Support of real and financial markets. The purpose of the payment system in market economies is to provide low cost, timely, and secure payments for both enterprises and households. The overarching goal is to support trade and exchange - among enterprises, among households, and between households and enterprises. This encompasses both real (goods and services) and financial markets. As enterprises and households engage in transactions that differ in frequency, value, and place, a broad range of both paper-based and electronic payment instruments have been developed to accommodate these different needs. The accounting and monitoring functions of a payments system - the primary goal in a centrally-planned economy - is basically separate from payment transactions in a market economy. Efforts to more completely integrate these two functions - through electronic business data interchange (EBDI) - are in their infancy.

While market economies often contain both privately-owned and government-owned banks, privately-owned banks are dominant. Government-owned banks may provide loans only to politically favored sectors of an economy (e.g., agriculture) or, like commercial banks, loan to all sectors. As well, government agencies may guarantee privately-provided loans to favored groups (e.g., small business, students, homeowners). Although exceptions exist, specifically in the form of the government-owned GIRO, in most market economies privately-owned banks typically provide the majority of transaction, savings, and loan services to both the household and the (privately-owned) enterprise sector.

The banking industry in market economies is usually concentrated, with the largest 10 banks holding 90% or more of all deposits or assets. The U.S. is an anomaly as it would take 3,000 banks to achieve this level of concentration. Differences in banking concentration, geographic distance, and antitrust policy, as well as (centralized) post office provision of savings and transaction accounts, have helped to determine the range of non-cash payment instruments that can be cost-effectively supplied. As discussed below, these differences have led the U.S. and Canada to rely on paper-based debit transfer instruments, such as checks, while Europe and Japan have focused more on paper and electronic credit transfer instruments, such as GIRO payments. (The word GIRO is derived from the Greek and reflects the flow of funds around a ring, making a circle.) Although the focus may be on one payment instrument, all developed countries offer both to users.

While individual banks, or the post office, provide for the processing, collection, and transfer of funds among themselves, the central bank typically provides for the final, same-day, net settlement of the multilateral net debit or net credit positions among these institutions. Thus government guarantees for the payment system usually only apply to the gross or net settlement component of the payment cycle, with privately-owned banks being responsible for risks in the other components.

Private responsibility for credit needs and risk assessment. The credit needs of enterprises are not determined by the government but rather by the assessment of individual enterprise owners regarding their ability to earn a "normal" or market return on invested capital. Invested capital is supplied by the enterprise owners, either personally or through a stock market, or from internally-generated cash flows - retained earnings - in the course of business (one source being the depreciation of physical capital). However, the government can and does influence the overall money supply and the business cycle and so indirectly influences both the supply of and demand for credit in a market economy.

Credit is granted to the enterprise and household sectors through the banking system based on an assessment of the risks and returns involved. While some credit is guaranteed by the state (usually for a small fee) or can be privately insured, the banking system has the primary responsibility (monitored by bank regulators) of assessing credit risk in making loans or in providing payment services. This process is information intensive and is guided by legislation (bankruptcy, rights and liabilities of payors and payees), regulations (loan limits to single borrowers, depositor access to funds), and case law (loan contracts, ownership of collateral, bank fees).

Enterprises, in general, face two payment risks when supplying goods or services: (1) they may never receive a non-cash payment; and (2) the payment instrument they receive may not lead to good funds being transferred. Both risks exist for checks while only the first can occur with a GIRO. Receivers of a credit transfer (GIRO) payment face no credit risk because the payment would not have been sent if the payor's balance (or the payor's credit agreement with the GIRO) was insufficient to cover the funds transferred to the payee's account. Thus GIRO payments, once received, will not be reversed and thus are final payments.

