Weaknesses in the Payments System

For the vast majority of people in sub-Saharan African countries, cash is the only medium for making payments. With the exception of Botswana, Lesotho, South Africa, and Swaziland, cash constitutes a relatively high share of GDP and of broad money. Low denominations of circulating cash, reflecting a high velocity of circulation in the face of high inflation, make large transactions difficult and inconvenient because of the large number of notes involved. In some areas, there is a shortage of domestic currency, and foreign currencies are sometimes used as a means of payment (“dollarization”). In some areas, bankers resort to bargaining, which directly increases the cost of transactions.

Where significant noncash payments systems have been emerging, these too have exhibited a number of weaknesses. First, they are generally not separated into retail and large-value systems, and second, most of the noncash systems are paper based. The check is the most common paper instrument. While post office payment services exist in some of these countries (Botswana, for example), in the region as a whole these services have tended to decline even though the advantages of a comprehensive post office network can support the use of postal orders as an alternative to checks. Third, in some countries, the noncash payment system has been subject to significant dollarization.

Banks typically exchange checks and other paper at clearinghouses in major cities and centers each morning; centers often hold a second clearing in the afternoon, sometimes just for large-value checks. Members and the supervisor of the clearinghouse calculate and agree on the net multilateral settlement positions for each member, which are then settled across the members' current accounts (settlement accounts) at the central bank, generally once each business day. The sorting of checks is mostly manual, the coordination of clearings nationwide is poor, and the rules and procedures of the clearinghouses and the allocation of responsibilities for settlement, resolution of disputes, and enforcement of compliance are often vague. In many countries, there is the possibility for increased automation of clearings and for improvements to the rules and procedures that govern clearing operations and their settlement.

In major cities throughout South Africa and other sub-Saharan African countries, there are often automated or electronic payments systems operating. Some banks have automatic teller machines, issue credit and debit cards, provide direct debit and credit services, and offer electronic transfers of funds at the point of sale. However, an absence of interbank co-operation arrangements limits these services to in-house transactions between customers of the banks offering them, except in the case of major debit and credit cards where other banks in the same country also issue the same brand cards (for example, in Botswana and Mauritius). Development of interbank cooperation would considerably improve the payments services available to bank customers.

Some countries have local foreign exchange clearings in which members interchange foreign-denominated checks issued by local banks. The settlement agent is then often a reputable international bank (for example, in Tanzania in recent years) or sometimes the central bank, or correspondent banks abroad may settle various positions. Typically, central bank oversight of these arrangements has not been as thorough as is desirable because of an insufficient awareness of the risks associated with these arrangements.

Several countries that now issue government securities and have stock exchanges are introducing book-entry systems, which have already facilitated the settlement of the security leg of transactions. However, often there has been little progress in organizing the associated payment settlements to support standards, such as delivery versus payment.

Improvements to Noncash Payments System

In general, the multilateral netting clearing systems do not comply with the Lamfalussy standards (see Box 5) and therefore expose the central bank to significant systemic risks. The clearing system may have basic rules that are sometimes little more than expressions of clearing processes. This situation often leaves bank customers, bank members of the clearing system, and, in particular, the central bank financially exposed if there is a crisis or a bank failure. Solutions include the development of clearing rules that cover not just the technical processes of the clearing and exchange of paper, but also settlement processes and procedures to follow if a member fails to settle. In sum, netting systems should comply with the Lamfalussy standards, and this is a high priority for large-value systems.

In countries where manual clearings dominate, banks are slow to provide final funds to depositing customers. In some countries, interregional clearings can involve significant delays, which means that the period between the initial deposit of a check and the depositor's access to funds from the deposit can be unduly long—sometimes several weeks.21 The reasons for delays are many, including the legal requirement to present checks to the paying bank branch for payment. This requirement, combined with infrequent secure transport links between paying and collecting banks' branches, results in long delays. Other problems include high levels of fraud and other related criminal activity that increase the amount of processing and checking that banks do before they credit or debit an account, as well as built-in incentives, such as float, that discourage rapid clearing and finalization of payments.

