Current Legal Issues Affecting Central Banks, Volume V
Chapter

Foreword to Chapters 4 and 5

Author(s):
Robert Effros
Published Date:
May 1998
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Author(s)
THOMAS C. BAXTER, JR.

Three basic themes interest central banks and their counsel: (i) monetary policy, (ii) banks and bank supervision, and (iii) the payment system. The third theme is the focus of Chapters 4 and 5. The payment system can be analogized to the circulatory system of an organism, the life blood that keeps the world’s economic organism healthy and operating. If this analogy is correct, a loss of confidence in the payment system may cause other destructive effects in the world’s economy. Such effects might include a breakdown in commerce, a cessation in commercial transactions, or an economic stagnation that would be of great concern to central banks and central bank counsel.

Public confidence in a payment system may wane if there is uncertainty about the risk of loss in particular transactions and who bears that risk. One way to ensure that public confidence in the payment system remains strong is to develop clear legal rules. Clarity in legal rules makes it easier for participants and central banks to evaluate, control, and, most importantly, limit the risks in various payments transactions.

When focusing on ways to minimize risk in the payment system, it is also important to consider the impact of globalization and technological advances. Business today is increasingly being transacted internationally. As business crosses national borders, so do the payments that are associated with such business. Cross-border payments involve, of course, the interaction between different legal systems and different currencies, thereby complicating the legal issues of interest to central bankers.

Along with globalization, technological advances also affect the way banks do business. Improvements in technology have increased access to information, thus enabling market participants to better understand credit risk. Technological advances also make it easier to transfer large sums quickly. Consequently, central bankers must think about the risks these advances may pose to the banking system. No longer is a “run on a bank” simply people queuing up in teller lines asking for their deposits back. Today, a far more serious threat exists. A “silent run” on a bank could occur by electronic transfers of money that quickly drain funds from a bank.

Globalization and technological advances play important parts in netting and foreign exchange settlement risk and electronic cross-border transactions, the topics of Chapters 4 and 5. These chapters assess the various risks involved in these transactions and analyze how different countries’ legal systems affect these risks. The chapters demonstrate that a lack of clarity in legal rules makes it very difficult to evaluate, control, and, most important, limit the risk in these various payment transactions.

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