) = 10!1(10-2)! = 101/81= 90 (0 correspondent accounts would be required). However, if the order of selection is not importnt then there are r! ways to order r objects and the number of combinations (C) of r objects taken from n objects C (r, n) =ln/fr! (n-rJ]_ = _P (r, n)/ rI = 9012 = 45._