1. Monetary effects of payment float ^4/

In the Russian Federation, as in many transition economies, the large size and variability of 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.^5/ 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 parent information.^6/ Such factors have been present in various degrees during the recent evolution of the payments system in the Russian Federation, causing large and variable float.^7/

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 both for the central bank and commercial banks, while a large float entails a commensurate settlement risk for the parties involved, which also tends to increase the demand for bank reserves at the central bank.

The volatility of bank reserves is illustrated in Chart 1 for a sample of Moscow banks during June 1992. These data, although taken from a month of particular instability in the central bank payments system, may be considered as representative of conditions that prevailed in the early period following the breakup of the former Soviet Union. Data from a broader sample of 21 banks in the same month suggest that banks held reserves in order to cover themselves against variations of up to two standard deviations in daily balances; this strategy appeared effective as only one bank resorted to a moderate two-day overdraft. The impact of float is also evident from the monthly changes in aggregate balances in the correspondent accounts of commercial banks at the CBR, which varied from 25 percent to 45 percent of total deposits during May 1992 to May 1994 (Chart 2).

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Daily Excess Reserves for a Sample of Moscow Banks¹

(In millions of rubles)

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

Source: Central Bank of Russia.¹ Observations relate to business days in June 1992.

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BANKS’ CORRESPONDENT ACCOUNTS AT CBR

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

SOURCE: CENTRAL BANK OF RUSSIA, AND STAFF ESTIMATES.

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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.^8/ As a result, in order to fund payment obligations, commercial banks hold large levels of correspondent account balances ^9/ 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.

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 float. For example, the conventionally defined net domestic assets (NDA) 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 total reserves. In general, the choice of an appropriate operating target will depend upon 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. ^10/ The behavior of float could influence this correlation as well as the instrument mix (as discussed further below), thereby affecting the choice of operating target. ^11/

Several other monetary consequences of float are noted below. ^12/ A large and highly variable bank float can complicate the measurement and interpretation of monetary statistics. ^13/ Moreover, specific accounting procedures for payments in many transition economies make it difficult to identify the payment float, or distort the size of balance sheets, thereby complicating the implementation of monetary policy. The procedural delays and other factors that cause a large and variable float could set up incentives for delaying payments in order to take advantage of the erosion in the real value of payments under high inflation, and contribute to payments system gridlock and inter-enterprise arrears. Factors causing float also exacerbate the risks in the payments system, thereby affecting the supply of reserves if the central bank assumes part of such risks. ^14/ In addition, operational delays in the payments processing, together with poorly designed security features, could create an opportunity for fraud and result in major losses in the banking system, often borne initially by the central bank.

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 long lead time. A major aspect of medium-term reforms of payments system structure consists of the introduction of a large value transfer system (LVTS)—a gross or net settlement arrangement using central bank money for large value interbank fund transfers that require finality, a high degree of security, and immediate, same-day or value-dated settlements—as well as introduction of net settlement arrangements through clearing houses typically for small payments. ^15/ Alternatively, depending upon the country size, volume of payment transactions and other initial conditions, a single gross or net system for all payments could suffice. The consequences of transitional and medium-term reforms for monetary policy and money market development, and the impact of the features of monetary arrangements for the design of payments systems, are more fully discussed elsewhere ^16/ and are selectively taken up in the next section.

2. Implications for the design and mix of monetary operations

The design and mix of monetary policy instruments, particularly the design of borrowing facilities for commercial banks such as a discount window, and the related monetary operations could be influenced by the need to counter the adverse consequences of large and variable float on system-wide liquidity. Following the breakup of the former Soviet Union, the practice in the Russian Federation was initially to offer only an overdraft facility at a high penalty rate, in addition to directed credits at a pre-announced rate with a lengthy application procedure, thus making the use of central bank credit highly inflexible with respect to market conditions. ^17/ This configuration of instruments is illustrated in Chart 3 which shows in Panel 1 the initial setup in the Russian Federation, and in Panel 2 an alternative mix of monetary instruments designed 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 initial instrument mix. OG is the supply of reserve that is not under the control of the central bank (e.g., credit to government, float, etc.); GR is the supply of reserves through directed credit; reserves to the right of R are supplied via the current CBR overdraft facility; r is the pre-announced finance rate charged by the central bank on directed credit. The portion of the supply curve to the right of point (G,r) is upward sloping to reflect the cost associated with obtaining directed credits; in general, the shape of the curve between points G and R, will depend upon the details of operating procedures that determine ease with which directed credits could be obtained. The vertical segment of the supply curve reflects the fact that additional reserves beyond OR can only be obtained through overdrafts at double the finance rate. The portion of the supply curve depicting the overdraft facility is steeply upward sloping in order to capture the stringent conditions associated with requests for overdraft—more often than not, the central bank may block payments instead of granting overdraft. ^18/

