The Central Bank and Payments and Settlement Systems

Transcription

1 The Central Bank and Payments and Settlement Systems Jean Monnet Autumn School, 2nd Edition: The Europeanisation of the Payment System, October 2015, Business and Law Department, University of Siena, Italy, Piazza S. Francesco Professor Benjamin GEVA Osgoode Hall Law School of York University 4700 Keele Street Toronto, Ontario, Canada M3J 1P3 1

2 Financial Market Infrastructure ( FMI ) Payment systems Central securities depositories Securities settlement systems Central counterparties Trade repositories 2

3 Financial Institutions Financial Markets Financial & Settlement Systems The Three Pillars of the Financial System The Financial System 3

4 Traditional Roles of a Central Bank (Morgan, 1943) The functions of a modern central bank are fourfold: to act as a manager of the National Debt and banker to the government; to regulate the currency; to be a banker s bank, and to act as a lender of last resort 4

5 Lender of Last Resort- LOLR A key characteristic of a central bank is its ability to act as LOLR by expanding its liability (in a superior form of monetary value). Function (may have?) evolved from central bank s role in clearing and settlement. Norman et als, Bank of England Working Paper no. 412 The history of interbank settlement arrangements (June 2011) 5

6 The central bank, money and the monetary system Issuer of bank notes/the official currency Holder of commercial bank s reserve/settlement accounts [effectuating the centralization of reserves] Monetary policy [management of money supply] through market operations [ reserves deposits/multiplier effect] 6

7 Central banks interest in payment and settlement systems BIS/CPSS May 2005 Supply of money as a means of exchange Maintenance of the stability of the financial system Implementation of monetary policy Two Aspects to Central bank s role in paymet and settlement systems: Scope and contents of the role; Role as a catalyst to evolution of other central bank s powers and responsibilities 7

8 Interest rates, money supply and price stability Central bank buys government debt securities from commercial banks Increase in money supply Low interest rate and higher price level; Central bank sells government debt securities from commercial banks decrease in money supply High interest rate and lower price level 8

9 Regulation of Money Supply Commercial Bank Money Central Bank Money Banknotes (and coins) held by the public Notes 1) Amount of Commercial bank money increases with the increase in the amount of central bank money 2) Amount of commercial bank money decreases with the decrease in the amount of central bank money Definition 1. Monetary base = central bank money + banknotes (and coins) held by the public 2. Money supply = commercial bank money + banknotes (and coins) held by the public 9

10 MS Goodfriend, in D. Humphrey, (ed) The US Payment System (1990), 247 Modern payment system is a complex set of arrangements involving such diverse institutions as currency, the banking system, clearing houses, the central bank, and government deposit insurance 10

11 Spindler and Summers: The Central Bank s Three Part Overall Mandate The conduct of monetary policy; Oversight of banks and financial markets to ensure their safety and stability; and: Involvement in the payment system: Supervising clearing organizations and banks that play key roles in the payment systems; Providing settlement across its books; Operating the LVTS; and Establishing appropriate public policy to govern the structure of private clearing and settlement arrangements. BJ Summers (ed.),the Payment System: Design, Management and Supervision(Washington DC: IMF, 1994) 11

12 Participants in the Domestic Payment System 12

13 Non-cash complex interbank payment Source: CPSS Publications No 55 August

14 Terminology [End-to-end non-cash] Payment: transfer of monetary value culminating in a debit to a payer account and credit to a payee s account. Clearing: processing and establishing [interbank] amounts to be settled Clearing house: centralized facility for clearing Settlement: payment of amounts established in clearing: In either central or commercial bank money [or otherwise?] 14

15 Central Bank Oversight of Payment and Settlement Systems BIS/CPSS May 2005 Oversight of payment and settlement systems is a central bank function whereby the objectives of safety and efficiency* are promoted by monitoring existing and planned systems, assessing them against these objectives and, where necessary, inducing change *Competition? Customer s protection? 15

16 Payment Systems (electronic and paper based) 1.Wholesale (single transaction/small groups focus)/lvts (wire transfers) 2. Retail (Batch processing)/bulk/ach; cheques; card payments 16

17 Policies relating to the efficiency and safety of retail payments should be designed by Central Bank, where appropriate To address legal and regulatory impediments to market development and innovation. To foster competitive market conditions and behaviours. To support the development of effective standards and infrastructure arrangements. To provide central bank services in the manner most effective for the particular market. Source: CPSS Publications No 52 March

18 LVPS Central Position Clearing and Settlement Retail Systems Securities Settlement System Cheque Clearing FX Settlement System LVPS Direct Debits/ Credits Central Counterparty ATM Networks Source: Manning et als, Economics of LVPS (2009) 18

