Cheque clearing

A clearing house is a financial institution organized by banks to exchange checks (English "cheques") and payments. It should not be confused with central counterparty clearing (CCP) which also provides clearing services, but very differently by taking on the settlement risks of the counterparties (member banks and broker-dealers).

Clearing houses were formed to facilitate transactions among banks. Imagine a city with ten banks. Clients of each bank deposit checks daily drawn on any of the ten banks. Those drawn on the same bank as the depositor are easily processed. But checks drawn on the other banks need to be presented to each bank in order to receive payments. All ten banks might have messengers taking checks to the others, and waiting for payment. That would be long and cumbersome. Clearing houses solve this problem.

With the development of cheques in England in the 1600s it was customary to return the cheque to the issuing bank for payment. However, as cheque usage grew some customers would deposit a cheque with their own bank who would arrange for it to be returned to the issuing bank for payment.

Until around 1770 an informal exchange of cheques took place between London banks. Clerks of each bank visited all of the other banks to exchange cheques, whilst keeping a tally of balances between them until they settled with each other. Daily cheque clearings began around 1770 when the bank clerks met at the Five Bells, a tavern in Lombard Street in the City of London, to exchange all their cheques in one place and settle the balances in cash. The first organization for clearing cheques was the "Bankers' Clearing House," established in London in the early 19th century. It was founded by Lubbock's Bank on Lombard Street in a single room where clerks for London banks met each day to exchange cheques and settle accounts. In 1832 Charles Babbage, who was a friend of a founder of the Clearing House, published a book on mass production, The Economy of Machinery and Manufactures, in which Babbage described how the Clearing House operated:

Beginning at 5 pm, a clerk for each debtor bank was called to go to a rostrum to pay in cash to the Inspector of the Clearing House the amount their bank owed to other banks on that day. After all of the debtor clerks had paid the Inspector, each clerk for the banks that were owed money went to the rostrum to collect the money owed to their bank. The total cash paid by the debtor banks equaled the total cash collected by the creditor banks. On the rare occasions when the total paid did not equal the total collected, other clerks working for the Inspector would examine the paper trail of documents so that the numerical errors could be found and corrected.

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