Chapter 11 Assessing Systemic Liquidity Infrastructure ling key features of central b markets- iency and effec 11 2000).Key features of financial market infrastructure and financial policy operations that affect liquidity management include the following: Design and operation of payment systems and securities settlement systems Design of monetary policy instruments and procedures for money and exchange markets operations .Public debt and foreign exchange reserves m gement strategies and operations. of money,exhange,an markets Those infras ary and fiscal the efficient functior ncial markets the soundness of fi ancia the broader systemic stability isa key focu of assessing systemic liquidity infrastructure.Another equally important consideration is to examine the extent to which limitations on the availability of infrastructure pose a constraint on the development of money and securities markets and on sound and profit- able operations of financial institutions.The remainder of this chapter highlights the key issues to consider in assessing the above-listed infrastructure elements. 11.1 Payment and Securities Settlement Systems The role and types of payment systems and securities settlement systems,key principles the sound operations of these systems,and the methodoloy for and practices to vance of these principles are discussed below. 289
289 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 Systemic liquidity infrastructure refers to a set of institutional and operational arrangements—including key features of central bank operations and of money and securities markets—that have a first-order effect on market liquidity and on the efficiency and effectiveness of liquidity management by financial firms (see Dziobek, Hobbs, and Marston 2000). Key features of financial market infrastructure and financial policy operations that affect liquidity management include the following: • Design and operation of payment systems and securities settlement systems • Design of monetary policy instruments and procedures for money and exchange markets operations • Public debt and foreign exchange reserves management strategies and operations. • Microstructure of money, exchange, and securities markets Those infrastructure elements are important for the effective implementation of monetary and fiscal policy, but their effect on the efficient functioning of financial markets, the soundness of financial institutions, and the broader systemic stability is a key focus of assessing systemic liquidity infrastructure. Another equally important consideration is to examine the extent to which limitations on the availability of infrastructure pose a constraint on the development of money and securities markets and on sound and profitable operations of financial institutions. The remainder of this chapter highlights the key issues to consider in assessing the above-listed infrastructure elements. 11.1 Payment and Securities Settlement Systems The role and types of payment systems and securities settlement systems, key principles and practices to govern the sound operations of these systems, and the methodology for assessing the observance of these principles are discussed below. Chapter 11 Assessing Systemic Liquidity Infrastructure
Financial Sector Assessment a Handbook 11.1.1 Payment Systems sysrems discused.1)playan in the f the maintaining a financial stability,and the fa broad international consensus has developed on the need to strengthen those systems by promoting internationally accepted standards and practices for their design and opera- tion.This section briefly reviews the Core Principles for Systemically Important Payment Systems(CPSIPS)developed by the Committee on Payment and Settlement Systems (CPSS 2001)of the central banks of the Group of 10 countries,the systems and issue they cover,and the way they can be Payment systems are characterized by a set of rules,procedures,and mechanism for transferring money between two or more financial institutions and their customer The principal mechanisms in a payment system are (a)the payment instruments,(b) the network arrangements for communication between the participants and the system provider,and (c)the facilities for clearing and for settlement operated by the system provider.Payment instruments can vary from a simple written order on paper to very mplex electronic dev ces in y schemes.In modern systems,the of pape ments is practically elimina ed.To promot effici ncy ar d toreduce the cycle,payment orders are sent electronically through an interati communicati network like SWIFT or through a proprietary network that is specifically constructed for the relevant payment system.Also,Internet technology is used for communications that 11 entail,in addition to payment orders,information exchange on statements of accounts. lists of settled payments,queued payments,and so forth.The facilities for clearing and settlement can vary considerably in complexity,depending on the way the settlement takes place the ay ailability of que euing mechar sms,the liq uidity man ageme nt and credit acilities,the links tooth payment systems ands itie systems,ands However,in countries with very low amounts of inter-bank payments,clearing and settle ment are sometimes done manually Payment systems can be divided into (a)large-value systems that are used for inter bank payments,financial market transactions,and execution of monetary policy,and (b)systems