ACCOUNTING ENTRIES IN PAYMENTS
Accounting Entries in Payments
As promised in my previous article, in this one we will talk about how money moves from one party to another. Before we start, let me introduce you to a few terms that will be used throughout this article.
Debit – Money being taken from your account
Memory Aid – When you pay for something your account is debited
Credit – Money being added to your account
Memory Aid – When you receive your salary your account is credited
Let us get one more question out of our way. What are accounting entries??? It is a process of keeping track of the different credits and debits in a transaction. As a rule, you can always say that the total sum of debits should be equal to the total sum of credits.
We also need to understand 4 types of accounts that aid in the transfer of funds.
- NOSTRO
- VOSTRO
- MIRROR NOSTRO
- MIRROR CLEARING ACCOUNT (Clearing Account)
NOSTRO – Citi bank opens an account with AXIS bank (We will look at the why part in the future). From the City bank’s perspective, the account in AXIS bank is called the NOSTRO account. NOSTRO accounts are generally held in a foreign country and in the local currency of that country.
Somehow remember this, use any memory aid that you feel will do the trick. All the other 3 will fall into place. Refer Pic A0401
VOSTRO – Using the same example from above, Citi bank’s account with AXIS bank from the perspective of AXIS bank is called a VOSTRO account. So basically, the account is the same but the name changes as the perspective from which we look at the account is different. If you are a bank then another bank’s account that you hold in your books is a VOSTRO account. Refer Pic A0401
There is something else called LORO account. We will look at that later.
MIRROR NOSTRO – From Citi’s perspective, it has a NOSTRO account with AXIS. Now, Citi opens a mirror account of that NOSTRO in its books (In Citi bank), which acts like a mirror and nothing more. Mirror inverts left and right likewise mirror account inverts credit and debit. It is used to reflect the status/balance of the NOSTRO account. At the end of the day, the NOSTRO account is reconciled (entries matched) with MIRROR NOSTRO and the net balance must be ZERO.
Example: If the MIRROR NOSTRO is credited then the actual NOSTRO is debited and vice versa.
You may ask “why?!!!”, The reason is simple. You will understand it if you read further.
MIRROR CLEARING ACCOUNT -When banks exchange funds with each other via a CSM, then they hold an account with the CSM. It’s slightly more complex than that but for now, let us not focus on the account that we hold with CSM instead let us focus on the mirror of that CSM account that we hold in our books (or bank.) It is called the mirror clearing account.
Now that we know the different types of accounts and the associated terminologies let us start with the topic at hand. If you have only 10 mins to prepare for a payments interview, I suggest you read the following.
Correspondent Banking (Without CSM):
Let us take the story of John to understand the movement of money in a credit transfer. John wants to send Tom $1000 and for now, let us assume that there are no charges for this transaction.
Step 1: John instructs his bank (Citi) to send funds ($1000) from his account to Tom’s account in AXIS bank via. the internet banking portal (Or any other channel).
Step 2: Citi bank will have a “payment engine” that will receive this instruction and perform a range of checks and if all the checks result in a positive outcome, then John’s account is debited $1000.
What is this “Payment Engine”, Is it a clue about my next article??!! What are the checks that are performed?? Ok, definitely it’s the next article.
Step 3: Now the money taken from John’s account is credited into the Mirror of the NOSTRO account that Citi bank has with Axis. This is like handing over the money to AXIS bank.
Note: There will be suspense accounts involved in the transfer of funds from John’s account to the Mirror account but let us skip that here as we are trying to get the big picture.
Step 4: Now that the accounting entries within Citi bank are completed a payment message is sent by Citi bank to AXIS bank. This will be a Customer FI to FI payment message. Check out my previous articles on message types for more details.
Step 5: AXIS bank will have its payment engine and it will receive and process the payment message sent by Citi. If all the checks are successful then Citi’s NOSTRO account is debited for $1000 and the same is credited to Tom’s account.
Step 6: Tom is intimated via email or SMS or credit advice that funds have reached his account.
Yes, It’s as simple as that. This whole process can be compared to sending a money order, where you give the details of the receiver and the money to the local post office (credit to MIRROR NOSTRO) and the receiver’s city will have a post office that will provide the money to the receiver (Debit NOSTRO and credit customer).
If you are not from India or a 2K Kid then forget about this example 
I just hope you understand the concept. If not please reach out to me.
Banking Via. Market Infrastructure (With CSM):
For a similar type of transaction mentioned above if the CSM is involved then the concept is pretty much the same only difference is that the Mirror CSM account is debited and credited on both sides. Here the assumption is that the CSM is an RTGS system. In RTGS systems there is no clearing but only settlement.
If it is a NET settlement, then transactions are exchanged between parties via. Clearing and only the position of the bank’s account with CSM are calculated and at the end of the day or during INTRA day the funds are settled between the different CSM accounts of different banks. This settlement generally happens in the RTGS system.
For detailed information on clearing and settlement kindly refer to these articles from paiementor.com where it’s perfectly explained.
Clearing House: https://www.paiementor.com/clearing-and-settlement-mechanisms-multilateral-clearing/
Settlement: https://www.paiementor.com/clearing-and-settlement-mechanisms-settlement/
If I may suggest something, try to find out the meaning of the terms that you do not understand in this article.
Quiz:
1) Can you tell me what a payment market infrastructure (PMI) is???
Ans:
Market infrastructure like High-value payments RTGS, low-value payments ACH, CSM (NPCI, NEFT), EuroNet (it's between the bank and NPCI) in UPI system are PMIs
2) Is a Clearing account another term for settlement accounts or a different account?
Ans:
Settlement account is a generic term used to describe any account with which we settle funds. In this context settlement account is the account that has with the central bank.
Clearing is a private entity with which banks hold accounts that are called clearing accounts.
Note:
LORO account: Foreign correspondent's account maintained with a third Bank is referred to as a LORO account ( third party account), for example, Deutsche Bank India is looking at an account maintained by Bank of America USA with DBS Singapore in Singapore dollars.
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