Frameworks for Monetary Stability
Chapter

24 Linkages Between Payments System Reforms and Monetary Policy: The Recent Experience in Russia and Other Former Soviet Union Countries

Editor(s):
Carlo Cottarelli, and Tomás Baliño
Published Date:
December 1994
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Author(s)
V. SUNDARARAJAN and GABRIEL SENSENBRENNER 

The experience of countries undertaking the transition from direct controls on credit and interest rates to indirect instruments of monetary management shows that effective implementation of this transition process requires many parallel and prior reforms in central banking and in the broader financial sector.1 In particular, successful transition is associated with, among other things, well-coordinated reforms of the monetary control system, consisting of:

  • (1) reforms of monetary policy instruments and operations, including information systems for policy design and implementation;

  • (2) reforms of institutional arrangements for money and interbank markets; and

  • (3) reforms of clearing and settlement systems for payments.

These reforms are technically interdependent and have to be pursued simultaneously, in a mutually reinforcing fashion.2 This interdependence derives from the fact that aspects of clearing and settlement systems—together with the characteristics of reserve requirements and refinance policies—affect the demand and supply of bank reserves, which are the ultimate means of noncash settlement for payments. At the same time, these reserves influence the nature of money markets, which are, among other things, a vehicle for obtaining and trading settlement balances. Similarly, the desired features of monetary operations and money markets could influence the design of payments system reforms.

In many economies in transition, significant reforms of clearing and settlement systems have been introduced early in the process of financial sector reform, in order to improve the reliability and security of payments as well as to ensure effective and smooth implementation of monetary policy through indirect instruments. The structure of the clearing and settlement systems inherited from the earlier monobank environment has been first adjusted to support the creation of a two-tier banking system by distinguishing between interbank and intrabank payments. In the course of making these adjustments, however, many aspects of the system have been re-examined from the perspective of both the ultimate users of the system and the needs of monetary policy. The traditional reliance on gross settlements using paper-based and manual clearing arrangements and a regulatory framework emphasizing control and account reconciliation have caused significant costs and risks, compromised the reliability and security of payments, and complicated the conduct of monetary policy. These problems have been tackled through several immediate reforms of the existing system with readily available technology in the short run, while redesigning the system based on modern telecommunications over the medium term. These reforms have had major consequences for the design and operation of monetary policy and for the evolving structure of money and interbank markets.

In most market economies, the effects of payments system changes on the money demand and money supply process and on the transmission mechanism of monetary policy are typically gradual and are often dwarfed by the impact of other financial sector reforms. However, the large onetime changes in the payments system arrangements in many economies in transition warrant close attention to the specific linkages between payments systems and monetary policy.

Against this background, some of the major analytical and operational linkages between payments system structure and monetary policy are first discussed. Next, the experience with payments system reforms in the former Soviet Union (FSU) is briefly reviewed from the perspective of these linkages. The case of the Russian Federation is then discussed in greater detail. The final part of the paper presents some concluding remarks. The Appendix contains the charts and tables referenced in the text.

Analytical and Operational Linkages

Initial Conditions: Monetary Effects of Payment System Float

In many transition economies, the large size and variability of a payment float have proven to be a bottleneck in the shift toward indirect money management. The term float refers to amounts that have been debited (credited) from a payor’s (payee’s) account before the corresponding credit (debit) entry has been posted in a payee’s (payor’s) account.3 It reflects the difference in the timing of crediting and debiting of accounts arising from delays in the transmission of payment information and in the subsequent execution of accounting entries. Large and variable lags between the time of crediting and debiting bank accounts with the central bank (bank float), or of customer accounts with banks (customer float), could arise from a lack of operating standards in the processing of payments, inadequate rules and regulations on clearing procedures and settlement methods, poor enforcement ability, and unreliability of systems used (e.g., postal services) for the transport and delivery of payment information.4

Both the size and variability of the float are major determinants of the demand for reserves (or demand for central bank overdrafts) and of the central bank’s ability to implement monetary policy by managing reserve money. These two dimensions of the float have mutually reinforcing effects. A volatile float makes it difficult to manage liquidity for both the central bank and commercial banks, while a large float entails a commensurate settlement risk for the parties involved that also tends to increase the demand for bank reserves at the central bank. The volatility of bank reserves is illustrated in Chart 1 of the Appendix for a sample of Moscow banks during June 1992.

If the bank float is quantitatively significant relative to bank reserves, its variability could be so large as to weaken control over the supply of bank reserves, complicating monetary management and hampering the development of the money and foreign exchange markets. For example, the debiting (crediting) of a bank settlement account before crediting (debiting) the receiving (sending) bank leads to a withdrawal (supply) of liquidity; variable lags in such debiting and crediting could result in large day-to-day variations in the size of reserves or of deposits, both in the aggregate and in individual banks. In the face of such large variability, the central bank cannot forecast reasonably well the supply of reserves in order to act on its own initiative.5 As a result, in order to fund payment obligations, commercial banks hold large levels of correspondent account balances6 in the central bank, or rely on sizable central bank accommodation, insofar as many central banks have allowed liberal overdraft access—even if at a penalty rate—as a buffer against large shocks to the supply of reserves. Moreover, the factors that cause a large and variable float also exacerbate risks in the payments system—discussed later—which could affect the supply of reserves if the central bank assumes part of such risks.7

Large shocks to the supply of reserves limit the scope of short-term liquidity management by the central bank, thereby influencing the choice of operating targets and the design of monetary policy instruments. Insofar as the authorities wish to target a reserve aggregate as part of a stabilization package, the specific choice of the aggregate could be influenced by the size and variability of the float. For example, the conventionally defined net domestic assets of the central bank—reserve money minus net foreign assets—may be subject to large variations owing to fluctuations in the interbank float, and this could affect the predictability and controllability of the variable and warrant a switch to an alternative operating target. In the presence of large shocks to the supply of reserves, currency plus required reserves or a measure of net-free reserves could be more predictable than the conventional net domestic assets. In general, the choice of an appropriate operating target will depend on the instrument mix used by the authorities and on the type of shocks affecting the monetary system, the latter influencing the degree of correlation between operating and intermediate targets. The behavior of the float could influence this correlation as well as the instrument mix (as discussed further below), thereby affecting the choice of an operating target.8

The design and mix of monetary policy instruments, particularly the design of borrowing facilities for commercial banks, such as a discount window, could be influenced by the need to counter the adverse consequences of a large and variable float on systemwide liquidity. Following the breakup of the Soviet Union, the practice in most FSU countries has been to offer only an overdraft facility at a high penalty rate, in addition to directed credits at a preannounced rate, thus making the use of central bank credit highly inflexible with respect to market conditions.9 This configuration is illustrated in Chart 2 of the Appendix, which shows in Panel 1 the current setup in a typical FSU country and in Panel 2 an alternative design of monetary instruments intended to address unexpected changes in float. In Panel 1, D is the downward-sloping demand curve for reserve money at the central bank, and S is the supply curve, with different segments reflecting the current setup of instruments.

OG is the supply of reserves not directly controlled by the central bank (e.g., credit to government, float, etc.); r is the preannounced finance rate charged by the central bank on directed credit. As market rates rise toward r, the use of directed credit increases by the amount GG1, and the additional directed credit G1R is made available at the finance rate r, also equal to the market rate. Further increases in central bank credit are possible only in the form of overdrafts available at double the finance rate. Therefore, at point A, there is discontinuity, represented by a vertical supply curve when the market rate ranges from r to 2r for a given supply of central bank reserves. In this instance, the market rate of interest is i0, given by the intersection of DD and SS.

Let us assume now a contractionary shock to the payments system, and therefore an unexpected increase in payment float (S shifts to S2). Because of the discontinuity in S2, the marginal cost of funds jumps from i0 to above 2r as the systemwide shortfall of reserves takes hold. A succession of contractionary and expansionary shocks that characterize FSU payments systems would result in large fluctuations in market interest rates (say, between r and 2r, and, in the extreme, market rates could exceed 2r). Even the best banks would be pushed into overdraft, as they cannot forecast the shocks to the payments system. As a result, payments of otherwise liquid customers may be blocked, depending on the stringency of overdraft access. The usual behavior would be for all banks to hold large amounts of excess reserves in order to avoid the penalty of overdraft financing. Under the circumstances, central banks are faced with the policy choice of letting interest rates fully reflect the shocks as in Panel 1 or accommodating part of the shocks through the refinance facility, in order to smooth out interest rate movements. Partial accommodation is often the preferred course of action because orderly price movements best promote market development. This can be achieved through redesigned central bank credit facilities that result in a more interest-elastic supply curve as shown in Panel 2.

In Panel 2, part of central bank credit (GG2) is made available at a fixed finance rate (as in Panel 1); the rest, however, is available only through credit auctions and Lombard credit, which rises with the increase in the market interest rate. As a result, the supply of reserves is more elastic and a leftward shift in the supply—due to payments system shock, for example—to S1S1 will increase the market interest rate from i0 to i1, in contrast to a large jump in the interest rate exceeding 2r as noted in Panel 1.

