transforming payment systems: meeting the needs of emerging market economies, parts 63-291

title:

TransformingPaymentSystems:MeetingtheNeedsofEmergingMarketEconomiesWorldBankDiscussionPapers,0259-210X;291

author: Satåo,Setsuya.;Humphrey,DavidB.publisher: WorldBank

isbn10|asin: 0821333550printisbn13: 9780821333556ebookisbn13: 9780585269535

language: English

subject

Banksandbanking--Developingcountries--Communicationsystems,Clearinghouses(Banking)--Developingcountries--Dataprocessing,Payment--Developingcountries--Dataprocessing,Electronicfundstransfers--Developingcountries.

publicationdate: 1995lcc: HG3550.S281995eb

ddc: 332.1/78

subject:

Banksandbanking--Developingcountries--Communicationsystems,Clearinghouses(Banking)--Developingcountries--Dataprocessing,Payment--Developingcountries--Dataprocessing,Electronicfundstransfers--Developingcountries.

RecentWorldBankDiscussionPapers

No.223TheDevelopmentofthePrivateSectorinaSmallEconomyinTransition:TheCaseofMongolia.HongjooHahm

No.224TowardanEnvironmentalStrategyforAsia.CarterBrandonandRameshRamankutty

No.225"FortressEurope"andOtherMythsaboutTrade:PoliciestowardMerchandiseImportsintheECandOtherMajorIndustrialEconomies(andWhatTheyMeanforDevelopingCountries)JeanBaneth

No.226Mongolia:FinancingEducationduringEconomicTransition.KinBingWu

No.227CitieswithoutLandMarkets:LessonsoftheFailedSocialistExperiment.AlainBertaudandBertrandRenaud

No.228PortfolioInvestmentinDevelopingCountries.EditedbyStijnClaessensandSudarshanGooptu

No.229AnAssessmentofVulnerableGroupsinMongolia:StrategiesforSocialPolicyPlanning.CarolineHarper

No.230RaisingtheProductivityofWomenFarmersinSub-SaharanAfrica.KatrineSaito

No.231AgriculturalExtensioninAfrica.ArunaBagchee

No.232TelecommunicationsSectorReforminAsia:TowardaNewPragmatism.PeterL.SmithandGregoryStaple

No.233LandReformandFarmRestructuringinRussia.KarenBrooksandZviLerman

No.234PopulationGrowth,ShiftingCultivation,andUnsustainableAgriculturalDevelopment:ACaseStudyinMadagascar.AndrewKeck,NarendraP.Sharma,andGershonFeder

No.235TheDesignandAdministrationofIntergovernmentalTransfers:FiscalDecentralizationinLatinAmerica.DonaldR.Winkler

No.236PublicandPrivateAgriculturalExtension:BeyondTraditionalFrontiers.DinaL.UmaliandLisaSchwartz

No.237IndonesianExperiencewithFinancialSectorReform.DonaldP.Hanna

No.238PesticidePoliciesinDevelopingCountries:DoTheyEncourageExcessiveUse?JumanahFarah

No.239IntergovernmentalFiscalRelationsinIndonesia:IssuesandReformOptions.AnwarShahandZiaQureshi

No.240ManagingRedundancyinOverexploitedFisheries.JoshuaJohn

No.241InstitutionalChangeandthePublicSectorinTransitionalEconomies.SalvatoreSchiavo-Campo

No.242AfricaCanCompete!:ExportOpportunitiesandChallengesforGarmentsandHomeProductsintheUS.Market.TylerBiggs,GailR.Moody,Jan-HendrikvanLeeuwen,andE.DianeWhite

No.243LiberalizingTradeinServices.BernardHoekmanandPierreSauvé

No.244WomeninHigherEducation:Progress,Constraints,andPromisingInitiatives.K.Subbarao,LauraRaney,HalilDundar,andJenniferHaworth

No.245WhatWeKnowAboutAcquisitionofAdultLiteracy:IsThereHope?HelenAbadzi

No.246FormulatingaNationalStrategyonInformationTechnology:ACaseStudyofIndia.NagyHanna

No.247ImprovingtheTransferandUseofAgriculturalInformation:AGuidetoInformationTechnology.WillemZijp

No.248OutreachandSustainabilityofSixRuralFinanceInstitutionsinSub-SaharanAfrica.MarcGurgand,GlennPederson,andJacobYaron

No.249PopulationandIncomeChange:RecentEvidence.AllenC.KelleyandRobertM.Schmidt

No.250SubmissionandEvaluationofProposalsforPrivatePowerGenerationProjectsinDevelopingCountries.EditedbyPeterA.Cordukes

No.251SupplyandDemandforFinanceofSmallEnterprisesinGhana.ErnestAryeetey,AmoahBaah-Nuakoh,TamaraDuggleby,HemamalaHettige,andWilliamFSteel

No.252ProjectizingtheGovernanceApproachtoCivilServiceReform:AnEnvironmentAssessmentforPreparingaSectoralAdjustmentLoanintheGambia.RogerioF.PintowithassistancefromAngelousJ.Mrope

No.253SmallFirmsInformallyFinanced:StudiesfromBangladesh.EditedbyReazulIslam,J.D.VonPischke,andJ.M.deWaard

No.254IndicatorsforMonitoringPovertyReduction.SoniyaCarvalhoandHowardWhite

No.255ViolenceAgainstWomen:TheHiddenHealthBurden.LoriL.HeisewithJacquelinePitanguyandAdrienneGermain

No.256Women'sHealthandNutrition:MakingaDifference.AnneTinker,PatriciaDaly,CynthiaGreen,HelenSaxenian,RamaLakshminarayanan,andKirrinGill

(Continuedontheinsidebackcover)

Pagei

291 WorldBankDiscussionPapers

TransformingPaymentSystemsMeetingtheNeedsofEmergingMarketEconomies

SetsuyaSatoDavidBurrasHumphrey

Pageii

Copyright©1995TheInternationalBankforReconstructionandDevelopment/TheWorldBank1818HStreet,N.WWashington,D.C.20433,U.S.A.

AllrightsreservedManufacturedintheUnitedStatesofAmericaFirstprintingJuly1995

DiscussionPaperspresentresultsofcountryanalysisorresearchthatarecirculatedtoencouragediscussionandcommentwithinthedevelopmentcommunity.Topresenttheseresultswiththeleastpossibledelay,thetypescriptofthispaperhasnotbeenpreparedinaccordancewiththeproceduresappropriatetoformalprintedtexts,andtheWorldBankacceptsnoresponsibilityforerrors.Somesourcescitedinthispapermaybeinformaldocumentsthatarenotreadilyavailable.

Thefindings,interpretations,andconclusionsexpressedinthispaperareentirelythoseoftheauthor(s)andshouldnotbeattributedinanymannertotheWorldBank,toitsaffiliatedorganizations,ortomembersofitsBoardofExecutiveDirectorsorthecountriestheyrepresent.TheWorldBankdoesnotguaranteetheaccuracyofthedataincludedinthispublicationandacceptsnoresponsibilitywhatsoeverforanyconsequenceoftheiruse.Theboundaries,colors,denominations,andotherinformationshownonanymapinthisvolumedonotimplyonthepartoftheWorldBankGroupanyjudgmentonthelegaltatusofanyterritoryortheendorsementoracceptanceofsuchboundaries.

Thematerialinthispublicationiscopyrighted.RequestsforpermissiontoreproduceportionsofitshouldbesenttotheOfficeofthePublisherattheaddressshowninthecopyrightnoticeabove.TheWorldBankencouragesdisseminationofitsworkandwillnormally

givepermissionpromptlyand,whenthereproductionisfornoncommercialpurposes,withoutaskingafee.PermissiontocopyportionsforclassroomuseisgrantedthroughtheCopyrightClearanceCenter,Inc.,Suite910,222RosewoodDrive,Danvers,Massachusetts01923,U.S.A.

ThecompletebacklistofpublicationsfromtheWorldBankisshownintheannualIndexofPublications,whichcontainsanalphabeticaltitlelist(withfullorderinginformation)andindexesofsubjects,authors,andcountriesandregions.ThelatesteditionisavailablefreeofchargefromtheDistributionUnit,OfficeofthePublisher,TheWorldBank,1818HStreet,N.W,Washington,D.C.20433,U.S.A.,orfromPublications,TheWorldBank,66,avenued'Iéna,75116Paris,France.

ISSN:0259-210X

SetsuyaSatoisfinancialadviserintheWorldBank'sFinancialSectorDevelopmentDepartment.DavidBurrasHumphreyisprofessoroffinanceandFannieWilsonSmithEminentScholarinBankingatFloridaStateUniversity,Tallahassee.

LibraryofCongressCataloging-in-PublicationDataSato,Setsuya,1952-Transformingpaymentsystems:meetingtheneedsofemergingmarketeconomies/SetsuyaSato,DavidBurrasHumphrey.p.cm.(WorldBankdiscussionpapers,ISSN0259-210X;291)Includesbibliographicalreferences(p.).ISBN0-8213-3355-01.BanksandbankingDevelopingcountriesCommunicationsystems.2.Clearinghouses(Banking)DevelopingcountriesDataprocessing.3.PaymentDevelopingcountriesDataprocessing.4.ElectronicfundstransfersDevelopingcountries.I.Humphrey,DavidB.II.Title.III.Series.

HG3550.S281995332.1'78dc2095-23991CIP

Pageiii

Contents

Foreword v

Abstract vi

Introduction 1

I.Differencesinpaymentsystemsincentrally-plannedandmarketeconomies

3

1.Thestructureandoperationofpaymentsincentrally-plannedeconomies

3

Centralplanninginagovernment-ownedmono-bankingsystem

3

Theroleofthepaymentsystems:monitoringtheplan 4

Stateguarantees:nocreditriskforpaymentreceivers 7

Timeinsensitivityofpayments 10

Limitedneedforcomprehensivelegal,accounting,andcommunicationsinfrastructure

10

Cash-basedretailpayments 10

2.Paymentsystemsinmarketeconomies 11

Supportofrealandfinancialmarkets 11

Privateresponsibilityforcreditneedsandriskassessment

12

Paymentfloatandincentivesfortimelypaymentandsettlement

13

Cash,check,GIROretailpayments,andelectroniclargevaluetransfers

14

3.Improvingthepaymentsystemintransitionaleconomies

16

Structure 17

Purpose 17

Enterprisepayments 18

Guarantees 18

Settlement 19

Retailpayments 19

II.Thepaymentcycle:Structureandchoices 21

1.Thestructureofthepaymentcycle 21

Aconceptualmodelofthepaymentcycle 21

Paymententry-Step1 23

Inboundprocessingandtransfer-Step2 23

Inboundclearing-Step3 24

Grossornetsettlement-Step4 24

Outboundclearing-Step5 24

Outboundprocessingandtransfer-Step6 24

Pageiv

Paymentdistribution-Step7 25

Floatandpaymentfinality 26

2.Clearingfinancialmarkettransactions 26

Clearingandsettlementforfinancialmarkets:clearinghouses

26

Paymentcycleforimmobilizedorbook-entrysecuritiesindepositories

28

3.Choicesinthepaymentcycle 30

Supplierandownershipchoice:banksversusthepostoffice

30

Local,regional,ornationalprocessingandsettlement 31

Privatebankversuscentralbankprocessing 32

Accessandsecuritychoices 32

Participantliabilitiesanderrorresolution 33

Settlementofcross-borderpayments 33

III.Marketneedsandchoicesinanevolvingpaymentsystem

35

1.Paymentsystemchoicesinmarketeconomies:theU.S.andEuropeanexperience

35

Centralizedversusdecentralizedsupplyofsavingsandpaymentservices

35

Paperversuselectronicpayments 36

Non-bankcompetitioninsupplyingpaymentservices 36

Paymentpricingandpaymentfloat 37

Commercialbankandcentralbankpaymentfunctions 37

2.Marketneedsintransitionaleconomies 38

Paymentsystemevolution:transitionaleconomies 38

Userneedsandpaymentsystemdesign 40

Appendix:Planningforpaymentsystemimprovements 42

Pagev

ForewordUntilveryrecently,interestinpaymentsystemissueshasoftenbeenofsecondaryimportanceinthefinancialsectordevelopmentagenda.Thisreflectedaviewthatthepaymentsystemisessentiallyamechanicalprocessandthatnothingmorethananautomationofcommercialbanks'back-officesupportfunctionisrequiredtoachievethegoal.

Today,thereisagrowingperceptioninboththeWorldBankanditsclientcountriesthatsuchalimitedviewunderestimatetherolepaymentsystemsplayintheprocessofsoundfinancialmarketdevelopment.Hence,paymentsystemsmodernizationisbecomingoneoftheprioritiesthatneedstobeaddressedatanearlystagetoeliminateconstraintsforthelaterstagesoffinancialsectordevelopment.

TheBank'sexperienceinseveraltransitionalanddevelopingcountries,bothsuccessfulandunsuccessful,shedslightonwhatneedtobeaddressedandansweredinpaymentsprojects,whyandhow.Thesevaluableexperiencesmustbeeffectivelytranslatedintoanimprovementinotherpaymentsystemsprojects.ThispaperbyMr.SetsuyaSatoandProfessorDavidHumphreyisonesucheffort.ItwasoriginallypreparedtobepresentedattheWorldBankProgramon"PaymentSystemsinFinancialSectorDevelopment,"whichwasjointlyorganizedwiththeFederalReserveBankofRichmondundertheinitiativeoftheFinancialSectorDevelopmentDepartmentinApril1995.Giventhepositiveresponsetothispaper,andtheensuingdebateitprovoked,wedecidedtopublishthispapertoawideraudience.

Wearesurethispaperwillprovetobeofgreatinteresttothosewho

specializeinpaymentsystemsissues,aswellasthosewithabroaderinterestinfinancialmattersduringtransitionanddevelopment.

GARYPERLINDIRECTORFINACIALSECTORDEVELOPMENTDEPARTMENTFINANCEANDPRIVATESECTORDEVELOPMENTTHEWORLDBANK

Pagevi

AbstractMarketeconomiesrelyonthepaymentsystemtofacilitatetradeandexchangeamongenterprisesandbetweenenterprisesandconsumersinproductmarkets.Atthesametime,thepaymentsystemisalsousedtotransformdomesticandinternationalsavingsflowsintoproductiveinvestmentsthroughfinancialmarkets.Emergingmarketeconomiesfacethedifficulttaskofattemptingtosimultaneouslypromotethedevelopmentofproductandfinancialmarkets,improvetheefficiencyofproduction,andmobilizedomesticsavings.Theseandothertasksaremadeeasierwhenacost-effectivepaymentsystemexistswhichisresponsivetouserneeds.

Theprimaryissuesassociatedwithtransformingandimprovingpaymentsystemsinformerlycentrallyplannedandemergingmarketeconomiesarediscussedinthispaper.Emphasisisplacedonmeetingthepaymentneedsofconsumersandenterprises,asusersofpaymentservices,andontheroleplayedbythebankingsystemandthecentralbankassupplierand/orregulatorofpaymentservices.Theindirectroleofcountrysize,bankingstructure,andinstitutionalframeworkarealsodiscussed.Theseinfluencesareillustratedbyoutliningtheevolutionofpaymentarrangementsinvariousmarketeconomies.

