V Payments Arrangements for Intraregional Trade
- Saleh Nsouli, John McLenaghan, and Klaus-Walter Riechel
- Published Date:
- August 1982
There are three principal modes of settlement of intraregional trade in the Community. The first involves essentially a clearing at the commercial banking level only, though foreign exchange must usually be obtained from the central bank. The second involves a bilateral clearing mechanism at the level of the central bank, while the financial transaction proper is carried out at the commercial banking level. The third mechanism involves a clearing of intraregional payments on a multilateral basis by the West African Clearing House, in which the central banks of all member countries of the Community, except Cape Verde, are participants. The characteristics and importance of these three modes of settlements are discussed below in more detail.
Apart from settlements made through official financial institutions, a significant number of settlements for trade transactions take place outside the official financial sector—in particular, unofficial and unrecorded border trade transactions, where settlement is made directly in cash. In some cases, however, border trade is of a barter nature and does not involve a financial transaction. Where payments and exchange transactions are necessary, they are frequently made in parallel markets either in a convertible currency or in the domestic currency that is the more convertible of the currencies of the two trading partners. The less convertible currency is also occasionally accepted, but at a substantial discount. Both illegal and legal border trade generally avoid clearing through official financial institutions, usually because of the unfamiliarity of small traders with the methods and requirements of the official financial system.
Clearing at the Level of Banks
Arrangements Among Central Banks
Within the Community two types of payments arrangements take place between central banks. The first involves bilateral payments agreements, such as the one between Cape Verde and Guinea-Bissau, under which all payments between the two countries are settled through clearing accounts maintained in the respective central banks. It should be noted, however, that in these two countries the central banks are also the only commercial banks. Special arrangements apply to oil imports from Nigeria by member countries. Most of these arrangements amount to an outright credit granted by the Central Bank of Nigeria to central banks of other member countries, usually on commercial terms. Only in a few cases does a direct clearing of oil payments against payments for other transactions take place. Settlement of net debits is usually made in convertible currencies.
Arrangements Among Commercial Banks
The most important mode of settlement of intraregional transactions is direct settlement at the commercial banking level. Two main types of arrangements can be distinguished. The first involves direct settlements between regional banks, for which banks in the region have established correspondent banking relationships with each other. When the volume of transactions is significant, banks may open for each other either clearing accounts or open accounts denominated in local currencies. In the former case, clearing takes place at regular intervals and balances are settled in convertible currencies; in the latter case, accounts are replenished as they reach a level considered too low for future payments. Replenishment of accounts involves the purchase of local currencies with convertible currencies.
The second type of arrangement for settlements of regional payments by commercial banks takes place through banks in major financial centers in Europe, notably London and Paris, and in the United States. Such settlements may involve up to four banks, two in the member countries of the Community and two in financial centers. In a sample transaction, the paying bank in a member country in the Community makes payment to a correspondent bank in Europe or the United States in foreign exchange acquired from the central bank or held in its account in the respective foreign correspondent bank. The second step involves the transfer in Europe or the United States of the payment by the foreign correspondent bank of the paying bank to a foreign correspondent bank of the receiving bank in a member country. On occasion, the correspondent banks are the same for the paying and the receiving bank in the two member countries involved in the transaction, in which case the transfer is effected within the first foreign correspondent bank by a simple debiting and crediting of accounts held within the bank. The final step is the transfer by the foreign correspondent bank of the payment to the receiving bank in a member country, its conversion into local currency, and the payment to the ultimate beneficiary.
Settlement through banks in Europe or the United States is still by far the most important mode of settlement for intraregional trade. This is particularly true for banks in the French-speaking member countries of the Community, which often use this mode even for payments occurring within the West African Monetary Union and denominated in CFA francs. There are a number of reasons for the preference of settlements through banks in Europe or the United States. It is generally claimed that this type of arrangement is the most efficient, both in terms of time elapsed before settlement and in terms of costs. Communications are said to be faster and more reliable between any member country of the Community and Europe or the United States than between regional countries. Waiting costs and possible exchange risks arising from delays in payments are thus reduced. Furthermore, costs arising from additional calls and cables in the case of poor or slow communications between member countries can be avoided.
More important cost differences between direct regional settlements and indirect international settlements arise in the context of a necessary accumulation of information about the partner bank and in connection with the execution of transactions. Before a correspondent banking relationship can be established between banks in member countries of the Community, a thorough examination of the financial position, reliability, and trustworthiness of the partner bank is necessary in order to establish the basis for such a relationship. This investigation involves relatively high information costs that banks are reluctant to incur, especially if the volume of transactions to be expected is low. In this case, it is more cost efficient for the banks to include the settlement of regional trade and payments in their general payments arrangements with correspondent banks in Europe and the United States, thereby benefiting from economies of scale in financial activities that reduce both information costs and transactions costs. Given the presently low level of regional trade, direct correspondent relationships between regional banks are, indeed, more often than not less cost efficient than indirect relationships with foreign banks. Only in a limited number of cases, where the level of trade between countries is important, or in cases where banks expect a reasonable level of payments to emerge in the near future, have correspondent banking relationships been established in the region.