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Russia: Monetary Impact of Payments System Shocks and Benefits of Alternative Monetary Instruments

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

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Let us assume as depicted in Panel 1 a contractionary shock to reserve money in the form of an unexpected increase in payment float (S shifts to S’, reserves shrink by G’G). The initial equilibrium point is (R,i). Because of the discontinuity in S, the marginal cost of funds jumps from i to i’, above 2r as a system-wide shortfall of reserves occurs. A succession of contractionary and expansionary shocks that characterize the Russian payments system would result in large fluctuations in market interest rates. Even the best banks would be pushed into overdraft because they could not forecast 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 reserves in order to ensure smooth payment services to their customers and 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 in order to smooth out interest rate movements through redesigned monetary instruments. An instrument mix that allows partial accommodation in the short run, while ensuring overall monetary control, is often the preferred course of action because orderly price movements best promote market development.

The redesign of instruments that results in a more interest-elastic supply of reserves is illustrated in Panel 2. The reserve supply curve in Panel 2 reflects new instruments and operating procedures aimed in part at offsetting the payments system shocks and smoothing interest rates. The segment to the right of point (G,r) represents the supply of reserves through a combination of directed credit, credit auctions, and a Lombard or equivalent facility that obviates the need for overdraft access. Credit auctions provide reserves at the initiative of the central bank at interest rates that reflect interbank market conditions. Auctioned amounts could be managed to influence market interest rates. The Lombard facility is drawn at the initiative of commercial banks at an interest rate that is above, but close to, market rates. ^19/ Such a facility is designed to provide short-term liquidity to the system as a whole, based on uniform access criteria, and its operations would be distinct from any lender-of-last-resort support provided to individual problem banks on a case-by-case basis.

While the introduction of market-based instruments, especially, a Lombard facility based on uniform criteria, has many benefits for monetary control and money market development, one important consequence would be to make the supply of reserves more elastic with respect to market rates. In the context of a reserve money program, elastic access to the Lombard window might have to be offset by other instruments operated at the initiative of the central bank (e.g., bill auctions) to maintain overall control on the desired operating target. These changes would help reduce the volatility of interest rates in response to payments system shocks, as shown in Panel 2 of Chart 3. As in Panel 1, a contractionary payments system shock would shift the supply curve from S to S’ and reduce reserves by G’G, but market interest rates would increase by less than in Panel 1, from i to i’ Interest rate volatility could be further dampened, if reserve averaging were permitted. In this case, the demand curve would become more elastic, reflected in the change from D to D’ in Panel 2, making the increase in the equilibrium rate due to payments system shocks even more subdued. In short, the task of managing the level of reserves or the level of short-term interest rates without excessive volatility would be facilitated if the central bank’s instrument mix were properly designed to take into account the vagaries of the payments system.

A shift in monetary management procedures to bring about more elastic supply of (and demand for) reserves requires several internally consistent changes in instrument mix, instrument design, payments system operations, and money market practices. First as already mentioned, market-based instruments to absorb reserves—e.g., T-bill auctions—are needed to ensure overall control over bank liquidity, even while accommodating individual banks who might be adversely affected by payments system shocks. This raises many operational issues to ensure coordination of technical features (maturities, settlement rules, etc.) and policy settings (interest rates, volumes) of different instruments, and calls for active short-term liquidity management using these instruments. Second, appropriate risk control measures would be needed to avoid excessive exposure to individual banks through credit auctions and Lombard facility. Such measures include provision of timely prudential information on the banks’ condition and market information on bank liquidity in order to guide responses to credit requests, the use of collateral requirements, or the development of repurchase operations in specified securities; and limits on access based on uniform criteria. Third, accounting and operating procedures in payments processing would have to be changed in order to provide timely and reliable information to both the central bank and the commercial banks, on current settlement balances, and on the amounts to be settled based on interbank payments clearing. Such reforms of clearing and settlement procedures would have to allow sufficient time for the commercial banks to seek funds in the interbank market based on information on the clearing balances before resorting to central bank credit, and for the central bank to assess market conditions before providing Lombard credit. ^20/ Finally, in order to support timely settlements of central bank credit and interbank funds transfers, the central bank should quickly provide a large value transfer system—even if limited in geographic and technical scope initially—for the transfer of balances in the correspondent accounts of the central bank for same-day and irrevocable settlement.