Theessentialdifferencesinpaymentsystemsbetweencentrally-plannedandmarketeconomiesareoutlinedandbothshort-termandlonger-termmethodstoimprovethesepaymentsystemsarenoted.Distinctionsamongvariouspaymentinstrumentsaremadeclearerbymodelingthepaymentcycleandchoicesregardingalternativesuppliersofpaymentservicesandthetieringofpaymentprocessingarrangementsarediscussed.MarketneedsinanevolvingpaymentsystemareoutlinedbyillustratingthedifferentpathstakeninEuropeandtheU.S.intheevolutionoftheirpaymentsystems.Thebenefits

andcostsofpaperversuselectronicpayments,theroleplayedpaymentpricingandfloat,andtheinterplaybetweencommercialbanksandthecentralbankinthisprocessarealsodiscussed.Thepaperendswithasurveyofthemanyissuesneedingtoberaisedfrompaymentinstrumentdesigntocostrecoverytoprovideuserswithaneffectivepaymentsystem.

IntroductionOneofthechallengesfacedbytransitionalanddevelopingcountriesistotransformandimprove,bothstructurallyandbehaviorally,theirpaymentsysteminordertomeettheneedsofemergingmarketeconomies.Financialinstitutionsandmarketsrelyonthepaymentsystemtocost-effectivelymobilize,allocate,andtransformdomesticandinternationalsavingsflowsintoproductiveinvestments.Thepaymentsystemalsotransfersvaluefromhouseholdsandenterpriseswhengoodsandservices,producedbytheseinvestments,areconsumed.Theefficiencyofbothofthesetasksishighlydependentontheexistenceofaconvenient,cost-effective,andlowriskmeansofdeliveringpaymentinformationandtransferringvaluefromoneentitytoanother,point-to-point,i.e.,apaymentsystem.Thethreeessentialelementsofapaymentsystemare:

(i)theinitiationofinstructionsbyadebtortomakeapaymenttoacreditor(bycheck,bankorpostalGIRO,debitorcreditcard,telephonecall,orsomeothermeans);

(ii)thetransferofpaymentinformation(bypost,courier,orelectronicmeans)amongbankinginstitutionsenablingthepayor'sinstitutiontodebitthepayor'saccountandthepayee'sinstitutiontocreditthepayee'saccount;and,

(iii)thesettlementofthetransferoffundsbetweenbankinginstitutions,usuallythroughaccountsheldbybanksatthecentralbank.

Thepurposeofthispaperistooutlineanddiscussthemajorissuesassociatedwithtransformingandimprovingpaymentsystemsinemergingmarketeconomies.Anation'spaymentsystemisintimatelyrelatedtothedevelopmentofmoneyandcapitalmarketsandthe

implementationofmonetarypolicy.Inthissense,apaymentsystemissomewhatanalogoustoaneffectiveinternaltransportationsystemwherethelayoutandconnectionsbetweenroads,highways,andothertransportationmodesinacountryhasaprofoundeffectonthefuturepatternoftradeanddevelopmentinaneconomy.Thisiswhyapaymentsystemprojectisregardedasapolicymatter,notasimpletechnologyissue.

Ourgoalistoprovideaframeworkinwhichthebasicelementsimportanttotransformingapaymentsystemareexplained(forthenovice)andtheirinterrelationshipsshown(fortheinformedreader).Inthisprocess,anumberofquestionsareineffectposedandanswered,suchas:

Whatarethemainproblemsraisedintransformingapaymentsysteminformerlycentrally-plannedeconomies?

Howsimilarordifferentarepaymentsystemsindifferentmarketeconomies?

Whatarethemainrisksinmakinglargevalue,inter-enterprisepaymentsandhowcantheybeminimized?

Whatarethespecificstepstakenwhenmakingapaymentwithdifferentpaymentinstrumentsandhowcanthisprocessbeimproved?

Howhavepaymentsystemsevolvedindevelopedcountriesandwhatdoesthisimplyforemergingmarketeconomies?

Whymightelectronicpaymentsbefavoredoverpaper-basednon-cashpayments?

Whatinformationisneededtoproperlyplanforpaymentsystemimprovements?

Inwhatfollows,thebroad,majordifferencesinpaymentsystemsbetweencentrally-plannedandmarketeconomiesarefirstoutlinedandwaystoimprovethefunctioningofthepaymentsystemintransitionaleconomiesarenoted.Althoughtheexampleofpaymentsystemsincentrally-plannedeconomiesisusedtocontrastthisdifference,theproblemsidentifiedareapplicabletodevelopingcountriesaswell.Second,togainadeeperunderstandingofsomeofthemorecomplexpaymentsystemissuesfacedbytransitionaleconomies(aswellasdevelopingcountries),adetailedmodelofthepaymentcycleispresented.Withsuchamodel,choicesamongalternativeaccess,communication,andsecurityarrangementsbecomecleareranditiseasiertoseewhereandhowdifferentpaymentinstrumentsfitintothenationalpaymentcycle.Third,theneedsofanevolvingandmarket-drivenpaymentsystemareoutlined.The

importanceofacountry'slegalandinstitutionalstructureisillustratedbycontrastingthedifferentevolutionarypathstakenbytheU.S.andEuropeanpaymentsystemsovertime.Thepaperendswithadiscussionofthemanyissuesneedingtoberaisedfrompaymentinstrumentdesigntocostrecoverytoprovideuserswithaneffectivepaymentsystem.Lastly,anAppendixprovidesasummarychecklistofinformationneededtoadequatelyplanforpaymentsystemchange.

IDifferencesinPaymentSystemsinCentrally-PlannedandMarketEconomiesTransitionaleconomiesaremovingfrombeingcentrally-plannedtobeingmarket-directed.Toappreciatethestructuralandbehavioralchangesthatpaymentsystemsintransitionaleconomiesface,itisnecessarytofirsthaveabasicunderstandingofhowpaymentsystemsactuallyoperateinbothcentrally-plannedandmarketeconomies.Whiletherearesomesimilaritiesinpaymentsystemoperationbetweencentrally-plannedandmarketeconomies,thedifferencesaremorenumerous.Thesedifferences,ofcourse,arewheretheproblemsliefortransitionaleconomies.

1TheStructureandOperationofPaymentsinCentrally-PlannedEconomies

Centralplanninginagovernment-ownedmono-bankingsystem.Centrally-plannedeconomieshaveasingleormono-bankstructure.Whilesuperficiallyitmayappearthatmanydifferentbanksexistwithsomefocusingonprovidingagriculturecredits,othersfocusingonraisingdomesticsavings,andstillothershandlingimportandexporttransactionsthesebanksareallgovernmentownedandcontrolledanddonotcompetewithoneanother.

Theprimarypurposeofbanksinacentrally-plannedeconomyistomonitortheplan.Theplanassignsproductionandoutputgoalsacrossstateenterprisesinabalancedmanner.Theseparategoalsaremadeinternallyconsistentthroughtheapplicationofinput-outputtechniques.Givenasetofplannedfinaldemands,consistingof

plannedlevelsofproductionofallgoodsandservicesforconsumer,military,government,investment,andexportuse,input-outputmodelsdeterminethelevelofstateenterpriseoutputsneeded(directlyandindirectly)tosatisfytheplan.

Theplandeterminestheallocationofalloftheoutputproducedtothesectorsoffinaldemandandalsoplanstheuseoflabor,physicalcapital,andmaterialsinputsbystateenterprises.Thustheplanembodiesvirtuallyalloftheproductionanddistributiondecisionsthatwouldhavebeenmadeseparatelybyindividualfirmsandhouseholdsinteractinginamarketeconomy.

Whiletheplanmonitoring,allocation,andperformancefunctionscouldbeperformedinphysicalterms,andindeedwerehistorically,itiseasiertoperformthesefunctionsinvalueterms.Oncepricesaredevelopedandassignedtoalltheinputsandoutputsinthephysicalorquantitativeplan,aduplicatefinancialplaninvaluetermsisobtained.Notonlyismonitoringsimplified,butthisprocedurealsopermitssomechoiceregardinginputmixin

productionandoutputmixinconsumption.Whilemanypricesaresettoapproximatescarcity,andthustruecosts,manyothersaresettoachievecertainsocialgoals(suchasprovidinglowcosthousingorinexpensivebasicfoodstuffs).

Theroleofthepaymentsystems:monitoringtheplan.Theprimaryresponsibilityformonitoringthefinancialplanisvestedinthebankingsystem.Eachenterpriseisallowedonlyone(zero-interest)accountwiththestatebankthroughwhichallofitstransactionsaremade.Agrosssettlementsystemisemployedwherebyeachtransactionissettledseparatelyasitoccurs.Thusthepaymentsystemprovidesacomprehensiverecordofallenterprisetransactions.Eachtransactioncanbetracedandcomparedtothefinancialplananddeviationsfromtheplan,onceidentified,leadtocorrectiveactiontoensurecompliance.(Box1containsabriefdiscussionofpaymentclearingversussettlementandanillustrationofgrossversusnetsettlement.)

Twoseparatepaymentcircuitsarecontainedinthefinancialplan:non-cashcreditsanddebitsforenterprisesandcashpaymentsforhouseholds.ThesetwopaymentcircuitsareillustratedinFigure1.1Followingthenon-cashcircuitofthefinancialplan(solidarrows),bankscreateandissuecreditstothestateenterprises.Enterprisesusethesecreditstopurchasephysicalcapitalforinvestment,payforlaboremployed,andcompensateotherstateenterprisesfortheportionoftheiroutputusedasanintermediateinputtoproducetheplannedoutput.

Onlywhenenterprisesaremakingwagepaymentstolaborarecashwithdrawalsallowed.Thisinitiatesthecashcircuitofthefinancialplan(doublearrows)usedbythehouseholdsector.Thecashreceivedbylaborisbyfartheprimarypaymentmethodusedbythissectorinconsumptionandsavingtransactions.However,cashtransactionsare

noteasilymonitored.Conformitytothiscircuitofthefinancialplanisensuredbymonitoringthenon-cashtransactionsbetweenstateenterprisesproducingoutputforthehouseholdsector(EnterpriseA)andthoseenterprisesresponsiblefordistributingthisoutputtohouseholdsthroughretailorotheroutlets(EnterpriseC).Thushouseholduseofcashisindirectlymonitoredbytheflowofgoodsandservices.

Thetwopaymentcircuitsofthefinancialplanrelyonpaperpaymentinstruments:householdsusecashwhileenterprisesusepaper-basedpaymentdemandorders(PDOs).APDOisadebit-basedinstrumentsimilartoacheckexceptthatitisinitiatedbythereceiverofthefunds(thepayee)notthesender(thepayor).ThusaPDOisthepaperequivalenttoanelectronicdirectdebitinamarketeconomy.(Asbackground,Box2(seepage8)outlinesthedifferencebetweenadebittransferandacredittransfer.)

1Seepage5.

Figure1Twopaymentcircuitsincentrally-plannedeconomies

Box1:PaymentclearingandgrossandnetsettlementPaymentclearingistheprocessbywhichpaymentinformationistransferredamongbankinginstitutionssothatthepayor'saccountisdebitedandthepayee'saccountiscredited.Thisincludestheinitialprocessingofthepaymentrequestbyabank,itsphysicalorelectronictransferwithinorbetweenbanksthatareinvolvedinthetransfer,andthedebitingandcreditingofthepayor'sandpayee'saccounts.Althoughaccountingentrieshaveoccurred,fundshavenotreallymovedbetweenthepayor'sandpayee'saccountsuntilsettlementoccurs.Settlementinvolvestheactualmovementoffundsamongbanks,usuallyintheformofbalancesheldbybanksatthecentralbank,toextinguishthepaymentobligation.Grosssettlementoccurswheneachtransactionissettledseparately(inrealtime)asitoccursandisbilateralinnature.ConsiderthefollowingfoursequentialtransactionsforvariouspayorsandpayeesofBanksA,B,andC:1.BankAowesBankB$150million;2.BankBowesBankA$75million;3.BankBowesBankC$10million;and4.BankCowesBankA$150million.Withgrosssettlement,eachofthefourbilateralpaymentsaresettledintheorderthattheyaremade.Underanetsettlementarrangement,thenumberofsettlementtransactionsisreducedbysettlingallfourpaymentssimultaneouslyasagroup,ratherthanseparately.Hereonlythenetpositionamongallparticipantsneedstobesettled.Thenetpositionisdeterminedbyaddingupallthecreditstoabanknomatterwhotheyarefromandsubtractingallthedebitsnomatterwhotheymaygoto.Inthissense,netsettlementrepresentsamultilateralpaymentarrangement,notabilateralone.Consideringallfourpaymenttransactions,thetotalcredits,totaldebits,andthenetpositionwouldbe:Banks Credits minus Debits equals NetpositionC 75+150 - 150 = 75B 150 - 75+10 = 65C 10 - 150 = -140Toeffectnetsettlement,C'saccountwiththecentralbankwouldbedebitedby$140millionandthesefundswouldbeplacedtemporarilyinaspecialsettlementaccount.Onlywhenallthenetdebitshavebeenplacedinthe

settlementaccountwouldthisaccountitselfbedebitedtogeneratethenetcreditsof$75millionand$65million,respectively,forA'sandB'saccountswiththecentralbank.Sinceallpaymentsaresettledsimultaneouslyundernetsettlement,itisnecessarytowaituntilallpaymentsareknownbeforenetsettlementoccurs.Thus,unlikegrosssettlement,netsettlementincorporatesariskthatabankinanetdebitposition(BankCabove)mayfailsometimeduringthedaybeforesettlementoccurs.Theriskassociatedwithasettlementfailureisdiscussedinmoredetailinthetext.

PDOsrepresentarequestforpaymentandaredirectlytiedtointer-enterprisetrade.Oncegoodshavebeenreceivedbyapurchasingenterprise(EnterpriseAthepayor),thesupplyingenterprise(EnterpriseBthepayee)depositsshippingdocuments,titleofownership,andamultiplecopiedPDOatitsbranchofthestatebanktoinitiatethepaymenttransactiondebitingthepayor'saccount(A)andcreditingthepayee'saccount(B).Thepayee'sbranchwilltypicallyextend85%oftheamountbeingcollectedintheformofaninterestfreeloantothepayee(B)priortotheactualtransferoffunds.Theloanisextinguishedandtheremaining15%ofthetransactionvalueisobtainedafterthefundshavebeentransferredtothepayee'sbranch,afterwhichthetitleofownershippassestothepurchasingenterprise(A).

EachpartytothepaymenttransactionhastoapproveandretainacopyofthePDOfromtheinitiatingenterprise,tothevariousbranchesofthestatebankinvolvedinthetransaction,tothereceivingenterprise.Aswell,allenterprisetransactionsareelaboratelycoded.Codingisusedtodeterminetheprecisesourceandpurposeofthecreditscreatedbythestatebankfortheenterpriseaswellasthepurposeandnatureofpaymentsmadebytheenterpriseindrawingdownthesecredits.Ineffect,thepaymentsystemnotonlytransfersvaluebutalsorecordsandretainstheequivalentofbankloanandfirmproductinvoicinginformationofamarketeconomy.

