Chapter

6 Payments System Reform

Author(s):
International Monetary Fund
Published Date:
May 1997
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Author(s)
Jean-Marc Destresse and Nicholas Roberts 

Most transition countries are undertaking far-reaching reforms of their payments systems both to resolve urgent problems and to underpin development of efficient and stable systems for the medium term. Measures were initially adopted to minimize fraud and operational risks and to streamline processing and delivery of payments documents, relying on readily available automation and communications technology. These reforms improved the speed, predictability, and security of payments, helped to reduce the size and variability of float in the central bank balance sheet, and thereby facilitated management and interpretation of monetary aggregates.

At the same time, medium-term reforms to support the development of money, banking, and capital markets were being designed and implemented to varying degrees in most transition countries. These reforms have strived to use modern telecommunications to centralize accounting, develop large-value payments systems, support regional and other specialized clearing arrangements, and adopt strong financial risk management frameworks, modern security procedures, and an appropriate legal framework.

Recent Experience with Payment Reform

The reform process has, by necessity, been multifaceted, including, inter alia, determining the strategy and role of the central bank in the reform process, developing a system of cooperation and coordination among the participants, preparing legal, regulatory, and organizational rules, and determining the appropriate instruments and systems to implement.

Status of Reform

Progress in payments system reform has varied markedly. Some have made considerable advances toward developing modern, efficient payments systems; others have strengthened the efficiency of their present systems, while they are in the process of designing and implementing major reforms. Still others have urgent problems to address in the current system and have not yet developed plans for significant structural changes to their payments systems for the medium term. For all countries, reforms are being slowed by the difficulty of developing a sound legal framework, problems of banking soundness, and, to varying degrees, inadequacies in transportation and telecommunications systems.

An important step toward developing sound payments systems and encouraging growth in money markets is for the central bank to adopt policies on settlement that encourage efficient liquidity and risk management by banks. Most countries have implemented policies that impose some constraint on commercial banks’ access to overdraft credit at settlement (Table 14). However, while some are charging for credit, they have no effective mechanism for restricting access to the credit. Thus, most of the countries are still prepared to allow overdrafts, but charge penalty rates to encourage alternative funding.

Table 14.Features of Payments System
Central Bank Settlement Services and PolicyDistribution of Settlement AccountsClearing TimesLarge-Value Transfer SystemsSecurity Transfer Systems
ArmeniaAn electronic large-value transfer system (LVTS) is planned. Telecom upgrade a prerequisite.A personal computer-based book entry system for treasury bills is in operation.
AzerbaijanTransactions that would overdraw a settlement account are rejected. Information on settlement positions is made available promptly.One account per bank per region.Delays and variable.No plans at this stage.No firm plans at this stage.
BelarusThe central bank is authorized to reject transactions that would result in overdrafts. In practice overdrafts are given, but at a high penalty rate. Information on current account positions is provided five times a day. Settlement is same day.Commercial banks have one central settlement account.Interbank clearing is quick and predictable. There are delays before funds are released to customers.Technical specifications for an LVTS have been drafted. The proposed system will be electronic and process gross payments. Decisions on risk control features and access to liquidity are pending.There is a planned book-entry system that supports delivery versus payment.
EstoniaSettlement is end of day after interbank trading of funds. Any potential overdrafts at settlement are avoided by the central bank rejecting payments to the amount of the potential overdraft.Banks have one central settlement account.Clearing is generally prompt. Customers may experience delays if the central bank rejects payments. In this case banks are required to carry our the payment order within 2 days.The central bank is planning an LVTS.
GeorgiaThe central bank does not give automatic overdrafts. Settlement is end of day. Banks receive information on account positions to facilitate liquidity management.Banks have one central settlement account.Clearing times are not quick or predictable.An LVTS based on real-time gross settlement is planned. It will be nationwide and run by the central bank.There is no book-entry securities transfer system
KazakstanThe central bank does not allow overdrafts, and payments may be rejected. Information to help liquidity management is promptly available in the capital but not nationwide.Commercial banks have a settlement account at each branch of the central bank. There is a project to centralize accounts.Clearing times for payments within the capital are quick and predictable. Overall the picture is mixed.A real-time gross settlement system is planned. Initially it will operate in the capital only.A book-entry system for transfers of treasury bills exists and will be linked to the proposed real-time gross settlement system.
Kyrgyz RepublicThere are no automatic overdrafts. Banks are required to access funds in the interbank market or use Lombard facility. Banks are provided with information on account positions promptly.Banks have one central settlement account.Clearing times are not quick and predictable.There is a paper-based system for processing large-value payments in the capital.A book-entry system for transfer of securities is operating.
LatviaNo automatic overdrafts are given.Banks have one central settlement account.Clearing times are quick and predictable.A book-entry system for transfer of securities is operating.
LithuaniaNo automatic overdrafts are given. Settlement is same day, and banks are given information on account positions promptly.Banks have one central settlement account.Clearing times are quick and predictable.A national electronic real-time gross settlement is operating.A book-entry transfer system is in operation. It is linked to the real-time gross settlement system.
MoldovaNo automatic overdrafts are given.Banks have one central settlement account.Clearing times are quick and predictable.Real-time gross settlement is planned.A book-entry system for transfer of securities is operating.
RussiaOverdrafts are no longer allowed. A Lombard facility has been started.Commercial banks hold settlement accounts with each branch of the central bank. Commercial banks are developing systems to monitor their account balances nationally to improve liquidity management.Processing is done within 24 hours within cities; longer and variable otherwise.Plans for a system are being finalized.A book-entry security transfer system is in operation. Links to a real-time gross settlement system are being explained. The current system supports delivery versus payment, but funds used in payment are not available for use by recipients until next day. Moreover, trading is prefunded.
TajikistanInformation on account positions is not available to banks to allow efficient liquidity management.Commercial banks hold settlement accounts with the central bank branches in each region. No rationalization is planned.Clearing times are not quick and predictable.There has been some discussion of an LVTS, but plans are not firm.A book-entry transfer system has been discussed.
TurkmenistanAutomatic overdrafts are given without penalty. Information on account positions is not available to banks to allow efficient liquidity management.Commercial banks have a single national settlement account.Clearing times are not quick and predictable.There are plans for an electronic national system to carry LVTS.There is a book-entry system for treasury bills
UkraineNo automatic overdrafts are given. Any access to credit is at penal rates. Information is available to allow banks to manage their liquidity positions within day.Some banks have centralized their settlement accounts, but not all.Clearing times are reasonably quick and predictable.LVTS are carried on an electronic system. The system is not a specialized high-value system.There is a book-entry system that is linked to the electronic payment system.
UzbekistanNo automatic overdrafts are given. Banks receive information on account positions to allow efficient liquidity management.Commercial banks hold settlement accounts with each regional branch of the central bank.Clearing times are quick and predictable.LVTS are carried on an electronic system. The system is not a specialized high-value system.There are no book-entry transfer systems.

