Debit card interchange fees generally lead to cash-promoting cross-subsidisation

Cards and cash are competing payment instruments at point-of-sale. The twosided market platform theory, based on general benefit assumptions, supports the use of multilateral interchange fees for card payments as a means of promoting the use of cards. However, analysis of the issue from the concrete processing cost viewpoint leads to the opposite conclusion: collection of debit card interchange fees by issuers results in subsidisation of cash and so actually promotes the use of cash instead of cards. Banks use card interchange revenues to cover cash distribution costs. For merchants, interchange fees increase payment costs and thus reduce the possibilities to pass through to customers the cost savings flowing from card efficiency. Moreover, because of high merchant fees due to high interchange fees, merchants are also more reluctant to accept payment cards. An MIF based on the tourist level approach will result in all parties being indifferent between cash and cards and thereby delay the realisation of the cost benefits of increased debit card usage. The resent actions of authorities to increase transparency and reduce cross-subsidisation seem to point in the right direction – towards more efficient resource allocation in payments.interchange fee; cross-subsidies in payments

Optimizing Liquidity Usage and Settlement Speed in Payment Systems

The operating speed of a payment system depends on the stage of technology of the system's communication and information processing environment. Frequent intraday processing cycles and real-time processing have introduced new means of speeding up the processing and settlement of payments. In a real-time environment banks face new challenges in liquidity management. They need to plan for intraday as well as interday fluctuations in liquidity. By employing various types of hybrid settlement structures, banks may be able to even out intraday fluctuations in liquidity demand. The aim of this study is to develop a framework for analysing fluctuations in liquidity demand and assessing the efficiency of different settlement systems in terms of speed and liquidity needs. In this study we quantify the relationship between liquidity usage and settlement delay in net settlement systems, real-time gross settlement systems and hybrid systems, as well as the combined costs of liquidity and delay in these systems. We analyse ways of reducing costs via optimization features such as netting of queues, offsetting of payments and splitting of payments. We employ a payment system simulator developed at the Bank of Finland, which enables us to evaluate the impact of changes in system parameters and thus to compare the effects of alternative settlement schemes with given payment flows. The data used covers 100 days of actual payments processed in the Finnish BoF-RTGS system. Our major findings relate to risk reduction via real-time settlement, effects of optimization routines in hybrid systems, and the effects of liquidity costs on banks' choice of settlement speed. A system where settlement takes place continuously in real-time and with queuing features is more efficient from the perspective of liquidity and risks than a net settlement system with batch processing. Real-time processing enables a reduction in payment delay and risks without necessarily increasing liquidity needs. Participants will operate under immediate payment/settlement if liquidity costs are low enough relative to delay costs and if the liquidity arrangements are sufficiently flexible. The central bank can therefore support risk reduction and payment speed objectives by providing low cost intraday liquidity as well as more flexible ways for participants to add or withdraw liquidity from the system. Optimizing and gridlock solving features were found to be effective at very low levels of liquidity. The efficiency of the different optimization methods for settlement systems are affected by the actual flow of payments processed. Gains from netting schemes with multiple daily netting cycles were found to be somewhat more limited.payment systems; clearing/settlement; liquidity; efficiency; gridlock

Simulating interbank payment and securities settlement mechanisms with the BoF-PSS2 simulator

The simulation technique provides a new means for analysing complex interdependencies in payment and securities settlement processing. The Bank of Finland has developed a payment and settlement system simulator (BoF-PSS2) that can be used for constructing simulation models of payment and securities settlement systems. This paper describes the main elements of payment and settlement systems (system structures, interdependencies, processing steps, liquidity consumption, cost and risk dimensions) and how these can be treated in simulation studies. It gives also examples on how these elements have been incorporated in the simulator, as well as an overview of the structure and the features of the BoF-PSS2 simulator.simulations; simulator; payment systems; clearing/settlement; liquidity

Restructuring securities systems processing – a blue print proposal for real-time/t+0 processing