for the clearing and settlement of retail payments.Large-value payment sys. tems are mostly characterized by a relatively low volume of payment orders,whereas the s settled are ofren huge oOn an al hasis the ver in a large-value systen a multiple of the gr mestic product t(GDP)in t ntry developed markets up to 100 times or more of GDI In retai payment it is the othe way around.The number of transactions(volumes)is huge,while,normally,the turnover (value)is modest.The separation of large-value and retail payment flows is not always clear-cut,and often in developing countries the same system is used for both inter-bank and retail payments,especially when checks are the main instrument used to transfer monev. Systems can settle on (a)a net basis,in which case an agreed bilateral or multilateral offsetting of pos ns or obligat ns by participants takes place,or (b)instruction-by instruction (gross)basis.In a multilateral netting system,a participant's net credit pos tion(the amount to receive)or net debit position(the amount to pay)is calculated as the 290
290 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 11.1.1 Payment Systems Payment systems (and securities settlement systems discussed in section 11.1.2) play an essential role in the functioning of financial markets, the maintaining and promoting of financial stability, and the facilitating of economic development. In the past decade, a broad international consensus has developed on the need to strengthen those systems by promoting internationally accepted standards and practices for their design and operation. This section briefly reviews the Core Principles for Systemically Important Payment Systems (CPSIPS) developed by the Committee on Payment and Settlement Systems (CPSS 2001) of the central banks of the Group of 10 countries, the systems and issues they cover, and the way they can be assessed. Payment systems are characterized by a set of rules, procedures, and mechanisms for transferring money between two or more financial institutions and their customers. The principal mechanisms in a payment system are (a) the payment instruments, (b) the network arrangements for communication between the participants and the system provider, and (c) the facilities for clearing and for settlement operated by the system provider. Payment instruments can vary from a simple written order on paper to very complex electronic devices in e-money schemes. In modern systems, the use of paper documents is practically eliminated. To promote efficiency and to reduce the settlement cycle, payment orders are sent electronically through an international communication network like SWIFT or through a proprietary network that is specifically constructed for the relevant payment system. Also, Internet technology is used for communications that entail, in addition to payment orders, information exchange on statements of accounts, lists of settled payments, queued payments, and so forth. The facilities for clearing and settlement can vary considerably in complexity, depending on the way the settlement takes place, the availability of queuing mechanisms, the liquidity management and credit facilities, the links to other payment systems and securities settlement systems, and so on. However, in countries with very low amounts of inter-bank payments, clearing and settlement are sometimes done manually. Payment systems can be divided into (a) large-value systems that are used for interbank payments, financial market transactions, and execution of monetary policy, and (b) systems for the clearing and settlement of retail payments. Large-value payment systems are mostly characterized by a relatively low volume of payment orders, whereas the amounts settled are often huge. On an annual basis, the turnover in a large-value system can be a multiple of the gross domestic product (GDP) in the country—in some highly developed markets up to 100 times or more of GDP. In retail payments, it is the other way around. The number of transactions (volumes) is huge, while, normally, the turnover (value) is modest. The separation of large-value and retail payment flows is not always clear-cut, and often in developing countries the same system is used for both inter-bank and retail payments, especially when checks are the main instrument used to transfer money. Systems can settle on (a) a net basis, in which case an agreed bilateral or multilateral offsetting of positions or obligations by participants takes place, or (b) instruction-byinstruction (gross) basis. In a multilateral netting system, a participant’s net credit position (the amount to receive) or net debit position (the amount to pay) is calculated as the