Using indirect market-oriented means of monetary control requires the central bank to have instruments that operate at its initiative, both to achieve its monetary targets and to foster active money and interbank markets. Therefore, the central bank will need to tighten over time the scope of its credit facilities at preannounced rates (including overdrafts), while increasing the scope of its market-based instruments for targeting bank reserves or a short-term interest rate. This will, in turn, promote the development of the money markets; the latter will facilitate further refinements in monetary and public debt operations and permit a smooth implementation of monetary and public debt management policy. These interactive and mutually reinforcing reforms in monetary operations and in money and government securities markets cannot be initiated if unpredictable, large variations in the float prevent effective liquidity management by both the central bank and commercial banks, as has been the case in many economies in transition.10 If banks are induced to hold large excess reserves as a buffer against the variability of reserves, this then clearly limits the demand for money market instruments, such as treasury and commercial bills. In any event, delays and uncertainties in the interbank transfer of funds would, by themselves, undermine active development of interbank markets, both in domestic instruments and in foreign exchange.

A large and highly variable bank float can also complicate the measurement and interpretation of monetary statistics. The float is typically recorded as one of the components of “other items net” in central bank and commercial bank balance sheets. The adjustment of monetary statistics for the amount of payment float poses many controversial questions. For example, it has been argued that items to be debited, such as checks in the process of collection, should be deducted twice from the gross sum of deposits—instead of subtracted only once as commonly done—in order to obtain a true measure of voluntary holdings of deposits.11 That is, insofar as both payor and payee regard the float as funds that are not available for transactions, check float should be subtracted once to avoid double counting (payor’s account has not been debited, but payee’s account has been credited following the deposit of the check) and a second time to recognize that payee typically has no access to the funds until the check is actually collected. Similarly, the knowledge of credit float—the amount to be credited—could influence perceived holdings of money and affect the relationship between measured money stock and nominal income.

Specific accounting procedures for payments in many transition economies also make it difficult to identify the payment float, or they grossly distort the size of central bank and commercial bank balance sheets. However, changes in accounting procedures to permit separate measurement of payment float, and to assess the factors influencing it, become highly important for monetary policy. Such measurement would help assess the extent of inefficiencies and risks in the payments system, and estimate and project the magnitude of changes in bank reserves that are due to changes in payments practices (reflecting both structural and seasonal factors).

The initial situation characterized by uncertain delays in clearing and settlements (settlement occurs as, and when, central bank funds are credited to the correspondent account of the payee’s bank) has often exacerbated inflationary pressures or complicated monetary management. Delays in the receipt of payments would sharply erode the real value of receipts under high inflation and increase the demand for credit by both the government and enterprises, similar to the effect of tax collection lags under inflationary conditions.12 In the absence of enforceable limits on payment lags, the lags in the processing of payments could respond endogenously to changes in inflation and credit conditions.13 An inflation-induced delay in execution of payments and the impact of a tightening of credit policies could together result in a payments system gridlock—payment delays or payment defaults by a few payors lead progressively to generalized default.14 This could create serious economic disruption and contribute to a sharp increase in interenterprise arrears, which, if monetized, could sharply ease the stance of monetary policy.

The float is also influenced by operational breakdowns in the payments system, which become more likely when the increase in the number of payments (due to a larger number of banks and the emergence of financial markets) puts pressure on existing processing arrangements. A buildup of backlogs in the processing of payments would raise the size of the float and affect the system’s liquidity. The resulting confusion in processing and verification of payments would create opportunity for fraud. Fraudulent payment transfers could profit from delays in verification and poorly designed security features and could result in major losses. Those losses are often borne by the central bank initially, until the affected financial institutions are liquidated or restructured and some of the losses are recovered.

Monetary Effects of Payments System Reforms

The preceding section discussed the potentially severe consequences on the financial system and on monetary policy of large and variable payment float. In the face of such difficulties, it is crucial to introduce very quickly both transitional and medium-term reforms in the payments system. Transitional reforms typically consist of measures based on readily available technology designed to reduce the size and variability of float by speeding up transportation of documents, modifying accounting practices, and standardizing operating procedures. Medium-term reforms based on modern telecommunications also need to be initiated as early as possible because of the long lead time. A major aspect of medium-term reforms of the payments system structure consists of the introduction of gross settlement arrangements for large-value transactions that require finality, a high degree of security, and immediate, same-day or value-dated settlements, as well as net settlement arrangements through clearinghouses for small payments.15 Alternatively, depending on the country size, volume of payment transactions and other initial conditions, a single gross or net system for all payments could suffice.16 Some monetary policy implications of payments system reforms are discussed below.

A large-value transfer system (LVTS) ensures secure, cost-effective, timely, and irrevocable transfer of central bank money among the accounts of the participating banks and thereby supports the interbank financial markets and the implementation of monetary policy. As such, these systems have become the backbone of efficient financial markets and have fostered technical efficiency, innovation, and integration of domestic and world financial markets. The resulting low-cost and secure arbitrage of funds between markets has enhanced the transmission of policy impulses from the central banks, and in tandem speeded up the transmission of shocks, such as bank failures, capital flows, or operational breakdowns, from market to market. In the context of the FSU, establishing at least a rudimentary LVTS can be viewed as essential for the development of integrated markets in foreign exchange, money, and government securities, and as providing the technical infrastructure for the effective implementation of monetary policy through indirect instruments.17 The specific design of interbank funds transfer and settlements in an LVTS—such as the choice between gross or net settlements—the specific interface of the settlement procedures with reserve requirements and refinance policies, and the operational connections between clearing systems and the LVTS together influence the demand and supply of bank reserves and the structure of money markets. The design of the LVTS would in turn be influenced by monetary policy considerations.

In the FSU, the initial structure of the payments system was one of gross settlements, but it was based on slow paper-based clearing procedures and lacked any explicit credit or guarantees to support settlement. As is well known, a gross settlement system without credit typically requires a larger amount of settlement balances than a net settlement system and can lead to gridlock in the face of insufficient settlement balances.

A net settlement system reduces those problems and also drastically reduces the volume of transactions that the central bank has to process. Provided commercial banks (by themselves or with central bank assistance) can set up an efficient clearing arrangement, a net settlement system can expedite the processing of transactions and reduce the float. However, it exposes participants to the risk that one member may be unable to settle after accumulating payables (in excess of receivables) in the interval between two settlements: the longer the interval, the greater this risk.

Settlement risk—either because of liquidity problems (liquidity risk) or because of solvency problems (credit risk)—if not properly contained and shared through appropriate risk management policies (discussed below), may result in a large provision of central bank credit in order to contain the spread of settlement failure from one participant to another (systemic risk).18 Such central bank intervention could result in an unplanned increase in the liquidity of the banking system. Similarly, provision of central bank credit to prevent or overcome a gridlock in a gross settlement system could also lead to unforeseen credit expansion.

The size and distribution of credit or liquidity risk in payments systems depend on the length of the interval between settlements in clearing arrangements, the types of risk controls and loss-sharing provisions in place, the range of institutions and instruments that have access to the systems, and the specific rules and practices that govern the timing of debit and credit entries in banks’ accounts at the central bank and in customers’ accounts at commercial banks.19 Policies governing these factors, which constitute the financial risk management framework in payments systems, provide a first line of defense against the spread of financial crisis and an initial means to share the losses from possible failures of participants. This is due to the fact that bank or nonbank failures will immediately prevent the execution of payments and to the fact that the payments system is where the consequences of those failures and incipient financial crises first appear. Thus, together with banking supervision, well-designed payments system policies help avert major disruptions to monetary stability. Reforms in the risk management framework will change the size of the float (supply of reserves), the demand for reserves by commercial banks, and the probability of central bank intervention to prevent the spread of crises. Alternatively, certain aspects of the payments system design could be influenced by the desired features regarding bank reserves and the extent of risk borne by the central bank. Some examples will illustrate the above propositions.

The size of settlement balances that banks hold, the characteristics of reserve requirement procedures, and the nature of the refinance mechanism all influence the architecture of interbank gross settlement systems, and vice versa.20 For example, if banks voluntarily hold large reserve balances—say, due to payment of interest on reserves—that they can draw down to honor their settlement obligations, then an interbank gross settlement system is easy to operate and does not require substantial overdraft facilities. That will be also the case if reserve requirements are large and required balances can be used for settlement purposes through reserve averaging rules. If reserves are low because of low reserve requirements, or banks wish to hold low levels of unremunerated reserves in excess of required reserves, the interbank payments system may require queuing mechanisms (if overdrafts are to be avoided); in this case, multilateral netting arrangements—where settlement of multilateral net positions occurs at designated settlement times—might be preferred for certain payment transactions to economize on reserves. However, multilateral netting arrangements entail systemic risks that have to be balanced against the benefits of economizing on reserve balances.21 Thus, the choice between gross settlement and multilateral net settlement systems for interbank payments using central bank money would be influenced by the marginal cost of central bank money used for settlements. The latter depends on the mix of monetary policy instruments in use and the structure of money markets.

