According to the Bank for International Settlement’s Committee on Payment and Settlement Systems Glossary, clearing is ‘the establishment of final positions for settlement’.
However, the term is often used to include settlement, and there can be a variety of steps that take place as part of the clearing process.
Set-off is one possible component of clearing, whereby existing obligations (e.g. invoices) are partially discharged against each other, without creating any new ones. This means that there is no additional risk introduced.
When there are multiple parties involved, this procedure is known as ‘multilateral obligation set-off’, and amounts to detecting and cancelling out ‘loops’ of debts (circular patterns of payments due that connect businesses in a network). With many participants there will be many possible loops, and hence many possible ways of determining a set of final positions. Algorithms such as MTCS are therefore used to get the best results.
Multilateral obligation set-off can directly increase the resilience of your business in a number of ways:
- • Reduced cash flow volatility means lower working capital requirements, saving on bank loans and associated charges
- • Resolution of payment gridlocks (where a business can’t pay its suppliers because it hasn’t yet been paid) means lower late payment risk
- • More timely payments mean better relations with suppliers.
All of these impacts have been documented over the thirty years that multilateral obligation set-off has been in use in Slovenia. The overall effect is to insulate businesses from financial crises when they need it most.