Academic journal article Journal of Money, Credit & Banking

Analyzing Alternative Intraday Credit Policies in Real-Time Gross Settlement Systems

Academic journal article Journal of Money, Credit & Banking

Analyzing Alternative Intraday Credit Policies in Real-Time Gross Settlement Systems

Article excerpt

This paper examines a central bank's choice of intraday credit policy for real-time gross settlement (RTGS) systems. Formal analysis of central bank objectives and commercial bank payment activity provides insight into both the choice and effects of several possible intraday credit policies. Observed intraday credit policies are interpreted within the context of the model. Among G-10 central banks, different combinations of prices, collateral, and quantity limits have been chosen to manage the supply of intraday credit. Conditions that rationalize these choices are shown to rely on (a) central bank preferences regarding credit risk and systemic risk, (b) liquidity management technologies, and (c) the cost of collateral.

Modern economies generate payment activity that is many multiples of the value of a nation's real product. In the G-10 countries in 1994, large-value payment flows were as large as one hundred times annual GDP. In the United States, in 1994, large-value payment flows exceeded seventy times GDP (Bank for International Settlements 1995). To date, much of this payment activity has been handled by systems that settle on a net rather than on a gross basis. As is well documented elsewhere, net settlement systems have the possibility to create systemic risk in the payments system (Van den Bergh 1994; Horii and Summers 1994; Borio and Van den Bergh 1993; Summers 1991; and Juncker, Summers, and Young 1991). As these authors discuss, without proper risk controls, failure of a net debtor in a net settlement system to meet its settlement obligation may cause other participants to face unexpected and significant liquidity shortfalls, credit losses, or both as a result of the settlement failure.

Because of systemic risks in the payment system and the desire to provide timely access to reserves for use in settlement, central banks have been increasingly interested in systems that process large-value payments using Real-Time Gross Settlement (RTGS) (European Union 1992, 1993). RTGS systems process and settle payment instructions individually, immediately, and with finality throughout the day across accounts held at the central bank. Given the intraday finality of RTGS payments, if a participant fails during the day, other participants who have received such payments during the day from the failing member will be unaffected. Hence, systemic risk in the RTGS system is eliminated through the central bank guarantee of finality. As a result of the systemic risk benefits of RTGS, such systems have begun to emerge in many countries as a competing or, in some cases, the replacement form of system designed to processes large-value payments.(1) The European Union countries, for example, are all installing RTGS systems. These systems, in turn, will be linked through the proposed Trans-European Automated Real-Time Gross Express Transfer (TARGET) system as a necessary precondition for monetary union (European Union 1992, 1993; Giannini and Monticelli 1995). Numerous Asian and Pacific Rim countries have also implemented or are moving toward implementation of RTGS systems, including Australia, Hong Kong, Thailand, and China (BIS 1997).

Central bank encouragement notwithstanding, commercial banks may be reluctant to process payments using a RTGS system because of certain costs that the system imposes on its participants. To settle each transaction on a real-time gross basis, a bank must either have the necessary funds in its central bank account at the time the payment is processed or be granted intraday credit by the central bank.(2) These two possible sources of funds, central bank account balances (reserves) and central bank intraday credit, are thus the sources of liquidity for making payments. Holding noninterest-bearing reserves overnight for settling payments during the day entails a significant opportunity cost to commercial banks and cost-effective, intraday money markets do not yet exist for obtaining intraday funds. …

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