The architecture of the interbank settlement system and the demand for reserves interact to influence the nature of instruments available in the money markets and the volatility of market rates for bank reserves, hence influencing the transmission mechanism for monetary policy. For example, the following factors strongly influence the demand for reserves and the type of instruments offered in the money markets: (1) whether interbank money market transactions are settled immediately, at the end of the day, or with a lag (or whether there is a mixed system); and (2) whether timely information on account positions is available to the participants from the interbank clearing and settlement systems. Also, the characteristics of the interbank settlement system would in turn be influenced by the changing composition of payments and the evolving structure of money and financial markets.22

In many transition economies, making the interbank settlement system efficient and cost-effective requires changes in the structure of commercial banks’ accounts. A consolidation of those accounts from a distributed accounting system—e.g., from the initial position of one account for each branch to one or a few accounts for each bank—is a crucial reform to facilitate the functioning of a gross settlement system and encourage money market development. Account consolidation—either physically, or logically through centralized processing—requires major changes in intrabank clearing arrangements and in the way monetary policy is implemented and sharply reduces the demand for bank reserves by obviating the need to maintain positive balances in a large number of settlement accounts. Also, any significant shift from interbank payment arrangements—based on correspondent banking among some or all domestic banks—toward arrangements requiring settlement with central bank funds (or a shift in the opposite direction) will clearly affect the demand for reserves.

Reforms in accounting and processing rules for the timing of bank and customer accounts’ crediting and debiting also influence the demand for, and variability of, reserves. Examples of such reforms include rules that require telegraphic verification and transmission of large check transactions before accounts are credited, accounting norms that better synchronize the timing of debit and credit transactions based on “availability schedules,” and better enforcement of rules on minimum times within which payments must be delivered and processed and funds made available to payees. Modifying such rules can induce changes in the timing of debits and credits that can sharply reduce the size and variability of the float and even its direction, with attendant implications for the demand and supply of reserves. These factors should be taken into account in implementing monetary policy.

Finally, the introduction of new payment instruments (e.g., new debt instruments for enterprises and households) or changes in the relative attractiveness of different instruments (pricing, reliability) might cause changes in the size and variability of bank reserves, particularly if there are pronounced seasonal or structural shifts in the relative use of credit and debit instruments. The dominance of cash in many economies in transition might also fall with the increasing access to direct debits, direct credits, and other retail payment instruments such as giro transfers. As has been the case in other countries, the introduction of electronic fund transfers, and other payments system innovations that enhance the liquidity of various saving instruments and that help integrate different segments of the financial market, can influence the stability of relationships between money and other economic variables.

Overview of Payments System Developments in the FSU Countries

The payments systems of the countries of the former Soviet Union shared the common heritage of the Soviet payments system, which served essentially as a detailed record-keeping for the ruble counterparts of the quantities contained in the central plan. The system lacked a concept of large-value payment; payments were freely effected on a gross basis; instructions were mostly paper-based; there was no monitoring of payment risks; and speed and security of processing were not emphasized since cash “deficits” anywhere in the system were automatically satisfied by a “central bank” that operated to facilitate the achievement of objectives given by the central production plan. Retail payments were effected in cash; a deposit money transfer system based on payment orders (PO-credit instruments, issued by the payor) and payment demand orders (PDO-debit instruments, issued by the payee) was used in the enterprise sector. Immediate settlement in cash for retail transactions was an accepted feature of the Soviet payments system, albeit at highly distorted prices. However, there was no incentive to promptly settle wholesale transactions, as enterprises did not own their bank deposits and could obtain cash (to pay wages and retail expenses) readily according to the needs spelled out in the central plan. In this system, the routine exchange of payment documents (PO and PDO) was, however, necessary to ensure the record-keeping of operations under the central plan. Significantly, the major instrument used for payment between enterprises was, until June 1992, the PDO (for Russia, up to 70 percent of the value of noncash payments in early 1992), which, because it was issued by the seller enterprise when shipping the goods, also proved that the seller had fulfilled the production plan.

Until 1988, the banking system consisted of a central bank (Gosbank) that acted as exclusive intermediary between five second-tier specialized banks, which maintained the accounts of enterprises. The accounting of payments was effected by Gosbank computer centers that the banks used also, for all their accounting and data processing needs. With the collapse of the centralized banking system starting in 1988–89, a large number of new private banks were created while the five Soviet specialized banks progressively split up into autonomous commercial banks. To respond to the new need for interbank payment services stemming from the decentralization of banking activities, the Gosbank created a network of so-called cash settlement centers (CSCs), which provided payments, accounting, and cash disbursement services to all banks and in which all banking institutions (including branches) could open correspondent accounts with Gosbank. The banks sent the payment instructions of customers to the CSC with which banks held their correspondent accounts; the CSC processed the instructions, debited the bank, and arranged for transportation via the postal or alternate mail system to the CSC where the payee bank was located. On receipt, the payee bank would be credited and the payment information forwarded to the bank for crediting to the customer. In summary, this was a typical paper-based gross settlement system subject to long transport and processing delays. As mentioned earlier, delays and risks were inconsequential to a system completely accommodative of the production plan.

In becoming the correspondent and service provider for all banks through the CSC system, the Gosbank continued the centralized payments system but with a decentralized account structure for banks. As a result, banks became dependent on the CSC processing facilities for most of their payments, both interbank and intrabank.23 At the same time, the number of payments increased dramatically, reflecting both the increased number of banks and bank customers, as well as the marketization of economic activity that accompanied the transition from a planned economy to a market economy. In these circumstances, the Gosbank payments system became rapidly overstretched in terms of processing capacity in the individual CSCs, and in terms of the inter-CSC transmission of payment instructions. There was no suitable computer grid to link the CSCs; the telegraphic network was not designed to handle large volumes of payments with an adequate level of security; and the mail and telegraphic systems became unreliable amid the general collapse of the Soviet Union.

At the time of the breakup of the Gosbank system in late 1991, the new countries inherited bits of a payments system already in disarray, while the management structure in the central banks was only beginning to learn about the role of the payments system in a market economy and about its technical operations. Throughout 1992 and 1993, additional shocks created new sources of instability for the payments system: inflation, cash shortages; interenterprise arrears; the introduction of a new organization for, and accounting of, interstate payments; the introduction and subsequent withdrawal of a new check; the withdrawal of the payment demand order; the introduction of new currencies; and a general weakening of security that led to an increase in fraud and errors.

Cash shortages were progressively eased through the issuance of larger denomination notes and/or the introduction of new currencies, in some cases supported by strong anti-inflationary programs. The buildup of interenterprise arrears was incorrectly blamed on inefficiencies in the payments system; it resulted primarily from the illiquidity of the buyers combined with the willingness of the sellers to continue delivering goods without requesting prepayment. The inefficient handling of payments described above and the cumbersome and detailed accounting practices inherited from the central plan system have led in many FSU countries to large and variable credit float, the effect of which is to drain sizable and variable amounts of liquidity from the system. Although the measurement of payment float is subject to numerous difficulties due to continuous adjustments in accounting practices to reflect new operations, an analysis of the payment float of the Central Bank of Russia and of its major determinants is developed in the next section.

There has developed a great deal of variation in the handling of payments among states of the FSU.24 Key differences are the expanse of the country, technical capacity of the central banks, organization and resources devoted to payments system reform, and the coordination between the central bank and the users of the payments system. Nevertheless, over the past two years, payments system developments in the FSU have shown certain common features.

(1) The evolving role of the central banks in the payments system has led to several features that affect monetary control and money market development: the assumption of payments system risk by the central banks in the form of automatic overdraft—even if at highly penal rates; the continued use in some countries of mutual accounts for interbank settlements, thereby avoiding settlement in central bank money and creating interbank exposures that are difficult to supervise and that can lead to excessive credit creation; and inadequate separation of clearing and settlement procedures that hampers money market development.

(2) Payments systems have been characterized by large shocks to the supply of money arising from high and variable float. This factor and the use of highly penal rates on overdrafts—which is often the only means of funding settlement—combined with uncertain rules of access have contributed to a continued high level of balances in the correspondent accounts at the central bank (see Appendix, Table 1).

(3) Central banks in most FSU countries still retain control and monopoly over processing of payments and do not yet have well-articulated policies toward the relative roles of the central bank and commercial banks.

(4) The relative strength of the automation capabilities in many of the FSU central banks resulted in payments system initiatives that were driven by technology instead of by a policy strategy adapted to a market economy. Technology is often viewed by the central banks as a means of providing all-encompassing payment services.

(5) Countries continue to rely on paper-based gross settlement systems, partly because the legal framework and standards definition that would allow for the introduction of netting and paperless payments has proven hard to establish or clarify.25 However, the smaller countries with only one computer center (or fewer banks that could be connected electronically to the central bank system) managed to provide reasonably timely processing services under these circumstances (e.g., Belarus, the Baltic countries, and Moldova).

(6) New payment instruments, such as checks and letters of credit, have not yet gained general acceptance. As shown in the Appendix, Table 1, the use of cash remains a dominant feature of the payments systems in the FSU. Pilot projects to introduce new instruments are under way in a few countries (e.g., check-processing projects in Ukraine and Russia).

(7) The accounting framework of the former Gosbank remains largely in place throughout the FSU. While not directly increasing the inefficiencies in the central bank payments system, this framework diminishes the timeliness and reliability of accounting information for monetary policy purposes. Also, the continuous changes in accounting practices combined with the inexperience of back office staff in the commercial and central banks have been the source of errors, thereby accentuating payment delays because of cumbersome paper-based reconciliation procedures.