Securities settlement is an area, where nobody seems to be content with the current international processing systems, but neither has a proposal for improvement emerged that has attracted common support. This paper describes a possible solution based on an international, harmonised and simplified institutional structure operating in an open real-time network structure. All deals are settled in immediate, t+0, real-time, which means that all assets and funds are delivered immediately and thereby removing settlement risk. Inter-custodian delivery problems of securities will disappear, because only securities available on investors’ accounts can be settled, which continuously equals the amount on the omnibus-accounts. This will also take out the risks related to ‘naked’ short selling, because in most cases investors have to make securities and funds available before trading. This may divide the current market in a spot t+0 and a short term t+3 futures’ market. Corporate actions can be organised in coordination and executed in synchronisation through the infrastructure network in which all custodians and registrars/CSDs participate. The paper describes the concrete new methods required (eg international custody account number system, ICAN, and DVP-codes for matching) also the probable impact of immediate real-time settlement on trading patterns, liquidity issues and risk containment. These are all areas, where the proposed new infrastructural solutions would bring benefits to the users, mainly faster/immediate delivery, less risks, lower processing costs, more competition and more efficient processing of corporate actions. Custodians’ liquidity management will need to focus on the sufficiency of the real-time balance of settlement money, which might be more or less strained compared to the current situation depending on the off- setting patterns of incoming and outgoing settlements during the day. International implementation will require coordination and engagement by key players.Securities settlement, securities settlement infrastructure, DVP processing, securities trading interfaces

Restructuring securities systems processing – a blue print proposal for real-time/t+0 processing

Securities settlement is an area, where nobody seems to be content with the current international processing systems, but neither has a proposal for improvement emerged that has attracted common support. This paper describes a possible solution based on an international, harmonised and simplified institutional structure operating in an open real-time network structure. All deals are settled in immediate, t+0, real-time, which means that all assets and funds are delivered immediately and thereby removing settlement risk. Inter-custodian delivery problems of securities will disappear, because only securities available on investors’ accounts can be settled, which continuously equals the amount on the omnibus-accounts. This will also take out the risks related to ‘naked’ short selling, because in most cases investors have to make securities and funds available before trading. This may divide the current market in a spot t+0 and a short term t+3 futures’ market. Corporate actions can be organised in coordination and executed in synchronisation through the infrastructure network in which all custodians and registrars/CSDs participate. The paper describes the concrete new methods required (eg international custody account number system, ICAN, and DVP-codes for matching) also the probable impact of immediate real-time settlement on trading patterns, liquidity issues and risk containment. These are all areas, where the proposed new infrastructural solutions would bring benefits to the users, mainly faster/immediate delivery, less risks, lower processing costs, more competition and more efficient processing of corporate actions. Custodians’ liquidity management will need to focus on the sufficiency of the real-time balance of settlement money, which might be more or less strained compared to the current situation depending on the off-setting patterns of incoming and outgoing settlements during the day. International implementation will require coordination and engagement by key players.securities settlement; securities settlement infrastructure; DVP processing; securities trading interfaces

Re-engineering Payment Systems for the E-world

Payment systems are undergoing rapid changes stimulated largely by technological progress. Distributed network technology, real-time processing and customers’ willingness to use electronic banking interfaces will further reshape payment systems during the coming years. Internet and e-commerce will have a major impact on payment systems. This paper presents the current developmental trends. It analyses the need to develop payment standards and the content of payment instructions in order to fully automate the payment process. Since interbank settlements comprise an essential part of payments, they should be made an integral part of the payment process within the Internet environment. With cross-border payments increasing in importance, any new developments should take an international perspective. Payment system development requires cooperation between the banks and other participants involved. In order to build the necessary consensus, banking industry organizations as well as central banks and other regulators will need to work together to re-engineer the present payment systems, making full use of the possibilities created by modern technology.payment systems; settlement systems; RTGS; payment system integration

Settlement in modern network-based payment infrastructures – description and prototype of the E-Settlement model