sum of the value of all payment transfers it has received during a certain period of time less the value of all transfers it has sent to all other participants in the system.Netting reduces the amount of liquidity needed to settle the payment flows between participants substantially.However,the underlying payments will be settled with finality if,and only if,all participants with a net debit position are able to fulfill their obligations to pay at the end of the settlement cycle.If there are no adequate safeguards in the form of liquidity and loss-sharing arrangements,the netting result has to be unwound,deleting some or all pro uidity pre res to ot er partic nay,in extreme cases,re significant and unpredictable system Such potential s con quences migh lead tostrong pressure on bank tointerveneand tobail out the participan involved.In a gross settlement system,the unwinding risk does not exist.In a Real-Time Gross Settlement(RTGS)system,payments are processed on an individual basis as they arrive during the day and are settled with finality in real time whenever the participant has a sufficient balance in its account with the settlement bank.If the participant has insufficient funds,the payment is queued and settled later with the proceeds of incoming nt,participants have to manage their payment flows heir a en intraday liquidity from the ank or by borrowing funds in the inter-bank money marke The e intraday finality in an RTGS system means that the receiver can immediately use the funds for settling its own obligation.Intraday finality reduces risk and facilitates: .Urgent inter-bank payments 11 The settlement of intraday and overnight credit transactions with the central bank-for instance,fine tuning operations.(Because those operations are most often collateralized,an effective link with a securities settlement system should be in place to ensure delivery versus payment [DVP]on a gross basis.) 。The settl。nent of m actions The delivery of cash colla Payment versu paymen (PVP)in cross-border arrangements.(For instanc settled at the same time as the corresponding transaction in another currency to avoid the settlement risk when the payment of one part of the currency transaction is delayed [due to time zone differences].) In the past decade,hybrid systems have been developed and have combined elements of RTGS systems and netting systems.A hybrid system is most often an RTGS system intended for each othe in their individual tem,if no part have ffic ent fun their accounts to sette the individual qu ents is no throughput.Hybrid systems,however,will have procedures in plad er to settle the queued payments(or part of them)on a bilateral netting basis.Within thi framework,the system tries to identify groups of payments that can be settled simultane- ously,most often on a bilateral basis but sometimes on a multilateral basis.The procedures enhance throughput in the system substantially. 397
291 Chapter 11: Assessing Systemic Liquidity Infrastructure 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 sum of the value of all payment transfers it has received during a certain period of time, less the value of all transfers it has sent to all other participants in the system. Netting reduces the amount of liquidity needed to settle the payment flows between participants substantially. However, the underlying payments will be settled with finality if, and only if, all participants with a net debit position are able to fulfill their obligations to pay at the end of the settlement cycle. If there are no adequate safeguards in the form of liquidity and loss-sharing arrangements, the netting result has to be unwound, deleting some or all provisional transfers that the participant is unable to settle. Such a procedure has the effect of transmitting liquidity pressures to other participants and may, in extreme cases, result in significant and unpredictable systemic risk. Such potential systemic consequences might lead to strong pressure on the central bank to intervene and to bail out the participant involved. In a gross settlement system, the unwinding risk does not exist. In a Real-Time Gross Settlement (RTGS) system, payments are processed on an individual basis as they arrive during the day and are settled with finality in real time whenever the participant has a sufficient balance in its account with the settlement bank. If the participant has insufficient funds, the payment is queued and settled later with the proceeds of incoming payments. In a real-time environment, participants have to manage their payment flows and balances in their accounts actively and can influence the throughput by obtaining intraday liquidity from the central bank or by borrowing funds in the inter-bank money market. The intraday finality in an RTGS system means that the receiver can immediately use the funds for settling its own obligation. Intraday finality reduces risk and facilitates: • Urgent inter-bank payments • The settlement of intraday and overnight credit transactions with the central bank—for instance, fine tuning operations. (Because those operations are most often collateralized, an effective link with a securities settlement system should be in place to ensure delivery versus payment [DVP] on a gross basis.) • The settlement of money market transactions • The delivery of cash collateral • Payment versus payment (PVP) in cross-border arrangements. (For instance, to ensure that in foreign exchange transactions, the payment in one currency will be settled at the same time as the corresponding transaction in another currency to avoid the settlement risk when the payment of one part of the currency transaction is delayed [due to time zone differences].) In the past decade, hybrid systems have been developed and have combined elements of RTGS systems and netting systems. A hybrid system is most often an RTGS system with special bilateral and multilateral netting facilities. Participants may have payments intended for each other in their individual queues. In an RTGS system, if no participants have sufficient funds in their accounts to settle the individual queued payments, there is no throughput. Hybrid systems, however, will have procedures in place that will try to settle the queued payments (or part of them) on a bilateral netting basis. Within this framework, the system tries to identify groups of payments that can be settled simultaneously, most often on a bilateral basis but sometimes on a multilateral basis. The procedures enhance throughput in the system substantially