(8) In countries with more vibrant banking sectors, demanding increasing reliability in payment services, the private sector has started to organize itself to provide payment services that bypass the central banks altogether. Some banks have made it their core business to develop large networks of correspondents in order to provide payment services. Such arrangements create weaknesses in the banking system at a time when central banks lack the capabilities to supervise the risks effectively, and also cause uncertainties in the demand for reserves.

Against this background, payments system reform has taken a two-pronged approach: (1) short-term improvements in the existing payments system infrastructure; and (2) longer-term reforms toward market economy payments systems led by the central banks in coordination with the private sector. Short-term improvements have focused on introducing and improving dedicated courier services, curtailing fraud by means of improved standards and streamlined reconciliation procedures and the development of new bank coding schemes, expediting large-value payments by stepped-up use of cable and telegraphic networks, the licensing of clearinghouses, and, in some cases, the consolidation of commercial banks’ accounts at the central banks. Pilot projects have been developed for the introduction of new payment instruments, clearinghouses, and large-value transfer systems. Within particular cities or regions that depend on one central processing facility, the central banks are now able overall to provide next day settlement.

Despite some efficiency gains in individual countries and areas, large-scale systemic changes remain generally limited. Progress in some countries has been slow because of the time needed for the authorities to recognize fully the requirements of payments systems in market economies, because of an apparent bias in favor of high-technology solutions that could take many years to develop and that are expensive, and because changes in payment processes are complex and involve many people and institutions. In recognition of these difficulties, several countries have established formal or informal committees under the leadership of the central banks for payments system reform.26 Broad reform strategies are not expected to bear fruit before 1995, about the same delay that was experienced in the Central and Eastern European countries.

The Case of the Russian Federation

This section briefly reviews payments system developments in 1992 and early 1993 in the Russian Federation, outlines some initial reforms undertaken by the Central Bank of Russia (CBR), examines the monetary implications of these developments, including the behavior and determinants of the payment float of the CBR, and outlines the medium-term reforms under way in Russia.

Initial Reforms27

Developments in the Russian payments system broadly mirrored the experience in other countries of the FSU, as described in the preceding section. Chart 3A shows that the use of cash as a percentage of ruble demand and savings deposits has steadily increased in 1992/93 from 45 percent in May 1992 to 97 percent in October 1993. This reflects the continued demand for cash in the settlement of retail transactions; to some extent, it also reflects the role of cash in large-value transactions when finality and irrevocability of settlement are paramount considerations. Chart 3B shows that the increase in the cash/deposit ratio is due to a fairly constant demand for cash in real terms and a declining demand for ruble bank deposits in real terms. The declining demand for ruble deposits is explained by the high rates of inflation that persisted throughout the period and that were reflected in negative real rates of interest on ruble deposits.

The behavior of excess reserves, as measured by correspondent account balances at the CBR as a percentage of demand and savings deposits, is also depicted in Chart 3A by means of two series. Balances of Sberbank, the Russian savings bank that attracts mainly deposits of individuals, averages about 10 percent of the deposits during the period and has remained fairly stable.28 By comparison, the other commercial banks have a much higher ratio, averaging about 55 percent. This pattern can be explained by the dominance of the other commercial banks in the provision of payment services to enterprises that typically involve large values. Moreover, Sberbank was able to maintain throughout the period an effective intrabank clearing system between its branches that allowed it to transfer internal funds more easily and thereby hold lower correspondent account balances at the CBR.

During most of 1992, the CBR was concerned about overcoming bottlenecks in the processing of payments and combating an increasing amount of payment fraud. The increase in the number of banks from five in 1988 to over two thousand at the end of 1993 overwhelmed the CBR processing and transportation capacity during most of 1992. The demand for banking and payment services in remote regions created the need to vastly and quickly multiply the number of CSCs of the CBR. These centers connected all the new banking institutions for the transfer of funds. Significant networks of correspondent banks that bypass the CSCs also began to emerge in the course of 1993 in response to commercial banks’search for faster and more reliable payments than could be obtained from the central bank system, which was facing processing bottlenecks. The limited training of the operators of the payments system at a time of an explosion in the number of documents, without adequate standards, formats, and bank-numbering schemes, and continuous changes in operating procedures to avert payment gridlock and adapt the system to the new demands of users resulted in numerous errors, significant rerouting or duplication in payment traffic, outright loss of documents, and processing of documents in violation of instructions from Moscow.29 Sizable fraud evolved from the disorganization and the crisis in the payments system, in particular following the introduction of the new Russia check.30 This situation led the CBR to tighten control over the processing of payments, which caused delays, reflecting difficulties in implementation of frequently revised processing procedures and the shortage of staff in relation to the growing work load (mainly in the CBR’s CSCs that service the newly established banks of the Moscow region).

The Russian payments system was also adversely affected by the congestion that developed owing to changes in the rules for processing interstate payments. Soon after the dissolution of the Gosbank in late 1991, the CBR established correspondent accounts in its CSCs for other central banks of the FSU and routinely processed the incoming and outgoing cross-border payment orders through these accounts, thereby automatically extending credit to other states to finance imports from Russia, reflecting Russia’s position as a net exporter. The level of financing through this de facto automatic overdraft in central bank correspondent accounts became clear with the accounting returns of the first few months of 1992. In order to limit balance of payments financing through these accounts, in two waves of measures (April and June), the CBR centralized the processing of interstate payments in Moscow by forbidding other CSCs to send or receive payments from abroad. These measures initially resulted in extra payment traffic in and out of Moscow with the regions and in confusion, owing to the rerouting of payment documents already under way—leading to a further bout of congestion in the Russian CSCs (particularly in Moscow), where new procedures had to be hastily implemented against a background of general strain in the system.

The clearing of domestic interenterprise arrears accumulated until June 1992 was another source of congestion and delays during August-October 1992, because the method used for the clearing consisted of reprocessing the pre-June 1992 unfunded payments on a gross basis. This “old” traffic was thus superimposed on the current traffic.31 Finally, the payment demand order, a debit instrument and the most heavily used in the FSU, was forbidden in July 1992 by the CBR, as the instrument was considered a factor contributing to inter-enterprise arrears. As a result, prepayment quickly became the general practice for interenterprise transactions.

In order to combat fraud and contain delays in the payments system, the CBR took a number of measures during 1992 and early 1993, while the private sector organized parallel channels for the clearing and settlement of payments.32 The CBR established dedicated courier services between its main cash-settlement centers,33 cleared the stock of interenterprise arrears (including interstate interenterprise arrears) as of July 1, 1992, reorganized the computer centers and updated the computer equipment, improved the usage of existing telegraphic infrastructure for large ruble payments by enhancing security, and proceeded to verify certain unusually large payments on a discrete basis instead of slowing the system down in order to verify each document separately. Because of the financial importance of the Moscow region, special efforts were applied there in early 1993 to reduce delays to no more than three days, with most of the transactions completed on a next-day basis. A comprehensive set of measures were also taken to improve data security by creating a separate Bank Information Protection Department within the CBR; special message security and coding systems were developed to protect information on paper and cable documents.34 Additional technical protection measures are still under development. Particular attention is being paid to speeding up and standardizing operations in the cash-settlement centers, provision of timely account information to commercial banks, and stricter enforcement of accounting rules (for debiting and crediting customers).

These measures served to stabilize the situation by improving the reliability and security of payments and set the stage for a systematic pursuit of medium-term reforms that are outlined later. The monetary consequences of the payments system developments in Russia are discussed in the next section with a particular focus on payment float, which captures, in part, the impact of these developments on monetary conditions.

Issues in the Measurement of the CBR Payment Float35

The initial difficulties in the payments system and the subsequent improvements in the reliability of payments as a result of measures initiated during 1992 seem to be reflected in the behavior of central bank payment float in 1992 and 1993. At any given time, the nominal stock of payment float of the Central Bank of Russia is measured as the sum of payments sent by each cash-settlement center to all the others minus the sum of payment documents received by each CSC from all the others.36Chart 4A shows the size and variability of the CBR payment float in 1992/93 as a ratio of reserve money. During this period, the CBR float was mainly a credit float—a withdrawal of liquidity from the system—and fluctuated between −6.4 and 31.1 percent of reserve money. A similar pattern is displayed on Chart 4B for float expressed in real terms—in billions of May 1992 rubles. In 1993, there was a tendency toward more stability, especially of float measured in real terms,37 even though the level of float remains relatively high following the sharp increase in November-December 1992. The sample may be conveniently split into two equal periods, before and after March 1993; post-March 1993 roughly corresponds to the period in which transitional CBR measures to improve payments system operation achieved full-scale effectiveness. When expressed in billions of May 1992 rubles, there was only a slight decline in the average float from Rub 188 billion to Rub 178 billion; the standard deviation of float in real terms however dropped from 149.5 to 63.0. The sharp drop of credit float in September-October 1992 may be attributed to the concomitant acceleration of inflation, while the increase in November-December is mostly due to the concomitant increase in credit to government.