The authorities should encourage banks to process, clear, settle, and transport checks more quickly. Central banks should also encourage commercial banks to automate their internal clearing procedures when the benefits outweigh the costs of doing so. Perhaps the largest gains will result from legal changes allowing the banks to “present” a payment instrument electronically to the paying bank. Such a change, when combined with the necessary infrastructure, can radically speed up the availability of funds to depositors, particularly in those areas where telecommunications are satisfactory. Further-more, enforced standards for checks, use of magnetic ink character recognition, and optical character recognition would allow automation of the processing and improve security in many payments systems. However, in many rural regions, the infrastructure is not developed or reliable enough, or the volumes are simply too small, to warrant investment in such processes. Thus, two systems may be required: manual in rural areas and automated in urban areas.

A lack of synchronization between accounting (posting) of final funds to the accounts of the payer, the paying bank, the receiving (collecting) bank, and the payees can result in float. For example, in manual check systems, it may take several days before a bank debits a payer's bank account for a check. Thus, the payer, who has initiated payment, retains the use of the funds for several days. Such a situation creates incentives to exploit the float and thus act in a way that will degrade the effectiveness of the payments system. Sometimes the arrangements benefit banks at the expense of bank customers, as in Zambia.

Float can also increase the difficulty of implementing monetary policy. In particular, if the central bank is the government's fiscal agent, the liquidity effects of the government's spending will be highly unpredictable, making liquidity management very difficult. But float may also affect monetary aggregates and credit aggregates that are used as indicators of the monetary policy stance.

Float may be decreased through a reduction of some of the operational delays and backlogs, which can often be achieved through better staffing, improved operational procedures, and better training of processing staff, or through the establishment of dedicated document delivery services to eliminate transportation delays where possible. Short of more fundamental reforms to speed up the payments process, several more partial solutions can be adopted to reduce float. Availability schedules, for example, may delay the credit for a check (or debit for a payment order) to a time equivalent to that in which the corresponding debit (credit) would normally be processed and posted. Another example is the provisional crediting of checks, where the value is credited to the payee's bank account, but the value cannot be withdrawn until the payment is finally settled. It may also be possible to discourage float through appropriate pricing, which will tend to offset the costs of float.²²

In a number of sub-Saharan African countries, fraud is a significant problem to the extent that it has undermined the use of the payments system in several countries. Fraud may include simple kiting schemes or can involve bank staff, forgers, and often clearing clerks. In designing measures to combat fraud, policymakers should avoid regulations and arrangements that may overburden the payments systems and slow the processing of transactions. In some countries, relatively simple improvement can be made to clearinghouse operations and to other procedures to improve security. The prevalence of fraud and forgery can also be decreased in many countries through actions that make it more difficult for forgers to alter checks or other bank paper. The introduction of secure check paper and secure printing can significantly improve matters, as can automated processing with automated verification procedures.

The legal systems in some countries also impede the development of noncash payments systems. They are slow, outdated, and often unpredictable in business and financial matters. Without improvements in the legal systems that will ensure financial discipline, it will be difficult to significantly improve the payments system. Legislation of insolvency, netting arrangements, and the authority of administrators and liquidators all need to be clarified and enforced. However, even countries in which the legal system operates satisfactorily may need to clarify the rules for electronic fund transfers so as to allow truncation, which will support the further development of the payments system.

Areas for Further Reform

The central bank should take the lead in reforming the payments system in all sub-Saharan African countries—a continuous and arduous process. First, the central bank is often legally committed to over-seeing the safety and efficiency of the payments system. Second, the other participants in the payments system, including users, banks, and other providers of payment services, will typically have vested interests—for instance, with regard to exploiting the float—and will thus not have the incentive to reform the system. Third, the central bank will typically bear the costs of an inefficient payments system, either by lower seigniorage or by assuming the risk of the system. A major first step to ensure continued improvement of the payments systems is to establish a national payments council, which should be headed by a high-ranking dynamic central banker. Several countries have now established a national payments council, among others, Malawi, South Africa, Zambia, and Zimbabwe.

A newly established payments council will typically have a two-pronged strategy: first, to identify and address immediate problems; and, second, to establish a strategy for the development of the payments system. The long-run strategy would include revising the legal framework to facilitate electronic payments, ensuring that multilateral netting systems comply with the Lamfalussy standards, and perhaps establishing a real-time gross settlement system for large and time-critical payments. A real-time gross settlement system and a linkage to the depository for government securities, which ideally should ensure delivery versus payment, are important elements of the infrastructure for a central bank to conduct quick and efficient open market operations. Further actions in this area are summarized in Box 6, page 39.