Financial Sector Assessment a Handbook RT的2 Ithcm the de In some nts,one netting and atio netting system nes,reta payments ar cleared and settled on a netting basis.A retail system can be dedicated to the settlemen of a specific instrument such as checks or card payments.In such a situation,there might be two or more retail payment systems in a country,each operating on a netting basis and completed by an RTGS. There are often links between the main payment system of the central bank and the so-called ancillary systems,most often netting schemes for large-value or retail payments operated by the pr tosettle in ce tral bank money.Furthermore,the ntral bank is ms :ide the central ba nates principal th risk that ofiet ot eiveayetoher tar th buyer will make a payment but will not receive delivery. The more links that are established,the greater the risk of contagion.An operational failure-or any other problem-in one system can prevent the timely settlement of a transaction-the delivery of cash of securities-in another system,thus spreading the problem across markets,and perhaps countries,and potentially magnifying its scale and Good descriptions of ities infras cture in tionalSedlcnecnt ntries can be found in publ ne (Red Books)and the Europear Cenra Bank (Books),which provide mation.Als 11 within the framework of payments initiatives of the World Bank in different regions, descriptions of the infrastructure,legal background,and regulation or oversight in a spe cific country in that region are published periodically(Yellow Books for countries in Latin America and the Caribbean,and Green Books for countries in southern Africa). 11.1.I.I Relevance to structural Develotment and stability Considerations The availability of an effective set of non-cash payment instruments and a well-designed are essential for the develop ent of the economy.Non-cash p ruments nhance the effic iency in the economy by reducing the Cost of kin reducing risks payment systems support the development and functioning of sophis ticated financial markets. The systems are also the channel for the implementation of monetary policy and liquidity management of commercial banks.With the development of financial markets.the call increases for a more-sophisticated payment and securities settlement infrastructure that relies fully on electronic payments,intraday finality,DVP. and PVP. y。ec roblems easily lead to and domin the failure of agio nstitution tom t it other participants or financial instituti Well-deiged paymen ffectand preve pllovers ther partici pants or systems.Weaknesses in the design and operational reliability of a payment system 292
292 Financial Sector Assessment: A Handbook 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 In some countries, two parallel systems exist for large-value payments, one netting and one RTGS system. In such a situation, the outcome of the clearing process in the netting system is settled in the RTGS system. In almost all countries, retail payments are cleared and settled on a netting basis. A retail system can be dedicated to the settlement of a specific instrument such as checks or card payments. In such a situation, there might be two or more retail payment systems in a country, each operating on a netting basis and completed by an RTGS.1 There are often links between the main payment system of the central bank and the so-called ancillary systems, most often netting schemes for large-value or retail payments operated by the private sector to settle in central bank money. Furthermore, the payment system of the central bank is often linked to securities settlement systems inside or outside the central bank to ensure DVP. DVP eliminates principal risk—the risk that the seller of securities will deliver the securities but will not receive a payment, or the risk that the buyer will make a payment but will not receive delivery. The more links that are established, the greater the risk of contagion. An operational failure—or any other problem—in one system can prevent the timely settlement of a transaction—the delivery of cash of securities—in another system, thus spreading the problem across markets, and perhaps countries, and potentially magnifying its scale and effect. Good descriptions of payment and securities infrastructure in specific countries can be found in publications of the Bank for International Settlements (Red Books) and the European Central Bank (Blue Books), which also provide statistical information.2 Also within the framework of payments initiatives of the World Bank in different regions, descriptions of the infrastructure, legal background, and regulation or oversight in a specific country in that region are published periodically (Yellow Books for countries in Latin America and the Caribbean, and Green Books for countries in southern Africa).3 11.1.1.1 Relevance to Structural Development and Stability Considerations The availability of an effective set of non-cash payment instruments and a well-designed payment system are essential for the development of the economy. Non-cash