The measurement of float that genuinely results from the operation of the payments system—that is, to funds in the process of settlement—poses many difficulties in Russia and in other FSU countries. For various reasons, the accounting framework inherited from the Gosbank does not permit a straightforward measurement of such a concept. This is partly due to the fact that the accounts and accounting procedures that reflect the operation of the payments system are also used to record other transactions. As a result, as shown in Chart 5, it is necessary to perform certain adjustments in order to isolate the genuine payment float. These adjustments remove special factors that are unrelated to the payments system, such as the clearing of domestic interenterprise arrears between July and October 1992 and the government reporting float.

The clearing of domestic interenterprise arrears (IEA) consisted in reprocessing the accumulated payment documents through the normal accounting entries for current payments. As a result, the clearing of the arrears resulted in the recorded increase of the CBR’s payment float. This, however, was a bookkeeping entry with no monetary effect at the time the payment documents were being processed.38

Government deposits collected in the CBR branches are periodically reported (not transferred) to Moscow. The reporting, however, triggers accounting entries that are identical to those that would be seen in the actual processing of payment documents. The actual transfer of government deposits from the CBR branches to Moscow occurs only once a year starting in January, with a final reconciliation round in June. Chart 5 shows how this factor unrelated to the payments system also affected the CBR float.

Determinants of CBR Float: A Simple Framework

This section presents an analytical framework for the CBR payment float in order to derive some testable hypotheses concerning its determinants. The hypotheses are tested using the Russian data. More specifically, CBR payment float is derived as a distributed lag function of the nominal value of transactions processed at various points in time, with the lags representing the delays in clearing and settlement. Only the shape of the lag distribution would reflect the efficiency of the payments system, as improvements in the payments system would lead to a reduction in delays in settlement and a corresponding change in the lag structure. Changes in the value of transactions processed in the CBR are jointly determined by inflation and the changes in the pattern of payment flows.

In the context of the accounting and payment practices of the FSU, central bank payment float may be represented algebraically in the following stylized manner in the case of payment orders. Let

Vt = value of payment orders entering the central bank payments system in period t

Nt = number of payment orders entering the central bank payments system in period t

vt = average value of individual payment order in period t, Vt/Nt.

During each period t, the correspondent accounts of commercial banks at the central bank are debited by the amount Vt, as this represents the aggregate value of payment orders that are presented by commercial banks to the cash settlement centers during period t for transmission to payee destinations where the payees’ banks will be credited. It is assumed that a proportion αi (i = 0,1,…,L) of payment orders that enter the system in period t is received at the cash-settlement center of payees’ banks in period t+i and that the amount αiVt is then credited to the payees’ banks (and in due course to the payees). The maximum lag in the transmission of payment documents is assumed to be L, and therefore:

Given the proportions αi, the aggregate of credits posted to the banks’ reserve accounts in period t due to payment order processing can be expressed as a distributed lag in current and past values of payment orders issued—that is,

The net effect on bank reserves due to payment order processing in period t can then be expressed as

Equation (3) represents the difference between the amount of payment orders debited in the current period t, and the amount of currently and previously issued payment orders (in periods t, t–1, t–2, etc.) that are being credited in the current period. This difference is typically positive; it represents then a contraction of reserves during period t. A negative difference would represent an expansion of reserves. Expression (3) can be regarded as a flow measure of central bank payment float.

In the balance sheet of the FSU central banks, however, a stock measure is typically used, representing the difference between the cumulative value of debits and the cumulative value of credits. The accounting framework is summarized in the table below.

TimeCumulative

Sum of Debits
Cumulative

Sum of Credits
Stock

of Float
tDt = ∑i=0,LVt–iCt = ∑i=0,L1=0, iα1Vt–iFt = Dt–Ct

In the above table, the summation is extended only for a lag of L periods. Accordingly, the value of payment orders debited in period t–L or earlier has been offset by corresponding credits and does not appear in the summation. Using the expression in the table, the nominal stock of float can be expressed as

where Vt = vtNt. It can be readily verified that expression (4) for the stock measure of float Ft can be used to derive expression (3) for ∆Ft = Ft − Ft–1.

Because Vi, the nominal value of transactions, increases pari passu with inflation, the measured value of float—both the stock measure as well as the flow measure—will rise with the general price level. In order to eliminate this mechanical pass-through effect of inflation, it is useful to examine the real value of ft = Ft/Pt (where Pt is a price index) expressed as

where μi is the average real value of individual payments.

According to expression (5), the real value of the float is influenced by factors that affect the weights αi, the average real value of transactions, and the number of transactions passing through the central bank system. The weightsαi, are time-varying, endogenous variables that depend on the characteristics of the central bank payments system, such as technology used to transmit payment information, interregional patterns of payment flows in the central bank system, organization of payment processing in the cash settlement centers, etc. The average real value of transactions would depend, among other things, on the timing of large disbursements, such as disbursements of government funds.

The number of transactions transiting via the central bank system would depend on the multiplier effect of base money expansion, on expected inflation, and on the rate of use of noncash payments—the degree of monetization of economic activity. The multiplier effect of central bank liquidity injections impinges on both the number of transactions as well as the lags in the transmission of the payment instructions. From an institutional point of view, an important distinction needs to be drawn between the payments system effects of CBR credit to banks and CBR credit to government. The release of credit to banks occurs locally in a much more diffuse way via the branches of the CBR. Lags in local, intraregional payments are smaller—typically one or two days under normal operating circumstances—than interregional payments, as most of these payments transit via one regional CSC. For this reason, one would not expect a significant first-round impact on CBR float of credit to banks. Second- and subsequent-round payments are, of course, a mix of local and interregional payments. However, where interregional payments are concerned, banks have tried to route them through bilateral accounts outside the CBR network of payment centers, and, therefore, the number of such transactions contributing to CBR payment float may have tended to decline throughout the period. In contrast, initial disbursement of any fresh credit to government occurs mainly in Moscow at the beginning of each month, and its transfer to the regions is effected through the central bank payments system. Accordingly, an increase in central bank credit to government is typically associated with an increased number of interregional payments and longer transmission lags. The relationship between CBR payment float, credit to banks, and net credit to government is illustrated in Chart 6 and Chart 7 of the Appendix. The relationship between float and net credit to government is particularly apparent in November 1992-January 1993.

An acceleration of inflation would reduce demand for reserve money in real terms; to the extent that inflation is anticipated, the market response of users of the payments system would be to attempt to offset this acceleration by delaying payments, captured in equation (5) as a reduction in the number of transactions. Also, in reaction to inflation, an increase in the use of cash or the development of alternative, faster—albeit not final—payments outside the central bank circuit would reduce float. The relationship between CBR payment float and inflation is depicted in Chart 8 of the Appendix. Notice in particular how the acceleration of inflation in October 1992 led to a self-equilibrating drop in float.

Based on the above analysis, the following propositions can be considered and tested empirically in the case of Russia. First, in the short run, the change in float in real terms would be influenced negatively by the size of the fiscal expansion measured by the change in central bank credit to government (in real terms), and negatively by the changes in the expected rate of inflation. Second, the effect of policy measures undertaken by the Central Bank of Russia to improve the central bank payments system in late 1992 and early 1993—as discussed earlier—reduced thereafter the level of float and its variability, after allowing for other economic factors that influence these variables.

Preliminary Estimations

An equation was estimated to explain the monthly variations in central bank payment float in Russia for the period June 1992 to December 1993. The quality of estimates is constrained by the limited number of observations and by the errors in the measurement of central bank payment float. Nevertheless, plausible results were obtained using a specification in first differences that explains the change in float in real terms (∆Ft) as a linear function of change in credit to government in real terms (∆Gt, a proxy for number and size of transactions), change in inflation (∆π, a proxy for changes in expected inflation), and a dummy variable (DUM = 1, in March 1993, zero otherwise) to test for the effects of the transitional measures to improve the operation of the payments system in the second half of 1992 and early 1993. (Figures in parentheses are t-statistics.)

Adjusted R2 = 0.41 DW = 1.33

Chart 9 in the Appendix compares the actual and fitted values of the float based on the above equation. All coefficients have the anticipated signs; an increase in credit to government led to an increase in the float and an increase in inflation reduced the float, although low significance levels render these interpretations provisional. A Rub 1,000 million increase in net credit to government leads to an estimated Rub 500 million increase in CBR float with a standard error of Rub 300 million. As explained above, the release of credit to government occurs in the Moscow ministries and, in the first round, generates potentially large payment orders for disbursement in the provinces. These payment orders travel between cash-settlement centers and are, therefore, reflected in the central bank float. In specifications including credit to banks as an explanatory variable, the coefficient of that variable was not significant.

An increase in expected inflation would tend to reduce the number of transactions as economic agents delay execution of payments—”play the float.” It appears that this effect existed in Russia: a 1 percentage point increase in inflation would lead on average over the period to an estimated Rub 7 billion decrease in CBR float, with a standard error of Rub 4.7 billion.

The dummy variable is significant at the 1 percent level, indicating that by the end of the first quarter of 1993, the effect of the initial CBR measures contributed to reduce the CBR float permanently by an estimated 98 billion in May 1992 rubles,39 all other things being equal. This reduction is concomitant with the coming on stream of the initial CBR measures to improve payments system operations. Moreover, the residuals of the estimated equation reflect the variability of float that is due to factors other than changes in net credit to government and changes in inflation. These factors include, among other things, the operation of the system itself. The standard error of the residuals dropped from 110 before March 1993 to 41 after. While there may be other factors at work, the drop in the standard error of the residuals also lends support to the notion that the CBR measures contributed to the reduction in the variability, in addition to the size, of the float starting at the end of the first quarter of 1993.

