Gross settlement refers to the transfer of funds (or securities) on an individual order basis, where transactions are settled one by one, without bundling or netting with any other transaction. In other words, every transaction is considered as a standalone and settled separately.
This is the opposite of net settlement, where multiple transactions are bundled together and only the net balance is settled.
A key example of a gross settlement system is the Real-Time Gross Settlement (RTGS) system used by banks in many countries for high-value, time-critical money transfers. As the name suggests, in RTGS, transactions are processed in real-time (i.e., immediately), and on a gross basis (i.e., individually, without netting against other transactions). This reduces the risk of a transaction failing due to insufficient funds, as each transaction is settled individually as soon as it’s processed.
Example of Gross Settlement
Let’s look at an example using the Real-Time Gross Settlement (RTGS) system, which is a common application of gross settlement in banking.
Suppose Bank A needs to transfer $1 million to Bank B, and Bank B needs to transfer $500,000 to Bank A. If these transactions were being processed on a net settlement basis, they would be bundled together, and only the net difference of $500,000 would be transferred from Bank A to Bank B.
However, in a gross settlement system like RTGS, these transactions are handled individually and immediately:
- First, Bank A transfers $1 million to Bank B. This transaction is processed and settled separately in real-time.
- Then, Bank B transfers $500,000 to Bank A. This is also processed and settled separately in real-time.
So, even though the net effect is the same in this example (Bank A ends up transferring $500,000 to Bank B), the difference is that each transaction is processed and settled individually in a gross settlement system. This decreases the settlement risk, as each transaction is completed in real-time without relying on the completion of any other transactions.