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The role of central bank money for large value payment systems

Robert LindleyDeputy Head, CPSS Secretariat

Regional workshop on reforming payment and securities settlement systems for the Middle East and North Africa

Bahrain, Wednesday 16 March 2005

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Overview

1. Some stylised facts about central bank money

2. Who must use central bank money

3. Who can use central bank money

4. Services on central bank accounts

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Importance of money

Almost every economic transaction involves money Economic agents free to choose means of payment Most money is “fiat” money – so acceptance depends on

trust Key role of central bank is to maintain trust in money –

both its value (monetary policy) and its circulation (payment systems)

1. Some facts about central bank money

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Money, money, money ….

Type of money

Cash (banknotes and coins)

Deposits (current/sight)

E-money

1 X not now

limited access X not yet?

Type of issuer

Central bank Commercial banks

1 Coins are usually issued by the Ministry of Finance (this complication is ignored in the rest of the presentation)

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Central bank cash

Central bank has monopoly But universal “access” – everyone can use cash Why? Cash is a bearer instrument Safe and convenient for users to have central bank

monopoly – no need to worry about the riskiness of the issuer

A monopoly? Inefficient? Cost may not be too high.

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Central bank deposits

Central bank and commercial banks both issue deposit money but access to central bank deposit money is usually very limited (eg mostly banks and government). Why?

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Architectureof deposit money

Central bank

Central bank and commercial bank money

A D

CB

A D

CB

“Free” bankingMore efficient but less safe?

A balance between safety and efficiency

MonobankingSafe but less efficient?

Central bank

Efficient - competition between banks (more important than with cash)

Safe – banks (and customers) indifferent about where payments come from

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Advantages and disadvantages of settling in central bank money

Advantages for banks Safety (credit and liquidity risk, business continuity) Liquidity (routine and emergency) Efficiency (single settlement institution) Neutrality (central bank is not usually a competitor) Other perceived benefits (safety net)

Disadvantages for banks No interest paid Regulatory costs

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“The singleness of the currency”

Originally a result of central bank monopoly of cash … … and, for deposit transfers, interbank settlement at the

central bank

More recently also supported by: deposit insurance banking supervision

which mean we worry less about bank failures

One dollar is one dollar is one dollar … regardless of whose liability it is.

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Three issues

Who must use central bank money – who must have a central bank account?

Who can use central bank money – who is allowed to have a central bank account?

What services should the central bank provide on the accounts?

A D

CB

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Payment systems

1 Systemically important payment systems

“Assets used for settlement should preferably be a claim on the central bank; where other assets are used they should carry little or no credit or liquidity risk”Core principles for systemically important payment systems (SIPS)

Reason: safety In practice, almost all SIPS do settle in central bank money Main exceptions: foreign currency systems (nb: CLS as key example)

2. Who must use central bank money

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2 Other payment systems?

Usually allowed to settle in central bank money but do not have to

In practice, most usually do

Efficiency and neutrality particularly important

Sometimes discouraged (particularly if system includes non-banks as participants)

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Individual banks?

Central bank

B E

DC

Single-tier structure

FA

B

Central bank

C

A

D

Two-tier structure

E

F

Second tier banks (indirect participants)

First tier banks (direct participants)

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Tiering

Extent of tiering depends partly on costs Partly on tradition Partly on cartels (especially in the past) … but rarely forbidden. (NB Hong Kong.) Usually central

banks leave it up to individual banks to decide. Why?

• Big banks typically do use central bank money

• Efficiency benefits may outweigh safety costs

• Difficult to enforce

• But ……

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Concentration ……

Central bank

B E

DC

Single-tier structure

B

Central bank

C

A

D

Two-tier structure

FA

E

F

Is this a quasi-system?

Flows via central bank:

A↔BA↔CA↔DA↔EA↔FB↔CB↔DB↔EB↔FC↔DC↔EC↔FD↔ED↔FE↔F

Flows via central bank:

A↔B

A↔FB↔CB↔DB↔EB↔F

C↔F

D↔FE↔F

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Quasi-systems

Central banks still considering what (if anything) to do Unlikely to lead to limits on tiering May lead to oversight of quasi-systems (ie some payment

system standards applied to Bank A) Practical issues (eg how big do you have to be to be a

quasi-system) Cooperation with banking supervisors likely

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Who can have access?

Always or almost always

Often Sometimes Never or almost never

Banks Non-bank securities firms

Other non-bank FIs

General public

Central banks and IFIs

Remote access banks

Corporates

Central government

Other government

Central bankstaff

Key: increasing trend no change decreasing trend

3. Who can use central bank money

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Increasing trend (1)

Non-bank securities firms and other non-bank financial institutions

May be similar to banks – the border line is not always clear

Advantages of allowing access systemic risk? competitive disadvantage? central bank neutrality?

Disadvantages of allowing access moral hazard? disintermediation? risk to central bank?

A D

CB

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USD

United States

Hong Kong

Germany

BankBank Bank

Bank

Bank

Bank

Increasing trend (2)

Remote access

Main issue is risk (especially if

credit is available)

Is there demand? NB CLS as key

example

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Decreasing trend

Government (central and other), central bank staff, general public, corporates

Advantages of allowing access “Experience” for the central bank Neutrality (for government)

Disadvantages of allowing access Unfair advantage? (re general public and corporates) No particular advantage – better to have a competitive tender (re government)

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Services on accounts

Credit– Account may be of little benefit without it– Risk to central bank (so collateral, limits, fees)

Reducing credit costs– System design (eg hybrids)– Wider range of collateral

Technical changes– Standards– Easier connectivity

Operating hours– CLS as an example

4. What services should central banks provide?

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CLS: a key example

USD

BANK A ZURICH

BANK B BAHRAINJPY

Continuous Linked Settlement is an example of settlement in commercial bank money, remote access, and the need for longer opening hours

(1) A foreign exchange deal

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(2) The current settlement method

BANK A ZURICH

Bank A's USD correspondent

Bank B's USD correspondent

USD payment system

USDUSD

USD

Bank A's JPY correspondent

Bank B's JPY correspondent

JPY payment system

JPY JPY

JPY

BANK B BAHRAIN

X

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(3) Under CLS

CLS

BANK

Bank A’s USD

corresp-ondent

USDUSD

Bank B’s USD

corresp-ondent

USDUSD

JPY

Bank A’s JPY

corresp-ondent JPY JPY

Bank B’s JPY

corresp-ondentJPY

BANK A ZURICH

BANK B BAHRAIN

CLS BANK NEW YORK

Settlement is on the books of CLS Bank (ie not central bank money)

CLS has remote access to RTGS systems around the world to receive and make these payments …

… and needs all systems to be open at the same time …

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“Core” CLS hours(7 to 12 CET)

0 6 12 18 24 6 12

Japan

Switzerland

USA (NY)

(4) Payment system hours

First day (in Japan) Second day (in Japan)

Day 1

Day 1

Day 1

Day 2

16 22 4 10 16 22 4

10 16 22 4 10 2216

Time in Japan

Time in Switz.

Time in USA

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Conclusion

A mixture of central bank and commercial bank money is important to achieve a balance between safety and efficiency.

But there are no clear rules about who can or must use central bank money. It is a matter of judgement about where the best balance lies.

A D

CB