In conclusion, it appears from the above analysis that the payment operations that generated the float served to offset temporarily the monetary effects of central bank credit operations and thereby dampened the impact of CBR credit to government on bank reserves. Accordingly, the float acted as a kind of automatic stabilizer that absorbed surges in CBR credit or equilibrated the effect of higher inflation on nominal balances. The analysis also revealed that the initial CBR measures to improve the operation of the central bank payments system contributed to a reduction both in the level and variability of the central bank float—that is, an improvement in the efficiency of the system. Nevertheless, significant residual variability, both intermonth and intramonth, remains, which would pose complications for the design of indirect instruments and the choice of appropriate operating targets for monetary policy. In particular, the past role of the float as automatic stabilizer should not be extrapolated into the future. Moreover, a permanent reduction in the level of the float, as a result of further reforms being undertaken to modernize the payments system, would need to be absorbed by appropriate monetary operations.

Medium-Term Reforms

As noted earlier, during 1992 and the first half of 1993, the authorities completed or initiated various reforms of the existing system, with readily available technology, to improve the security of payments, streamline the processing and transportation of documents, and selectively test new automation and electronic communications methods to speed up payments clearing and processing. A large number of other measures were being planned, including continuing studies of CSCs to improve the timeliness and quality of their operations, consideration of measures to standardize payment documents, and development of regulations governing electronic interbank clearing procedures.

In this fluid environment, the authorities recognized that further improvements over the medium term would require a fundamental redesign of the payments system, as the basis for a systematic and wider application of electronic technology. However, several organizational and strategic issues remained to be addressed in order to design a new conceptual and operational framework of the future structure of the Russian payments system and to begin to implement specific reforms within this overall framework.

First, a clear mechanism was needed to build consensus on technical and policy issues between the central bank and commercial banks and between different departments of the central bank. Payments system reforms are highly interdisciplinary, involving accounting, monetary policy, regulatory policy, and technology, and they also call for coordination of actions and plans of commercial banks and the central bank. Therefore, effective implementation of payments system reforms required both coordination of reforms in different central banking functions and a clear delineation of the CBR’s role in the regulation and operations of the payments system.

Second, a large number of automation projects relating to payments clearing were being developed in different parts of Russia, both by the CBR and by commercial banks. As part of the automation program of the CBR, a number of payments-related projects have been in progress since 1992 in six regions, each implemented by a different vendor. In addition, numerous regional offices of the CBR have been independently implementing different payments-related automation projects. Several commercial banks were striving to establish their own network systems for internal fund management and improved customer service, including interbank fund transfer. These developments raised several issues. First, the business requirements of various users of the payments system had to be synthesized to define the architecture of the needed technology rather than adapting technology-driven solutions that could be wasteful and expensive. Second, technical specifications of different projects had to be coordinated, based on agreed standards for payment documents, form and format, bank routing codes, electronic message formats, and message security. Third, risks in interbank fund transfer systems offered by commercial banks had to be monitored and contained.

In order to address such organizational and coordination issues, to provide overall direction for payments system reforms for the medium term, and to adapt a systematic approach to project management, the authorities constituted the International Steering Committee for Improvement of the Payments System in Russia (ISC), which includes representatives from different departments and regional offices of the Central Bank of Russia, several commercial banks, the Association of Commercial Banks, five international organizations (IMF, IBRD, OECD, EU, EBRD), and four cooperating central banks.40 The ISC, chaired by a Deputy Chairperson of the CBR, serves as a forum for the Russian officials from the central bank and commercial banks to build a consensus on various technical and policy issues, with the technical support of international advisors. The ISC is assisted by six working groups. Each working group, composed of officials from both the CBR and commercial banks and chaired by a Russian official, focuses on a specific component of payments system design and implementation. The six subjects covered by the working groups are (1) large-value ruble transfer systems, (2) interbank clearing and netting arrangements, (3) new payment instruments, (4) intrabank settlement, (5) information systems and technology, and (6) payments system training.

Building on the organizational framework of the ISC and the supporting working groups, the authorities have made significant progress in the design and implementation of various medium-term reforms. The state of these reforms is discussed below.

A consensus has been built up on certain broad strategic directions:

(1) The future structure of the payments system will comprise realtime gross settlement systems for interbank transfers of large ruble values and multilateral netting of small values through clearinghouses.

(2) While the CBR will play an active regulatory and supervisory role in ensuring the safety and soundness of the payments system, its operational role will be flexible.

(3) A high priority will be attached to developing a large-ruble transfer system (LRTS), which will be owned and operated by the CBR.

(4) The clearing system for payments would be based on a mixture of public and private sector participation. Appropriate criteria for the licensing and operation of private clearinghouses have been formulated, and the scope for developing some of the existing cash-settlement centers into clearinghouses is being studied.

The CBR has also begun to formulate a medium-term conceptual design for the payments system and an implementation framework based on the work of the different working groups. First, the CBR is addressing several technical and policy issues that would shape the payments system design: appropriate legal and regulatory framework, particularly for electronic fund transfers; technical and security stan dards and formats for paper instruments and electronic messages, and the degree of centralization of account processing and holding. Second, as a basis for decisions on the overall design and on the choice of pilot sites for initial implementation, the CBR has collected extensive statistics from most regions on the volume and value of payment flows according to the size of individual payments and their destination (intra-CSC, intraregion, interregion, and interstate). This data-collection process is still under way.

Against this background, some of the specific reforms in progress are described below.

Clearing System

Two types of private clearinghouses have been licensed. One type would perform conventional multilateral netting with settlement in central bank books, and the other, a prefunded clearinghouse, would allow settlement on the books of the clearinghouse, with members transferring funds from their correspondent accounts at the CBR into clearinghouse accounts for the purposes of settlement. Both types of clearinghouses are based on multilateral netting with revocability clauses. In November 1993, four institutions were granted clearinghouse licenses by the CBR, initially for one year.41 One of the four institutions has a conventional standard license. None of them has really begun operating. Another two clearinghouses are expected to be licensed soon. The detailed operating rules of the clearinghouses, stating the rights and obligations of different parties, are under preparation.

Effective implementation of a clearinghouse system would require many interim changes in the existing system. Accounting, communications, and control procedures in the CSCs have to be further modified to allow prompt settlement of multilateral net positions of members holding accounts in different cash settlement centers, to monitor account balances of members each day, and to open a period between the time of availability of clearing results and the time limit for the final settlement of net amounts due by members with a debit position. This last measure, supported by an interim procedure for banks to transfer money into their accounts for immediate and final settlement (until an LRTS becomes operational), would greatly facilitate money market development and monetary management. The CBR is considering these issues and is also developing a strategy for the medium term, including conditions for transformation of CSCs into clearing houses, policy on pricing of clearing services, and standardization of forms and formats. Depending on the speed with which netting arrangements through clearinghouses were established, the opportunity for banks to economize on reserve holdings at the central bank would grow.

Large-Ruble Transfer System (LRTS)

The CBR has decided to implement a system along the lines of the Swiss model (SIC) in three stages.42 The system would be used for payment orders in excess of Rub 100 million, with the amount adjusted according to economic condition, especially inflation, and for interregional payment orders of any size and other “urgent payment orders.”43 Stage 1 (at present) is to test converting paper payment orders to electronic messages in 12 regions and prepare the legal and regulatory structure to support the LRTS. Stage 2 is to undertake a pilot project in two regions—Tula and Sverdlovsk—to process large-ruble payment orders in a real-time gross settlement system. The design of Stage 2 is expected to be completed by mid-1994 with implementation by year-end. The system’s operating hours would take into account the number of different time zones in Russia and the ramifications of operating hours on the development of a national and same-day money market in Russia.

Stage 3 (which would begin in 1995) is to add additional regions to the second stage’s pilot project and to improve the pilot’s features. Enhancements would include a queuing procedure for transfers that cannot be processed because the sending commercial bank does not have sufficient funds when the order is received.

The design of the gross settlement system for interbank transfers will necessarily involve several key decisions affecting monetary operations and instrument design, including decisions on the degree of centralization of bank accounts, and on whether to use required reserves for settlement purposes through period averaging or to develop specific central bank credit facilities and their pricing. Depending upon the specific monetary arrangements that are used in the design of LRTS, the demand for bank reserves would be affected significantly. In any event, measures to centralize account holding or processing would lead, in due course, to a major reduction in the demand for reserves.

Other Areas of Reform

Regulations on the creation, discounting, and collection of certain types of bills of exchange—a form of banker’s acceptance—are being developed. This has implications for the central bank’s refinance policy and for the distribution of risks that arise in any bill collection service provided through the CSCs.

