Developments in euro payment systems Challenges for accession countries

2. Developments in euro payment systemsChallenges for accession countries Tom Kokkola, Senior Policy Expert European Central Bank Budapest, 28 November 2002

3. Introduction: The role of the ECB/Eurosystem • Article 3.1 (Basic tasks of the ESCB): • definition and implementation of monetary policy • conduct of foreign exchange operations • holding and management of official foreign reserves of the Member States • promotion of smooth operation of payment systems • Article 22 (Clearing and payment systems): “The ECB and national central banks may provide facilities, and the ECB may make regulations, to ensure efficient and sound clearing and payment systems within the Community and with other countries.”

4. The role of the ECB/Eurosystem The objectives • Maintaining systemic stability • Ensuring efficiency of payment systems • Maintaining public confidence in payment systems, instruments and currency • Protecting the transmission channel for monetary policy

5. Introduction The Eurosystem’s role in payment systems Different roles to perform the same task of “promoting the smooth operation of payment systems” • Operational role • for example, TARGET and provision of settlement facilities • Catalyst role • for example, cross-border retail payment services • Regulation • Oversight

6. Contents: 1. Implications of the move to a common currency 2. Large-value payment systems, including future developments in TARGET 3. Retail payments issues 4. Securities settlement and collateral 5. The utmost importance of co-operation Introduction

7. Before Monetary Union (-> 1998) In Monetary Union (1999 ->) One single currency - Several currencies - - Autonomous national monetary policies One monetary policy - - Segmented money markets One money market - - NCBs + European Monetary Institute Eurosystem - - National payment systems An integrated payment system - 1. Implications of the move to a common currency The needs of the single currency

8. 1. Implications of the move to a common currency • New borders: geographical borders no longer matter, but those of the single currency. • Part of what was foreign activities becomes domestic (= euro area). • Single European passport. • Remote access. • Strong foreign participation.

9. 1. Implications of the move to a common currency Foreign ownership (expressed as a % of total bank assets, end 2001)

10. 2. Implications of the move to a common currency

11. 2. Large-value payment systems, including future developments in TARGET

12. Trans-European • Automated • Real-time • Gross-settlement • Express • Transfer 2. Large-value payment systems

13. 2. Large-value payment systems Objectives • To contribute to the smooth conduct of monetary policy and the singleness of the money market • To improve the soundness of payment systems (risk reduction) • To increase the efficiency of cross-border payments in euro

14. Guiding principles • Market principle • Decentralisation principle • Minimum approach with regard to harmonisation of national RTGS systems 2. Large-value payment systems

15. Market principle • Use of TARGET not mandatory • Only payments directly connected with central bank operations (in which the Eurosystem involved either on the receiving or the sending side) and settlement of large-value net settlement systems have to go through TARGET • Other payment arrangements (Euro 1, PNS, correspondent banking) can operate in parallel to TARGET 2. Large-value payment systems

16. Decentralisation principle • Use of RTGS infrastructures in EU countries • Banks settlement accounts at NCBs • Direct exchange of payments between NCBs • Some centralised functions undertaken by ECB (TARGET co-ordinator, end-of-day functions, helpdesk, test centre, settlement accounts for Euro 1 and CLS) 2. Large-value payment systems

17. NCB NCB Bank Bank Interlinking Bank NCB ECB Bank NCB NCB Bank Bank 2. Large-value payment systems The decentralised structure “The central bank correspondent banking model”

18. Minimum approach • Rationale: minimising time and cost for the establishment of TARGET • Harmonisation only if necessary to ensure - singleness of monetary policy or - level playing field for banks • Not entirely identical services offered by the different national RTGS systems 2. Large-value payment systems

19. S 100 NCB (R) Queuing + cash management facilities 100 2. Large-value payment systems TARGET NationalRTGS Interlinkingsystem NationalRTGS Credit institutions Communication Credit institutions NCB (S) NETWORK 100 R 100 2 INTERLINKING MESSAGE 1 3 FORMAT DOMESTIC MESSAGE FORMAT DOMESTIC MESSAGE FORMAT

20. 2. Large-value payment systems • Operating hours and days • Common operating hours, ECB time: Customer payments from 7.00 am to 17.00Interbank payments from 7.00 am to 18.00 • Operating days calendar: in addition to Saturdays and Sundays TARGET closed on New Year’s Day, Good Friday, Easter Monday, 1 May, Christmas Day and 26 December • On closing days: no standing facilities, no settlement of euro money market or FX transactions involving the euro, EONIA not published

21. 2. Large-value payment systems Practical experiences • Capability of processing a high number of payments • End-to end completion of payment execution within minutes in normal operating conditions • No liquidity shortages • TARGET is de facto standard for large-value payments in euro • Three objectives have been met

22. 2. Large-value payment systems Challenges • Better meet customers’ needs, inter-alia, by providing an extensive harmonised service level • Cost-efficiency • Is prepared for swift adaptation to future developments including the enlargement of the euro area and the Eurosystem • But leave the responsibility for the business relations with the credit institutions with the NCBs

23. 2. Large-value payment systems Principles for TARGET2 1. Market principle 2. Decentralisation principle: business level, but less platforms than central banks 3. Broadly defined core service 4. Single price structure 5. Cost effectiveness

24. 2. Large-value payment systems • 1. Have an own platform that has to be cost recovery capable at the single price structure and compliant with all agreed TARGET2 features: • outside interface, • common services, • ... 2. Join the single shareable platform

25. 2. Large-value payment systems

26. Daily average volume 2. Large-value payment systems TARGET EURO 1 TARGET cross-border

27. 2. Large-value payment systems Daily average value TARGET TARGET cross-border EURO 1

28. 2. Large-value payment systems Average size of transactions TARGET cross-border TARGET EURO 1

29. 2. Large-value payment systems Figures as of May 2002

30. 2. Large-value payment systems EURO1 - Institutional set-up => EURO 1 is a real cross-border system: • The EBA Clearing Company S.A., which is in charge of the daily management and operation of EURO 1, is located in Paris, • the legal basis and the clearing rules of EURO 1 are under German law, • the netting centre (SWIFT) is incorporated in Belgium and • the participants come from 20 different countries.

31. 2. Large-value payment systems EURO1 - Type of system • EURO 1 is a net system, but not a netting system: • “Netting” is a legal concept • “Net system” is an economic concept

32. 2. Large-value payment systems EURO1 - Legal structure • SOS (Single Obligation Structure) => Economically the SOS is equal to multilateral netting, but legally it is different! => The SOS foresees that a participant has always only one single claim or obligation towards the system (i.e. the community of other participants), payment orders become part of the single claim/obligation upon processing; no bilateral obligations exist at any time. => Due to the SOS an unwinding is not possible.

33. 2. Large-value payment systems EBA Clearing System: Euro 1 Features: 1. Single obligation structure (SOS) 2. Bilateral credit lines (min EUR 5 million; max EUR 30 million)  multilateral credit and debit limits (max. EUR 1 billion) 3. Cash liquidity pool 4. If failure > liquidity pool, surviving banks provide additional liquidity 5. Settlement at the ECB via TARGET at the end of business day 6. Role of the ECB: Settlement agent, holder of the liquidity pool and overseer

34. 2. Large-value payment systems EURO1 - Types of transactions • EURO 1 processes credit transfers (customer and interbank payments) • At present: Division between interbank and customer payments: 35% interbank payments and 65% customer payments • Processing of direct debits planned

35. 2. Large-value payment systems EURO1 - Access criteria • Own funds of at least EUR 1.25 billion • Short-term credit rating of at least P2 (Moody’s) or A2 (Standard & Poor) • Direct access to an EU RTGS system connected to TARGET • Adequate technical and operational facilities • =>Since 17 September 2001: 73 participants from all 15 EU countries and from Australia, Japan, Norway, Switzerland, USA (EU branches of the latter five countries)

36. 2. Large-value paymentsystems Continuous Linked Settlement CLS is a project for establishing a multi-currency system for the settlement of foreign exchange transactions on a PVP basis in the books of a private bank acting as settlement agent where all members will open multi-currency accounts. Start of operations: September 2002 Eligible currencies from the start: euro, pound sterling, US dollar, Swiss franc, Canadian dollar, Japanese yenandAustralian dollar. Later on also: Norwegian krone, Hong Kong dollar, Danish krone, Swedish krona and New Zealand dollar.

37. 2. Large-value paymentsystems What is FX settlement risk ? • You deliver the currency being sold • but • you do not receive the currency you bought •  • the full amount of each trade is at risk = principal risk

38. 2. Large-value payment systems PvP mechanism Settlement of one leg occurs if, and only if, the other leg settles If you pay, you will either get paid or get a refund  No risk of losing principal amount of fx transactions

39. 2. Large-value payment systems General Overview of CLS Corporate structure:

40. …to receive and pay funds through The CLS Bank... ...has settlement accounts with NY Fed Fedwire ECB TARGET FEYCS/ BoJ Bank of Japan CLS Bank NewChaps Bank of England SIC Swiss National Bank LVTS Bank of Canada Reserve Bank of Australia RITS 2. Large-value payment systems USD EUR JPY GBP CHF CAD AUS

41. 3. Retail payments issues

42. 3. Retail payment issues Payment instruments Trends within the European Union:

43. 3. Retail payment issues Banknotes and coins in circulation outside credit institutions, as a percentage of GDP

44. 3. Retail payment issues

45. The current situation 3. Retail payment issues • Relatively poor service level for cross-border retail payments • in terms of pricing • in terms of speed of payment execution • Low volumes, but not necessarily low demand

46. 3. Retail payment issues Too expensive • On average EUR 15.51 to transfer EUR 100 • Double charging in 25% of the transfers • Total average price: EUR 17.10 Too slow execution • Average execution time 3.4 working days • Seven working days or more for 5% of the transfers

47. 3. Retail payment issues

48. 3. Retail payments issues Future prospects What is needed Straight-through-processing • – consistent routing mechanism --> IBAN/BIC – IPI – SWIFT MT102+/103+ interbank exchange fee • Common default • Reduced balance of payments reporting requirements

49. 3. Retail payments issues How to achieve the single payment area? • Integrate national and cross-border activity • Clubs • ACH network • Single ACH • Technology jump a possibility?

50. EURO1 - STEP 1 3. Retail payments issues STEP 1: • EBA developed STEP 1 in order to offer cross-border retail payment services • STEP 1 is operating since November 2000 • It uses the technical platform of EURO 1 • STEP 1 participants settle their balances via a EURO 1 participant