The payment process consists of clearing—the transfer of payment instructions—and settlement—the transfer of value associated with a payment. When the value being transferred takes the form of deposit money in banks, the performance of back-office accounting becomes an important part of the payment process and is a crucial factor determining who has the benefit of the value being transferred at any instant in time. In an ideal payment system, processing and related accounting should result in the payor’s account being debited and the payee’s account being credited at the same time.

When accounting for payments is not synchronized with the clearing of payment instructions, arbitrary costs are imposed on some payment system users and windfall gains are conferred on others. In particular, these windfall costs and gains can result when accounting entries for the two sides of a payment, that for the payor and payee, are not posted simultaneously. The accounting effects of the asynchronous posting of payment entries to the accounts of the payor and payee are known as float. The ideal connection between clearing and settlement times can be broken, particularly when intermediaries are involved in a transaction and when systems used to transport and process payments are relatively slow or unreliable. In such circumstances, special attention needs to be given to the accounting treatment of payments.

This chapter explains the significance of payment system float for individual participants in the payment system and as a public policy issue. It describes the mechanics by which payment system float is generated and explains both why float is important from the business and public policy perspectives and some of the causes of float. It then describes the “availability schedule” approach to float management (an appendix presents a detailed example of how to construct such a schedule), and also describes bank cash management services designed to help bank clients manage float.

The Mechanics of Float

Consider the following transactions made by cash, check, and credit transfer. If an obligation is settled using cash, the payor gives up the cash at the same instant that the payee receives it. The payee is able to use the cash just as the payor was able to use it an instant before the exchange. Alternatively, if a payor settles an obligation using a paper debit instrument such as a check, say, late on a Friday afternoon, it may be several days before the payor’s bank account is debited for the check. Thus, by using a check, the payor has initiated payment but retains use of the funds for several days. The result of delayed processing will be somewhat different in a credit transfer, with the payor possibly losing the use of funds before value is transferred to the payee. The key benefit of retaining use of funds while a payment is being cleared is the interest income that can be earned by investing the funds.

Thus, payment system float is the balance sheet effect of crediting (in a debit transaction like a check) or debiting (in a credit transaction like a payment order) the bank account of the entity originating a payment before the offsetting entry is made to the account of the entity receiving the payment. The presence of float can affect any of the parties to a payment—the payor, the payee, either party’s bank, a third commercial bank that is an intermediary to the transaction, or the central bank.

Because of float, some parties may have the use of funds that enter the payment process at the expense of others who are legally due the funds. If banks pay interest on transaction accounts from which payments are initiated and to which receipts are credited, or if there is a market in short-term funds, short-term funds have investment value. Which of the parties to a payment has the opportunity to invest these funds during the payment process depends on (1) whether the payment is made using a debit or credit instrument—for example, a check or a payment order; (2) whether the instrument is electronic or paper—in paper-based transactions it is more difficult to enter all the information into accounting systems simultaneously; (3) the presence of incentives that encourage parties deliberately to delay or to speed up processing of payments; and (4) whether there are rules in force to ensure timely and uniform processing and posting of entries to customers’ accounts.

Credit Payments

Assume that firm B supplies goods to firm A. Firm A elects to pay for the goods using a credit instrument, such as a payment order through a giro system. Firm A instructs its bank, bank X, to credit firm B’s account at bank Y. The flow of goods and payment is shown in Chart 1.

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Credit Payment Flow

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The first step in the payment process will be for bank X to debit firm A’s account. Some time can then elapse before funds are credited to firm B’s account at bank Y because of processing time at bank X, time to transport the payment instruction to bank Y, and processing time at bank Y. As a result, firm A’s account will be debited and bank X may have use of the funds if there is a delay before they are actually transferred to bank Y. Similarly, once bank Y receives the funds and until it credits firm B’s account, bank Y has use of the balances. Under these circumstances, banks X and Y have gained the use of funds at the expense of their customers. It is not hard to see that it could benefit the banks deliberately to delay the processing and crediting of payments to customer accounts.

Float can occur at another potential level, with different implications from those just outlined, which involves the central bank as a payment intermediary between commercial banks. Payments can be cleared and settled in several ways, and the exact mechanism will be crucial to how float is generated. Typically, however, the central bank plays a crucial role in interbank settlement, as value is transferred between banks X and Y through their nostro accounts at the central bank. The process can be generalized as illustrated in Chart 2.