The CBR has developed a book-entry clearing and settlement system for treasury bills. The treasury bills are currently maintained in book entry form in the books of an agent, the Moscow Interbank Currency Exchange (MICEX), and the acquisition and transfer of bills are also settled in the books of the agent, with funds transferred ahead of time from CBR accounts to MICEX accounts for the purposes of settlement. In order to facilitate a national market in treasury bills and to avoid major risks for the settlement agent, the working group has been developing a new system for transferring settlements back to the books of the CBR, while MICEX and its regional branches concentrate on developing securities depository and clearing services. The CBR’s offices would buy and sell short-term government securities on behalf of commercial banks and provide same-day settlement on the books of the CBR for these purchases and sales. The corresponding ruble clearing and settlements would be integrated with the overall design of clearing services and LRTS.

The CBR is also developing a network design, as an application-independent communications carrier, based on advanced but proven technology. When implemented, it should satisfy the needs of the new payment arrangements. However, in order to design the payments processing architecture on the network, the user requirements of different components of the clearing and settlement system need to be spelled out in detail. Several institutional and policy issues remain to be addressed, including decisions on ownership of telecommunications networks, the policy toward access to and the pricing of data communication services, and whether the intrabank communications network (for intrabank transfer of funds and liquidity management) is to be shared with CBR or separate.

Concluding Remarks and Summary

Some of the consequences of payments system developments for monetary policy—and the transition to indirect means of monetary control—in the FSU are illustrated by the behavior of the payment float in the balance sheet of the central banks. Initial difficulties in ensuring the security and reliability of payments led to a large and variable float, high risks borne by the central bank, and large and variable balances in the correspondent account of banks at the central bank. The latter also reflected the absence of well-developed interbank money markets, in part a consequence of unreliable settlement systems.

The level and variability of the float have been reduced significantly by the transitional reforms of the payments system implemented by the Central Bank of Russia in 1992 and early 1993. This is confirmed by the empirical analysis of the central bank float and its determinants. Nevertheless, the level and variability of float still remain high, contributing to a continued large demand for reserves, given the typically penal interest rates charged on overdrafts and the absence of liquid interbank markets. Some of the reforms under way to streamline operating procedures of cash settlement centers and to separate adequately the clearing and settlement procedures would strengthen interbank money markets and facilitate monetary management.

The medium-term reforms being implemented should be closely monitored as to their scope and timing so that their monetary implications can be taken into account in the conduct of macroeconomic policy. The consolidation of accounts, the spread of netting arrangements through clearinghouses and the greater liquidity to interbank markets through large-value transfer systems would all lead to a drop in the demand for reserves and to a reduction in credit float (an increase in the supply of reserves). The resulting expansionary thrust should be closely monitored and offset. The implementation of large-value transfer systems may have additional effects on the demand for reserves, depending on the specifics of the design and its alignment with the monetary regime. This underscores the importance of proper coordination of payment system reforms with the ongoing reforms of monetary operations.

Appendix
Table 1.Reserves and Currency in Circulation for Selected Eastern European and Former Soviet Union Countries
Reserves1Currency in CirculationTotal DepositsReservesCurrency in Circulation
Country199119921993199119921993199119921993199119921993199119921993
(As a percentage of total deposits)
Former Soviet Union
Belarus22,73645,26915,69571,042101,014309,6822.7114.6215.5422.94
Kazakhstan3735341551,3055221,94213.9827.5029.6967.20
Kyrgyz Republic47,9604517,90415832,45935324.5212.6955.1644.76
Latvia5nana14,66115,39935,57438,21241.2140.30
Lithuania65,16211,8567,5057,95730,494105,94116.9311.1924.617.51
Moldova79,44444,25953,991148,69817.4929.72
Russian Federation81712,0274,6681671,6019,3848315,11318,64920.5839.6425.0320.1031.3150.32
Turkmenistan9378575337258.8410.7815.8510.37
Ukraine101146416471,2432,0404,6475.6013.7831.7426.74
Eastern Europe
Poland118,5967,5717,31756,17777,98491,883197,222321,366359,4204.362.362.0428.4824.2725.56
Romania121591421401764121,0488151,0972,14219.5112.956.5421.6037.5348.93
Czech Republic13313(8)6259473944855400.762.68(1.41)15.7512.178.70
Bulgaria1421261218559838.1826.5321.8218.37
Hungary152602868941,03429.0727.67
Sources: International Monetary Fund, International Financial Statistics, and reports on recent economic developments.Note:& indicates data are not available.

Reserves are bank correspondent account balances at the central bank, unless otherwise specified.

Data for June 1992 and February 1993 in millions of rubles.

Data for end-1992 and end-1993 in billions of rubles.

Data for end-1992 and end-1993 in millions of rubles, and June 1993 in millions of soms.

Data for end-1992 and March 1993 in millions of Latvian rubles.

Data for March 1992 and September 1992 in millions of talonai. Reserves include required reserves.

Data for end-1992 and July 1993 in millions of rubles.

Data for March 1992, December 1992, and October 1993 in billions of rubles.

Data for September 1992 and August 1993. Reserves include required reserves.

Data for end-1992 and March 1993 in billions of karbovanets. Excess reserves include required reserves.

Data for end-1991, 1992, and June 1993 in billions of zlotys.

Data for end-1991, 1992, and 1993 in billions of lei. Reserves include required reserves.

Data for March 1992, end-1992, and September 1993 in billions of koruny.

Data for end-1991 and 1992 in billions of leva. Reserves include required reserves. (Deposits are deposits of the state savings, specialized commercial, and common commercial banks at the National Bank of Bulgaria.)

Data for end-1991 and September 1992 in billions of forint.

Sources: International Monetary Fund, International Financial Statistics, and reports on recent economic developments.Note:& indicates data are not available.

Reserves are bank correspondent account balances at the central bank, unless otherwise specified.

Data for June 1992 and February 1993 in millions of rubles.

Data for end-1992 and end-1993 in billions of rubles.

Data for end-1992 and end-1993 in millions of rubles, and June 1993 in millions of soms.

Data for end-1992 and March 1993 in millions of Latvian rubles.

Data for March 1992 and September 1992 in millions of talonai. Reserves include required reserves.

Data for end-1992 and July 1993 in millions of rubles.

Data for March 1992, December 1992, and October 1993 in billions of rubles.

Data for September 1992 and August 1993. Reserves include required reserves.

Data for end-1992 and March 1993 in billions of karbovanets. Excess reserves include required reserves.

Data for end-1991, 1992, and June 1993 in billions of zlotys.

Data for end-1991, 1992, and 1993 in billions of lei. Reserves include required reserves.

Data for March 1992, end-1992, and September 1993 in billions of koruny.

Data for end-1991 and 1992 in billions of leva. Reserves include required reserves. (Deposits are deposits of the state savings, specialized commercial, and common commercial banks at the National Bank of Bulgaria.)

Data for end-1991 and September 1992 in billions of forint.

Chart 1.Daily Excess Reserves for a Sample of Moscow Banks1

(In millions of rubles)

Source: Central Bank of Russia.

1Observations relate business days in June 1992.

Chart 2.Effects of Alternative Central Bank Credit Facilities

Chart 3A.Cash and Excess Reserves

(In percent of short-term deposits)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 3B.Cash and Deposits in Real Terms

(In billions of May 1992 rubles)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 4A.CBR Payment Float

(In percent of reserve money)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 4B.CBR Float in Real Terms

(In billions of May 1992 rubles)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 5.Adjustments to CBR Float

(In percent of reserve money)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 6.CBR Float and Credit to Banks in Real Terms

(In billions of May 1992 rubles; first differences)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 7.CBR Payment Float and Credit to Government in Real Terms

(In billions of May 1992 rubles; first differences)

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 8.CBR Float and Inflation

Sources: Central Bank of Russia; and IMF staff estimates.

Chart 9.CBR Payment Float: Actual vs. Fitted

(In billions of May 1992 rubles; first differences)

Sources: Central Bank of Russia; and IMF staff estimates.

References

    AngeliniPaolo and CurzioGiannini“On the Economics of Interbank Payments Systems,”Banca d’Italia Discussion Paper SeriesNo. 193 (May1993).

    AngellWayneD.“Large-Value Payments Systems: What Have We Learned?,” in Payments Systems WorldwideVol. 3 (Winter 1992–93) pp. 5761.

    BaliñoTomásJ.T.JuhiDhawan and V.Sundararajan“The Payments Systems Reforms and Monetary Policy in Emerging Market Economies in Central and Eastern Europe,”IMF Working PaperNo. 94/13 (Washington: International Monetary FundJanuary1994).

    Bank for International Settlements and Group of TenReport of the Committee on Interbank Netting Schemes of the Central Banks of the Group of Ten Countries (Basle: BISNovember1990).

    BorioC.E.V. and Paul van denBergh“The Nature and Management of Payments System Risks: An International Perspective,”BIS Economic PapersNo. 36 (Basle: Bank for International SettlementsFebruary1993).

    Central Bank of RussiaAnnual Report 1992 (Moscow: Central Bank of Russia1993).

    GarberPeterM. and Steven R.WeisbrodThe Economics of Banking Liquidity and Money (Lexington, Massachusetts: D.C. Heath1992).

    HoriiAkinari and Bruce J.Summers“Large-Value Transfer Systems,” in The Payment System: Design Management and Supervisioned. by Bruce J.Summers (Washington: International Monetary Fund1994) pp. 7388.