A similar assurance does not exist with a debit transfer (check) instrument. In the U.S., 1% of the 60 billion checks received by payees (600 million) are returned each year, even though a fee of from $15 to $25 is incurred by payors for each returned check. Items are most often returned because of insufficient funds in the payor's account, but returns also occur because a check is drawn on a closed account or there is no payor signature or the date is too old. Thus check payments, once received, can be reversed and thus are provisional payments. Bank credit is often extended to business payees to cover the time gap between receipt of a check and its final settlement. Japan and France have addressed their return item problem by simply removing banking privileges for enterprises and individuals when checks are returned unpaid. In general, payment instrument use is determined by the convenience, cost, and finality of the different instruments available within a country and the perceived trade-offs among these attributes for both payors and payees.

Payment float and incentives for timely payment and settlement. The time it takes between when a payment instrument is received as payment and when the payee actually has access to good and final funds is termed payment float. Depending on the instrument used, the availability of funds can be immediate (for cash), to less than one day (for large value, electronic wire transfers), to the same or next business day (real-time debit card point of sale, credit card, GIRO, checks drawn on a local bank), to two business days (non-local checks).

As interest is paid on deposited funds, and even higher returns may be obtained through purchasing short-term money market instruments (overnight interbank funds or highly liquid government securities), the principle that money has a time value is well-developed in market economies. Correspondingly, there exists a strong (private sector) incentive to minimize payment float and invest in methods that will provide timely payment and settlement. While this investment is "unproductive" from a social point of view, since float is a transfer payment and little or no real output is being produced, there are significant distributional effects from either expanding or contracting float. Indeed, in some countries the banking system captures much of the float benefit and so will be required to look for alternative revenue sources if float is reduced.

Float reduction can be achieved by purchasing high speed paper processing machinery and dedicated motor and air courier collection systems for checks. For debit and credit card payments and automated clearing house (ACH) transfers, float reduction occurs by having an extensive network of card-reading terminals, computer to computer hookups, and a sophisticated electronic communication infrastructure for electronic payments. Payments made over large value wire transfer networks are typically cleared and settled within the day they are made and so usually do not create any (overnight) float.

Cash, check, GIRO retail payments, and electronic large value transfers. Cash is the most used of all the payment instruments. This holds for both centrally-planned or market-driven economies. For countries where estimates have been made, cash transactions account for more than 75% of the total. The stock of cash held per person, an approximate indicator of cash use across countries, is shown for 11 developed countries in Table 1. Countries with low crime rates, an aversion to credit use, or a history of holding savings outside of the banking system all tend to hold large amounts of cash.

The use of four types of non-cash payment instruments for the same 11 countries is shown in Table 2. Countries that have a high use of cash (Switzerland, Japan, Germany, Sweden, Netherlands, Belgium, and Italy in Table 1) tend to have the lowest incidence of check use, choosing instead to concentrate on credit transfers (GIRO) and direct debits (a payee initiated electronic debit to a payor's account). Thus intensive use of one type of final payment (cash) is positively correlated with two others (credit transfers and direct debits), to the detriment of checks (a provisional payment instrument). However, in some other countries (India, Korea, Australia, and South Africa in Table 3 check use in non-cash payments is as high or higher than that of major check users among developed countries (U.S., Canada, France). While different developed countries rely on different mixes of non-cash payment instruments, the one common theme is a continuing shift away from paper-based to electronic payments.

The primary method for making large value enterprise and government payments within market economies is through highly secure electronic wire transfer networks, such as Fedwire and CHIPS in the U.S., BOJ-NET in Japan, CHAPS in the U.K., SAGITTAIRE in France, and SIC in Switzerland. To control for the possible systemic risk associated with one institution's failure to settle real time or end-of-day net positions on these different networks, risk control procedures have and are being adopted. The purpose is to prevent a possible domino-like series of settlement failures or the risky extension of credit by the central bank. Risk control procedures involve one or more of the following items: net debit limits, private loss-sharing agreements (common in stock and commodity markets), the posting of liquid collateral, larger payment clearing balances, or rejection of a payment request if the balance is insufficient.