In the previous post, we explained how to make a deposit and perform an account-to-account transfer within a single core banking system. However, in the real world, we have many banks and financial institutions that need to be able to transfer money to account holders across different banks. This means that our funds are not limited to just the bank that holds our account.
For example, we can transfer money to our friends and family who have bank accounts at different banks. In this post, we will examine how this process works in the core banking system, as well as how liquidity is managed in these transactions.
Before we delve into the mechanics of cross-bank settlements, let's examine the flow of funds in a typical scenario. Imagine that Bob and Alice both have balances of $1000 in their respective bank accounts. Bob wants to transfer $500 to Alice, but there's one catch: Bob's bank account is with Teal Bank, while Alice's bank account is with Purple Bank.
In the absence of a core banking system and infrastructure to handle this type of transfer, Bob would have to physically withdraw the $500 from his account at Teal Bank, travel to Purple Bank, and deposit the money into Alice's account. This process is cumbersome and time-consuming. However, with a core banking system in place, cross-bank settlements can be conducted seamlessly and efficiently. In the next section, we will look at how this process works.
To understand how this transaction would be reflected in the ledger, let's consider the steps that occur:
- The Teal Bank subtracts $500 from Bob's account and gives the cash to Bob.
- Bob takes the cash and deposits it into Alice's account at Purple Bank.
- Purple Bank adds $500 to Alice's account.
In the ledger of both Teal Bank and Purple Bank, these transactions would be recorded as debits and credits to the appropriate accounts. Specifically, Bob's account at Teal Bank would be debited by $500, while Alice's account at Purple Bank would be credited by $500. This ensures that the balances in both accounts are accurately reflected and that the overall integrity of the ledger is maintained.
As we have seen, cross-bank transactions involve the transfer of funds from one bank's ledger to another. This raises the question: is it possible to design a core banking system that can facilitate this process in a more efficient manner, and how would liquidity be managed in such a system? In the following section, we will explore these questions and examine how a core banking system might handle cross-bank transactions.
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