    International Monetary Fund“Financial Relations Among the States of the Former Soviet Union,”Economic ReviewNo. 1 (Washington: International Monetary Fund1994).

    LeiteSergioPereira and V.Sundararajan“Issues in Interest Rate Management and Liberalization,”Staff PapersInternational Monetary Fund (Washington)Vol. 37 (December1990) pp. 73552.

    LiangMing-Yih“Bank Float, Mail Float, and the Definition of Money,”Journal of Banking and FinanceVol. 10 (December1986) pp. 53348.

    MarquardtJeffreyC.“Monetary Issues and Payment System Design,” in The Payment System: Design Management and Supervisioned. by BruceJ. Summers (Washington: International Monetary Fund1994) pp. 4152.

    SummersBruceJ.“Remarks on Technical Assistance to the Central Banks of the Former Soviet Union on Payments Reform”(unpublished paper presented at the Coordinating Meeting of Cooperating Central Banks Bank for International SettlementsBasle, SwitzerlandNov. 71993).

    SundararajanV.“Financial Sector Reforms and their Appropriate Sequencing,” in The 19th SEANZA Central Banking Course (Tokyo: Bank of JapanOctober-November1992) pp. 177203.

    TanziVito“Inflation, Lags in Collection, and the Real Value of Tax Revenue,”Staff PapersInternational Monetary Fund (Washington)Vol. 24 (March1977) pp. 15467.

    VitalChristian“SIC: Market Responses to the Introduction of an Electronic Interbank Payments System”(paper presented at the International Symposium on Banking and Payment Services sponsored by the Board of Governors of the Federal Reserve SystemWashington, D.C.June 7–91989).

    YoungJohnE.“The Rise and Fall of Federal Reserve Float,”Economic ReviewFederal Reserve Bank of Kansas CityVol. 71 (February1986) pp. 2838.

A revised version of the paper was presented at the central banking seminar. We wish to thank T. Paramonova, Deputy Chairperson of the Central Bank of the Russian Federation, other participants in the seminar, and colleagues from the International Monetary Fund’s European II Department for valuable comments and suggestions.

See Leite and Sundararajan (1990).

See Sundararajan (1992) and Baliño, Dhawan, and Sundararajan (1994).

For a detailed discussion on float, see Young (1986); a later section of this paper provides an algebraic framework for the analysis of float in the FSU countries.

Even in well-functioning payments systems, a large float could develop because of transportation delays and processing bottlenecks that lead to holdover of payment documents, or because of errors in documents or in processing.

By contrast, a large but predictable float may not create problems for monetary management.

Correspondent account balances are reserve money balances in excess of the required reserves. The required reserves are held in separate blocked accounts in all FSU countries. Therefore, the terms correspondent account balances and excess reserves are used interchangeably. Excess reserves include both desired reserves—balances held voluntarily to fund anticipated payment obligations—and surplus reserves—involuntary balances in excess of desired reserves.

The extent to which the central bank assumes the risks will depend on specific risk management and risk-sharing arrangements in payments systems. See Borio and van den Bergh (1993).

This choice is thus an empirical matter, which is beyond the scope of analysis of the present paper.

In the meantime, some central banks have introduced auctions of unsecured central bank credit as a means of allocating some portion of their financing. When held frequently enough, credit auctions have enabled the central banks to price credit according to market conditions.

Moreover, the development of the money and foreign exchange markets requires that market participants have confidence in the reliability of the payments system.

The negative effect of collection lags and inflation on tax revenues is often referred to as the Tanzi effect. See Tanzi (1977).

Such effects are measured in the section below on the Russian experience of 1992/93, when sharp increases in inflation may have induced delays in execution of payments in some periods.

A large accumulation of payment demand orders that could not be processed because of insufficient funds was the tangible manifestation of interenterprise arrears in the FSU and Baltic states up to the middle of 1992, when the system of payment demand orders was discontinued.

These reforms have to be supported by appropriate changes in legislation, organizational arrangements, bank account structure, a technology platform, and technical standards. Other key components of medium-term reforms in the payments system include the introduction of new payment instruments, particularly for bulk payments, modification of intrabank clearing and fund management arrangements, and establishment of linkages with securities clearing.

Gross settlement refers to systems where each payment instruction is processed item by item—alone or in batches. Net settlement refers to systems where the incoming and outgoing payments are accumulated and only the net amounts—either bilateral or multilateral—are settled using balances in the central bank or in a clearing bank at prespecified settlement times, usually the end of each day. Finality refers to a situation when a payment instruction, once executed, is considered irrevocable. The guarantee of irrevocability under specified conditions is a desirable feature to foster money and foreign exchange markets.

See Horii and Summers (1994).

The absence or lack of enforcement of bankruptcy laws has prevented many insolvency problems from coming into the open. This will be changing as those laws are beginning to be more strictly enforced.

For a discussion of risk control in multilateral netting arrangements, see Bank for International Settlements (1990) and Borio and van den Bergh (1993).

See Marquardt (1994) and Vital (1989). Angell (1992–93) notes that a monetary regime and payments system design (i.e., a large-value interbank fund transfer system) need to be compatible, but market participants and policymakers should not mechanically subordinate payments system design to a particular existing monetary policy regime.

The optimal length of the settlement interval involves equating the expected marginal cost of failure of a participant with the expected marginal cost of holding reserves: see Garber and Weisbrod(1992).

Angelini and Giannini (1993) analyze the value of information to participants in the payments system and the institutional factors governing the features of interbank systems. An illustration of the effect of payments system architecture on money markets is the evolution of intraday money markets in Japan following the development of the BOJNET, a large-value transfer system; see Horii and Summers (1994).

In some instances, the correspondent accounts at the central bank ended up being used mainly for government and centralized credit transactions and not for interbank transactions, which relied increasingly on bilateral correspondent accounts where interbank exposures can build up without limit. This was the case in Azerbaijan and. for some time, in Ukraine.

The central bank of the Kyrgyz Republic has introduced a netting arrangement in its cash settlement center.

For example, National Payments Councils have been established in Ukraine and Kazakhstan.

All ruble aggregates in this section refer to deposits in rubles unless mentioned otherwise.

This low level of excess reserves of Sberbank reflected both the dominance of retail deposits of households that mostly use cash and the Internal network of the bank for intrabank transactions, reducing the need for reserves at the central bank.

With the breakup of the Gosbank system, banks in border areas of the Russian Federation were often connected to payment centers now situated “abroad,” and vice versa, resulting in confusion as to processing rules and recuperation of documents and funds sent abroad, errors, and duplication. In addition, the expanse of the country, combined with tendencies toward greater regional autonomy from the center, sometimes made it difficult to regain control over standards and procedures and to reconcile the validity of payments.

The Russia check came in the form of a prepaid check book with a preauthorized ruble limit on each check. However, long collection times and inadequate verification methods led to serious abuses, including counterfeiting. In response, the CBR limited its use to local areas where the verification of fund availability is typically faster.

Interstate interenterprise arrears created by themselves payment defaults within Russia’s domestic payments system, and it has often been argued that this effect in itself contributed to the disorganization of Russia’s domestic payments and in particular to the buildup of domestic arrears However, in mid-1992, interstate arrears were more than ten times smaller than domestic arrears. Both types of arrears originated not in intrinsic payments system inefficiencies but in the buyers’ lack of funds (notwithstanding substantial financing by the CBR of the FSU central banks).

For a description of measures implemented in 1992. see Central Bank of Russia (1993).

Dedicated couriers were also being introduced for interstate payments. Prior to this system, documents could stay in transit for up to one month; the new standard was a maximum of 72 hours to deliver payment documents between two CSCs.

According to the CBR, as of April 1, 1993, the telegraphic security system has enabled it to prevent about Rub 500 billion from being fraudulently paid into the accounts of commercial banks and their customers through false documents.

The payment float between the banks and their customers (or customer float) is not analyzed in this section owing to the uncertainties in the quality of data from commercial banks. Data on customer float would provide an additional measure of the impact of the payments system on the end-users.

See next section for the formula defining the stock measure of float. Within this measure, a distinction is made between debit payment instruments that create a debit float and credit instruments giving rise to a credit float.

Other factors affect reserve money and, for the period under consideration, the variability of reserve money exacerbated the variability of the float/reserve money ratio.

The monetary effect occurred starting in October 1992 when the CBR began extending credit in order to settle the net amounts due after offsetting payables and receivables.

Standard error of Hub 16 billion. Alternative specifications included a dummy variable in February 1993 or April 1993. The coefficients were small and insignificant.

The International Monetary Fund, the World Bank, the Organization for Economic Cooperation and Development, the European Union, and the European Bank for Reconstruction and Development; Banks: Deutsche Bundesbank, Bank of France, U.S. Federal Reserve, and Bank of England.

The Moscow Clearing Center, Interbank Financial House, Banking Information Technologies, and the URAL Financial Group.

SIC stands for Swiss Interbank Clearing, a real-time gross settlement system for interbank payments through accounts at the Swiss National Bank.

For example, aggregate statistics for 32 regions in early December 1993 show that individual payment orders over Rub 100 million account for less than 1 percent in terms of total number of transactions but account for over 60 percent in terms of aggregate value.

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