As already noted, the design and implementation of LVTS is a crucial reform, as it ensures the secure, cost-effective, timely, and irrevocable transfer of central bank money among the accounts of the participating banks and thereby supports the development of interbank money and foreign exchange markets, and the implementation of monetary policy through indirect instruments. ^21/ As such, LVTS has become the backbone of efficient financial markets and has 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 innovations from market to market).

A comprehensive LVTS based on modern telecommunications could take many years to implement, warranting the development of transitional systems that could provide more immediate support to the payments system and to monetary policy. In the Russian Federation—and in other transition economies—developing a full-fledged interbank settlement system that is efficient and cost-effective requires centralization of commercial banks’ accounts with the central bank from the initial situation of highly distributed accounting system (one account for each branch) to one or few accounts for each bank. The account consolidation—either physically or logically through centralized processing—requires major changes in intrabank clearing and central bank account processing, and this will necessarily take some time. In the meantime, a “low-tech” transfer system could be designed as a step toward and consistently with the development of a full-fledged LVTS in the medium term. The low-tech system would be based on readily available technology, but would fulfill the objectives of same-day settlement on the books of the central bank and timely account information to participants. As a first step, it would be dedicated to the clearing and settlement of transactions between local banks, perhaps only for a limited window of time during which banks would fund their payment obligations at the central bank. Progressively, the window could be enlarged and real-time links would be established with other financial centers. This approach would provide the needed support to the development of money and foreign exchange markets during the transition. It would also help reduce the size of float to some extent (a substantial reduction in float will require significant progress in the implementation of medium-term reforms), and facilitate redesigned monetary operations and market-based instruments discussed earlier.

3. Monetary aspects of payments system design

In general, the choice of payments system design and the monetary operations framework should be mutually compatible. The monetary aspects of medium-term reforms of the payments system, such as the design of LVTS, new payment instruments, and new accounting and risk management systems are summarized below and discussed more fully in Baliño, Dhawan, and Sundararajan (1994).

The specific design of interbank funds transfers and settlements in an LVTS, such as the choice between gross or net settlements, the type of information flows among participants, the nature of the interface between settlement procedures and reserve requirements and refinance policies, and the operational connections between clearing systems, money markets, 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, as noted in Marquardt (1994).

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 the market rate 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: 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 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 centralization of commercial banks’ accounts, as mentioned earlier. The centralization of accounts 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 and the size of the float.

Reforms in accounting and processing rules for the timing of bank and customer accounts’ crediting and debiting (e.g., funds availability rules, electronic verification of large checks, etc.) also influence the demand for, and variability of, reserves. 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.

As payment reforms proceed, the dominance of cash might decline, 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 funds 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.

Finally, the introduction of an appropriate financial risk management framework in payments systems would reduce the likelihood of losses, and unexpected pressures, on central bank credit, thereby enhancing monetary stability.

1. Institutional and operational aspects of the Russian payments system

Recent developments in the policies, institutions, and operations relating to the Russian payments system are discussed in greater detail in the Appendix; key developments are summarized here for convenience. The CBR inherited, as did other countries of the former Soviet Union, a payment, clearing, and settlement system, characterized by dominance of cash, limited range of noncash payment instruments, main reliance on credit payment instruments, slow paper-based clearing operated by the central bank with uncertain and often long lags between debiting and crediting, and gross settlements with automatic recourse to central bank overdrafts, although at a penalty rate. These features, together with a highly decentralized accounting system, contributed to payment delays and significant float. There are some 1,600 CBR branches known as cash settlement centers (CSCs), which maintain accounts for each commercial bank branch in the territory, and perform cash disbursement and payment processing services. ^23/ Moreover, the increase in the number of banks—from five in 1988 to over 2,000 by the end of 1993—initially outstripped the payment processing and transportation capacity of the CBR. This was especially true in the Moscow region in light of the concentration of banks and payment traffic there (some 70 percent of the total value of payments in the Russian Federation).

Against this background, structural inadequacies quickly emerged in the CBR system, while the commercial banks organized alternative arrangements for clearing and settlement, particularly for intercity payments, as explained more fully in the Appendix. Reflecting episodes of congestion and logjams in payment processing, and the concerns of the authorities to contain fraud, most of 1992 was characterized by frequent changes in operating procedures and large disruptions to payment services. Congestion and delays in the summer and fall of 1992 resulted in part from the centralization of processing and accounting of interstate payments in Moscow, and the processing of accumulated payment documents relating to the clearing of inter-enterprise arrears. In addition, limited training of the new users in payments system procedures at a time of an explosion in the number of documents, without adequate standards, formats, and bank numbering scheme, and continuous changes in operating procedures—some of them with retroactive effect—also resulted in numerous errors, significant rerouting or duplication in payment traffic, outright loss of documents, and processing in violation of instructions from CBR headquarters. Persistent fraud is alleged to have evolved in this context. ^24/ It led the CBR at various times to tighten control over the processing of payments. These measures caused further delays as a result of difficulties in the implementation of frequently adjusted processing rules to tackle fraud, and the general shortage of staff, particularly in key centers, such as Moscow.

Table 1 contains a summary of measures and developments in the domestic payments system operated by the CBR during 1992-94; details and context can be found in the Appendix. Overall, the CBR measures were initially designed to speed up the transportation of payment documents, streamline operating procedures, strengthen security to contain fraud, and reorganize and update automation and computer systems. While these measures served to stabilize the CBR payments system or respond to particular emergencies, the CBR has also planned a series of medium-term reforms aimed at establishing a modern payments system within 3-5 years. Main components of the medium-term reform are the establishment of an LVTS based on real-time gross settlement, the clearing of bulk payments through CBR-licensed private clearing houses and through selected CSCs converted into CBR-operated clearing centers, the further development of standards, a legal and a supervisory framework, the planning of new instruments, and the construction of a technology platform, including a communications system. 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. ^25/ The CBR has begun to license commercial bank-operated clearing houses, developed in cooperation with the commercial banks detailed operating procedures for the clearing houses, and has started work on specifying concrete user requirements for large value transfer system, a project to which CBR attaches high priority. The CBR is also considering the establishment of a dedicated large value transfer system to support the rapidly growing treasury bill, foreign exchange, and interbank markets, and steps to centralize commercial bank accounts with the CBR. For example, the system of settlements for treasury bill transactions is being modified to permit settlements in the accounts with the CBR rather than the current settlement method of using funds predeposited with an outside settlement agent. The CBR is also modifying its monetary operations procedures to better manage money market liquidity. In particular, the CBR has already introduced credit auctions, and is planning to introduce Lombard and bill rediscounting facilities.

Table 1.

Russian Federation: Major Developments in the Domestic Payments System Operated by the CBR. 1992-94

Table 1.

Russian Federation: Major Developments in the Domestic Payments System Operated by the CBR. 1992-94

Date	Measure	Comments (Purpose/Effects)
January 1992	New Russia check introduced.	New debit payment instrument; led to fraud owing to weak regulatory and operational framework; use was sharply curtailed in second half of 1992.
April 1992	Procedural changes in CSCs to contain fraud.	Requirement to process all payments—including local—through the CBR led to congestion in CSCs; withdrawn in May.
April-June 1992	Centralization of processing of interstate payments, first in main regional offices (April), then in Moscow (June).	To improve monitoring of accounts of other FSU states with CBR, and thereby control any balance of payments financing of other states. Led to congestion in Moscow.
July 1992	Payment demand order discontinued.	To strengthen financial discipline in inter-enterprise payment practices, contain inter-enterprise arrears, and reduce processing work load of commercial banks.
Summer 1992	Processing of unpaid payment documents as of July 1, 1992.	To clear inter-enterprise arrears; led to congestion due to cumbersome processing arrangements; net arrears were eventually monetized.
Fall 1992	Dedicated courier services between CSCs.	To improve security of transportation on trunk lines, speed up document transmission, and standardize transportation time.
Fall and winter 1992	New security procedures for telegraphic payments.	To introduce arrangements for large value payments; scope was tightened on January 1, 1993.
Spring 1993	International Steering Committee and six working groups were established.	To develop medium-term reforms and build consensus between the CBR and commercial banks.
June-October 1993	Special authentication procedures for large values (above Rub 100 million).	To combat fraud; withdrawn in October 1993.
June-November 1993	Steps to streamline overdraft use of commercial banks at the CBR.	To curtail arrears in repaying CBR overdraft credit, and prevent further recourse to overdraft. Reflected basic weaknesses in CBR payments system and requires comprehensive reforms to eliminate overdrafts.
August 1993	Provisional guidelines on interbank electronic funds transfers.	To guide regional pilots and to serve as a basis for future funds transfers rules.
November 1993	Licenses for private clearing houses issued.	To introduce the possibility of netting arrangements.
Throughout 1993 (also 1992)	Development of special program for information technology for the CBR.	To automate accounting in CSCs and introduce electronic funds transfer system; continued implementation of regional pilots under this framework.
Fall 1993	Proposal for altering settlement system for treasury bill is discussed in CBR Board.	Draft regulations prepared in March 1994.
May 1994	Detailed operating rules, and privileges and obligations of participants, of clearing houses approved by CBR.	Several operational and regulatory constraints continue to delay the establishment of clearing houses.
May 1994	Detailed user requirements for a pilot large value transfer system prepared.	Consultations with commercial banks and regional offices are proceeding.

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Table 1.

Russian Federation: Major Developments in the Domestic Payments System Operated by the CBR. 1992-94

Date	Measure	Comments (Purpose/Effects)
January 1992	New Russia check introduced.	New debit payment instrument; led to fraud owing to weak regulatory and operational framework; use was sharply curtailed in second half of 1992.
April 1992	Procedural changes in CSCs to contain fraud.	Requirement to process all payments—including local—through the CBR led to congestion in CSCs; withdrawn in May.
April-June 1992	Centralization of processing of interstate payments, first in main regional offices (April), then in Moscow (June).	To improve monitoring of accounts of other FSU states with CBR, and thereby control any balance of payments financing of other states. Led to congestion in Moscow.
July 1992	Payment demand order discontinued.	To strengthen financial discipline in inter-enterprise payment practices, contain inter-enterprise arrears, and reduce processing work load of commercial banks.
Summer 1992	Processing of unpaid payment documents as of July 1, 1992.	To clear inter-enterprise arrears; led to congestion due to cumbersome processing arrangements; net arrears were eventually monetized.
Fall 1992	Dedicated courier services between CSCs.	To improve security of transportation on trunk lines, speed up document transmission, and standardize transportation time.
Fall and winter 1992	New security procedures for telegraphic payments.	To introduce arrangements for large value payments; scope was tightened on January 1, 1993.
Spring 1993	International Steering Committee and six working groups were established.	To develop medium-term reforms and build consensus between the CBR and commercial banks.
June-October 1993	Special authentication procedures for large values (above Rub 100 million).	To combat fraud; withdrawn in October 1993.
June-November 1993	Steps to streamline overdraft use of commercial banks at the CBR.	To curtail arrears in repaying CBR overdraft credit, and prevent further recourse to overdraft. Reflected basic weaknesses in CBR payments system and requires comprehensive reforms to eliminate overdrafts.
August 1993	Provisional guidelines on interbank electronic funds transfers.	To guide regional pilots and to serve as a basis for future funds transfers rules.
November 1993	Licenses for private clearing houses issued.	To introduce the possibility of netting arrangements.
Throughout 1993 (also 1992)	Development of special program for information technology for the CBR.	To automate accounting in CSCs and introduce electronic funds transfer system; continued implementation of regional pilots under this framework.
Fall 1993	Proposal for altering settlement system for treasury bill is discussed in CBR Board.	Draft regulations prepared in March 1994.
May 1994	Detailed operating rules, and privileges and obligations of participants, of clearing houses approved by CBR.	Several operational and regulatory constraints continue to delay the establishment of clearing houses.
May 1994	Detailed user requirements for a pilot large value transfer system prepared.	Consultations with commercial banks and regional offices are proceeding.

In the current operation of the CBR payments system, reliable next-day settlement has become the norm for in-city payments. However, intercity payments through the CBR system remain too uncertain and settlement time cannot be guaranteed. In response, a major development in the Russian payments system has been the emergence of private sector payment services through clearing banks beginning in 1993. The resulting payments system is a mixture of private services for clearing of intercity payments combined with CSC services for the clearing and settlement of mostly local payments. In this system, any intercity payment is essentially converted into a series of local payments that ensure finality on the books of the CBR; the configuration is illustrated in the Appendix. Several commercial banks have expanded the network of correspondent banks through which interbank funds transfers can be completed rapidly, and interbank money market transactions can be initiated and completed efficiently. Also, new institutions to service interbank credit needs emerged. ^26/ The developments in commercial bank correspondent banking and the related settlement and money market trading services have exacerbated concerns of systemic risks due to large interbank exposures, and have underscored the urgency of developing an appropriate risk management framework, including the establishment of a rapid and secure interbank gross settlement system using central bank money.

2. Issues in the measurement of the payment float of the CBR^27/

We now turn to the analysis and measurement of payment float of the CBR whose size and variability mirrors the impact of developments and reforms of the payments system. Data on float were constructed from the monthly trial balance sheets of the CBR, based on the section of the Soviet plan of accounts dealing with interbranch settlements; the 70 or so accounts in this section remained broadly in consistent use throughout the period as suspense accounts for items in transit. ^28/ However, it is necessary to monitor the use of these accounts, as well as several other accounts outside the section on interbranch settlement, in order to identify possible changes in account usage, consolidation or discontinuation of transactions, and generally, the accounting effects of CBR measures designed to stabilize the payments system.

At any given time, the nominal stock of payment float of the CBR 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. ^29/ Chart 4 shows the size and variability of the CBR payment float since May 1992 as a ratio to GDP. During this period, CBR payment float has mainly been a credit float—a withdrawal of liquidity from the system, and fluctuated between -1.5 percent and 7 percent of GDP around an average of 2.7 percent. The variability is a product of the prevalence of credit over debit payment instruments; in typical payments systems, delays in payment processing equally affect credit and debit instruments, giving rise both to credit and debit floats with a tendency for the two to offset each other. Initial difficulties in the payments system and the subsequent impact of reforms designed to improve the reliability of payments as a result of measures initiated in the second half of 1992 are reflected in the behavior of central bank payment float; since mid-1993, there has been a tendency toward more stability. When expressed as a percent of GDP, average float measured before and after May 1993 declined from 3.3 percent to 2.5 percent; the standard deviation declined from 2.1 percent before May 1993 to 1.1 percent after May 1993. Clearly, these statistics are dominated by onetime events of the second half of 1992 as depicted in Chart 4. In particular, 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 increase in net credit to government. The effects of inflation and credit to government on CBR float are discussed below.

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CBR PAYMENT FLOAT

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

SOURCE: CENTRAL BANK OF RUSSIA, AND STAFF ESTIMATES.

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The measurement of float that genuinely results from the operation of the payments system, that is, funds in the process of settlement, poses many difficulties in Russia. 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 which 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 inter-enterprise arrears (IEA) between July and October 1992, and the recording of government reporting float.

• The clearing of domestic inter-enterprise arrears 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 when the payment documents were being processed. ^30/ Chart 5 shows the size of this adjustment in 1992.

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CBR PAYMENT FLOAT, ADJUSTED

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

SOURCE: CENTRAL BANK OF RUSSIA, AND STAFF ESTIMATES.

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• Government deposits collected in the CBR branches are periodically reported (but 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 occurred 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 CBR float, particularly in 1992 and 1993. ^31/

3. Determinants of CBR float—an analytical 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 CBR 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.

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

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

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

v_t = average value of individual payment order in period t, V_t/N_t

During each period t, the correspondent accounts of commercial banks at the central bank are debited by the amount V_t, 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 α_i (i=0, 1,...,L) ^32/ of payment orders which enter the system in period t is received at the cash settlement center of payees’ banks in period t+i and that the amount α_iV_t 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 α_i, 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. The expression (3) can be regarded as a flow measure of central bank payment float.

In the balance sheet of the CBR 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.

Time	Cumulative Sum of Debits	Cumulative Sum of Credits	Stock of Float
t	Dt=∑i=0, LVt-i	Ct=∑i=0, L∑l=0, iαlVt-i	Ft=Dt-Ct

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Time	Cumulative Sum of Debits	Cumulative Sum of Credits	Stock of Float
t	Dt=∑i=0, LVt-i	Ct=∑i=0, L∑l=0, iαlVt-i	Ft=Dt-Ct

In the above table, the summation is extended over L periods. Accordingly, the value of payment orders debited in period t-L or earlier have been offset by corresponding credits and do not appear in the summation. Using the expression in the table, the nominal stock of float can be expressed as,

where V_t = v_tN_t. It can be readily verified that expression (4) for the stock measure of float F_t can be used to derive the expression (3) for ΔF_t = F_t - F_t-1.

