Payment Systems in Global Perspective

Maxwell J. Fry

• Publisher: Routledge
• Year: 1999
• ISBN:
  9781134621569
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book provides an authoritative overview of the complex practical and policy implications of international payments systems by central bankers from both developed and developing countries, Payments Systems in Global Perspective presents the results of a survey of international central bank practice conducted by the Bank of England.

Chapter 1
Introduction

INFORMATION ON PAYMENTS ARRANGEMENTS in transitional and developing countries is both scarce and not generally available in a form suitable for comparative analysis.¹ So in January 1998, the Bank of England asked central banks in a sample of countries, hereafter referred to as the BoE group, to complete a questionnaire both to supplement published information and to supply comparative data for analytical purposes.² The questionnaire responses provide new statistical and institutional information that we report and analyse in this study, from central bankers’ perspectives, of selected aspects of payment systems in industrial, transitional and developing countries. As we did not choose the 70 respondent countries listed in Table 1.1 at random, they are not necessarily representative. We chose them because members of their central banks attended conferences on payment systems at the Bank for International Settlements in December 1997 or at the Bank of England in January 1998 or were invited to the Bank of England's Central Bank Governors’ Symposium in June 1998.

No two central banks in the world are identical. There is a wide range of functions carried out by central banks in different countries and each central bank undertakes a different set of activities from the full list. But there are clear common themes. Central banks are typically the monetary authority. They are usually involved in financial stability issues and, in various ways, in payment system matters.

Table 1.1. The Bank if England Group

Industrial	Transitional	Developing
Australia	Armenia	Bahrain
Austria	Belarus	Barbados
Belgium	Bulgaria	Bermuda
Canada	China	Botswana
Finland	Czech Republic	Brazil
France	Hungary	Colombia
Germany	Latvia	Cyprus
Greece	Poland	Eastern Caribbean
Hong Kong	Russia	Egypt
Iceland	Slovak Republic	Fiji
Italy	Slovenia	Guyana
Netherlands	Tanzania	Jordan
New Zealand	Vietnam	Kenya
Norway		Korea
Portugal		Kuwait
Singapore		Lebanon
Spain		Malawi
Sweden		Malaysia
Switzerland		Malta
United Kingdom		Mauritius
United States		Mexico
		Morocco
		Mozambique
		Namibia
		Nigeria
		Pakistan
		Peru
		Saudi Arabia
		South Africa
		Swaziland
		Tonga
		Turkey
		Uganda
		United Arab Emirates
		Zambia
		Zimbabwe

This book describes the variety of ways in which central banks are involved in payment systems, and this introductory chapter seeks both to explain why central banks are involved and to provide some form of framework as an introduction to the analysis. It does so by describing the central banks’ objectives and then looking at the range of risks that can arise in payment systems. It discusses some of the choices that are faced in payment system design and then moves on to describe the environment in which those choices are made. It outlines some of the choices that have been made by considering recent trends in payment and settlement systems and concludes by discussing the process by which central banks can try to achieve their objectives for payment systems.

1.1
Central Bank Objectives

Most central bank activities can be considered under the heading of monetary stability or financial stability. Indeed, the Bank of England finds this distinction sufficiently useful to have organised the institution on that basis, with the Bank's new constitution reinforcing this distinction by providing a separate Deputy Governor for each of these two aspects of the Bank's responsibilities. When the decision to organise the Bank in this way was taken, each of the activities had to be grouped into one part of the Bank or the other. The area that caused most difficulties in determining its location was that dealing with payment systems. And the reason for the difficulty lies in the fact that the objectives and interests of payment systems fall clearly under both the financial and monetary stability headings.

On the monetary stability side there is an obvious need for a mechanism to carry out monetary operations in support of monetary policy. Without an efficient payment system, it is extremely difficult to ensure that monetary policy is implemented effectively. In addition, both government and the public expect the payment infrastructure to work and expect central banks to be expert on these issues. Payment systems are a key part of the infrastructure supporting economic activity. Without an efficient method of exchanging payment, commercial activity would be severely constrained.

On the financial stability side the concern is that problems in individual financial institutions may well first be manifested in the payment system. The payment system can then transmit this instability from one institution to another. Good payment system design can contain these effects but bad payment system design can exacerbate them. So central banks have an interest in payment system design to reduce the risk of a domino effect, i.e., one bank failure causing other failures.