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Credit Payment Flow and the Central Bank

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If the central bank debits the nostro account of bank X at the same time it credits that of bank Y, no central bank float is generated. If, however, the central bank debits bank X’s account and there is a delay before it credits bank Y’s account, the central bank would have the use of float at the expense of the banking system as a whole. This is central bank credit float that decreases the nostro balances of the commercial banking system at the central bank, thus decreasing commercial bank reserves.

Central bank credit float could arise because the central bank is inefficient at processing or, in paper payments, because of distances between central bank payment processing centers and commercial banks. Alternatively, central bank credit float might occur only periodically, as a result of delays caused by peak processing loads or occasional operational problems.

Debit Payments

Most of the literature on float deals with the debit float generated in connection with check processing. The literature on float comes mainly from the United States, where, in contrast to most European countries, checks are overwhelmingly the most important payment instrument, at least in terms of the number of transactions.

Chart 3 illustrates the flows involved in check payments. Continuing the earlier example, firm A knows that if it gives firm B a check when it takes delivery of goods, it will take some time before its account at bank X is debited. In the meantime, firm A will continue to have the use of the balances that will eventually be used to settle the payment obligation. In fact, firm A’s finance director may even take the risk of not funding the account at bank X until he expects the check to be presented, instead using the funds for other purposes, such as short-term money market investments. Management of cash balances is an important aspect of a firm’s overall financial management. The effect of payment patterns, including both disbursements and receipts, is an important part of cash management. Accordingly, as discussed below in the section on cash management, banks have begun to offer rather sophisticated payment services to their corporate customers that are designed to minimize the idle balances held to fund payments.

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Check Payment Flow

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As in the previous example, a number of levels of float are generated when debit instruments are used. At the bank customer level, if bank Y credits firm B’s account when a check is deposited but before bank X debits firm A’s account, firm B gains the use of funds before firm A’s account is debited for those funds. Essentially, bank Y is making an interest-free short-term loan to firm B during the time it takes to clear the check.

As described in Chapter 2, and as with credit instruments, interbank settlement can involve transfers across banks’ nostro accounts at the central bank, thus creating the potential for float between the central bank and the commercial banks. In this case bank Y, the bank at which the check has been deposited, will be quick to advise the central bank to credit its nostro account. If the central bank provides credit before it debits the account of the bank on which the check is drawn, in this example bank X, the central bank will be creating debit float. The central bank debit float created by this practice increases the reserves of the banking system. The central bank is effectively granting the commercial banking system as a whole a subsidy in the form of an interbank loan. This subsidy is ultimately paid by the taxpayer because it reduces the earnings of the central bank.

In relatively small countries where distances between processing centers are not great, transportation delays should not lead to major problems with debit float. Assuming major backlogs do not occur in the central bank’s own processing, it will not be too difficult to make the credit and debit entries to the banks’ nostro accounts on the same day. But in larger countries with many processing centers and where checks are transported over long distances, several days can elapse between the posting of credit and debit entries. For instance, a central bank branch in one part of a country could credit the account of a bank in its region and then send details of the transaction to another of its branches or processing centers or directly to a commercial bank thousands of miles away. In the United States, in particular, a great deal of careful design and execution has been devoted to the transportation aspects of check processing to meet the challenges posed by vast distances. Moreover, as discussed in Chapter 8, new methods whereby paper checks are converted into electronic instructions, called check truncation, are being more widely used.

The debit float generated through processing of debit payments has different effects than those generated by credit payments. In debit instruments such as checks, banks’ customers can gain float at the expense of the banking system. Also, commercial banks may gain float at the expense of the central bank. Table 1 summarizes the types of float generated as a result of using different types of instruments and by account relationship.

Table 1.

Types of Payment System Float

Table 1.

Types of Payment System Float

Account Relationship	Credit Float	Debit Float
Commercial banks and their customers	Generated by credit payments such as a giro or payment orders. The commercial bank benefits at the expense of the customer.	Generated by debit payments such as checks. Customers benefit at the expense of commercial banks.
Central bank and commercial banks	Generated by credit payments when the nostro account of the payor bank at the central bank is debited before the account of the payee bank is credited. The central bank benefits at the expense of the commercial banks as commercial bank reserves are decreased.	Generated by debit payments when the nostro account of the payor bank at the central bank is debited after the account of the payee bank is credited. The commercial banks benefit at the expense of the central bank as commercial bank reserves are increased.

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Table 1.