Another factor that may impede the establishment of a direct clearing mechanism between regional commercial banks, especially if it involves the setting up of clearing accounts with each other, is that no forward cover is available for regional currencies while forward cover is common for all convertible currencies used in indirect clearing through correspondent banks in Europe and the United States.
A final aspect in favor of indirect settlements through foreign banks is the convenience of well-known procedures of payments mechanisms and the often personal knowledge of bankers “at the other end.” The language used also plays a role in transactions between countries with two different languages.
On balance then, most banks seem to prefer the indirect clearing of regional payments through correspondent banks in Europe and the United States, primarily because of its greater efficiency in cost and time and because of its greater convenience.
The West African Clearing House
General Features of the System
On March 14, 1975, the central banks of 12 West African countries16 signed in Lagos, Nigeria, the Articles of Agreement for the establishment of the West African Clearing House. The Clearing House was established on July 25, 1975 in Freetown, Sierra Leone, and its operations commenced on July 1, 1976. According to Article II, Section 2, of its Articles of Agreement, the objectives of the Clearing House are:
To promote the use of the currencies of the members of the Clearing House for Sub-Regional trade and other transactions.
To bring about economies in the use of foreign reserves of the members of the Clearing House.
To encourage the members of the Clearing House to liberalize trade among their respective countries.
To promote monetary co-operation and consultation among members of the Clearing House.
Article III states that all central banks and monetary authorities in the region can become members. In fact, since the inception of the Clearing House, three more countries—Guinea, Guinea-Bissau, and Mauritania—have joined the clearing agreement. This leaves Cape Verde as the only member country of the Community that is not also a participant in the Clearing House.
Articles VII and VIII of the Articles of Agreement of the Clearing House outline in more detail the method for achieving the general objectives of the clearing mechanism, especially those stated in subsections (a) and (b) of Article II, Section 2. Article VII makes reference to a common unit of account, parities, and exchange guarantees, and Article VIII addresses itself to credits, transactions, and exceptions in the clearing mechanism.
Given the large number of currencies of the membership of the Clearing House and the diversity of the exchange arrangements involved, a stable unit of account had to be introduced if the clearing system was to succeed in increasing the use of regional currencies in the settlement of intra-Community trade. The unit chosen for this purpose was the West African Unit of Account (WAUA), which is equivalent in value to one special drawing right (SDR) of the International Monetary Fund. Because of its composition, the WAUA has maintained relative stability since the inception of the Clearing House.
The choice of the WAUA as the unit of account necessitated the establishment on a daily basis of the rate of exchange for the currency of each member bank of the Clearing House in terms of the WAUA. This required, first, the determination of the central rate of each currency in terms of its intervention currency, and, second, a conversion rate for the currency in terms of the SDR by means of the intervention currency’s rate in terms of the SDR. In order to minimize fluctuations in rates used for clearing operations and in order to reduce the administrative burden and the costs of operations, two rate determination periods are distinguished in each month and only two official exchange rates are established for each currency. The first determination period covers the first to the fifteenth day of the month, and the second covers the sixteenth day to the end of the month. Within each determination period the average of the daily rates is calculated and is applied as the official rate to all settlements in the following determination period.
When exchange rates are fixed as average values over a past period and are applied to settlements in a future period, there is a possible exchange risk. This tends to favor countries in a net debtor position with other member countries of the Clearing House whenever the currencies of these debtor countries are devalued with respect to the WAUA. This problem was not addressed in either the Articles of Agreement or in the Rules and Regulations of the Clearing House. However, at a meeting of central bank governors in Banjul, The Gambia, early in 1980 an agreement was reached whereby at the time of a change in the official exchange rate of a country’s currency with respect to the country’s intervention currency by more than 2.5 per cent, the new rate of that currency in terms of the WAUA would apply immediately for transactions channeled through the Clearing House. The agreement became effective on May 1, 1980. Since it applies only to discrete changes in official exchange rates in terms of the intervention currency, the agreement does not cover possible important changes in the WAUA rate of currencies that may occur as a result of the floating of intervention currencies vis-à-vis the SDR or the WAUA. Thus, an exchange risk still remains, even if it is a small one.
