The Payment and Settlement Systems Act, 2007 (PSS Act) defines settlement as the process of transferring funds from one account to another. Netting is the process of offsetting payments against each other so that only the net amount is settled.
The PSS Act requires payment system operators to use settlement and netting mechanisms to reduce the risk of payment failures. The RBI has also issued guidelines on the use of settlement and netting mechanisms.
There are two main types of settlement mechanisms: gross settlement and net settlement.
- Gross settlement: In gross settlement, each payment is settled individually. This means that the funds for each payment must be available in the payer’s account before the payment is processed. Gross settlement is the most secure type of settlement, but it can also be the most expensive.
- Net settlement: In net settlement, payments are netted off against each other before settlement. This means that only the net amount of payments is settled. Net settlement is less secure than gross settlement, but it can be more efficient and less expensive.
There are two main types of netting mechanisms: multilateral netting and bilateral netting.
- Multilateral netting: In multilateral netting, all the participants in the payment system net their payments against each other. This means that only the net amount of payments is settled. Multilateral netting is the most efficient type of netting, but it can also be the most complex.
- Bilateral netting: In bilateral netting, only the payments between two participants are netted against each other. This means that the net amount of payments between each pair of participants is settled. Bilateral netting is less efficient than multilateral netting, but it is also less complex.
The PSS Act requires payment system operators to use settlement and netting mechanisms that are appropriate for the size and complexity of the payment system. The RBI has also issued guidelines on the use of settlement and netting mechanisms.
MCQs on Settlement and Netting as per Payment & Settlement Systems Act, 2007
- Which of the following is the process of transferring funds from one account to another?
- Settlement
- Netting
- Both (a) and (b)
- None of the above
The answer is (a). Settlement is the process of transferring funds from one account to another.
- Which of the following is the process of offsetting payments against each other so that only the net amount is settled?
- Settlement
- Netting
- Both (a) and (b)
- None of the above
The answer is (b). Netting is the process of offsetting payments against each other so that only the net amount is settled.
- Which is the most secure type of settlement?
- Gross settlement
- Net settlement
- Both (a) and (b)
- None of the above
The answer is (a). Gross settlement is the most secure type of settlement because each payment is settled individually.
- Which is the most efficient type of netting?
- Multilateral netting
- Bilateral netting
- Both (a) and (b)
- None of the above
The answer is (a). Multilateral netting is the most efficient type of netting because it nets off payments between all the participants in the payment system.