Upvoted by Ohad Samet. 2.5 years in Paypal's risk management t…
This is a pretty wide open question. Will try to answer as much as I can. I've included more visual versus text, as visuals can very easily get the point across, in a few minutes. Should you wish to explore further, I have provided some relevant links for further reading.
First of all, the definition. When discussing payment systems, it is so easy to have different understanding of what a payment system is.
WHAT IS A PAYMENT SYSTEM?
a payment system consists of a set of instruments. banking
procedures and, typically, interbank funds transfer systems that
ensure the circulation of money
Glossary definition from the Committee on Payment and Settlement Systems (BIS - Bank of International Settlements). See glossary at: http://www.bis.org/publ/c pss00b.pdf (March 2003)
In its basic form a payment ecosystem has this very important singular relationship, without which a payment cannot be made:
The whole concept of a "payment" is to exchange money between two parties, so hence the Payer and Payee concept.
*Barring Bitcoin. regulated money (which is what 99.999+% of us use) requires a bank. It is not necessarily that a bank is required to move money, but a Bank is at the core, for example in Cash-to-Cash transaction, whilst a bank is not involved, a Bank was the source of the cash and could very well be the destination of cash as well (if) and when it gets deposited.
The definition of a Payment System can be visualized as follows:
The Payment Instrument section above can be expanded as:
Central to all this is the Bank, and how the bank interacts with various entities would be explained below. First, you have to understand with whom a commercial bank can interact with:
The above essentially represents the eco-system in which a commercial (non-investment bank) is operating in. The ovals in purple, represents the various verticals a bank can choose to associate themselves with and work in/with.
A slightly wider view of the same would be:
Credit: Above visuals are extracted from the presentation "An Introduction of Payment Systems " by Dyah N.K. Makhijani, Bank Indonesia. Source: http://www.bi.go.id/NR/rd onlyres.
As far as Banks are concerned, there are many types of banks, below is a pictorial representation of the different types of banks:
PAYMENT SYSTEMS LAYER (REGULATORY)
cases, a payment's ecosystem has a hierarchy of how the central bank is, then commercial banks, the payments layers and companies that work with the payments layer (as one of the examples, here is how a payments system hierarchy looks like for startups in a particular model that I was trying to demonstrate):
The concept shown in the above diagram in a rudimentary form was to show that in most cases, Startups work with a Payment Service Provider who work with Banks, who are regulated by the Central Banks .
THE FINANCIAL SWITCH ECOSYSTEM
The Switch in the Payment's Ecosystem is extremely important, it is what allows for a lot of the connectivity and transactions routing/communication to go through.
Below is an example what the transaction set of a unified switch would look like. Not every transaction set shown below has to be on the switch, this is just a unified example, it all depends from switch to switch and operators/usage of that switch.
BANK TO BANK (SETTLEMENT OF FUNDS)
One thing that confuses people a lot is how is the bank to bank settlement done?
To better understand how money is actually transferred between banks and different countries, you would most likely want to read up on this: Faisal Khan's answer to How does money transfer between banks and different countries work?
WIRE TRANSFERS - HOW DO THEY WORK?
From a wire transfer point of view, what exactly happens when a Wire Transfer is made, please read this answer: Faisal Khan's answer to What exactly happens when a wire transfer is made?
Even more important is to understand what exactly happens when a remittance transfer is made? What are all the steps involved in a money-transfer transaction: Faisal Khan's answer to How does a remittance money transfer work? What are all the steps and who is involved?
Because PayPal will so frequently be cited as an example, many people need to learn up as to what exactly PayPal is and how does money loading/off-loading on a PayPal wallet actually work?
To understand how it all works, here is a detailed answer on how PayPal works: Faisal Khan's answer to What is a Paypal account?
WHAT HAPPENS WHEN YOU CHARGE YOUR CARD?
From a merchant's POV, the payments ecosystem processing looks something like this:
In a process flow, it would look something like this: