Academic journal article Journal of Corporation Law

The Shadow Payment System

Academic journal article Journal of Corporation Law

The Shadow Payment System

Article excerpt

I. Introduction

Banking, derivatives, and structured finance may attract the lion's share of accolades and approbation in global finance-but payment systems are where the money is. Effective payment systems are vital to the smooth and efficient operation of the modern economy. Whenever your employer deposits your salary into your bank account, whenever you use your debit or credit card to purchase goods or services, and whenever you write a cheque to your landlord or to pay a bill, you are invariably relying on one or more payment systems to complete the transaction. collectively, these payment systems facilitate over $400 trillion in non-cash transactions per year: roughly five times global gross domestic product.1 Accordingly, while we often take for granted the important functions that payment systems perform within the global financial and economic system, there are few parts of this system that have a more direct impact on our daily lives.

Historically, payment systems in most jurisdictions have been legally and operationally intertwined with the conventional banking system. Banks accept deposits from households and firms in exchange for a promise to pay back deposited savings, along with any accrued interest, on demand. These deposits are credited to accounts that serve as the backbone of a complex institutional architecture that facilitates non-cash payments among and between households, firms, and governments. This architecture typically includes a network of correspondent accounts that banks hold with one another, along with one or more interbank clearing and settlement systems. Residing at the apex of this architecture is then a central bank such as the Federal Reserve, Bank of England, or European Central Bank that issues the ultimate settlement asset, oversees the functioning of the payment system and, importantly, stands ready to provide liquidity during periods of institutional or systemic stress.

The defining feature of banks is that they invest deposited savings in loans and other longer term investments.2 The resulting mismatch between their short-term liquid liabilities (demand deposits) and longer term and potentially illiquid assets (loans) renders banks susceptible to destabilizing runs by depositors and other short-term creditors.3 In order to minimize the risk of institutional and broader financial instability-and to effectively manage this instability should it arise-bank regulators have developed a range of prudential regulatory strategies.4 These strategies include emergency liquidity assistance or "lender of last resort" facilities, deposit guarantee schemes, and special bankruptcy or "resolution" regimes for failing banks. Importantly, these strategies often have the practical effect of relaxing the strict application of the general corporate bankruptcy law regimes that apply to virtually all other types of distressed firms; thereby enabling banks-and the payment systems embedded within them-to continue to perform their vital payment, investment, and other functions even under conditions of severe institutional stress. To address the resulting moral hazard problems, bank regulators then subject banks to intensive prudential supervision and impose capital, liquidity, and other regulatory requirements designed to constrain socially excessive risk-taking.5

Technological innovation is rapidly changing the way we make payments. To see how, you need only go to a grocery store, use public transit, or sell your old sofa on eBay. Perhaps most importantly, while banks and bank-based payment systems still dominate the financial landscape in most jurisdictions, recent years have witnessed the emergence of a vibrant, diverse, and rapidly growing shadow payment system. This shadow payment system includes peer-to-peer (P2P) payment systems such as PayPal, mobile money platforms such as Kenya's M-Pesa, and crypto-currency exchanges such as Mt. Gox.6 Despite this diversity, the financial institutions that populate the shadow payment system share two core features. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.