Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation

By Jean-Charles Rochet | Go to book overview

Chapter Six

Controlling Risk in Payment Systems

Jean-Charles Rochet and Jean Tirole

Over the past twenty years the growing integration of financial markets, the development of new financial instruments, and the advance of computer technology have all contributed to a remarkable growth of financial activity in the main industrialized countries. One of the most significant consequences of this growth has been the unprecedented increase in the volume of trade on the large-value interbank payment systems (see table 6.1), which itself has resulted in a massive increase in intraday overdrafts on those systems (see table 6.2).

The central banks of the large industrialized countries, concerned with the risks that this growth was creating for their banking systems, have been studying the risks of interbank payment systems, work that has borne fruit with the Angeli Report (Basel Committee 1989) and the Lamfalussy Report (Basel Committee 1990) both under the aegis of the Bank for International Settlements (BIS), and the Padoa-Schioppa Report (European Community 1992) under the aegis of the EC.

Of particular concern is the organization of interbank large-value transfer systems. Banks have traditionally concluded among themselves multilateral netting arrangements which settle at discrete time intervals. This is the modern form of clearinghouses, which still operate for small-value transfers. These arrangements (“clearing or net settlement systems”) are designed to reduce the need for settlement balances and to reduce the number of portfolio adjustments. On the other hand, central banks worry about the settlement lags and implicit overdrafts associated with net systems and tend to favor “real time” or “continuous gross systems” for large-value interbank transfers. Whereas in a net system a payment is cleared with the settlement of the balance to the settlement agent (typically at the end of the day), in a gross system payment orders are examined one after the other in real time. If the sender's account has a sufficient funds balance, the order is executed irrevocably. If not, it is in principle canceled. Such cancelations, however, are costly. To make them less frequent, two mechanisms are used: the settlement agent can grant participants intraday overdrafts; and unexecuted orders can go into a queue, with an “optimization” enabling the highest number of waiting

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