To assist with liquidity management, six of the transition countries have completely centralized their settlement account structures, while others are planning further centralization (Kazakstan, Ukraine). In Russia, the commercial banks are developing systems to monitor their account balances nationally so that liquidity can be effectively managed without disturbing prevailing central bank arrangements for decentralized processing of payments. Centralization of accounts improves the commercial banks’ ability to manage liquidity and, if associated with a streamlining in the processing of payments, is helpful in reducing float.

Float is largely determined by the speed with which instruments are cleared; reforms in the payments area that improve the efficiency of clearing arrangements help to reduce float and increase the predictability of monetary aggregates. Float continues to complicate the implementation of monetary policy in most of the transition countries, although in some, the introduction of computer systems and electronic processing have effected significant improvements. Clearing times are still long and unpredictable in more than half the countries, while Belarus, Estonia, Lithuania, Ukraine, and Uzbekistan clear payments promptly and without delay.

While speed is the main factor affecting float, it is only one dimension of total payments system performance; others are security and cost-effectiveness. In a cost-effective system, the relative prices of payment services, including those provided by the central bank, reflect their relative costs. Central bank payment services should be priced so as not to hinder the development of alternative private arrangements.

Security, both operational and financial, requires that adequate risk control measures, consistent with international best practice, be in place for all payments systems (large-value transfer systems, clearinghouses, and so forth). A common approach to risk control in modern economies is to apply different requirements to the clearing and settlement circuits for high- and low-value payments. The more stringent and usually more costly measures are reserved for the systems supporting the massive values of payments transacted in capital and foreign exchange markets. Because of their key role in the financial system, large-value transfer systems (LVTS) dedicated to large value, time-critical payments, are an essential component of a modern payments system. By providing fast, efficient, and secure processing, specialized LVTS facilitate the implementation of monetary policy through development of efficient interbank money and exchange markets. The trend among industrial countries has been for the LVTS to be a real-time gross settlement system (RTGS) operated by the central bank. Because transactions are done on a real-time gross basis, there are larger demands on banks’ settlement funds than in the netting systems that the new systems are displacing. To compensate, most of these systems provide sophisticated queue management facilities or allow access to intraday loans from the central bank with the loans secured against collateral, or both.

None of the transition countries is yet operating a specialized LVTS, but some are operating electronic systems that carry the bulk of their high-value payments, notably Belarus, Kazakstan, Ukraine, and Uzbekistan. Generally, though, the bulk of countries are quite well advanced in their plans for LVTS. As can be seen from Table 14, only one country has no plans at this stage for an LVTS (Azerbaijan), while the rest are at various stages of planning LVTS systems. Only Kazakstan, Lithuania, Moldova, and Russia have committed themselves to follow the trend in industrial countries of embracing a real-time gross settlement system as the basis for their LVTS; other countries have yet to make decisions on the critical risk control features of their proposed systems.