In view of the establishment of an artificial unit of account, the smooth operation of the system depends on the guarantee by central banks of member countries of the Clearing House to convert their own currencies freely into the WAUA for all eligible transactions. Under the Clearing House agreement, all central banks of member countries of the Clearing House have accepted this obligation and have thereby largely eliminated the inconvertibility of regional currencies, at least for eligible transactions.
According to Article VIII, Section 3, of the Clearing House agreement, all current account transactions—that is, goods, services, income, and unrequited transfers—are eligible for clearing through the Clearing House, with the exception of (a) those specified by the Exchange and Clearing Committee,17 and (b) payments relating to trade in goods not originating in the territory of a member country—that is, goods from third countries.18 Furthermore, trade transactions between member countries of the West African Monetary Union and between Mali and the Union are exempted from the need to settle through the Clearing House. So far, payments for petroleum imports from Nigeria have also been settled outside the arrangements of the Clearing House.
Article VIII, Section 9, of the Clearing House agreement provides for a settlement of net credit and debit positions at the end of each month. The central banks of member countries are notified on a weekly basis of their current net position. A settlement before the normal settlement date at the end of each month takes place if the debtor position of any central bank exceeds the maximum credit level of 10 per cent of the average total value of trade (imports plus exports) with other member countries of the Clearing House over the three years preceding the year of the calculation. The net extension of credit by a creditor country is limited to 20 per cent of its total trade, as defined above. The limits can be exceeded if agreement is reached between the central banks involved in the net creditor/debtor relationship. Settlement of net balances takes place in convertible currencies agreed between the central banks concerned, mainly in U.S. dollars, pounds sterling, French francs, Swiss francs, and deutsche mark. Settlement of debts is to be effected within five working days after the receipt by the debtor bank of the notification of its position vis-à-vis creditor banks. However, with the agreement of the creditor bank, a debtor bank can delay the settlement of its debt, in which case it will have to pay interest at a rate determined by the Exchange and Clearing Committee.
The clearing of transactions channeled through the Clearing House takes place at three levels: the first is through the commercial banks, which deal with the original payor and the ultimate payee; the second is at the level of the central banks, which receive from and make payments to the commercial banks; and the third level is that of the Clearing House, which credits and debits the participating central banks in accordance with notifications from the central banks. The official clearing procedure distinguishes between settlements involving a payment order and those involving a letter of credit.
In the case of a payment order, the clearing procedure follows the steps below and the related Flow Chart 1:
A resident in an exporting country (called country A) sends goods or renders services to an importer in country B.
The importer in country B makes payment for the goods or services to his commercial bank in country B for transmission to the exporter.
The same importer in country B advises the exporter in country A that he has made payments to his commercial bank in country B for remittance to the exporter in country A. For other remittances that do not involve goods and services (for example, remittances for educational purposes), the payor also advises the beneficiary (payee).
The commercial bank in country B sends a transfer or payment order to the central bank in country B where the funds collected are deposited.
The central bank in country B advises the central bank in country A of the amount in WAUA to be paid through a designated commercial bank to the named beneficiary in country A.
The central bank in country B at the same time informs the West African Clearing House of the amount to be paid in WAUA to the central bank in country A.
The West African Clearing House debits the account of the central bank in country B and credits the account of the central bank in country A, advising accordingly.
The central bank in country A, on the advice of the central bank in country B, pays the commercial bank of the beneficiary in country A the amount that was received for the beneficiary in country A.
The commercial bank in country A pays the amount received to the beneficiary in country A.
Flow Chart 1.West African Clearing House: Clearing Procedure for All Payments Except Those Under Letters of Credit
In the case of a letter of credit, the clearing procedure follows the steps below and the related Flow Chart 2:
An exporter in country A (the exporting country) sends goods or renders services to an importer in country B (the importing country).
The exporter presents his documents to his commercial bank in country A.
If the documents are in order, the commercial bank in country A pays the exporter immediately.
The commercial bank in country A then forwards the documents to the commercial bank in country B that opened the credit, asking for a refund.
The commercial bank in country A at the same time advises the central bank in country A of the claim it is making on the commercial bank in country B in respect of payments made under the letter of credit.
At the request of the commercial bank in country B, the importer in country B pays the amount due for the goods or services received.
The commercial bank in country B, on receipt of payment from the importer, releases the documents in respect of the goods or services to the importer.
The commercial bank in country B pays to the central bank in country B the amount it has collected from the importer.
The central bank in country B advises the central bank in country A of the amount in WAUA it has received for the exporter in country A.
The central bank in country B at the same time advises the West African Clearing House of the amount it has received, requesting that its account be debited and the account of the central bank in country A be credited.
The West African Clearing Housé debits the account of the central bank of country B (the importing country) and credits the account of the central bank of country A (the exporting country), advising the central bank in country A of the amount credited.
