How Money Moves

Written by: Steve Lemon
Published on: September 16, 2014

Thanks to the prevalence and ease-of-use of modern internet banking, making payments between bank accounts is a commonplace occurrence that can be carried out by anyone, from big businesses to individual account holders. Major banks make it their business to ensure that the process of authorising a transaction is as quick and easy to follow online as possible so you can tell them where to move your money with the minimum of fuss. How Money Moves

However, although the authorisation side of things is simple, that’s not the whole story. To the average account holder, moving money simply means tapping in the requisite amount and clicking a confirmation button (along with following some security measures, of course) but obviously there’s a little more activity occurring behind the scenes. In this post, we take a more detailed look at the actual mechanics involved in transferring money between bank accounts, both domestically and internationally. 

A Matter of Liability

Before we explain further, it’s vital to understand the concept of liabilities. In the digital banking age, it’s neither necessary nor practical to move actual currency between physical bank facilities, so instead banks simply let the numbers do most of the travelling. When you make a deposit, the money isn’t stored away with your name on it, the bank simply notes the amount which then becomes one of their many liabilities; they owe you that money. This is what it means to have an account that is in credit, because you are in effect extending credit to the bank. It is exactly the same in reverse; if you become overdrawn, you owe money to the bank and that amount has become your liability and their asset.

Moving Money between Accounts at the same Bank

An easy one to start with! Moving cash between different accounts both held by the same bank is a doddle. It doesn’t matter if it’s Lloyds, Barclays, HSBC, whoever, the process of an internal transfer requires only a simple accounting update that can be accomplished electronically in mere moments.

So, let’s say that Jeff has gone out to dinner with his friend Julie but has forgotten his wallet. The following day he wants to pay Julie back and decides to send her the £50 online. Both of them happen to bank with Lloyds so the process couldn’t be simpler. Once Jeff’s instructions are sent through the Lloyds TSB website, it is carried out almost instantaneously by the core banking system. The bank’s books are electronically altered to show that Lloyds now owes Jeff £50 less and owes Julie £50 more. No money has been moved but the transaction has been completed swiftly with just a simple adjustment of the liabilities held by the three parties involved: Jeff, Julie and Lloyds.

This kind of transaction is just as quick and easy regardless of the sum involved. Whether it’s £50 or £50,000 being moved between accounts, as long as they’re held by the same bank it’s a simple case of updating the books to accurately show how much is owed.

Moving Money between Different Banks

Moving Money between Different Banks

With basic accountancy software, it’s possible for any bank to reliably keep track of its customers’ assets and liabilities and shift these around with ease. However, what happens when you want to pay someone who uses a different bank to you?

Say that Sunshine Construction, a US company, wants to pay one of its suppliers, Charlie’s Cement, $10,000 for its latest delivery. Sunshine hold a business account with Citigroup but Charlie’s bank with US Bancorp, so although it’s easy for Citigroup to reduce the money it owes Sunshine by $10,000, why would US Bancorp agree to owe Charlie’s Cement $10,000 more than they did previously? This is where the transaction would become impossible, if it weren’t for the fact that the two banks involved also hold accounts with each other.

To complete the business transaction between the two companies, the flow of liabilities would look like this:

  • Citigroup reduces Sunshine Construction’s balance on its account with them by $10,000
  • Citigroup increases US Bancorp’s balance on its account with them by $10,000
  • Citgroup informs US Bancorp of the increase and asks them to increase Charlie’s Cement’s balance by $10,000 in turn
  • US Bancorp now knows that it has $10,000 extra credit on its account with Citigroup and can happily agree to the request to increase Charlie’s Cement’s balance accordingly

This is what’s known as corresponding banking as it relies on the major banks making corresponding arrangements to allow their respective customers’ funds to flow quickly and easily between them.

More Banks, More Problems

As you can see, that example is still pretty simple when you break it down to its basic stages. This is all well and good if the banks have a direct relationship with each other, but what happens if they don’t? In our example above, Citigroup would need to route the payment through another bank that both they and US Bancorp had a relationship with. In some cases, a fourth or even fifth bank might be needed to route the money from its original source to its intended recipient.

Moving Money Internationally

Moving Money Internationally

Still, even with intermediary banks involved, making domestic transfers – even between different banks – is a relatively straightforward process. With huge amounts of assets shifting between the accounts of national banks every day, it needs to be. When it comes to the matter of sending money abroad, that’s when things get a little more complex – and costly.

Let’s return to Sunshine Construction, our fictional US-based firm. Sunshine wants to expand into Spain and has its eye on some real estate property that it wants to buy and then develop. The asking price from the owning company Future Holdings is 9 million Euros.

Now, the principles of liabilities that we’ve established in our previous example still holds true, it’s just that there are a few more complications involved. Many major banks have similarly direct working relationships with banks in different countries; they hold accounts with each other to facilitate quick transfers of their customers’ funds and those that don’t use intermediary banks to bridge the gap if necessary. However, online international payments are a lengthier and more costly affair than domestic ones as the banks involved are likely to charge handling fees dependent on the financial regulations that their country’s government imposes on them. In addition, there’s the currency exchange rate to consider, where a commission of anywhere from two to five percent could be levied by the banks involved.

Fortunately, the process has been made much simpler as today the majority of international banks utilise SWIFT (Society for Worldwide Interbank Financial Telecommunication) which enables them to send and receive financial transaction information in a standardised, secure and reliable environment. SWIFT has now more than 10,000 members worldwide (in more than 200 countries) and handles more than 15 million electronic instructions every day. However, SWIFT is not without its drawbacks either, as there is a charge for using its services which the banks take out of the money being transferred. Often this process is opaque, as what you send might not necessarily be what the other party receives. This means that SWIFT is ideal for large transactions but when a business needs to make multiple transfers of smaller amounts on a daily basis then a more economic alternative is needed.

So in the deal between Sunshine and Future Holdings, it would look like this:

  • Sunshine informs Citigroup to transfer 9 million Euro to Future Holdings, who bank with Banco de Valencia.
  • Citigroup and Banco de Valencia don’t hold accounts with each other, so they use Spain’s central bank, Banco de España to facilitate the transfer. After calculating exchange rate commission, handling and administration fees for all banks involved (which Sunshine had previously agreed to cover as part of the property deal) Citigroup reduces Sunshine’s account balance by just over $12.5 million.
  • Citigroup uses SWIFT to send Banco de Valencia a request to increase Future Holdings account balance by 9 million Euros which is routed through Banco de España who simultaneously reduce Citigroup’s account balance and increase Banco de Valencia’s accordingly, once all transfer fees have been taken into account.

Sending Money Faster, Further, more Safely

So whether you’re sending your friend £50 or organising an international property investment involving millions of pounds, the convenience of modern digital banking means that there are mechanics in place to get your money from point A to point B with the minimum of delay and fuss.

However, the more complicated your transfer is, either the waiting time or the cost of the transaction (sometimes both) will subsequently increase. Even in this modern age of convenience, routing funds across the world can still be time consuming, costly and confusing. Fortunately, the increasing sophistication of automated payment platforms provides a viable alternative