Stateguarantees:nocreditriskforpaymentreceivers.Underthefinancialplan,creditcreation,enterprisepayments,andbankingsystemviabilityareallessentiallyguaranteedbythestate.Creditcreationanditsallocationtoenterprisesisdictatedbythefinancialplanandthusisnotconstrainedbytheavailabilityofdomesticsavingsorhouseholddepositsinthebankingsystem.Thecreditcreatedbythebankingsystemisusedbyenterprisestopayotherenterprisesandinjectcashintothehouseholdsector.Sinceall

enterprisesareownedbythestate,inter-enterprisepaymentsmerelyrepresentatransferofcreditsfromonepartofthestatetotheother.Suchanarrangementissimilartoanintra-firmtransactioninamarketeconomy.Thusinter-enterprisepaymentsareintra-statepayments.lntra-statepaymentsposenorealriskoflossforpaymentreceiversnorforthebankingsystemthatistransferringcreditsfromonestateaccounttoanother.

Aswell,withgrosssettlementofenterprisepaymenttransactions,oneaccountisdebitedbeforeanotheraccountiscredited.Ifcreditsintheaccounttobedebitedareinsufficient,extracreditsareoftenmadeavailablebythestatebank,reducingtheincidenceofenterpriseliquidityproblems.

Box2:Thedifferencebetweenadebitandacredittransfer

Non-cashpaymentscanbeeitherdebittransfersorcredittransfers.Theconventionalwaytodistinguishbetweenthemdependsonwhothepayororthepayeeisactuallyinitiatingthetransferoffundsfromthepayor'saccounttothepayee'saccount.However,asecondimportantdistinguishingcharacteristicconcernswhetherornotthepaymentbeingmadeisprovisional(andthereforesubjecttoreversal)orisfinalwhenmade.AcommondebittransferinstrumentisthepapercheckwhileacommoncredittransferisapaperorelectronicGIROpayment.DebitandcredittransfersareillustratedinFiguresAandBbelow.

AsshownbythearrowsinFigureA,adebittransferinvolvesgoingfromthepayorwhowritesacheck,tothepayeewhoreceivesthecheck,tothepayee'sbankwherethecheckisdeposited,tothepayor'sbankwhofinallypaysthecheckiftherearesufficientfundsinthepayor'saccount.Ifthefundsinthepayor'saccountareinsufficient,thenthecheckisreturnedbyreversingthepathittooktobecollectedandpresentedforpayment.

Whilethepayorwritesachecktoinitiatethepaymentcycle,itisthepayee(oritsagentbank)whoisactuallyinitiatingthetransferoffundsfromthepayor'saccounttothepayee'saccount.Thepayeeisineffectsaying''debitthepayor'saccount"whichstartsthefundstransferprocess,soacheckisadebittransferinstrument.Importantly,thereisrisktothepayeeinacceptingacheckaspayment:thepayor'sbankmayrefusetopaythecheckifthefundsintheaccountareinsufficienttocoverthedebit.Thusacheckisonlyaprovisionalpaymentinstrumentwhichcanbereturnedunpaid.

Acredittransferfollowsadifferentroute.AsseeninFigureB,a

payorinstructshisGIROtotransferfundsfromhisaccounttothepayee'saccount.Thepayorisineffectsaying"creditthepayee'saccount"tostarttheactualfundstransferprocess,soaGIROpaymentisacredittransfer.Ifthefundsinthepayor'saccountareinsufficient,thetransfernevertakesplace.ThusreturnitemsdonotexistwithinaGIROframework.Asaresult,whenfundsarereceivedinthepayee'saccount,theyaregoodandfinalfunds(notprovisional).

WithaGIROpayment,theentiretransactionoccurswithinasingleorganizationalstructurethepostalorbankGIROsothefundstransferandsettlementprocessisbothsimplerandlessexpensivethanwithadebittransfersystemwhereinterbankpaymentandsettlementistherule.Apaper-basedcheck(debittransfer)systemisbothmorecostlyandcontainsmoreriskoffraudandlossthandoesanelectronic-basedGIRO(credittransfer)system.However,aGIROsystemrequireseitheranaggregatedbankingsystemand/oragreatdealofcooperationamongbankstoworkproperly.Countrieswithahighlydisaggregatedbankingsystemandlittlecooperation(suchastheU.S.)havenotbeenabletodevelopaneffectiveGIROsystemandthusrelyonchecks.

FigureAIllustrationofadebittransfer

Check:AdebittransferSolidline:Routeofforwardcollection,Point1toPoint4.

Routeofreturneditems,Point4toPoint1.

FigureBIllustrationofacredittransfer

GIRO:AcredittransferSolidline:RouteofforwardcollectionPoint1toPoint2.Therearenoreturnitems.

Timeinsensitivityofpayments.Enterprisebalancesareheldinstatebankaccountsthatpaynointerest.Thusthereisnoincentivetoreconfiguretheauditingfunctionofthepaymentsystemsothatthisneedismetwhilealsoprovidingfortimelypaymentandsettlementofenterprisetransactions.Aswell,noimportantpenaltyisimposedwhenenterprisesfailtomakepaymentsinatimelymanner.Forthesereasons,paymentsarenotviewedasbeingtime-criticalandthenotionofatimevalueformoneyisundeveloped.Consequently,largevaluepaymentsamongenterprises,orbetweenanenterpriseandaforeignsupplier,cantakedaystocomplete.Whilesuchasystemisacceptableinacentrally-plannedeconomywherenointerestispaidandfundsessentiallymovefromonestateagencytoanother,suchpaymentdelayswouldplaceanunacceptablylargeopportunitycostonpaymentreceiversinamarketeconomywheremoneyhasatimevalue.

Limitedneedforcomprehensivelegal,accounting,andcommunicationsinfrastructure.Asenterprisepaymentsaretransfersfromonestateagencytoanother,thereisonlyalimitedneedforpaymentlawsandregulationsthatdeterminetherightsandliabilitiesofthepartiestoapaymenttransaction.Thisneedislimitedbecausethereisreallynocreditriskortimevalueofmoneyinvolvedinapaymenttransaction.Ifcreditriskexistedandmoneyhadatimevalue,thelegalstructurewouldhavetobeexpandedtospellouttheconditionsunderwhichpayorsandpayees,respectively,wouldbeliableforlossesduetoenterprisefailureordelayedpayments.

Inmonitoringthefinancialplan,theseparatebranchesofthestatebankarereliedupontoindividuallycollect,accountfor,andreportenterprisepaymentinformationtoacentralagency.Inthiscapacity,eachbranchofficeeffectivelyoperatesasifitwereaseparatebanksinceenterpriseaccountsarenotcentrallymanagedandcontrolled.Thusthereislittleneedforacommunicationsinfrastructurethatcould

rapidlyprocessandtransmitpaymentorotherinformationamongbranchesofthestatebank.Indeed,paymentinformationisinpaperformandphysicallytransportedbetweenbranchesusingthepostofficeandothernon-time-criticaltransportationmethods.Domesticcommercialairlineflightsorevendedicatedmotorcourier,commoninamarketeconomy,arenotused.

Cash-basedretailpayments.Currencyistheprimarymethodofpaymentforthehouseholdsectorandissuppliedthroughcashwagepaymentsbyenterprises.Sinceenterpriseoutputallocatedtothehouseholdsectorisdeterminedbytheplan,anyexcessofcurrencyincirculationovertheassignedvalueoftheoutputsuppliedtothissectorisabsorbedasforcedsavings.Althoughhouseholdscandepositexcesscurrencyinbanksandearnaninterestreturn,thisreturniscontrolledbytheplanandnoshort-termmoneymarketinstrumentsexistwhichcouldpayahigherrate.

Therelianceoncashasvirtuallytheonlymeansofpaymentforthehouseholdsectormeansthatalternativestocashpaymentshavenotdevelopedincentrally-plannedeconomies.Paymentsystemswhicharepredominantlycash-basedoftenareassociatedwithlowcrimeratesand/orfundamentalweaknessesinthebankingsystem.Thisincludestheexistenceofinefficient,costly,orunreliablenon-cashpaymentinstruments,negativerealdepositrates,ordepositorfearofgovernmenttaxationorappropriationmeasures.Ifcrimeratesarelow,inflationiscontrolled,andcurrencyisavailableinlargedenominations,thenuseofcashforallhouseholdtransactionsmaybesafeandnottooinconvenient.However,iftheseconditionsarenotmet,thenalternativestocashforpaymenttransactionscanbequiteuseful.Thisisespeciallytrueforlarger-valuepayments.Herethetransactioncostrelatedtocashuse,forboththebanksandconsumers,canbequitehigh.Thisisduetotheexpenseofcashstorage,countingandverification,andthephysicalshipment(underguard)inordertoeffectpayment,alongwiththeopportunitycostofholdingnon-interest-earningcashbalances.Wheninflationisnotadequatelycontrolled,thisopportunitycostwilldominatetheothercostinfluencesassociatedwiththeuseofcash.

2PaymentSystemsinMarketEconomies

Supportofrealandfinancialmarkets.Thepurposeofthepaymentsysteminmarketeconomiesistoprovidelowcost,timely,andsecurepaymentsforbothenterprisesandhouseholds.Theoverarchinggoalistosupporttradeandexchangeamongenterprises,amonghouseholds,andbetweenhouseholdsandenterprises.Thisencompassesbothreal(goodsandservices)andfinancialmarkets.Asenterprisesandhouseholdsengageintransactionsthatdifferinfrequency,value,andplace,abroadrangeofbothpaper-basedandelectronicpayment

instrumentshavebeendevelopedtoaccommodatethesedifferentneeds.Theaccountingandmonitoringfunctionsofapaymentssystemtheprimarygoalinacentrally-plannedeconomyisbasicallyseparatefrompaymenttransactionsinamarketeconomy.Effortstomorecompletelyintegratethesetwofunctionsthroughelectronicbusinessdatainterchange(EBDI)areintheirinfancy.

Whilemarketeconomiesoftencontainbothprivately-ownedandgovernment-ownedbanks,privately-ownedbanksaredominant.Government-ownedbanksmayprovideloansonlytopoliticallyfavoredsectorsofaneconomy(e.g.,agriculture)or,likecommercialbanks,loantoallsectors.Aswell,governmentagenciesmayguaranteeprivately-providedloanstofavoredgroups(e.g.,smallbusiness,students,homeowners).Althoughexceptionsexist,specificallyintheformofthegovernment-ownedGIRO,inmostmarketeconomiesprivately-ownedbankstypicallyprovidethemajorityoftransaction,savings,andloanservicestoboththehouseholdandthe(privately-owned)enterprisesector.

Thebankingindustryinmarketeconomiesisusuallyconcentrated,withthelargest

10banksholding90%ormoreofalldepositsorassets.TheU.S.isananomalyasitwouldtake3,000bankstoachievethislevelofconcentration.Differencesinbankingconcentration,geographicdistance,andantitrustpolicy,aswellas(centralized)postofficeprovisionofsavingsandtransactionaccounts,havehelpedtodeterminetherangeofnon-cashpaymentinstrumentsthatcanbecost-effectivelysupplied.Asdiscussedbelow,thesedifferenceshaveledtheU.S.andCanadatorelyonpaper-baseddebittransferinstruments,suchaschecks,whileEuropeandJapanhavefocusedmoreonpaperandelectroniccredittransferinstruments,suchasGIROpayments.(ThewordGIROisderivedfromtheGreekandreflectstheflowoffundsaroundaring,makingacircle.)Althoughthefocusmaybeononepaymentinstrument,alldevelopedcountriesofferbothtousers.

Whileindividualbanks,orthepostoffice,providefortheprocessing,collection,andtransferoffundsamongthemselves,thecentralbanktypicallyprovidesforthefinal,same-day,netsettlementofthemultilateralnetdebitornetcreditpositionsamongtheseinstitutions.Thusgovernmentguaranteesforthepaymentsystemusuallyonlyapplytothegrossornetsettlementcomponentofthepaymentcycle,withprivately-ownedbanksbeingresponsibleforrisksintheothercomponents.

Privateresponsibilityforcreditneedsandriskassessment.Thecreditneedsofenterprisesarenotdeterminedbythegovernmentbutratherbytheassessmentofindividualenterpriseownersregardingtheirabilitytoearna"normal"ormarketreturnoninvestedcapital.Investedcapitalissuppliedbytheenterpriseowners,eitherpersonallyorthroughastockmarket,orfrominternally-generatedcashflowsretainedearningsinthecourseofbusiness(onesourcebeingthedepreciationofphysicalcapital).However,thegovernmentcananddoesinfluencetheoverallmoneysupplyandthebusinesscycleandsoindirectlyinfluencesboththesupplyofanddemandforcreditina

marketeconomy.

Creditisgrantedtotheenterpriseandhouseholdsectorsthroughthebankingsystembasedonanassessmentoftherisksandreturnsinvolved.Whilesomecreditisguaranteedbythestate(usuallyforasmallfee)orcanbeprivatelyinsured,thebankingsystemhastheprimaryresponsibility(monitoredbybankregulators)ofassessingcreditriskinmakingloansorinprovidingpaymentservices.Thisprocessisinformationintensiveandisguidedbylegislation(bankruptcy,rightsandliabilitiesofpayorsandpayees),regulations(loanlimitstosingleborrowers,depositoraccesstofunds),andcaselaw(loancontracts,ownershipofcollateral,bankfees).

Enterprises,ingeneral,facetwopaymentriskswhensupplyinggoodsorservices:(1)theymayneverreceiveanon-cashpayment;and(2)thepaymentinstrumenttheyreceivemaynotleadtogoodfundsbeingtransferred.BothrisksexistforcheckswhileonlythefirstcanoccurwithaGIRO.Receiversofacredittransfer(GIRO)paymentfacenocreditriskbecause

thepaymentwouldnothavebeensentifthepayor'sbalance(orthepayor'screditagreementwiththeGIRO)wasinsufficienttocoverthefundstransferredtothepayee'saccount.ThusGIROpayments,oncereceived,willnotbereversedandthusarefinalpayments.

Asimilarassurancedoesnotexistwithadebittransfer(check)instrument.IntheU.S.,1%ofthe60billionchecksreceivedbypayees(600million)arereturnedeachyear,eventhoughafeeoffrom$15to$25isincurredbypayorsforeachreturnedcheck.Itemsaremostoftenreturnedbecauseofinsufficientfundsinthepayor'saccount,butreturnsalsooccurbecauseacheckisdrawnonaclosedaccountorthereisnopayorsignatureorthedateistooold.Thuscheckpayments,oncereceived,canbereversedandthusareprovisionalpayments.Bankcreditisoftenextendedtobusinesspayeestocoverthetimegapbetweenreceiptofacheckanditsfinalsettlement.JapanandFrancehaveaddressedtheirreturnitemproblembysimplyremovingbankingprivilegesforenterprisesandindividualswhenchecksarereturnedunpaid.Ingeneral,paymentinstrumentuseisdeterminedbytheconvenience,cost,andfinalityofthedifferentinstrumentsavailablewithinacountryandtheperceivedtrade-offsamongtheseattributesforbothpayorsandpayees.

Paymentfloatandincentivesfortimelypaymentandsettlement.Thetimeittakesbetweenwhenapaymentinstrumentisreceivedaspaymentandwhenthepayeeactuallyhasaccesstogoodandfinalfundsistermedpaymentfloat.Dependingontheinstrumentused,theavailabilityoffundscanbeimmediate(forcash),tolessthanoneday(forlargevalue,electronicwiretransfers),tothesameornextbusinessday(real-timedebitcardpointofsale,creditcard,GIRO,checksdrawnonalocalbank),totwobusinessdays(non-localchecks).

Asinterestispaidondepositedfunds,andevenhigherreturnsmaybe

obtainedthroughpurchasingshort-termmoneymarketinstruments(overnightinterbankfundsorhighlyliquidgovernmentsecurities),theprinciplethatmoneyhasatimevalueiswell-developedinmarketeconomies.Correspondingly,thereexistsastrong(privatesector)incentivetominimizepaymentfloatandinvestinmethodsthatwillprovidetimelypaymentandsettlement.Whilethisinvestmentis"unproductive"fromasocialpointofview,sincefloatisatransferpaymentandlittleornorealoutputisbeingproduced,therearesignificantdistributionaleffectsfromeitherexpandingorcontractingfloat.Indeed,insomecountriesthebankingsystemcapturesmuchofthefloatbenefitandsowillberequiredtolookforalternativerevenuesourcesiffloatisreduced.

Floatreductioncanbeachievedbypurchasinghighspeedpaperprocessingmachineryanddedicatedmotorandaircouriercollectionsystemsforchecks.Fordebitandcreditcardpaymentsandautomatedclearinghouse(ACH)transfers,floatreductionoccursbyhavinganextensivenetworkofcard-readingterminals,computertocomputerhookups,andasophisticatedelectroniccommunicationinfrastructureforelectronicpayments.Paymentsmade

overlargevaluewiretransfernetworksaretypicallyclearedandsettledwithinthedaytheyaremadeandsousuallydonotcreateany(overnight)float.2

Cash,check,GIROretailpayments,andelectroniclargevaluetransfers.Cashisthemostusedofallthepaymentinstruments.Thisholdsforbothcentrally-plannedormarket-driveneconomies.Forcountrieswhereestimateshavebeenmade,cashtransactionsaccountformorethan75%ofthetotal.Thestockofcashheldperperson,anapproximateindicatorofcashuseacrosscountries,isshownfor11developedcountriesinTable1.Countrieswithlowcrimerates,anaversiontocredituse,orahistoryofholdingsavingsoutsideofthebankingsystemalltendtoholdlargeamountsofcash.

Table1.Valueofcurrencyandcoinperperson(1992,11developedcountries)

ValueinU.S.dollars Transactions:cash/total*Swtzerland 2,748Japan 2,739Germany 1,534 86%Sweden 1,467Netherlands 1,354 78%Belgium 1,239Italy 1,023France 828Canada 652U.S. 465** 83%U.K. 446 90%Source:BIS,December1993.*Varioussources**($1,167totalreported)×(estimated.40insidethecountry)=$465perperson

2Foradiscussionofthetechnologyusedinprocessingelectronicpayments,seeSendrovic(1994).

Theuseoffourtypesofnon-cashpaymentinstrumentsforthesame11countriesisshowninTable2.Countriesthathaveahighuseofcash(Switzerland,Japan,Germany,Sweden,Netherlands,Belgium,andItalyinTable13)tendtohavethelowestincidenceofcheckuse,choosinginsteadtoconcentrateoncredittransfers(GIRO)anddirectdebits(apayeeinitiatedelectronicdebittoapayor'saccount).Thusintensiveuseofonetypeoffinalpayment(cash)ispositivelycorrelatedwithtwoothers(credittransfersanddirectdebits),tothedetrimentofchecks(aprovisionalpaymentinstrument).However,insomeothercountries(India,Korea,Australia,andSouthAfricainTable34checkuseinnon-cashpaymentsisashighorhigherthanthatofmajorcheckusersamongdevelopedcountries(U.S.,Canada,France).Whiledifferentdevelopedcountriesrelyondifferentmixesofnon-cashpaymentinstruments,theonecommonthemeisacontinuingshiftawayfrompaper-basedtoelectronicpayments.

Table2.Non-cashpaymentuseindevelopedcountries(1992,percent)

Useofchecks

Useofcredittransfers

Useofcards

Useofdirectdebits

Switzerland 4% 81% 12% 3%Japan* 8 32 14 46Germany 9 50 2 39Sweden 9 77 9 5Netherlands 12 61 3 24Belgium 19 56 16 9Italy** 40 42 4 4France** 51 15 15 10Canada 63 4 29 4U.S. 81 2 16 1U.K. 45 21 19 15Source:BIS,December1993.*EstimatedfromBISandothersources.

**Excludesotherpaymenttransactions(electronicbankreceiptsandbillsofexchange.)

3Seepage14.4Seepage16.

Table3.Non-cashpaymentuseinothercountries(1991or1992,percent)

Useofchecks

Useofcredittransfer

Useofcards

Useofdirectdebits

India 99% 0% 1% 0%Korea 74 16 5 5Australia 60 20 16 4SouthAfrica

60 6 19 15

Thailand 26 7 65 2Source:DattandShanmugham,1994.

Theprimarymethodformakinglargevalueenterpriseandgovernmentpaymentswithinmarketeconomiesisthroughhighlysecureelectronicwiretransfernetworks,suchasFedwireandCHIPSintheU.S.,BOJ-NETinJapan,CHAPSintheU.K.,SAGITTAIREinFrance,andSICinSwitzerland.Tocontrolforthepossiblesystemicriskassociatedwithoneinstitution'sfailuretosettlerealtimeorend-of-daynetpositionsonthesedifferentnetworks,riskcontrolprocedureshaveandarebeingadopted.Thepurposeistopreventapossibledomino-likeseriesofsettlementfailuresortheriskyextensionofcreditbythecentralbank.Riskcontrolproceduresinvolveoneormoreofthefollowingitems:netdebitlimits,privateloss-sharingagreements(commoninstockandcommoditymarkets),thepostingofliquidcollateral,largerpaymentclearingbalances,orrejectionofapaymentrequestifthebalanceisinsufficient.

3ImprovingthePaymentSysteminTransitionalEconomies

Thebankingandpaymentsystemincentrally-plannedeconomieswasgoodatwhatitwasdesignedtodonamelytocloselymonitorenterpriseperformancerelativetothefinancialplanand,inthat

capacity,providecashforpersonaltransactionsandpaymentordersforinter-enterprisepayments.Itisthusnotsurprisingthat,whenthegoalsarealteredastheyareinatransitionaleconomy,anumberofproblemsarise.SiximportantissuesneedingtobeaddressedareoutlinedinTable4.5

5Seepage17.

Table4.Summaryofpaymentsystemcharateristicsandproblemsfortransitionaleconomies

Centrally-plannedeconomy

Market-driveneconomy

Problemsoftransitionaleconomies

Structure State-ownedmono-bank

Privately-ownedmultiplebanks

Expandlegalstructuretoaccommodateprivateownership

Purpose Monitortheplan Speedyvaluetransfer Improvetimesensitivityofpayments

Enterprisepayments

Paper-based Paperandelectronic Developelectronicpaymentandcommunicationsinfrastructure

GuaranteesStateguarantee(nocreditrisk)

Privateobligation(creditrisk)

Improvecreditriskassessments

Settlement Grosssettlement(alltransactionsthroughoneaccount)

Grosssettlement,netsettlementwithcollateral(manyaccounts)

Developsame-daysettlementforlargevaluepayments

Retailpayments

Cash-based Cash,GIRO,check,electronic(debit/creditcards)

Expandretailpaymentalternatives

Structure.Theshiftfromastate-ownedmono-bankingstructure,toonewherethereismorethanonebankandeachisprivatelyowned,meansthatthelegalstructureunderlyingboththebankingsystemandthepaymentsystemhastobeconsiderablyexpandedfornon-cashpayments.Thisinvolvespropertyrights(forprivateownership),bankruptcylaw(becausebankscanfail),andalegal/regulatorystructurewhichclearlyspellsouttherightsandliabilitiesofpayorsandpayeesinthepaymentschain.6Inthisprocess,itisimportantthattheselawsandregulationspermitnewandcost-effectivepaymentinstrumentstodevelopandevolveiftheymeetbetterthepaymentneedsofhouseholdsandenterprisesinamarketeconomy.Theold

procedure,wherethegovernmentdecides,inisolation,whatpaymentarrangementsshouldbepermittedandthentightlycontrolsallaspectsofapaymentcycle,willnotachievethedesiredresults:household,enterprise,andbankingneedsshouldbegivenalargeweightwhenthepaymentsystemisbeingrestructured.Thisismoreimportantforinter-enterpriseandinterbankpayments,whichtypicallyrelyonnon-cashinstruments,thanitisforhouseholdswhichwillgenerallyrelyoncashformostoftheirpersonaltransactions.

Purpose.Transitionaleconomiesrecognizethatthereisatimevaluetomoney.Thisrecognition,andthefactthatthepaymentsystemisnolongeranenforcementcontroldeviceforthefinancialplan,meansthatthepaymentsystemwillhavetobeadjustedtoservetwopurposes:theaccountingpurposeofprovidinganaudittrailforinter-enterpriseandother

6AgooddescriptionoflegalissuesinapaymentsystemisprovidedbyBhala(1994).

transactionsplusthetimelyvaluetransferpurposetominimizetheenterpriseandhouseholdfloatcostsassociatedwithtransactions.

Thecostsofuntimelypaymentscanbesubstantial.InRussia,ithasbeenestimatedthatupwardsofone-thirdoftheincreaseinthemoneysupplyhasbeenabsorbedandusedonlytoclearpayments.Becauseofcreditriskandfraud,thePDO(adebittransferinstrumentinitiatedbythepayee(seeFigure1)7hasbeenoutlawed.Initsplaceisthepaymentorderacredittransferinitiatedbythepayor.Whileinthepastapaymenttransactionwasusuallycompletedinamatterofdays,currentlyinRussiaweekscanelapsefromthetimewhenanenterpriseaccountatabankisfirstdebitedtowhenthecreditfinallyentersanotherenterprise'saccountandcanbeused.Thistimegapistheresultofincreasedlagsinprocessing,collecting,andsettlingpaymentswithinthebankingsystemaswellasincreaseddelaysbyenterprisesinmakingrequestedpayments(evidencedbyrisinginter-enterprisearrears).

Thecosttoenterprisesofdelayedpaymentsiseither:(a)thecostofborrowingworkingcapitaltocoverthetimeneededtocollectandsettlepaymentswhich,ifreceivedearlier,couldhavebeenusedasworkingcapital;or(b)ifworkingcapitalreservesaresufficient,thelostinterestrevenuewhichwouldhavebeenearnedoncollectedfundsifthesefundswerecollectedearlier.Inaddition,thecostof(b)isincreased,whilethecostof(a)isreduced,wheninterestratesdonotfullyreflectinflationandthereductioninpurchasingpowerwhichresults.Whenpaymenttransfersarespeededup,theseenterprisecostsarereduced.However,iftheproportionofthemoneysupplytiedupinthepaymentsystemfalls,theproportioninthehandsofthepublicrises.Thischangeisequivalenttoariseinthemoneysupplyandneedstobecoordinatedwiththemonetaryauthority.

Enterprisepayments.Paper-basedenterprisepaymentsmaybe

adequatewhenvaluesaresmallbutareexpensivewhenvaluesarelarge.Intheshort-run,thetimelinessofpaper-basedenterprisepaymentscanbegreatlyimprovedthroughthedevelopmentofmachine-readableMICRencodingforchecksorpaymentordersandprocessingtheseitemsusinghighspeedreader-sorters.Collectiontimescanbemarkedlyreducedbyswitchingfromthepostofficetodedicatedmotorcouriers,domesticcommercialairlines,andevendedicatedaircouriers.Inthelonger-run,particularlywithinandbetweenmajordomestictradingcenters,itwillbecost-effectivetodevelopapersonalcomputerormainframe-basedtelecommunicationsinfrastructurethatwillaccommodateenterprise,moneymarket,andinternationallargevaluepaymentsonasame-daybasis.

Guarantees.Aspaymentsarenolongerfromonestate-ownedenterprisetoanother,thestatenolongerguaranteeseithertheviabilityofthebankingsystemnorthecredit-

7Seepage5.

worthinessofenterprisepayments.Privateownershipcomesatthecostofalossofstateguaranteesforthepaymentsystem.Thusreceiversofpaymentsneedtodevelopprocedurestoassessthecreditriskofthecounter-partytheydealwithintransactions.Thisisnotasimpleprocess,eveninamarketeconomy:itrequiresinformationonacounter-party'scredithistory,itsfinancialviability,andathoroughunderstandingoftherightsandliabilitiesofallpartiesindifferenttypesofpaymenttransactions.Whenthelegalunderpinningsofthepaymentsystemisitselfuncertain,asitcanbeinatransitionaleconomy,creditriskisevenmoredifficulttojudge.Inthisevent,itisquiteimportanttohavepersonalknowledgeofthecounter-partyandhiscredithistorypriortoengagingintrade.

Settlement.Withthebreakupofamono-bankingstructureintonumerousprivately-ownedbanks,enterprisesmayhavemorethanjustoneaccountanddealwithmorethanjustonebank.Inmarketeconomies,thecentralbankprovidesforinter-banksettlementoflargevaluepaymentsusingeitherreal-timegrosssettlement(RTGS),whereeachtransactionissettledwhensentoveralargevaluenetwork,orend-of-daynetsettlement,whereonlythemultilateralnetpositionofanentireday'sseriesoflargevaluetransactionsissettled.Toreducesystemicrisk,netsettlementnetworkslimitthenetdebitexposuresofbankparticipantsusingreal-timenetdebitcaps,developloss-sharingagreementsallocatingthecostofasettlementfailure,and/orrequirethepostingofliquidcollateraltocoverthesinglelargestpossiblenetdebitinasettlementfailure.Theseandotherpaymentrisk-reductionprocedureshavebeendevelopedbyG-10centralbanksundertheauspicesoftheBankforInternationalSettlements(referredtoasLamfalussystandards).

OnaRTGSnetwork,adequatebalancesareheldtoclearallpaymentsatthetimetheyoccur.However,theopportunitycostofholdingidlepaymentclearingbalancesexceedstheexpenseofpositingliquid

collateral(whichcanearnaninterestreturn).ThusnetsettlementoflargevaluepaymentsbackedbyliquidcollateralisalowercostalternativetoRTGSandcanbestructuredtobejustasfreeofsystemicrisk.Butsystemicriskisonlyoneproblem.Asnotedabove,same-day(orevennext-day)paymentandsettlementofenterpriselargevaluetransactionsshouldbeanimportantgoaltoreducepaymentfloat.

Retailpayments.RetailpaymentscanbemademoreconvenientandsaferifmanyhouseholdpaymentsthatpreviouslyreliedalmostentirelyoncashwereexpandedtopermitcheckorGIROpaymentsandperhapsevenelectronicpointofsaledebitorcreditcards.Whilecashwilllikelyremainthedominantpaymentinstrumentintermsofthenumberoftransactions(e.g.,Table18),largervaluehouseholdtransactionsandtransactionswhereface-to-facecontactiseitherinconvenientorunnecessaryrepresentareaswherealternativepaymentinstrumentuseislikelytoarise.

8Seepage14.

Animportantsideeffectofareduceduseofcashforlargervaluehouseholdpaymentsisacorrespondingreductioninthefuturegrowthofseignioragebenefitstothegovernment.Whenthegovernmentissuescurrency,itgivesitselfalong-term''loan":thenewlyissuedcurrencyisusedtopurchaserealgoodsandservicesforthegovernment(thevalueofwhichfarexceedstheactualcostofprintingthecurrency)andthepublicmayneverredeemthecurrency(althoughtherewillberecurringcostsofcurrencyreplacementovertime).Whilethestockofcurrencyincirculationneednotfallashouseholdsdevelopandusealternativenon-cashpaymentinstruments,therateofgrowthofcurrencyandhencethebenefitfromseigniorageshouldslowovertime.Asseignioragecreatesrevenueforthegovernment,alternativesourcesofrevenuemustbedeveloped.9Anexpansionofcentralbankcreditstogovernmententerprisesisnottheanswer.Althoughrapidgrowthineithercashorcentralbankcreditscancreateaninflation"tax"ontheeconomy(sincetherealvalueofdebtisreduced),cashrepresentsa"loan"fromthepublictothegovernmentthatisunlikelyevertoberepaid(seigniorage)whilecentralbankcreditstogovernmententerprisesrepresentsaloanthatifnotrepaid,reducesgovernmentpurchasingpowerinthefuture.

9TheseigniorageissueisdiscussedinmoredetailinHumphrey(1995).

IIThePaymentCycle:StructureandChoicesInordertoillustrateinmoredetailthepaymentchoicesfacingtransitionaleconomies,itisusefultodevelopaconceptualmodelofthepaymentcycle.Withsuchamodelthechoicesamongalternativeaccess,communication,security,andsettlementarrangementsbecomeclearerandtheimplicationsofnewpaymentinstrumentsforanation'spaymentsystemaremoreeasilyidentified.

1TheStructureofthePaymentCycle

Aconceptualmodelofthepaymentcycle.Althoughstylizedandsimplified,Figure210illustratesthemajorcomponentsofatypicalnon-cashpaymentcycle.Non-cashtransactionssuchascheck,GIRO,debitcard,creditcard,directdebit,andwiretransferrequireclearingandsettlementinordertotransfervaluebetweenpayorandpayee.Incontrast,cashtransactionstransfervaluedirectlybetweenpayorandpayeeoutsideofthebankingsystemandthusdonotrequireclearingandsettlement.Thisalsoholdsformanypre-paidinstruments,suchaspre-paidrailroad(Japan),telephone(mostdevelopedcountries),andsubway(U.S.,Japan)cardsissuedbythecommercialfirmsprovidingtheseservices.However,pre-paidinstrumentssuchaspostalmoneyorders,travelerschecks,andbankcashierschecksenterthepaymentcycleasa(pre-paid)checkinstrument.

ThepaymentcyclestartsatthetopofFigure211withanenterpriseorhouseholdprovidingsomegoodorservicetosomeotherenterpriseorhousehold,whothenmusttransfervalue.Thesevenstepsinthe

paymentcycleare:

(1)Paymententry

(2)Inboundprocessingandtransfer

(3)Inboundclearing

(4)Settlement(grossornet)

(5)Outboundclearing

(6)Outboundprocessingandtransfer,and

(7)Paymentdistribution.


Figure2Paymentcyclefornon-cashpayments

PaymententryStep1.Entryintothepaymentcyclecanoccurwhentheenterpriseorhouseholdneedingtotransfervaluethepayorinitiates,throughitsentrybankorbranch,acredittransfer(GIROpaymentorwiretransfer)forthebehalfofthereceivingentitythepayee.Alternatively,ifthepayeehasaninstrumentoragreementforadebittransfer(checkordirectdebit)fromthepayor,thepaymentcycleisinitiatedbythepayeethroughthepayee'sentrybank.Dependingontheinstrumentused,eitherpayororpayeemayinitiatethepaymentcycle.Ineithercasethegoalisthesame:totransfervaluefrompayortopayee.

Entrymaybepaper-based(checksorpaperGIROinstructions)orelectronic(ACH,electronicGIRO,debitorcreditcard,wiretransfer).Entrymayalsooccurusingtelexortelephoneinstructionsoracomputer-to-computerinterfacewiththeentrybank.Specificmessageformatshavetobefollowedforelectronicentryintothepaymentcycle.

Regardlessofthetypeofpaymentinstrumentused,theinformationnecessarytoenterthepaymentcycleincludes:(a)thenameandaccountnumberofthepayor(inordertodebitthecorrectaccount);(b)thenameandaccountnumberofthepayee(tocreditthecorrectaccount);(c)thevaluetobetransferred;(d)thedateofthetransactionand/orthedatethevalueistobetransferred;and(e)anauthorizationtoinitiatethetransaction.TheauthorizationmaybethesignatureofthepayorforcheckandpaperGIROpayments,acodenumberreadbyaterminalatthepointofsalefordebitandcreditcardtransactions,awrittenagreementpre-authorizingapayeetodebitapayor'saccount(adirectdebit),atestkeyorsequencenumberfortelextransactions,andpassword,call-back,testkey,anddedicatedcomputer-to-computerinterfaceforlargevaluewiretransfers.

Ifthepayorandpayeehappentohaveaccountsatthesameentrybank

orpostalGIRO,thentheprocessing,clearing,andsettlementofthepaymentisentirelyinternaltotheentryinstitution.Thisisa"on-us"transactionandclearingandsettlementisdeemedtohavetakenplacewhentheentrybank'sinternalaccountingcycleiscompleted,usuallyduringtheeveningofthedaythepaymentinstructionwasreceived.Ifbranchofficeaccountsarecentrallyintegratedandcontrolled,thenthemoreconcentratedisthebankingindustry,thehigherwillbetheproportionofpaymentsthatareon-usratherthan"on-other".Ifintra-bankaccountsarenotcentrallyintegratedtheneachbranchofabankeffectivelyactsasaseparatebankandanon-ustransactioncontinuesthroughthepaymentcycleasifitwasanon-otherpayment.

InboundprocessingandtransferStep2.Theentrybankorbranchinitiallyprocessestheinboundpaperorelectronicpaymentinstructionbycheckingthepaymentinformation,applyingappropriatesecurityprocedures(whennecessary),anddebiting/creditingtheappropriateaccounts.Thepaymentsarethensortedintonumerouson-othercategoriesandforwardedtoitssettlementbankusingcourierphysicaldelivery,off-linetelecommunication(telephone,telex,facsimile),oron-lineelectroniccomputerinterface.Theinboundsettlement

bankwilleitherbetheheadofficeofthebranchthatactedastheentrypointoritcouldbeanseparatecorrespondentbankthathasagreedtoactasasettlementagentintheclearingprocess.Useofacorrespondentasasettlementbankiscommonwhenmanybanksexist,therearenumerouscentersoftradeandproduction,and/orthecountryislargegeographically.

InboundclearingStep3.Clearingtakesplacewhentheinboundsettlementbankforwardsthepaperorelectronicpaymenttoa(local,regional,ornational)clearinghouseorprocessingcenter.Iftheprocessingcenterreliesonrealtimegrosssettlement,thenthepaymentsaresettledimmediatelyastheyarrive.Suchanarrangementsofarappliesonlytolargevaluepaymentsovercertainwiretransfernetworks(FedwireintheU.S.,SICinSwitzerland,andasubsetofpaymentsoverBOJ-NETinJapan).Muchmorecommonisnetsettlementwherethenetpositionofawholeseriesofinter-banktransactionsaresettledatvarioustimesoftheday:morningforACH,debitcard,creditcard,anddirectdebitsfunctionedthepreviousevening;mid-dayforchecksprocessedandsentovernighttoclearinghouses;orend-of-dayformanywiretransfernetworks(CHIPSintheU.S.,BOJ-NETinJapan,CHAPSintheU.K.,andothersinEurope).

GrossornetsettlementStep4.Settlementisalmostalwaysperformedthroughthecentralbankwhoirreversiblydebitsandcreditsclearingorreserverequirementbalancesofthesettlingbanks.Grosssettlementisbilateral,aseachtransactionbetweentwobanksinvolvesanimmediateandseparatesettlement.Netsettlementsareusuallymultilateral.Inamultilateralsettlement,thesetofallbilateraltransactionsisnetteddowntoasinglenetdebitornetcreditforeachparticipant.Thedebitsoccurfirstandareallpostedtoaspecialsettlementaccount.Thefundsinthissettlementaccountarethendistributedascreditstotheremainingbanksandthenetsettlementiscomplete.Whilealternativesettlementarrangementsexistthatrelyon

correspondentbalancesheldwithasettlingbank,ratherthanthecentralbank,thisalternativecanbetime-consumingandcostlyiftherearemanybankparticipants.Aswell,becauseasettlingbankmayfail,thepreferredsettlementarrangementisthroughthe(governmentbacked)centralbank.

OutboundclearingStep5.Oncesettlementoccurs,theclearinghouseorprocessingcenterinformstheoutboundsettlementbankthatthetransactioniscomplete.Whilesettlementbythecentralbankisfinalandisnotreversible,thepaymentcycleforaprovisionalpayment,suchasacheck,maybereversed.Ifthecheckwriterhasinsufficientfundsattheexitbanktocoverthevalueofthecheckwritten,thenthecheckisreturnedasanentirelynewtransactionwhicheffectivelyreversestheoriginaltransaction.Returnedchecksdonotinvalidatetheoriginalsettlement;theyjustbecomeapaymentinstructionintheoppositedirectionrequiringadditionalprocessingandclearingaswellasanewsettlement.

OutboundprocessingandtransferStep6.Afterthesettlementbankmakesthe

appropriateaccountingentries,itforwardsthepaymentinformationtotheexitbank.Thisprocessusesthesamepaperorelectronicmethodthatwasusedfortheinboundpartofthepaymentcycle(step2).

PaymentdistributionStep7.Ifthetransactionwasadebittransfer,theexitbankcomparesthedebitwiththecustomer'sbalanceandwillrejectthetransaction(orprovideashort-termoverdraftloanatpositiveinterest)ifthebalanceisinsufficient.Ifthebalanceisadequatetocoverthedebit,theexitbankforwardsthetransactioninformationtotheenterpriseorhouseholdwhoseaccountwasdebited.Ifthetransactionwasacredittransfer,theexitbankcreditsitscustomer'saccountandprovidesthepaymentinformationtotheaccountholder.

Exceptwhenpaperitemsaretruncatedortranslatedintoelectronicterms,exitfromthepaymentcycleisthesameasthemethodofentryandcanbepaper-based(check,paper-basedGIRO)orelectronic(ACH,electronicGIRO,debitorcreditcard,orwiretransfer).Voiceinstructionsoverthephoneorcomputer-to-computerlinkagesareusedforlargevaluetransactions.Forsmallvaluetransactions,accountholdersareinformedofpaymentdebitsorcreditsthroughmonthlyaccountstatementsmailedtocustomersor,ifdesiredsooner,uponcustomerinquiry.

ThemaindifferencesinthepaymentcycleforcheckandGIROpaymentsconcernspaymententry,inboundclearing,settlement,andpaymentdistribution.Insummaryform,thesedifferencesare:

Check GIROPaymententry

Payeereceivescheckfrompayorandinitiatescollection

PayorinitiatesGIROpaymenttopayee

Inboundclearing

Clearingison-usoron-otherinstitutions

Clearingistypicallyon-us

Settlement Effectively,onlyprovisionalnet Typically,finalgross

settlement settlementPaymentdistribution

Checkcanbereturnedtopayeeunpaid

Noreturns

Debitandcreditcardpayments,becausetheyusuallyarehandledatthepointofsaleinareal-timemodeorarecomparedagainstanegativefilewhichisconstantlyupdated,donotinvolvereturnitems.Settlementbetweentheaccountholder'sbankandthepayee'sbankusuallyinvolvesnetsettlement.

Floatandpaymentfinality.Indevelopedcountries,largevaluepaymentscancompletethepaymentcycleinamatterofminuteswhilemostlowervaluepaymentsarecompletedonanext-daybasis.Thelongerittakestocompletethepaymentcycle,thelargeristhefloatcostofthepaymentsystem.

Almostallpaymentcyclesoffersenderfinalitywhichdoesnotpermitthepaymentsendertoreversethetransactiononcethepaymenthasbeensent,evenifitisinerror.Errorsarereversedbyconvincingthepaymentreceivertoinitiateanewtransactionwhichreversestheoneinerror.Centralbankcontrolledlargevaluepaymentnetworks(Fedwire,BOJ-NET,SIC)andmanyprivatelyoperatedlargevaluenetworks(thetwolargestofwhichareCHIPSandCHAPS)whichsettlethroughthecentralbank,alsoprovideforsettlementfinality.Settlementfinalityiswheresettlementcannotbereversedevenifthereisafailurebyabankparticipanttosettleitsnetdebitposition.Thecentralbank,bylendingfundstoasettlingparticipantforafee(Fedwire),liquidatingcollateralpostedbyparticipants(CHIPS,CHAPS),orbyhavingpreviouslyrejectedtransactionswherebalanceswereinsufficient(SIC,certainBOJ-NETtransactions),allprovideforthefinalityofsettlement.12Alternatively,settlementfinalitymaybeprovidedwhenpaymentnetworkparticipantswithnetcreditslendfundstoparticipantswithnetdebits(mostofBOJ-NETtransactions).

Lastly,thereisreceiverfinalitywheretheexitbank,uponcompletionofthetransaction,wouldirrevocablycreditacustomer'saccountwithgoodandfinalfunds.Nopaymentnetworkhasreceiverfinality,largelybecausebankswishtoreducecreditriskbyhavingtheoptiontousefundsreceivedonbehalfofthecustomertocoveranyofthecustomer'sdefaultedloansornetdebitsinotheraccountsatthesamebank.

2ClearingFinancialMarketTransactions

Clearingandsettlementforfinancialmarkets:clearinghouses.Financialmarketsmobilizesavings,allocateinvestment,andprovidederivativeinstrumentsthat(whenproperlyused)reduceenterpriseriskfromfluctuatinginterestrates,foreignexchangerates,andrawmaterialorcommodityprices.Financialmarkettransactionsincludeinterbankovernightborrowings,banklargevaluecertificatesofdeposit,governmentdebtsecurities,enterpriseequityand(shortandlong-term)debtsecurities,aswellasawholehostoffutures,options,andotherderivativeinstrumentsrelatedtomoneymarketsecurities,foreignexchange,andcommodities.Alltransactionsinfinancialmarketshavetobeclearedandsettled,justliketransactionsthatoccuramongenterprisesorbetweenenterprisesandconsumers.

12AfullerdiscussionoftheseandotherissuesregardingtheoperationofvariouslargevaluepaymentnetworksisprovidedinHoriiandSummers(1994).

Financialmarkettransactionsaretypicallylargevaluetransactionsandtherearetwoprimarywaystheyareclearedandsettled.13Themostcommonmethodistosetupaclearinghousethatonlyclearsaparticulartypeoffinancialinstrument,suchasonlygovernmentsecurities(foragovernmentdebtmarket)oronlyenterpriseequitysecurities(forastockmarket).Oncethedirectandindirectpartiestoafinancialmarkettransactionhavebeennotifiedbytheclearinghousewhatthenetpositionsarethattheyoweaftereachday'strading,thepaymentandsettlementofthesetransactionsisthenhandledthroughthebankingsystemandthecentralbank,essentiallyfollowingthepaymentcycleoutlinedfornon-cashpaymentsinFigure2.14Thesecondmethodforhandlingfinancialmarkettransactionsinvolvesaspecializeddepositorywhichimmobilizesthesecuritybeingtradedand,asdiscussedbelow,integratestheclearinghousefunctionwiththepaymenttransaction(calleddeliveryagainstpayment).

Financialmarketclearinghousescentralizepurchaseandsaleinformation,performmultilateralnettingofcontractstobuyandsell,andnotifymarketparticipantsofthenetpositionstheyoweoneanother.Ifparticipantsaretradingfortheirownaccount,theythennotifytheirrespectivebankinginstitutionstomakepaymentstypicallyusingelectronicwiretransferstoparticipants'bankstocompletethetransaction,withphysicalorbook-entrydeliveryofthesecuritiesoccurringwithalagthatdiffersamongmarkets.Settlementoftheseinterbankpaymentsiseitherimmediate(onaRTGSnetwork)orend-of-day(onanetsettlementnetwork).Additionalpaymentsanddeliveryarerequiredifparticipantsareactingasanagentinthetransactionforenterprises,banks,orothertypesoffinancialinstitutions(whomaybetheultimatepurchaserofthesecurity).ThepaymentcycleforfinancialmarkettransactionsfollowsthatshowninFigure2.15Asshowninthefigure,paymentsareinitiatedbypurchasersoffinancialinstrumentsthroughanentrybank,whichthen

maygotoasettlementbank,toaprocessingcenter(e.g.,wiretransfernetwork),tothereceivingbank(typicallyalsotheexitbank),andfinallytothepaymentreceiver(whichcanbetheclearinghouseactingasanagentforthesellerofthefinancialinstrument).Settlementisthroughthecentralbank.

Whilesettlementoffinancialmarkettransactionsistimely,clearingmaynotbe.Theefficiencyoftheclearingprocessisafunctionofthenumberofparticipants,thetradingvolume,andtheextentthatthetradinginformationiscomputerized.OnlyrecentlyintheU.S.hasthetimelagformanystockmarkettransactionsandtheirfinalsettlementmovedfrom5to3days.Thistimelaggeneratesrisk.

Iftheparticipantsellingasecurityfailspriortosettlement,twotypesofriskmayoccur.First,paymentmayhavebeenmadebeforethesecuritiesweredeliveredtothe

13GreaterdetailisprovidedinParkinson,etal.(1992).14Seepage22.15Seepage22.

purchaser,inwhichcasethepurchaserisnowacreditorofthefailedparticipant.Alternatively,ifnopaymentordeliveryofsecuritieshasoccurred,thenthepurchaserfacesthe(likelysmaller)riskthatthepriceofthesecuritymayhaverisenandthepurchaserwillnowhavetopaymoreforthesecuritythanbefore.Theserisksarereducedby(a)reducingthetimelagbetweenwhenafinancialtransactionoccursandwhenthetransactionissettledand(b)institutingloss-sharingagreementsamongparticipantsintheclearinghouse(therebyinternalizingtheriskandprovidinganincentivetocarefullyscreenandcontroltheriskybehaviorofclearinghousemembers).Amajorproblemwiththeclearinghouseapproachhasbeenthatsomeparticipantsaremembersofmanydifferentspecializedclearinghouses,reflectingtheirtradingindifferentfinancialinstruments,sothatafailureofoneparticipantinoneclearinghousemayaffectthesolvencyofparticipantsinclearinghouseswherethefailedparticipantwasnotevenamember(creatingsystemicrisk).Greaterconsolidationandcoordinationamongclearinghousescanreducethisproblembutamoreeffectivesolutionatleastforcertaintypesoffinancialmarketinstrumentsistheestablishmentofadepository.

Paymentcycleforimmobilizedorbook-entrysecuritiesindepositories.Financialtransactionsinvolvepromisestopay(debtsecurities,futures,options)orownershiprights(equitysecurities).Inthosecaseswherethepromisetopayorownershiprightsarehighlyvaluedbythemarket,becauseofthecreditworthinessoftheinstitutionmakingthepromiseorthesolvencyoftheinstitutionbeingowned,itispossibletoimmobilizethesecuritybeingtradedinbook-entryformwithinacentralizeddepositoryanduseittocollateralizetheunderlyingtransaction.Ifthepurchaser(newowner)ofthesecurityfailstopayforthesecurity,thesecurity(collateral)canbereturnedtotheoriginalseller(whoisunpaid)oritcanbeliquidatedinthemarketwiththefundsthentransferredtotheseller.This

arrangementsubstantiallyreducestheriskoflossfromthefailureofafinancialmarketparticipantandtherebyalsoreducesthepossibilitythatthefailureofaparticipantinonemarketwillcauseproblemsforparticipantsinothermarketsinasystemicmanner.

Depositoriesalsofurtherreduceriskbyadoptingrulesandoperatingproceduresthatpermitdeliveryagainstpayment,whichiswhenownershipoftheunderlyingsecurityisnottransferreduntil,andsimultaneouslywith,theactualreceiptofthepayment(overaRTGSwiretransfernetwork).Thiseliminatesthetimegapbetweenwhenatransactionoccursandwhenpaymentandsettlementtakesplace.Ineffect,deliveryagainstpaymentgoesonestepfurtherthana(credittransfer)GIROpaymentsincethetransactiondoesnotevenoccuruntilthesecuritybeingpurchasedisinfactpaidforinfinalfunds.

Figure316illustratesthepaymentcycleforfinancialtransactionswithindepositories.IntheU.S.,depositoriescurrentlyhandleU.S.governmentdebtsecurities,mortgage-backedsecurities,andenterprisecommercialpaper,bonds,andequities(butnot16

16Seepage29.

futures,options,orforeignexchangetransactions).Indepositorieswithoutdeliveryagainstpayment,thereisaninitiatingfinancialtransactionbetweenthepurchaserandsellerofthesecurity.Thedepository,actingasaclearinghouse,clearsthetradeandnotifiesthepurchaserwhotheninitiatesthepayment(throughitsbankorthroughthedepositoryifitactsasabank)overaRTGSwiretransfernetwork.Thewiretransfernetworksettleseachtransactionseparatelyasitoccursthroughthecentralbankanddistributesthepaymenttothesecurityseller'sbankortothedepository(fortheseller'saccount).Theactualtransferofownershipofthesecuritiesneednotbesimultaneouswiththereceiptofthepayment.Onlyindepositorieswithdeliveryagainstpaymentwilltheownershiptothesecuritiesoccursimultaneouslywiththereceiptofpayment,therebyeliminatingalmostallofthepaymentriskinthefinancialmarkettransaction.

Figure3Paymentcycleforfinancialmarkettransactionsindepositories

3ChoicesinthePaymentCycle

Supplierandownershipchoice:banksversusthepostoffice.Thepaymentcyclemerelytransfersvaluefrompayortopayee.Theoperationofdebitingoneaccountandcreditinganothercanbedonewithinasinglestate-ownedmono-bank(inacentrally-plannedeconomy),withinasinglestate-ownedpostofficesystem(asoccursinEuropeandJapan),oramongvariousprivately-ownedbanks(asinalldevelopedcountries).

Ingeneral,thesmalleristhenumberofseparatepaymentsuppliersinacountry,thegreaterwillbetheproportionofon-uspayments.Asanon-uspaymentcanbetruncatedsothatthepaymentcycleoccursentirelywithintheentryinstitution,on-uspaymentsaretypicallyperformedatalowercostwithlowerclearingandsettlementriskthanarepaymentsthatrequireprocessingandcollectionthroughmorethanjusttheentryinstitution.

Thelowercostofon-usversuson-othertransactionsmeansthat,otherthingsbeingequal,postalGIROsshouldbeabletoprovidepaymentservicesatalowercostthancanbeobtainedthroughalessthancompletelyaggregatedbankingsystem.17Inturn,anaggregatedbankingsystem(asexistsinEurope,Canada,andJapan)shouldbeabletoprovidelowercostpaymentservicesthanabankingsystemthatishighlydisaggregated(asexistsintheU.S.).Althoughcompletebankaggregationisachievedunderamono-bankingsystem,whereallpaymentsareon-ustransactions,thisarrangementiscostlybecausepaymentsarepaper-basedandaccountsatbranchesofthestate-ownedbankarenotcentrallymanaged(soeachbranchistreatedasifitwereaseparatebank).Whilewedoknowfromvariousstudiesthatelectronicpaymentsindevelopedcountriesarecheaperthanpaper-basedpayments,thepresumptionthatpaymentcostsarelowerfor

moreaggregativebankingsystemsislogicallybasedonthefactthatanon-uspaymentischeapertoprocessthanisanon-othertransaction.

Anadditionalfactorinfluencingpaymentcostsisprivateversusstateownership.Insometransitional(anddeveloping)countries,thecentralbankisdefactotheonlynationwidebankandthesoleproviderofpaymentservices.Whileexceptionssuchasthisexist,theincentiveforprivategaininacompetitivemarketforpaymentservicescanleadtolowercoststhanwhenthesamepaymentservicesareprovidedthroughastate-ownedsupplier.However,thebenefitoflowercostneednotberealizedbyusersofthepaymentsystemifaprivately-ownedbankingsystembecomestooaggregated.Atsomepoint,dependingbothontheeaseofentryintotheindustryandacountry'santitrustpolicy,theincentivetolowercoststoimprovereturnstoownersandmanagersshiftsinsteadtoraisingprice.Thisconsideration,alongwith

17Ifenterprisedeposittransactionaccountspaidclosetoamarketinterestrate,thensomeinterbankpaymenttransactionsthoseforovernight,enterprisecashconcentrationpurposeswouldnotbenecessary,reducingsomewhatthedemandforon-othertransactions.

costsavingsfromon-uspayments,affectsthechoicebetweenbanks(whichareoftenprivately-owned)versusthepostoffice(whichisstate-owned)aspaymentsystemsupplier.

Local,regional,ornationalprocessingandsettlement.Insmallcountries,withonlyoneorafewclosely-locatedtradecenters,allclearingandsettlementcanbecentralized.However,inlargecountrieswithmultiplemoneyortradecenters,paymentprocessingandsettlementhasmanytiersinordertominimizecollectioncosts.Transfersoffundsbetweenpayorsandpayeeslocatedclosetooneanotherareclearedlocallywithsettlementhandledelectronicallythroughtheregionalofficeofthecentralbank.Paymentsbetweenpartiesmoredistantfromoneanothermayrequiremultiplehandling,ineitherpaperorelectronicform,withinterregionalsettlementamongcentralbankoffices.

Atieringofpaymentprocessingandcollectionfunctionsbetweenlocal,regional,andnationalpaymentsexiststodayintheU.S.andwillbethemodelfollowedinRussia.TheU.S.haslocalclearinghousesforlocalcheckpaymentsandlocalelectronicnetworkstoclearandprocesslocaldebitcardpayments.Ofthetwomajorbankcreditcardissuers,oneprocessesallpaymentsatasinglecentrallocationwhiletheotherhaschosenaregionalconfiguration.

Ingeneral,paymentsrequiringregionalclearingarehandledbothbynetworksofcorrespondentbanksandthe36regional(24branchand12head)officesofthecentralbank.Paymentsbetweenregionsareclearedbymovingpaymentinformationbetweentheseregionalcentersthroughregionalcorrespondentbanksoramongthe12headofficesofthecentralbank.Settlementiseffectedeitherthroughthemovementofcommercialbankbalancesatandwithinoneofthe12headofficesofthecentralbank(forbothlocalandregionalpayments)orthroughthemovementofthesebalancesbetweenthe12head

offices(fornationalpayments).Inbothcases,settlementeffectivelytakesplaceusingthecentralbank'snationwidelargevaluewiretransfernetworkwithentrypointsateachofthe12headoffices.Atpresent,thereisnoneedtocentralizetheholdingofcommercialbankpaymentclearingandsettlementbalancesbecausetheU.S.doesnotyethavenationwidebanks,althoughthiswillchangeinthenearfutureandlikelyleadtosuchcentralization.

Thedistinctionbetweenlocal,regional,andnationalpaymentsinRussiaparallelsthatoftheU.S.forthesimplereasonthatittooisquitelargegeographicallyanddoesnotyethavenationwidebanks.InRussia,thereare1400localofficesofthecentralbanktoprocessandclearlocalpaymentsanddisbursecash.Regionalandinterregionalpaymentsarehandledat71regionalprocessingsites(equivalenttothe24centralbankbranchesintheU.S.)and10superregionalcenters(similartothe12regionalheadofficesintheU.S.).Acentralizednationalprocessingcenterwillclearinterregionalandnationalpayments(similartoFedwire,thecentralbank'swiretransfernetworkintheU.S.)

Thetieringofprocessingandsettlementinthepaymentcycleassociatedwithcountrysize,bankingaggregation,andtheproportionofon-uspaymentsdictatethenumberofinter-bankcommunicationlinksneededforpaymentsystemoperation.Thetimeliness,cost,andsecurityofdifferenttypesoflinkswilldeterminewhethercommunicationwillbepaper-basedorelectronic.

Privatebankversuscentralbankprocessing.Privately-ownedbanks,ortheiragents,performthevastmajorityoftheclearingandprocessingofpaymentsindevelopedcountries.Consequently,centralbanksinthesecountriesessentiallyprovideonlysettlementservicesforthepaymentsystem.TheU.S.centralbankisthemainexceptiontothisdivisionofresponsibilityasitprovidessettlementservicesaswellasaboutone-fourthofallcheckprocessingandoverone-halfofallACHandwiretransferprocessingservices.Thisoccurredforanumberofspecifichistoricalreasons,involvingrecurrentbankingcrises,thefailureofprivately-operatedclearinghouses,adesiretoimprovepaymenttimelinessbyeliminatingnon-parchecking,andrestrictionsonbankbranchingwhichpreventedthedevelopmentofnationwide(orevenregional)bankingwithahighlevelofon-uspayments.

Tothedegreethatthesespecificproblemsarenotexperiencedintransitionaleconomiesandaviableprivatesectorcanprovideadequateclearingandprocessingofpayments,thecentralbankshouldprobablylimititselftoprovidingonlysettlement,notclearingandprocessing.Usually,theprofitincentiveissufficientfortheprivatesectortomorefullyandcost-effectivelymeettheneedsofpaymentusersthanmaybepossibleforthecentralbank,whichtypicallylacksaprofitincentive.

Settlementcanbeinnetterms,asoccurswithbulkprocessingofaseriesofpaymentswithend-of-periodsettlement,oritcanbegross

whereeachpaymentissettledinrealtimewhenitoccurs.Asnotedearlier,netsettlementcanbestructured(usingcollateralandotherriskreductionprocedures)tobeasrisk-freeasRTGS.Ifthisisdone,thenthelowestcostsettlementmethodwhichisnetsettlementcanbechosenforthepaymentcycle.

Accessandsecuritychoices.Accesstothepaymentsystemhashistoricallybeenlimitedtothebankingsystem.ThemajorexceptionisthepostalGIROwhosepaymentswereinitiallyallon-ustransactions,andthereforerequirednointeractionorsettlementbetweenbanksanditself.Incertaininstances,wheretherearealargenumberoftransactionsamongcommercialfirms,inter-firmpaymentsarenettedoutsideofthebankingsystempriortoentryintothepaymentcycletobesettled.Sucharrangementsexistintheairline,petroleum,andtruckingindustries(whereairlineshaveexchangedcustomerflightticketswhencustomerschangeflights,oilfirmshavetradedoilshipments,andtruckingfirmshavenettedfreightfeeswhentheyheavilyuseeachother'sservicesincompletingshipments).

Attemptsbycommercialfirmstobypassbanksandobtaindirectaccesstothepaymentsystem,andthusthelow-costandrisk-lesssettlementserviceprovidedbycentralbanks,havebeenrejected.Onereasonisthatinmostcountries,bankingandcommercehavealwaysbeenseparate(goingbackover300years).Aswell,commercialfirmshaveahigherearningsvariancethandobanks,yieldingagreaterprobabilityofbankruptcy.Keepingbankingandcommerceseparateservesbothtolimitdisruptionofthemoneysupplyandthepaymentsystemaswellasrestrictaccesstoacountry's(usuallysubsidized)depositinsurancefundandcentralbankdiscountwindowloans.Althoughstringent''firewalls"couldbebuilttoseparatebankingandcommercialactivitieswithinasinglefirm,muchasthetrustactivitiesofabankareseparatedfromtherestofthebank,thesolutionadoptedinalmostallcountrieshasbeentolimitorprohibittheownershipofbanksbycommercialfirmsandviceversa.Thusbothdirectandindirectaccesstothepaymentsystembycommercialfirmsisseverelylimitedandbanks,relyingontheirmonopolyaccesstocentralbanksettlement,remainthepredominantsupplierofpaymentservices.

Paymentsystemsecurityneedsaredirectlyrelatedtothevalueofthepaymentsbeingprocessed.Lowvalue(check,GIRO,creditanddebitcard)paymentsdonotusethemoreexpensiveproceduresinvolvedinlargevalueelectronicACH,GIRO,orwiretransferpayments.Largevaluepaymentstypicallyusededicatedcommunicationlines,passwords,testkey,andmessageencryption.Thesenetworksalsohavedevelopedback-upfacilitiesintheeventofmessageinterruption(frompoweroutage,naturaldisaster,oreventerroristattack).Ausefulcriteriaindecidingwhetherornottoadoptaparticularsecurityprocedureistocomparetheamortisedcostofadoptingtheprocedurewiththeestimatedcostofinsuringagainsttheexpectedlossifitisnotimplemented.

Participantliabilitiesanderrorresolution.Althoughanadequate

legalstructureshouldcontainacomprehensivelistofpayor,payee,andagentbankrightsandliabilitiesfordifferentpaymentinstrumentsundernumerousfailureconditions,thisdoesnotalwaysoccur(evenindevelopedcountries).Thusthereisaneedforadditional,andoftenmorespecific,banksupervisororcentralbankrulesandregulationscoveringtheseandotheraspectsofthepaymentcycle(likepaymentinstrumentstandards,customeraccessofdepositedfunds,andconditionsforprovidingsettlement).Inaddition,participationinclearinghousesisgovernedbyrulesconcerningbankdepositdeadlines,whensettlementoccurs,andtheresolutionoferrors.Typically,errorsareresolvedbyinitiatinganewpaymentwhichreversestheoriginalerror.Ifthevalueoftheerrorislarge,thecorrectionprocessincludesaninterestpayment.Errorsunidentifiedwithinastipulatedperiodoftimearenotsubjecttoreversalorcompensation.

Settlementofcross-borderpayments.Becausethereisno"worldcentralbank"andnocommoncurrency,cross-borderpaymentsbetweenenterprisesintwodifferentcountriesaretypicallyperformedusingcorrespondentaccountsatoneortwobanksinoneofthe

countries,usuallythecountrywheretheenterprisereceivingthepaymentislocated(enablingtheenterprisetoreceivepaymentindomesticcurrency).Cross-borderpaymentsrelyonamessagetransfernetwork,suchasSWIFT(SocietyforWorldwideInterbankFinancialTelecommunication),totransmitpaymentinformationwhichtellsthereceivingcorrespondentbanktodebitoneofitscorrespondentbalancesandcreditanother.Thetwocorrespondentbalancesmaybewithinthesamebank(an"onus"transfersettledwithinthebank)oratanotherbankwithinthesamecountry(withsettlementprovidedbythecentralbank).ThusSWIFTtransmitsthemessage,thecorrespondentbanktransfersthefunds,andthebankorthecentralbankprovidesthesettlement.

Correspondentbalancesusedforcross-bordersettlementarereplenishedbybuyingforeignexchangeandliquidatedthroughdebitsorwithdrawaldenominatedindomesticcurrencyunits.Althoughclearingandsettlementofcross-borderpaymentsismorecumbersomethanclearingandsettlementwithinacountry,theSWIFTarrangementiscost-effectivecomparedtootheralternatives(which,historically,involvedtheactualphysicalmovementofgoldorareservecurrencybetweencountries).

IIIMarketNeedsandChoicesinanEvolvingPaymentSystemThepaymentsystemofatransitionaleconomyneednotevolveinapre-determinedway.Indeed,differentcountrieshaveattimeschosentorelyupondifferentpaymentinstrumentsfornon-cashpayments.Theyhavealsosometimesallocatedpaymentsystemfunctionsandresponsibilitiesdifferentlybetweencommercialbanksandthecentralbank.TheproximatecausesofthesedifferencesaremorehistoricandpoliticalthaneconomicandarebestillustratedbynotingthedifferingevolutionofthepaymentsystemsoftheU.S.andEurope.Thechoicesfacingtransitionaleconomiesinimprovingtheirpaymentsystemareoutlinedandtheirinterrelationshipsnoted.Issuesimportanttothisprocess,particularlyinlettingmarketneedsinfluencethepaymentarrangementspermittedanddeveloped,arediscussed.AsummarychecklistofinformationneededtoadequatelyplanforpaymentsystemchangeispresentedinanAppendix.

1PaymentSystemChoicesinMarketEconomies:TheU.S.andEuropeanExperience

Centralizedversusdecentralizedsupplyofsavingsandpaymentservices.With81%ofallnon-cashtransactionsmadebycheck(Table2),18theU.S.istheheaviestuserofthispaymentinstrumentamongdevelopedcountries.(CheckuseinIndia,at99%,isevenhigherTable3.19Checkuseisassociatedwithadisaggregatedbankingsystem,alargegeographicarea,andahistoricalrelianceonaprivately-ownedbankingsystemforsafekeepingofsavingsforthegeneralpublic.

MostcountriesinEurope,incontrast,relyuponGIROpaymentsratherthanchecks.AlthoughEuropeanbanksareaggregated,whileU.S.banksarenot,thisdifferenceisnotthemainreasonforEurope'srelativelylowuseofchecks.Theprimaryreasonisthat,untilrecently,banksinEuropedidnotfocusonprovidingsavingsortransactionservicestothegeneralpublic:thistaskhashistoricallybeenthepurviewofthecentralizedandpublicly-ownedpostoffice.Thishistoricalrelianceonacentralizednon-bankproviderforsavingsservices,andthefactthatmostcountriesinEuropearerelativelysmallgeographically,madetheshiftfromcashpaymentstonon-cashGIROpaymentseasyinEuropebutimpossibleintheU.S.Instead,thehistoricallycost-effectivewaytomakepaymentsinadisaggregatedbankingsystemwithinalargecountryhasbeenbycheck.


Paperversuselectronicpayments.ThesamereasonsthathavedeterminedtheuseofdifferentpaymentinstrumentsintheU.S.andEuropehavealsoinfluencedtheshiftfrompapertoelectronicpayments.EuropeancountrieshavebeenmuchmoresuccessfulinimplementingelectronicpaymentsthanhastheU.S.foratleastfourreasons.Europehas:(1)acentralizedpostalGIROandanaggregatedbankingsystem;(2)asystemofnationwidepostalandbankingoffices;(3)agreateremphasisonexplicitpricingofpaymentservicestousers;and(4)agovernment/bankingsystempolicyofdirectingpaymentinstrumentusetowardthemostcost-efficientmethods.Thefirsttworeasonsleadtoahighproportionofon-uspaymentssothatelectronicpaymentsareanaturaloutgrowthofshiftingfrompapertoelectronicaccountingwithineachbankorthepostoffice.ThelasttworeasonsexplicitpricinganddirectinterventioninthemarketforpaymentserviceshasbeenmoreevidentinEuropeandhelpedtoshiftusersfrommoretolesscostlypaymentalternatives.

Importantly,onceacountryisinthepositionofrelyingheavilyonapaperpaymentinstrument,itisverydifficulttochangethatrelianceevenwhennewelectronicinstrumentsaredevelopedwhichhavedemonstrablyloweraveragecosts.Thisisbecausetheappropriatecostcomparisonisessentiallybetweentheaveragevariablecostofthepaperinstrumentandtheaveragetotal(fixedplusvariable)costofthenewelectronicinstrument.Onlyvariablecostisrelevantforthepaperinstrumentbecausethefixedexpenseshavealreadybeenmadetheyaresunkcostsand,typically,theonlynewfixedexpendituresareforreplacementoffullydepreciatedcapitalandtrainingofnewworkers.Sincenoneofthefixedexpensesofthenewelectronicinstrumenthaveyetbeenmade,averagetotalcostneedstobecoverediftheelectronicinstrumentisadopted.Thusanewelectronicpaymentinstrumentwillonlybeadoptedifitsaveragetotalcostislessthanthevariableexpensesoftheexistingpaperinstrument,whichisamore

difficulthurdletosurmount.

Non-bankcompetitioninsupplyingpaymentservices.InEuropetoday,bothbanksandthepostofficeprovidepaymentservices.Ifonesupplieroffersamoredesiredinstrument,theirmarketshareandpaymentrevenuesrise.Competitionbetweenbankandnon-bankprovidersofpaymentserviceshasbeenafactorinpromotingtheshiftfrompapertoelectronics.

AsimilarincentivedoesnotexistintheU.S.asbanksare(effectively)theonlysuppliersofbothpaperandelectronicpaymentservices.Shiftingacustomerfromcheckusetoelectronicpaymentsmerelysucceedsinshiftingtransactionbusinessfromonepartofthebanktoanother.Marketshareandrevenuesarelittleaffectedaselectronicpaymentscannibalizecheckvolume.Evenso,aredistributionofpaymentbusinesswithinabankwouldbeinabank'sinterestifstrongscaleeconomiesexistedforelectronicpayments.Althoughthereissomeevidenceofsuchscaleeconomies,bankshavenotpricedtheircheckandelectronicpaymentproductsinamannertomakethesecostdifferencesevidenttotheir

customers.

Paymentpricingandpaymentfloat.Thepriceofdifferentpaymentinstrumentsshouldreflecttheirunderlyingcostsousers,giventheirneeds,canchoosethelowestcostalternative.IntheU.S.,thepertransactioncostofusingcash,acheck,ortheequivalentofaGIROpaymentisestimatedtobe,respectively,$.04,$.79,and$.29.20Intermsofrealresources,cashischeapestwhilechecksaremoreexpensivethanGIRO(orevendebitcard)payments.However,oncefloatcosts/benefitsareincluded,theusercostsrealresourcecostplusfloatbecomes$.09,$-.04,and$.29.Whenfloatisnotchargedfor,checksareusuallycheaperforusersthanisaGIROoradebitcardpayment.Butthesecostdifferences,especiallyfornon-cashpayments,willnotbeclearly"seen"byuserswhenbankschargeforpaymentservicesbyrequiringaminimumbalancetobeheldand/orpayabelow-marketinterestrateontransactiondeposits.Herethemarginalcostofpaymentinstrumentuseseenbytheuseriseffectivelyzero,notpositiveanddifferentiatedasitwouldbeifadirectfeewereassessedfordifferentnon-cashpaymentinstruments.Withoutanexplicitfeeonpaymentinstrumentuse,thereisnorealincentiveforuserstodemandthelowestcostinstrument.Althoughrelativebankcostsmayfavorelectronicpayments,asintheU.S.,usershavetoseethiscostdifferencereflectedintherelativepricestheypayinordertodemandthelowcostservice.Becauseofdistortionsassociatedwithcheckfloatandbankpricingpolicies,resourcesarewastedandpaymentcoststousersarehigherthanwhattheywouldotherwisebe.Thisillustratestheresultthatanefficientpaymentsystemcanonlyariseinamarketeconomywhenpaymentservicesareproperlypricedsothatuserscancorrectlychoosethelowestcostservice.

Commercialbankandcentralbankpaymentfunctions.Inprinciple,allofthefunctionsofapaymentsystemuserinterface,clearing,

settlement,andregulationcouldbeprovidedeitherentirelybycommercialbanksorbythecentralbank.Inpractice,thesefunctionsaredivided.Commercialbanksperformtheuserinterfacefunctionandtypicallyprovideforallofthetransferofpaymentinformationneededtoprocess,clear,andaccountforthepaymentsbeingmade.Centralbanksprovideforthefinalsettlementofinterbankpaymentsandcontrolthevastmajorityoftheregulatoryfunction.Thisisthetypicaldivisionofpaymentfunctionsforallbutlarge-valuepaymentsinmostcountries.Becauseoftheirimportanceforthesmoothoperationofcommerceandfinancialmarkets,centralbanksoftenownand/oroperatelarge-valuepaymentnetworksthemselvesandthusdirectlyprovidethesespecificpaymentprocessingandclearingservicesratherthanleavethisfunctionsolelytocommercialbanks.

Whenthereisamajordifferenceinpaymentfunctionsprovidedbycommercialandcentralbanks,itconcernsthepaymentprocessingandclearingfunctionforlow-valueconsumerandenterprisepayments.IntheU.S.,thecentralbankprocessesaroundone-fourth

20MoredetailissuppliedinHumphrey(1995),Chapter2.

ofallcheckpaymentsandcompeteswithcommercialbanks.Thisisthedirectresultofhavingahighlydisaggregatedbankingsystem(withover11,000banks),whichwasduetoalonghistoryofpoliticallymotivatedgeographicalrestrictionspreventingthedevelopmentofasmallsetofverylarge,trulynationalbanksthatexistsinvirtuallyallotherdevelopedcountries.Whenthebankingsystemisconcentratedandtrulynationalinscope,commercialbankstypicallyprovidealloftheprocessingandclearingoflowvaluepayments,postalGIROpaymentsexcepted.Thegreatertheconcentration,thelargeristhepercentageofpaymentswhichcanbeclearedinternally.Withanationalbranchnetwork,paymentsdrawnonotherinstitutionscanoftenbepresentedforpaymentatthelocalofficeofotherlargebanksratherthanneedingtransportationtothe(possibly)non-localofficewherethepayor'saccountisactuallylocated.Inthisevent,paymentsdrawnonotherinstitutionscanbecost-effectivelycollectedusingabank'sownresourcesratherthanthoseofcompetingcorrespondentbanks(orthecentralbank).ThisisthearrangementthatcurrentlyexistsinCanada.

2MarketNeedsinTransitionalEconomies

Paymentsystemevolution:transitionaleconomies.Transitionaleconomiesaremovingfromapaper-basedmono-bankingsystemwithlocal/regionalclearingandsettlement.Thetransitionisaccompaniedwithashiftfromstatetoprivateownership,thedisaggregationofthemono-bankingstructure,seriouslegaluncertainties,ariseincreditrisk,andexpandedpaymentfloatwhichsignificantlyaffectsenterprisetradeandthemoneysupply(seeTable4).21Theseandotherproblemsareaddressedbysimultaneously:(a)expandingthelegalstructuretosupportprivateownershipandpayments;(b)speedinguptheprocessingandsettlementprocessforexistingpaper-

basedpayments;(c)developingasame-dayornext-daypaymentnetworkrestrictedtoenterpriseandinternationallargevaluepayments;and(d)determiningthedegreethatthebankingandpaymentsystemwillbeautomatedandcentralizedinthefuture.Thisisanexceedinglycomplexundertakinganditishelpfultohavealist,suchasthatprovidedinTable5,22ofthevariousissuesoneshouldbeawareofinthisprocess.

Pointsofexcessivepaymentdelaysshouldbeidentifiedandthevalueoffloatestimated.Relativelylow-costprocedurescanbeimplementedtoalleviatethisproblemintheshort-run.Existing"off-the-shelf"paymenttechnologycanusually,withsomemodification,beadaptedtolocalconditionsandperformwithsimilareffectivenessinmostenvironments.Overall,paymentsystemchangeshouldbeevolutionaryratherthanrevolutionary;successfulimprovementstoapaymentsystemdependtoalargedegreeonidentifyingimportantunmetmarketneedsandworkingcloselywithuserstofindsolutionstheycanaccept.Theseconditions


forsuccessrecommendprovenpaymentsproceduresratherthanthenewesttechnology.Indeed,itwouldnotbeanexaggerationtosaythatallshort-runandlong-runchangestoapaymentsysteminatransitionaleconomycanbemorethanadequatelyhandledwithcurrenttechnologyandprocedures:thenewesttechnologyisnotneededandwillnotbecost-effectiveifused.

Table5.IssuestoaddressinrestructuringapaymentsystemUSERNEEDS SYSTEMREQUIREMENTSEnterprises VolumeforecastsConsumers CapacityBanks ProcessingspeedCentralbank Timing(clearing/settlement)Government CostsNon-bankfinancial ReliabilityIntra-regional Controls/oversightNational Inter-networkinterfacingInternational Typeofsettlement(net/gross)PAYMENTINSTRUMENTDESIGN

OWNERSHIPANDCONTROL

Paper PrivateversuspublicElectronic DegreeofaggregationCards(debit/credit/ATM/pre-paid)

Accesstoclearing/settlement

Hybrid(truncatedpaper) PerformancestandardsCredit/debittransfer StandardizedformatsFinalfunds(highvalue) Finalfunds(highvalue)Provisionalfunds(lowvalue) COSTRECOVERYBatchprocessed Directfees/balancesOn-lineprocessed Full/partial(subsidy)recovery

Pricecontrol(market/government)RISKCONTROLDESIGN OTHERISSUESSettlementrisk Legal/regulatoryrequirementsFraudrisk Technology(off-the-shelfversusstateofthe

art)

ClearinghousefailureSecurityriskBankfailureSource:AdaptedfromListfieldandMontes-Negret,1994.

Userneedsandpaymentsystemdesign.Adetailedknowledgeofhowpaymentsystemsindevelopedmarketeconomiesarestructuredandoperateisquitehelpfultoaccuratelyidentifyareaswherepaymentsystemsmaybeimprovedinemergingmarketeconomies.Aproperlystructuredpaymentsystemshouldhaveanumberofattributes,drivenbyenterpriseandhouseholdneedforacceptability,timeliness,andreliability.Afterthiscomessafety,efficiency,andeaseofuse.Inrestructuringapaymentssystem,thegoalistolookforeffectivewaystoimprovetheseattributesforbothcurrentandfutureusers.

Theinitialstepinimprovingapaymentsystemshouldbetoaccuratelydetermineuserneedswhich,inturn,willformthebasisforappropriatepaymentsystemdesign,systemrequirements,legalstructure,andriskcontrols.AnAppendixprovidesinformationneededforthistask.Thisinvolvesanassessmentofthecurrentphysical,legal,andinformationinfrastructure,aknowledgeofthestructureandtechnologyofthefinancialsystem,aninventoryofcurrentlyusedpaymentinstrumentsandhowtheyareprocessed,andtheexistenceofincentivestoguidepaymentusetowardthemostcost-effectiveoutcomes.

Enterpriseneedsforpaymentsprimarilyconcerntheabilitytoquicklyandsafelytransferlargevaluesamongfirmsdistantfromoneanotherwithinandbetweencountries.Aswell,enterprisesrequirefinancingwhichistypicallyobtainedbyissuingdebtandequitysecuritiesinfinancialmarkets.Thisalsorequiresthetransferoflargepaymentvalues.Theseenterpriseneedsarelargelymetthroughthedevelopmentofasinglesecureelectroniclargevaluetransfernetworkwhichconnectsacountry'smajortradingcentersandtiesintoexistinginternationalfundstransferarrangements.Suchanetworkmaybepubliclyownedandoperatediftheprivatesectorisinsufficientlydevelopedtohandlesuchatask.Inanycase,settlementcanbemostcost-effectivelyhandledthroughthecentralbank.Riskisminimized

withRTGSusingeitheridleorinterest-earningbalancesorpostedliquidcollateral.Feesshouldbesettofullyrecovercostsandthelegalrightsandliabilitiesofthevariouspartiestothepaymenttransactionshouldbeclearandenforceable.

Whilemostconsumerneedsforpaymentsarelargelymetthroughtheprovisionofcashforsmallervalueretailtransactions,thisisusefullysupplementedwithnoncashpaymentinstrumentswhichallowforlargervalueconsumerpaymentsbothatandawayfromthepointofsale(e.g.,forbillpayments).Inrelativelyaggregatedbankingsystems,whichisthetypicalcase,thiscanbecost-effectivelyrealizedthroughacentralizedpaper-basedorelectronicGIROsystemdeveloped,owned,andoperatedeitherbythebankingsystemorsomegovernmententity.GIROpayments,oncemade,arefinalpaymentsandsettlementisinternal(socentralbanksettlementisnotneeded).Acheck-basedsystemisreallyonlyaviablealternativewhenthebankingsystemishighlydisaggregatedandwhenthereareeffectiveinstitutional,legal,orcommunicationinfrastructurebarrierstoelectronicallyconnectlargenumbersofinstitutionstoacentralizedclearinghouse.Also,checkscostmorethanGIROpaymentstoprocess,clear,and

settleand,becauseofreturnitems,representaprovisionalratherthanafinalfundstransfer.

Theissueofwhatentitiesbanks,non-bankfinancialinstitutions,orenterprisesmayhavedirectaccesstothepaymentsystemisthesameonefacedinmostcountries.Thetypicaloutcomehasbeentoallowdirectaccesstothepaymentsystem,andhencetocentralbanksettlement,almostexclusivelytobanksandothertypesofdeposit-basedfinancialinstitutions(savingsbanks,creditunions,co-operativebanks,etc.)Directaccessisnotusuallygiventonon-depositfinancialinstitutions(insurancecompanies,securitiesfirms)ortoenterprisesandtheirfinancialsubsidiaries.Althoughthepaymentaccessissuehasneverbeenadequatelyinvestigatedandseeminglyrestsonadesiretoseparateriskycommercialenterprisesfromlessriskybankingactivities,scaleeconomiesarelikelyrealizedattheclearinghouseandpaymentnetworklevelwhenthenumberofdirectpaymentparticipantsaresmallratherthanverylarge.

Ownershipofpaymentprocessingcentersandpaymentnetworksisusuallyintheprivatesector.TheexceptionsaretheU.S.whereaboutone-fourthofallpaymentsareprocessedbycentralbankoffices(duetoadisaggregatedbankingsystem)andvariouscountries'GIROcenters(ownedbythepostalservice).Theownershipissueistiedinwithhowpaymentservicesarepriced.Iftheprivatesectorownsthesefacilities,thenpricingshouldcoverallcosts,includingareasonablereturnoninvestedcapital.Whenacentralbankownsandprovidestheseservices,theyhavebeeneitherbeensubsidized(asintheU.S.priortothe1980s)orpricedasiftheywereprivatelyownedwhereallcostsarecovered(theU.S.currently).Ingeneral,resourceallocationisenhancedifpaymentservicesarepricedtorecoverallthecostsoftheirproduction.

AppendixPlanningforPaymentSystemImprovementsAdequatelyplanningforpossibleimprovementsinacountry'spaymentsystemfirstinvolvesstock-takingknowingwhereyouaretobeginwithandforecastinglikelypaymentsystemgrowthknowingwhereyoumightbeinthefuture.AsummarylistofquantitativeinformationusefulforthistaskisshowninTableA1.Stock-takingconcernsthedevelopmentofbenchmarkinformationregardingacountry'sinfrastructure(communication/transportation,legal,andinformational)itsfinancialsystem(bankingsystemstructure,distribution,andtechnology),itsexistingpaymentsystem(instrumentsused,typesofprocessing,andclearingarrangements),anditsincentivestructureanduserneeds.Ifdatadonotalreadyexist,surveyscanbedevelopedtocollectsampledataontheseelements.Alloftheseelementshavebeentouchedonordiscussedinthetextandthusrepresentsausefulsummaryofpaymentissuesraisedinthispaper.

Althoughnotexplicitlylistedinthetable,thedatacollectedshouldincludeestimatesofcurrentvolumesandvaluesofpaymentflowsbymajortypesofpaymentinstruments,focusingonflowsbothwithinandamongacountry'smajortradingcenters.Withthisdata,projectionsoflikelypaymentgrowthcanbeapproximatedbytieingpaymentgrowthbytypeofpaymenttotheexpectedgrowthinproductionandtrade.Informationoncurrentandprojectedpaymentvolumesiscrucialinordertoproperlydesignthemajorcomponentsofalltypesofpaymentsystems,includinglarge-valuenetworks,clearinghousesforsmall-valuepayments,andtheinterbankandbank-centralbankcommunicationsinfrastructurethattiesthemtogether.

TableA1.Informationneededforstock-takingInfrastructureanalysis

Financialsystem Currentpaymentsystem

Incentivesanduserneeds

PHYSICAL STRUCTURE INSTRUMENTS COSTSCommunication Centralbank Debit RelativepricesTransportation Commercial

banksCredit Float

Mailsystem Postoffice Paper AvailabilityCountrysize Moneymarkets Electronic SubsidiesTradingcenters Concentration Non-bank SeigniorageLEGAL DISTRIBUTION PROCESSING USERNEEDSLaws/rules Local/nationwideBatch TimelinessContracts Banksize On-line InterestratesJudicialsystem Proportionon-us Automation Largevaluepayments

convenienceEnforcement Settlementaccess

Inter-network

Supervision Tiering Networkaccess SecurityINFORMATIONTECHNOLOGY CLEARING COMPETITIONAcountingsystem

Paper-based Bilateral Intense

Reliability Electronic Multilateral WeakTimeliness Decentralized Correspondents InternationalInstitutions Centralized SettlementtypeBackup Security RiskcontrolsSource:AdaptedfromListfieldandMontes-Negret,1994.

BibliographyBhala,R.,''LegalFoundationsofLarge-ValueTransferSystems",inB.Summers(editor),ThePaymentSystem:Design,Management,andSupervision,InternationalMonetaryFund,1994.

BankforInternationalSettlements,CommitteeonPaymentandSettlementSystemsofthecentralbanksoftheGroupofTencountries,PaymentSystemsintheGroupofTenCountries,Basle,December,1993.

Datt,S.andA.Shanmugham,"NewDataonPaymentSystemsinDevelopingCountries",PaymentSystemsWorldwide,Spring1994.

Horii,A.andB.Summers,"Large-ValueTransferSystems,"inB.Summers(editor),ThePaymentSystem:Design,Management,andSupervision,InternationalMonetaryFund,1994.

Humphrey,D.,PaymentSystems:Principles,Practice,andImprovements,FinancialSectorDevelopmentDepartment,TheWorldBankTechnicalPaperNo.260,1995.

Listfield,R.andF.Montes-Negret,ModernizingPaymentSystemsinEmergingEconomies,PolicyResearchWorkingPaper1336,FinancialSectorDevelopmentDepartment,TheWorldBank,August1994.

Parkinson,P.,J.Stehm,A.Gilbert,E.Gollob,L.Hargraves,R.Mead,andM.Taylor,ClearanceandSettlementinU.S.SecuritiesMarkets,StaffStudies#163,BoardofGovernorsoftheFederalReserveSystem,Washington,D.C.,March1992.

Sendrovic,I.,"TechnologyandthePaymentSystem",inB.Summers(editor),ThePaymentSystem:Design,Management,and

Supervision,InternationalMonetaryFund,1994.

BackgroundMaterial

BankforInternationalSettlements,Large-ValueFundsTransferSystemsintheGroupofTenCountries,Basle,May1990.

BankforInternationalSettlements,ReportoftheCommitteeonInterbankNettingSchemesoftheCentralBanksoftheGroupofTenCountries,Basle,November1990(Lamfalussyreport).

BankforInternationalSettlements,CommitteeonPaymentandSettlementSystemsofthecentralbanksoftheGroupofTencountries,CentralBankPaymentandSettlementServiceswithRespecttoCross-BorderandMulti-CurrencyTransactions,Basle,September1993.

Boeschoten,W.,CurrencyUseandPaymentPatterns,FinancialandMonetaryPolicyStudies,Vol.23,KluwerAcademicPublishers,1992.

CommitteeofGovernorsoftheCentralBanksoftheMemberStatesoftheEEC,PaymentSystemsinECMemberStates,September1992.

CommitteeofGovernorsoftheCentralBanksoftheMemberStatesoftheEEC,"MinimumCommonFeaturesforDomesticPaymentSystems",WorkingGrouponECPaymentSystems,November1993.

NationalCommissiononElectronicFundTransfers,EFTintheUnitedStates,Washington,D.C.,1977.

Thomsom,F.,GIROCreditTransferSystems,MacmillanCompany:NewYork,1964.

transforming payment systems: meeting the needs of emerging market economies, parts 63-291

Documents