Payment systems are undergoing rapid and fundamental changes stimulated largely by technological progress especially distributed network technology and real-time processing. Internet and e-commerce will have a major impact on payment systems in the future. User demands and competition will speed up developments. Payment systems will move from conventions that were originally paper-based to truly network-based solutions. This paper presents a solution – E-Settlement – for improving interbank settlement systems. It is based on a decentralised approach to be fully integrated with the banks’ payment systems. The basic idea is that central bank money, the settlement cover, is transferred as an encrypted digital stamp as part of the interbank payment message. The future payment systems would in this model operate close to the Internet/e-mail concept by sending payment messages directly from the sending bank’s account/payment server to the system of the receiving bank with immediate final interbank settlement without intervening centralised processing. Payment systems would become more efficient and faster and the overall structure would be come straightforward. The E-Settlement and network-based system concept could be applied with major benefits for correspondent banking, ACH and RTGS processing environments. In order to assess this novel idea the Bank of Finland built a prototype of the E-Settlement model. It consist of a group of emulated banks sending payments to each other via a TCP/IP network under the control of a central bank as the liquidity provider and an administration site monitoring the system security. This paper contains an introduction to network-based payment systems and E-Settlement, the specifications of the E-Settlement model and the description, results and experiences of the actual E-Settlement prototype.network-based payment systems; settlement systems; interbank settlement; payment system integration

Simulation studies of liquidity needs, risks and efficiency in payment networks

This publication consists of nine separate studies on payment and settlement systems conducted using simulation techniques. Most have been carried out using the payment and settlement system simulator BoF-PSS2 provided by the Bank of Finland. The preliminary versions were presented at the annual simulator seminars arranged by the Bank in 2005 and 2006. The main focus of the analyses is on liquidity requirements, settlement speed, gridlock situations, gridlock resolution methods, liquidity economising, systemic risk and the impact of shocks on system performance as well as network analysis and modelling of payment systems. The studies look at systems in several countries and cover both RTGS and netting systems as well as securities settlement systems.simulation; payment and settlement system; payment networks; liquidity; gridlock; systemic risk; counterparty risk

Simulation analyses and stress testing of payment networks

This publication consists of ten separate studies on payment and settlement systems employing simulation techniques. Most of these were carried out using the payment and settlement system simulator BoF-PSS2 provided by the Bank of Finland. The preliminary versions were presented at the annual simulator seminars arranged by the Bank in 2007 and 2008. The main focus of the analyses is on continuity arrangements, operational stability, liquidity requirements, liquidity economising, gridlock resolution, transaction queuing arrangements, network features and network topologies. The studies examine systems in several countries and cover different kinds of payment systems and regimes.simulation; payment and settlement system; liquidity; gridlock; system risk; network topology

Interbank funds transfer systems: liquidity needs, counterparty risks and collateral

Over the next few years, we will see a pronounced increase in the speed at which payment transactions are executed and in the share of cross-border transactions, particularly in the euro area. Counterparty risks and liquidity needs connected with the transfer of funds continue to evolve and to provoke discussion. The fact that funds transfers occur and systems operate on a real-time and gross basis will significantly alter the operational character and technical solutions in this field. Systems following a daily timetable are being replaced by continuously operating systems, which will have a significant impact on banks' liquidity management. The trend toward immediate real-time payment transactions seems inevitable in the light of present trends. It is generally presumed that RTGS systems operating on a gross basis require more liquidity than netting systems. Liquidity needs depend on payment system structures and payment flows. An even flow of payments requires less liquidity than an uneven flow. Liquidity needs can be significantly reduced by choosing an appropriate payment system structure, taking measures to even out payment flows and agreeing on market practices. The pricing, collateral and reserve requirement policies of the central bank affect also the efficiency of alternative payment systems. Thus the overall efficiency of a gross or net system depends on many factors. Factors arguing for a gross system are differences in counterparty risks, lack of reciprocity, steady interday payment flows and stable liquidity needs, both within and between days. Factors favouring net systems are the existence of small and varying counterparty risks and structurally unsteady payment flows that result in large interday variations in liquidity, even though overnight variations may be moderate. Current, daily-oriented practices have focused on overnight liquidity needs. In a continuously operating environment, liquidity needs are continuously monitored across time-period borders. This means that banks' liquidity management will in the future operate under a new and broader time perspective. Significant liquidity needs and large counterparty risks are inherent parts of Finland's present funds-transfer solutions. Liquidity can be freed for other uses and counterparty risks reduced by changing the structures. The necessary changes have been agreed and soon we will see fundamental changes in Finnish payment systems.payment system settlement; gross settlement; RTGS; payment system counterparty risks; payment system liquidity needs