For low-value systems, most modern economies support clearinghouse arrangements using batch processing with multilateral netting arrangements. Because these systems economize on liquidity and because the technical requirements of the systems are less onerous, they offer banks a low-cost method of processing payments. Risk control measures in these systems (control of membership, clear legal agreement exposure, limits, loss sharing, and collateral arrangements) are, appropriately, usually less stringent than in the high-value systems at the core of the financial system. Only a few of the transition countries have yet developed clearinghouses based on netting. As payments activity grows, the flexibility and different risk and cost trade-offs available through developing specialized systems will become increasingly apparent.

Whatever mix of risk controls is chosen for particular payments systems, an important requirement for all systems that carry significant values is that settlement should be across the books of the central bank. If banks settle clearinghouse obligations across correspondent accounts held in the private sector, the failure of the settlement bank will disrupt the clearinghouse and put other participants under financial stress. Because of the potential systemic risks arising from large correspondent account positions, the central bank will need to decide whether participants in clearing arrangements should be allowed to offer correspondent accounts arrangements to other banks, including those that could not qualify for membership of the clearinghouse in their own right. If such correspondent account arrangements are permitted, then these should be subject to prudential scrutiny by the central bank to determine the extent and acceptability of the risks involved. This prudential scrutiny is particularly important when risk controls are tightened in clearinghouse or LVTS systems as private arrangements may arise to circumvent the new controls.

A further area where payments system reform offers important support to development of market-based arrangements for policy implementation is in developing book-entry systems for securities that link delivery of securities to payment. Several countries have book-entry systems, but these are mostly small systems that are not linked to payments systems that support delivery of securities to payment. Kazakstan is operating a book-entry system and is planning to link this to its proposed LVTS. In Russia, a book-entry system is operating that does support delivery of securities to payment, but limits market liquidity because of next-day settlement of the payment, and the requirement to redeposit funds before beginning securities transactions (both in primary and secondary markets).

Institutional and Legal Framework

In most transition countries, the banking sector is weak, and commercial banks have taken few initiatives in payments reform. The central bank has typically had to lead the reform agenda. However, the need for coordination and cooperation—either among banks or between banks and the central bank—to establish new payments systems is well understood. Central banks are fostering coordination and cooperation by pushing the development of cooperative bodies such as payment councils, which now operate in all the transition countries except Azerbaijan, Russia, Tajikistan, and Turkmenistan.

Weaknesses in the legal framework persist and frustrate reforms. A particular problem in countries that have introduced electronic clearing systems is that the benefits of electronic clearing can be lost because customers cannot access funds cleared through the system before paper confirmations of the transactions have been processed. These kinds of problems will increasingly come to the fore as electronic LVTS and security transfer systems are developed.

Uncertainties about transactors’ rights and obligations, and their enforcement, also reduce confidence in payment instruments and limit growth in payment services, particularly in the household sector. To reduce these uncertainties, the authorities should encourage development of laws, regulations, or codes of practice. Users including government departments responsible for transfer payments, enterprises (particularly those involved in retail activities), and representatives of consumer interests could usefully be represented on payment councils to help develop these.

Uncertainty about the enforceability of agreements or the absence of appropriate bankruptcy laws limits the options for designing safe payments systems. For example, in netting systems, the netting agreement must be recognized in law so when a participant fails, all other participants are only bound to pay their net obligations to the system and do not run the risk of being required to pay gross obligations to the failed participant.

Priorities for Reform

All transition countries have far to go in developing payments systems that exhibit all the desirable characteristics of a modern system, although it is now clear that substantial and reasonably rapid progress is possible. The differing rates of progress give some clues about what helps and hinders the reform process, as well as indications about how best to approach reform.

The basic precondition for reform is that the central bank, or other implementing agency, recognizes the need for reform, identifies the objectives of reform, and develops a strategic plan. The problem then becomes one of implementation, where progress depends on the commitment, power, and influence of the implementing agency, as well as the size of the task at hand.

Priority must also be given to risk management. At the most basic level, a payments system will not be used unless it is reasonably secure from default and fraud. More important, with a weak banking system, sound risk management policies are critical to countering systemic risk. If there is a strong perception by banks that the central bank will be forced to bail the banks out in the event of a crisis, the central bank may be forced to underwrite excessive risk taking by banks.

Where poor risk management leads to failures, central banks may react by easing monetary policy even where this compromises achievement of monetary targets set to support broader economic strategies. Thus, central banks must try to ensure that adequate risk management rules and procedures are present in all payments systems, whether under the control of the central bank or not. As a minimum, all payments systems should settle across the books of the central bank, and for large value payments, this will ideally be through a real-time gross settlement system, that is, on a payment-by-payment basis.

A further reform priority is to develop, upgrade, and enforce the legal and regulatory framework for clearing and settlement arrangements and for new payment instruments, particularly to support sound risk management practices.

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