V_t, the nominal value of transactions, increases pari passu with inflation and general economic activity. In order to take into account the pass-through effect on float of inflation and growth, it is useful to compute the value of float as a ratio to GDP, f_t - F_t/GDP_t expressed as,

where μ_t is the average real value of individual payments processed by the CBR, and N/gdp is the number of payment documents processed by CBR per unit of real GDP (gdp).

According to expression (5), CBR float is influenced by factors that affect the weights α_i the average real value of transactions, and the number of transactions passing through the central bank system. The weights α_i are time-varying, endogenous variables that depend upon 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, to the extent that such large payments go through the central bank system.

The number of transactions (adjusted for economic activity) transiting via the central bank system would depend on the multiplier effect of base money expansion, on expected inflation, on the rate of use of noncash payments, and on the share of noncash payments passing through the CBR system. The multiplier effect of central bank liquidity injections influences both the number of transactions as well as the lags in the transmission of the payment instructions. In this regard, 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, i.e., in a much more diffuse way via the branches of the CBR. Lags in local, intracity payments are smaller—typically 1-2 days under normal operating circumstances—than intercity payments, as most of these payments transit via one local CSC. ^33/ For this reason, one would not expect a significant first-round impact on CBR float of credit to banks. Second and subsequent rounds of payments are, of course, a mix of local and intercity payments. ^34/ However, as discussed, banks have progressively routed intercity payments via correspondents outside the CBR payment centers and, therefore, the number of such transactions contributing to CBR payment float has declined throughout the period.

In contrast, the initial disbursement of new credit to government occurs in Moscow and its transfer to the regions is effected through the CBR network of CSCs. Accordingly, an increase in central bank credit to government is typically associated with an increased number of interregional payments and longer transmission lags. CBR payment float and credit to banks are plotted in Chart 6; there is no apparent co-movement between the two series. On the contrary, float and net credit to government shown in Chart 7 display a marked co-movement throughout the period.

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CBR PAYMENT FLOAT AND CREDIT TO BANKS

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

SOURCE: CENTRAL BANK OF RUSSIA; AND STAFF ESTIMATES

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CBR FLOAT AND NET CREDIT TO GOVERNMENT

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

SOURCE: CENTRAL BANK OF RUSSIA AND STAFF ESTIMATES

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An acceleration of inflation would reduce demand for reserve money in real terms; to the extent that inflation is anticipated, the typical response of users of the payments system would be to attempt to offset an anticipated rise in inflation by delaying payments, if feasible, captured in equation (5) as a reduction in the number of transactions. Also, in reaction to inflation, an increase in the use of cash (to ensure immediate settlement) or the development of faster payment services outside the central bank circuit would reduce float. ^35/ The historical relationship between CBR payment float and inflation is depicted in Chart 8. Notice in particular that the acceleration of inflation during July-October 1992 is associated with a switch from the usual credit float to a debit float, suggesting possibly an endogenous response of float to inflation expectations. In October 1992, the value of payment documents entering the CBR system (value of debits) measured as a ratio to GDP dropped from 198.1 percent to 188.4 percent, while the value of payments exiting the CBR system (value of credits) only dropped from 197.5 percent to 192.1 percent, leaving a gap of 3.6 percent corresponding to the debit float of that month. However, in addition to inflationary expectations, these numbers may be explained by a bout of congestion in the CBR system. Overall, August-October 1992 were difficult months of operations for the CSCs, particularly in Moscow, as new procedures for interstate payments were introduced, the paper flow related to the clearing of inter-enterprise arrears slowed down current payments, and instances of payment fraud multiplied, leading to a slowdown of paper flow to conduct payment by-payment verification. The importance of congestion may be seen in the surge in float in November 1992, when the backlogged documents were processed (thereby raising the value of debits in relation to credits).

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CBR PAYMENT FLOAT AND INFLATION

Citation: IMF Working Papers 1994, 133; 10.5089/9781451855425.001.A001

SOURCE: CENTRAL BANK OF RUSSIA, AND STAFF ESTIMATES.