payment instruments can enhance the efficiency in the economy by reducing the cost of making payments and reducing risks. Large-value payment systems support the development and functioning of sophisticated financial markets. The systems are also the channel for the implementation of monetary policy and liquidity management of commercial banks. With the development of financial markets, the call increases for a more-sophisticated payment and securities settlement infrastructure that relies fully on electronic payments, intraday finality, DVP, and PVP. The payment infrastructure is one of the first places where financial stress from credit and liquidity problems manifests itself. Liquidity problems can easily lead to contagion and domino effects, where the failure of one institution to meet its required obligations causes other participants or financial institutions to be unable to fulfill their obligations. Well-designed payment systems contain the effects and prevent spillovers to other participants or systems. Weaknesses in the design and operational reliability of a payment system
Chapter 11:Assessing Systemic Liquidity Infrastncture may expose the financial system to systemic risk,impair the effectiveness of monetary policy instruments,and jeopardize effective liquidity management by banks.Thus,an assessment of the soundness,safety,and efficiency of payment systems is a crucial element of any assessment of stability and financial sector development. 11.1.1.2 The CPSS Core Principles The CPSS has defined 10 core principles and 4central bank responsibilities with respect to payment systems.The core principles are intended to apply to a wide range of circum stances and types of systems.and can be considered as universal guidelines to encourage the design and operation of a safe and efficient payment infrastructure.The core prin ciples cover (a)legal issues,(b)effective risk ma ment,(c)electronic data proce (EDP)audit aspects,(d)efficiency and level playing field,and (e)goverance,and are summarized in box 11.1. The core principles apply to any system whose role in the economy is so critical that it is regarded as a systemically important payment system(SIPS).A system is regarded as systemically important if it(a)is the system in the country or the Box 11.1 Summary of the CPSS Core Principles Legal Foundation VI.Assers used for settl should preferably b 11 Risk Management I.The system's rules and procedures should enable arrangements for timely comple Efficiency and Level Playing Field pavm ng the ens ng the timelycom of daily Governance of the Payment System X.The system's governance arrangements should be effective,accountable,and transparent. 293
293 Chapter 11: Assessing Systemic Liquidity Infrastructure 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 may expose the financial system to systemic risk, impair the effectiveness of monetary policy instruments, and jeopardize effective liquidity management by banks. Thus, an assessment of the soundness, safety, and efficiency of payment systems is a crucial element of any assessment of stability and financial sector development. 11.1.1.2 The CPSS Core Principles The CPSS has defined 10 core principles and 4 central bank responsibilities with respect to payment systems. The core principles are intended to apply to a wide range of circumstances and types of systems, and can be considered as universal guidelines to encourage the design and operation of a safe and efficient payment infrastructure. The core principles cover (a) legal issues, (b) effective risk management, (c) electronic data processing (EDP) audit aspects, (d) efficiency and level playing field, and (e) governance, and are summarized in box 11.1. The core principles apply to any system whose role in the economy is so critical that it is regarded as a systemically important payment system (SIPS). A system is regarded as systemically important if it (a) is the only payment system in the country or the principal system of aggregate value of payments, (b) handles mainly payments of high individual Box 11.1 Summary of the CPSS Core Principles Legal Foundation I. The system should have a well-founded legal basis under all jurisdictions. Risk Management II. The system’s rules and procedures should enable participants to have a clear understanding of the system’s effect on each of the financial risks that they incur through participation in it. III. The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks. IV.* The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day. V.* A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation. VI. Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk and little or no liquidity risk. Security and Operational Reliability, plus Contingency Arrangements VII. The system should ensure a high degree of security and operational reliability, and should have contingency arrangements for timely completion of daily processing. Efficiency and Level Playing Field VIII.The system should provide a means of making payments that is practical for its users and efficient for the economy. IX. The system should have objective and publicly disclosed criteria for participation, which permit fair and open access. Governance of the Payment System X. The system’s governance arrangements should be effective, accountable, and transparent. * Systems should seek to exceed the minimum in those core principles. Source: CPSS (2001)