In emerging economies the issues of ensuring an efficient mechanism for supporting economic activity and enabling monetary policy operations to be carried out may be paramount. In more developed countries, however, the reliability of payment systems is typically taken for granted; the issues which dominate tend to be those of reducing risk, particularly in sophisticated financial markets. For this reason, the Bank of England decided to locate work on payment and settlement policy in the financial stability wing but with a clear instruction that policy makers in this area should work closely with colleagues on the operational side located in the monetary stability area.

Central banks’ objectives for payment systems, under both the monetary and financial stability headings, may be summarised as reducing risk and promoting efficiency in payment systems. Risk reduction is paramount, but the promotion of efficiency is a complementary goal. Efficiency has many dimensions that broadly can be encapsulated by cost, speed and robustness. Robustness encompasses both the reliability of the service and the certainty of its effects, which may depend on the clarity of the rules or the precision of the relevant legal framework. It is perhaps obvious that efficiency is a desirable objective in its own right but, in addition, it may well be necessary to achieve the risk reduction objective. Typically, users have a choice about whether or not they use particular systems. There is no point developing a very safe system if nobody is prepared to use it. So the risk reduction and efficiency objectives have to be pursued in parallel but recognising that, while market participants may have an equal interest in the promotion of efficiency, they may not have as strong an interest in risk reduction if the private and social risks are different. As a result, it is sometimes left to the central bank to highlight the risk reduction questions.

1.2
Risks in Payment Systems

There are many different types of risk raised by payment systems including legal, operational, security and various forms of economic risk. Legal risks are one aspect of the need for certainty about how the system operates. Participants need to know what happens in different circumstances. If a participant defaults, for example, what will be the impact on other participants? This is particularly important where a payment mechanism is part of a settlement system, e.g., for settling securities. Good design of a securities settlement system involves the synchronised exchange of title to the security with final funds. This is the principle of delivery versus payment (DVP). But it is a satisfactory mechanism only if there is little doubt that title has in fact moved when the funds move (and vice versa).

Operational risk is perhaps more obvious. It is the risk of system malfunction because of information technology or mechanical failure, which may include problems in the wider infrastructure, such as an unreliable electricity supply or failures in the national communications infrastructure. It is extremely difficult to have a reliable and safe payment system without an adequate legal framework and basic social infrastructure.

Security risks are perhaps also relatively apparent. They arise from fraud or other abuse of the systems. Payment systems must be designed in a way that ensures that users or operators cannot interfere with the integrity of the data being transmitted or the instruments being exchanged. There need to be adequate safeguards and audit trails.

Economic risks come in many different forms but can be divided broadly into credit and liquidity risks. Credit risks generally arise as a consequence of the failure of a participant. One form of credit risk is market risk, also known as replacement cost risk, which is larger the greater the gap between a contractual agreement to make a payment and the settlement of that obligation. For example, if a participant has entered into a foreign exchange or securities transaction with a counterparty, and the counterparty fails before fulfilling its side of the bargain, the price of the asset may have moved against the seller. The difference in price is the market risk. An even more important credit risk (in the sense of involving larger values) faced in payment and settlement systems is principal risk. That is the risk of losing the entire value of the payment. It may arise in a payment system that is insecure or in a settlement system where the exchange of payment for a security (or other counter-value) is not synchronised, or in a system which does not have adequa...

Table of contents

• Front Cover
• Title Page
• Copyright
• Contents
• List of Figures
• List of Tables
• Authors
• Foreword
• Acknowledgements
• Acronyms
• 1 Introduction
• 2 Payment Instruments
• 3 Payment Systems
• 4 Deferred Net Settlement versus Real-Term Gross Settlement for Large-Value Transfer Systems
• 5 Reserve Requirements, Liquidity and Risk
• 6 Central Bank Roles in Payment Systemsb
• 7 Some Links between Payment Systems, Monetary Policy, Fixed Exchange Rates and Financial Stability
• Appendix 1 Payment and Settlement Systems Questionnaire
• Appendix 2 Deferred Net Settlement Systems
• Appendix 3 Real-Time Gross Settlement Systems
• Appendix 4 Central Bank Risk Exposure
• Appendix 5 Central Bank Settlement Failure Guarantee
• Appendix 6 Payment System Development Strategies
• Appendix 7 Separate Accounts for Required Reserves
• Appendix 8 Reserve Maintenance Periods
• Appendix 9 Use of Required Reserves for Payment Purposes
• Appendix 10 Interest Paid on Reserves
• Appendix 11 Formal Central Bank Supervision of Payment Systems
• Appendix 12 Informal Central Bank Supervision of Payment Systems
• Appendix 13 Commercial Bank Involvement in Payment Systems
• Appendix 14 Exchange Rate Regimes and Monetary Policy
• Bibliography
• Index