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4. Regression results and impact of reforms

Based on the above discussion of determinants of CBR float, the following propositions may be considered. First, in the short run, the change in float would be influenced positively by the value of nominal transactions processed by the CBR, proxied by the change in central bank credit to government, and negatively by the change in inflation.

Second, the effect of measures undertaken by the CBR to improve the central bank payments system in late 1992 and early 1993 reduced thereafter the level of float and its variability, after controlling for other factors that influence float.

These propositions imply the following reduced form equation:

Δf = a₀ Δg - α₁ Δπ - α₂ DUM, where

Δf = change in float as a ratio to GDP

Δg = change in net credit to government as a ratio to GDP

Δπ = change in inflation

DUM = dummy variable to capture the impact of payment system reforms in late 1992 and early 1993

The above equation was estimated to explain the monthly changes in central bank payment float in the Russian Federation, for the period May 1992 to May 1994. The quality of estimates is constrained by the limited number of observations, by ongoing difficulties in the measurement of central bank float, and by structural factors that cannot easily be captured, e.g., growth in correspondent banking network, which would reduce the value of payments processed by CBR. Nevertheless, plausible results were obtained as shown in the estimated equation below:

Δf = 0.74 Δg - 0.06 Δπ - 1.93 DUM

(2.17) (0.95) (4.88)

Adjusted R² = 0.44 ; DW = 1.56

(Figures in parentheses are t-statistic)

Coefficients have the anticipated signs; an increase in credit to government led to an increase in float and an increase in inflation reduced the float, although the latter effect is not statistically significant. Each 1 percentage point increase in net credit to government as a ratio to GDP led to an estimated 0.74 percent increase in CBR float with a standard error of 0.34 percent. This suggests that the CBR payments system acted as a buffer temporarily absorbing up to three fourths of new net credit to government. Specifications including credit to banks as explanatory variable yielded insignificant coefficients. ^36/

As explained, an increase in expected inflation would tend to reduce the number of transactions as economic agents delay execution of payments—“play the float.” However, when considered over the full period May 1992-May 1994, it appears that this effect played only a minor role in Russia, suggesting that congestion may have been the driving force behind movements in float in September-November 1992.

The dummy variable (DUM = 1, for March 1993 and DUM = 0, otherwise) captures the effect of payments system reforms during late 1992 and early 1993; it is assumed these reforms had their full effects by March 1993. The coefficient is statistically significant at the 1 percent level, indicating that by the end of the first quarter of 1993, the initial CBR stabilization measures contributed to reduce the CBR float permanently by almost 2 percent of GDP, ^37/ all other things equal.

The impact of payments system reforms is also reflected in the behavior of the residuals of the estimated equation, which capture the variability of float 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 that were not captured by the dummy variable. The standard error of the residuals declined from 1.8 percent before March 1993 to 0.55 percent after. The sharp drop in the standard error of the residuals suggests that the CBR measures contributed to the reduction in the variability of float starting at the end of the first quarter of 1993, in addition to reducing its size. However, this line of reasoning must be used cautiously, as a key structural factor affecting the Russian payments system starting in 1993 is the emergence of significant correspondent banking specifically to bypass the CBR payments system. The estimated equation does not control for this factor.

One particular CBR measure aimed at detecting fraud consisted of imposing between June and October 1993 special authentication requirements on large value payments. Using a dummy variable to capture the impact of this measure, a temporary increase of CBR float of 0.16 percent of GDP (standard error of 0.15 percent) was noted.

In conclusion, the main result of the above analysis is that the payment operations which generated the float served to offset the monetary effects of central bank credit operations and thereby dampened, in particular, the impact of CBR credit to government on money expansion. Accordingly, float acted as a kind of automatic stabilizer which absorbed surges in CBR credit, specifically credit to government. No such stabilization effect on credit to banks has been found to exist. The analysis also revealed that the initial measures to stabilize the central bank payments system have contributed to a sizable reduction both in the level and variability of the central bank float, that is, a significant improvement in the efficiency of the system. Another factor at work has been the development of correspondent banking.

Significant residual variability in CBR float, 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 float as automatic stabilizer should not be extrapolated into the future. Moreover, a permanent reduction in the level of float, as a result of further reforms being undertaken to modernize the payments system, would need to be absorbed by appropriate monetary operations.