The central bank in country A then pays to the commercial bank of the exporter the amount due for the goods or services exported to country B.
Flow Chart 2.West African Clearing House: Clearing Procedure for Payments Under Letters of Credit
Data on transactions through the Clearing House from the beginning of its operations in 1976 to the second half of 1978 show an upward but uneven trend (see Table 10). Since no reliable data on intra-Community trade during the periods covered by Table 10 were available, it was not possible to calculate the percentage of that trade channeled through the Clearing House. Indications are, however, that some countries, such as Ghana and Guinea, have channeled an increasing proportion of their payments for regional trade and transfers through the Clearing House, while others, notably the member countries of the West African Monetary Union, have shown a reluctance to do so. On balance, there has probably been a slight increase in the percentage of regional payments channeled through the Clearing House.
|Transactions channeled through the Clearing House||18.4||27.8||17.4||22.4||29.6|
|Line 1 adjusted for financial transfers||10.9||19.0||16.0||19.0||16.7|
|Line 3 as percentage of line 1||23||25||36||35||21|
|Line 3 as percentage of line 2||29||36||39||41||37|
Line 3 of Table 10 gives the amounts cleared—i.e., settlements of regional transactions that do not necessitate a transfer of foreign exchange (convertible currencies) from one central bank to another. These figures can be viewed as an indication of a reduced requirement for foreign exchange on the part of the participating central banks. Lines 4 and 5 show that, as a percentage of transactions, this reduction in foreign exchange needs varied substantially during 1976-78. Until mid-1978, there appears to have been no noticeable upward trend in the savings of foreign exchange reserves.
Problems of the Clearing System
Delays in payments have been the most frequently cited problem of the clearing mechanism of the West African Clearing House. Final settlements of payments may take as long as 4–6 months and, in some cases, even longer. On the basis of the clearing arrangements described above, delays can occur at any or all of the three levels of the clearing mechanism: the commercial bank level, the central bank level, and the level of the Clearing House.
Several factors have been identified as responsible for delays in settlements at the level of commercial banks. The first is the relative unfamiliarity of a great number of banks with the mechanics of the clearing system, notwithstanding the fact that the Clearing House has been in operation for a number of years. This unfamiliarity appears to reflect a relative lack of interest by banks in this new payments channel, due partly to the smooth working of other channels and partly to the low level of intra-Community trade, which makes such transactions a small proportion of the banks’ overall operations. A second cause of delay is said to be the relatively low priority given by many banks to transactions channeled, or to be channeled, through the Clearing House. An additional reason for delays is attributed to efforts by banks to accumulate transactions of the same type before acting on them. This leads to delays, in particular in situations where branches of banks handle the original transaction.
Delays in regional transactions may also occur in some central banks when there is a shortage of foreign exchange, especially if trade with other member countries of the Community is given a low priority in foreign exchange budgets or other formal or informal foreign exchange plans. As a result, transactions cleared through the Clearing House may have to wait their turn in these central banks.
At the level of the Clearing House, some central banks do not always receive promptly data on the applicable exchange rates of their currencies in terms of the WAUA. As a result, transactions are not processed until the confirmed rates are available. This problem is generally ascribed to difficulties in regional communications.
Delays in the clearing process also arise at other points besides those examined above and cannot be attributed to the financial institutions involved. Such delays are primarily due to the inadequate system of communications and postal services in the region. Telephone and telex contacts are said to be effected more rapidly and efficiently via Europe than directly between member countries of the Community. This is also the case, and perhaps even more so, for postal connections. As a result, shipment of documents related to regional trade and other payments is extremely slow.
Aside from problems directly related to the clearing mechanism that affect its speed and efficiency, the settlement period of one month is regarded by some observers as a problem of equal importance. Countries that normally tend to be in a debtor position with their partners in the Clearing House have suggested that the settlement period is too short and that the efficiency of the clearing mechanism would be enhanced by extending the settlement period. Such an extension would, of course, increase the net credit extended to debtor countries within the settlement period, which at present is provided without payment of interest.
By contrast, central banks that are commonly in a creditor position tend to argue that the current settlement period of one month is already too long and should be reduced to two weeks. Some of them also argue that interest should be payable on outstanding balances on a daily basis, thus eliminating the present arrangement whereby no interest is paid on balances accumulating within the settlement period. These proposals, in turn, are regarded as unacceptable by debtor countries.
Benin, The Gambia, Ghana, Ivory Coast, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone, Togo, and Upper Volta.
The Exchange and Clearing Committee of the Clearing House comprises at least two representatives of each member central bank and meets at least twice every year.
The Clearing House has no means of verifying the origin of goods for which payments are channeled through its clearing mechanism. It is reported that in trade between certain countries of the region most of the goods originate in third countries.