Types of Payment System Float

Account Relationship	Credit Float	Debit Float
Commercial banks and their customers	Generated by credit payments such as a giro or payment orders. The commercial bank benefits at the expense of the customer.	Generated by debit payments such as checks. Customers benefit at the expense of commercial banks.
Central bank and commercial banks	Generated by credit payments when the nostro account of the payor bank at the central bank is debited before the account of the payee bank is credited. The central bank benefits at the expense of the commercial banks as commercial bank reserves are decreased.	Generated by debit payments when the nostro account of the payor bank at the central bank is debited after the account of the payee bank is credited. The commercial banks benefit at the expense of the central bank as commercial bank reserves are increased.

Importance of Float

Why is float important? Key issues include the distortions that float can cause to the incomes of economic actors and the problems that it can cause for the implementation of monetary policy by making it more difficult to assess the demand for and supply of bank reserves. The existence of float means that one of the parties to a payment transaction—an enterprise or individual bank customer, a commercial bank, or the central bank—is either granting or receiving free or subsidized credit. Who gains and who loses payment float depends on how payment instructions are cleared and whether credit or debit instruments predominate. Clearly, float effects are potentially greater in a paper-based system, in which processing and transportation delays are potentially lengthy, than in an electronic system, in which such delays should be much shorter.

The value of float can be substantial. Float value is calculated by determining the return on investment of funds during the period that the float exists. For example, if the annual interest rate is 10 percent, the value of $1 million in float for one day is computed as

Amount of float	$1,000,000
Annualized return	× .10 _________
Annual value	$100,000
Divided by 365
Value of float for one day	$273.00

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Amount of float	$1,000,000
Annualized return	× .10 _________
Annual value	$100,000
Divided by 365
Value of float for one day	$273.00

The higher the market rate of interest and the longer the float time, the greater is the value of the float.

Because float has value, it influences choices made by payment system participants regarding the type of instruments they use and the processing options they follow. By definition, float is a zero-sum game, that is, total float gains exactly offset total losses. In this sense, the social costs of float might be thought of as being zero. But the income redistribution effects resulting from float are arbitrary and unlikely to be in any sense optimal. More important, the incentives provided by float to take actions to be a net gainer in the “float game” can degrade the effectiveness of the payment system. The damage that float can do to the reputation of the banking system as a whole is well recognized. To minimize these costs and help ensure an efficient payment system and maintain public confidence, participants in most mature payment systems have agreed to rules governing the minimum times within which payments must be delivered and processed and funds made available to payees. Because of their responsibility for the safe and efficient operation of the payment system, central banks usually play an important role in setting these rules. Even if such rules exist, attempts to exploit float can lead to increased credit, liquidity, and fraud risks to participants. It can also increase the difficulty of implementing monetary policy. Accordingly, from a public policy standpoint, float is undesirable and should be minimized.

Causes of Float

The earlier discussion outlined how payment system float is generated and pointed out some of the effects that float can have on payment system efficiency. Rules and procedures are necessary to establish and enforce performance standards for payment system participants to minimize float. Such rules and procedures should address the particular types of delays that can lead to float.

All of the operational causes of float discussed below are relevant whether debit or credit payments are being processed. Inefficiencies are more likely to occur in connection with paper-based processing than with electronic processing. Nonetheless, even electronic systems can generate considerable float, especially when they are not fully integrated with bank accounting systems used to post customer accounts.

Four major causes of float are discussed below. These are posting procedures, transportation, holdovers and backlogs of payments, and processing errors.

Posting procedures float arises from the practice of posting an interbank transaction to a customer’s account before making an entry for the other side of a transaction. For example, this float occurs when a bank gives credit at the time its customer deposits a check but before it receives credit for the check from the paying bank. That is, the bank receiving the check does not take into consideration the time that is normally needed to present the check and receive payment. This type of float can be reduced by adjusting posting procedures using deferred settlement and availability schedules, as discussed in detail below.

Transportation float occurs because paper payments must be transported between the various participants in the payment system. Transportation delays can be considerable in large countries where payment instruments are transported over slow transportation networks. This float can be reduced by using dedicated air and ground-based transportation networks designed to expedite the movement of value.

Transportation float can also be reduced by utilizing electronic delivery, especially for large-value payments. Electronic delivery helps ensure same-day delivery, processing, and posting of the largest-value payments. In most countries with well-developed financial markets, a relatively small number of large-value payments account for a very high proportion of the total value of payments. If these payments can be completed within one day, float can be significantly reduced. Especially if the volume of payments is not high, the technology required for an electronic large-value transfer system need not be complex or unduly expensive. Float arising in connection with these largest-value payments can be eliminated using properly controlled telephone, telegraphic, or computer-to-computer techniques to transfer funds. As discussed in Chapter 6, developed economies rely on specialized large-value transfer systems, an important feature of which is that they do not generate float.

