Current Legal Issues Affecting Central Banks, Volume V

Afterword to Chapters 6 and 7

Robert Effros
Published Date:
May 1998
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The two preceding chapters focused on matters concerning payment systems. It is clear from them that payment system processes and issues are detailed and complex. In order to provide certainty as to how the issues that arise in these systems will be resolved, the law applicable to a system may also need to be detailed and complex. For low-value payments, the need for this certainty may be relatively low, and the development of a complex legal framework to support the arrangement may not be justified. However, as payment values grow, either in terms of the size of individual payments or in terms of the aggregate size of the payments, the case for a detailed legal framework for the payments becomes stronger.

As the need for the law crystallizes, it becomes necessary to consider how that framework might be supplied. Two broad sources are apparent—public law and private law. In this context, public law means governmental statutes or regulations, and private law means private agreements, whether in the form of individual agreements between the parties, clearinghouse rules, or the like.

Public law has the advantages of certainty, stability, and convenience. Statutes and regulations can be developed, and their character may afford a relatively high degree of assurance that they will be enforced by the courts. Furthermore, statutes and regulations can be applied to all interested parties in a transaction, even though they may not have entered into agreements covering all aspects of the transaction. Thus, the conduct of business under public law may be simpler than under private law because the step of obtaining agreements from all interested parties can be bypassed. On the other hand, public law can be relatively inflexible—preventing or discouraging innovation or experimentation that does not fit its precise standards.

Private law offers the advantage of greater flexibility than public law. This flexibility facilitates innovation and experimentation in the development of payment systems because individual systems can tailor their legal rules to their needs by means of agreements. However, the private law approach has disadvantages because agreements may have to be obtained between the parties, and initially, judicial willingness to enforce at least some portion of the agreements may be in doubt.

Generally, the use of public law for defining the rights of participants in payment systems is most appropriate where the procedures and practices with respect to that payment system are well established. In these circumstances, the public law serves to codify existing practices, thereby obviating the need for specific agreements. In these circumstances, public law can also serve to correct problems that have developed, which the private markets have been unable to rectify. The check collection system in the United States and the application of the Uniform Commercial Code to that system is a good example of the codification of the rules of an established system, although the area of truncation has many of the characteristics of an emerging system. Various consumer protection statutes in the United States, such as the Truth in Lending Act1 and Truth in Savings Act,2 are examples of a felt need to rectify problems in established markets through public law.

For newer payment systems, reliance on private law may be more appropriate. In these circumstances, procedures and practices may be fluid rather than well established. In addition, the volume of payments that will ultimately be involved in new systems is usually unclear. Reliance on private law will allow the maximum possible innovation and experimentation in developing procedures and risk allocations that are best suited to new systems. Reliance on private law will entail costs to the developers of the system in terms of the need to obtain appropriate agreements. Indeed, the desire to avoid these costs may cause system developers to advocate the adoption of public law. However, reliance on private law has the advantage of avoiding the public costs of developing laws that may have limited applicability if the system does not attain wide acceptance. The current status of e-cash in the United States is a good example of an emerging payment system that might well be handled most effectively through private law.

Finally, central banks must always be cognizant of an additional factor in formulating their views as to whether public law or private law is most appropriate in particular circumstances. This factor is consideration of systemic risk. Where it is apparent that a payment system is, or will rapidly become, so large that a disruption in its activities may have unacceptable systemic consequences to the payment system and even beyond it, central bankers will want to be confident that legal problems will not be a significant factor in contributing to those consequences. In certain cases, the greater certainty of public law, as well as other public policy considerations potentially including the appropriate allocation of risk, will weigh in favor of public law for systems that otherwise may present unacceptable levels of systemic risk.

In sum, careful consideration should be given to how a legal framework for payment systems is established. Central bankers should resist the temptation to codify arrangements too early. While codification may reduce visible problems such as litigation, it often has less visible effects and costs, such as discouraging or limiting desirable innovation and development.

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