Holdover float is generated when a payment is only partially processed during a business day. Holdover occurs when a commercial bank debits its customer for a payment order or gives credit for a check deposited but does not complete processing and forward the payment by the end of that business day. Backlog float is similar to holdover float. In backlog float, however, the payments are not even partially processed. Rather, processing is delayed, as is accounting, owing to backup in workloads.

Holdover and backlog float can be avoided if sufficient processing capacity is available to process the volume of payments received on a same-day basis. That is, the proper types and amounts of equipment and staff must be available to handle each day’s payment volumes. These resources need to be flexibly managed to efficiently handle low-, average-, and high-volume days.

Processing error float is created when errors occur during the handling of payments, including accounting for payments. For example, errors can result from payments being sent to the wrong bank, lost in transit between banks, or recorded in the wrong amount. During the time it takes to detect and resolve such errors, float is generated. Careful monitoring of work quality can reduce handling errors and processing error float. When errors do occur, an effective and timely error correction process will help contain the float that is generated by shortening the time needed to correct the error. To be effective, procedures for handling errors must be published, accepted, and used. Bank compensation rules commonly provide incentives for the speedy resolution of processing errors that arise in the payment system.

Availability Schedules

Although it would be ideal if the payment system functioned perfectly and all processing occurred in a timely, error-free manner, this is not a practical goal. At some point, the costs of reducing float by incurring added processing and administrative costs will outweigh the benefits. Nonetheless, float can be significantly reduced by synchronizing relevant accounting entries.

Float can be reduced by the use of funds availability schedules. The purpose of availability schedules is to synchronize the accounting performed for both sides of a payment. Availability schedules recognize the physical constraints that cause delays, such as processing and transportation, and attempt to compensate for the delays by adjusting the timing of accounting to achieve near simultaneity for entries to accounts even if physical handling of a payment results in processing and/or transportation delays between the payor and the payee.

For example, the debit to an account for initiating a payment order could be delayed to approximate the time it normally takes to process, deliver, and post the credit to the receiver’s account, thereby reducing float in the banking system. Similarly, the credit for a check could be delayed to approximate the time it normally takes to process, deliver, and post the offsetting debit to the payer’s account. These methods essentially tie the timing of accounting for the payment to the timing of the physical handling of the payment. The timing of the accounting entries is known as an availability schedule.

Although use of an appropriately designed availability schedule will reduce float, this method does not improve the speed or reliability of the payment system. Indeed, use of availability schedules, at least in debit payments, may diminish incentives for banks to improve the timeliness of the payment process. A detailed description of how an availability schedule is calculated and how it would be applied in daily processing is given in the appendix. The example is based on a payment system that relies on central bank processing centers and paper-based credit payments.

The example in the appendix raises a number of key issues that need to be addressed when availability schedules are being designed, including the proportion of local and interregional payments in the mix of total payments and the average transportation times for payments sent to and received from various destinations. The appendix makes clear that designing an availability schedule involves a trade-off between the goal of eliminating float and additional procedural and operational complications. Availability schedules should not be overcomplicated so that their use requires an undue amount of time and resources.

Cash Management Services

The analysis of float presented here suggests that enterprises, commercial banks, the central bank, and even individuals can increase income by carefully managing their payment flows. Similarly, the opportunity costs of failing to manage temporary cash balances effectively can be high. This has not escaped the notice of the treasurers of large corporations in particular.

As pressures on firms to minimize costs and maximize revenue intensify and as financial markets spawn new, convenient short-term investments with low transaction costs, corporate treasurers have found more sophisticated ways to avoid the cost of, or even to enjoy the benefits from, payment system float. Competitive pressures have forced commercial banks to offer their larger customers—both corporations and correspondent banks—a range of services to help them manage their cash balances more efficiently and profitably. Although not treated here, some retail banking products, such as overdraft protection for transaction accounts, also offer similar services to consumers.

The types of cash management services offered by banks to their customers fall into three main classes: (1) cash concentration; (2) disbursement; and (3) investment.

Conclusions

Float can cause significant distortions to the payment system and decrease its efficiency. In addition to its effect on individual payment system participants, float is an important public policy concern because it affects the efficiency of the entire payment system. Two broad approaches to dealing with float have been identified in this chapter. First, improvements in delivery and processing efficiency reduce the delays that lie at the heart of the float problem and bring better service to the customer. Such improvements, however, can be costly, especially in a paper-based payment environment. A second means of controlling float is to use availability schedules that synchronize accounting entries for the payor and payee regardless of the time it takes to process the physical payment.