19 Balancing Oversight and Innovation in the Ways We Pay: A Consultation Paper (released on April 13, 2015) Government of Canada has developed an oversight framework in which each system is assigned a place along a continuum according to the overall level of risk it poses to the economy. Systems were divided to three categories: (i) National retail payment systems processing low-value payments such as card networks and online payment systems; (ii) Prominent payment systems such as the ACSS, and (iii) Systematically important systems (such as the LVTS). 19

20 Payment Systems Are: instrumental both to the exercise and evolution of powers or functions by the central bank. They are: the foundation on which central banks core functions are built the bridge between them, for a breakdown of the payment system would inevitably disrupt both monetary and financial stability *AG Haldane & E. Latter, The Role of Central Banks in Payment Systems Oversight (2005), 45 Bank of England Quarterly Bulletin 66, at p

21 Statue of ESCB and ECB Art 2: Primary objective: to maintain price stability Art 3.1: Basic tasks: define and implement monetary policy; conduct foreign exchange operations; hold and maintain states foreign reserves; promote smooth operations of payment systems Art 16: exclusive right to authorize banknotes issue; Art. 22: ECB and NCB may provide facilities and the ECB may make regulations, to ensure efficient and sound clearing and payment systems.. 21

22 Payment System (Defaultsettlement incompletion) Risks 1. Legal uncertainty 2. Operational risk (e.g. equipment failure) 3. Credit risk (bank insolvency) 4. Liquidity risk (bank temporary inability to pay debts) 5. Systemic risk (domino effect of bank failure or settlement default) 22

23 Systemic Risk caused by settlement failure in SIPS Systemic risk the spread of inability to complete settlement into the financial system Designation, oversight and regulation in relation to clearing and settlement systems. Legal powers in relation to systemic risk: - Designation by the authorities; - Powers over clearing house, central counterparty, and participants. - Power to issue directives, agreements and general powers to control risk. 23

24 PCSA (1996) s. 4(1) If the Governor of the Bank [of Canada] is of the opinion that a clearing and settlement system could be operated in a manner that poses a systemic risk or payments system risk* and the Minister is of the opinion that it is in the public interest to do so, the Governor may designate the clearing and settlement system as a clearing and settlement system that is subject to this Part *Added in December

25 PCSA s. 2: systemic risk is: 1. the risk that the inability of a 25 participant to meet its obligations in a clearing and settlement system as they become due, or a disruption to or a failure of a clearing and settlement system, could, by transmitting financial problems through the system, cause:

26 PCSA s. 2: systemic risk will cause: (a) other participants in the clearing and settlement system to be unable to meet their obligations as they become due, (b) financial institutions in other parts of the Canadian financial system to be unable to meet their obligations as they become due, or (c) the clearing and settlement system s clearing house or the clearing house of another clearing and settlement system within the Canadian financial system to be unable to meet its obligations as they become due, As of December also: (d) an adverse effect on the stability or integrity of the Canadian financial system 26

27 PCSA: Payment system risk (as of Dec. 2014) the risk that a disruption to or a failure of a clearing and settlement system could cause a significant adverse effect on economic activity in Canada by (a) impairing the ability of individuals, businesses or government entities to make payments, or (b) producing a general loss of confidence in the overall Canadian payments system, which includes payment instruments, infrastructure, organizations, market arrangements and legal frameworks that allow for the transfer of monetary value 27

28 PCSA: Powers in relation to systems-i PCSA s. 6 authorizes BOC Governor to issue directives to a clearing house of a designated clearing and settlement system and its participants to take or refrain from an action in relation to systemic and payment system risks. As well, the PCSA provides the BOC with certain powers to enable it to monitor and control risk in designated systems: Under PCSA s. 5 Systems must provide the BOC with such information as the Bank requests. 28

29 PCSA: Powers in relation to systems-ii Under s. PCSA s. 9 Systems must provide the BOC with advance notice of any significant changes to the system, including changes to: operation of the system; the by-laws, rules or agreements which govern the system. Under PCSA s. 10 the BOC may conduct audits and inspections of a system and its clearing house. BOC may enter into an agreement with a System, governing such matters as netting, risk control, certainty of settlement and finality of payment, nature of financial arrangements among participants and 29 operation of the system.

30 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-I 181 Overview This Part enables the Bank of England to oversee certain systems for payment between financial institutions. 30

31 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-II 184 Recognition order (1) The Treasury may by order ( recognition order ) specify an inter-bank payment system as a recognised system for the purposes of this Part. 31

32 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-III 185. Recognition criteria (1) The Treasury may make a recognition order in respect of an inter-bank payment system only if satisfied that any deficiencies in the design of the system, or any disruption of its operation, would be likely (a) to threaten the stability of, or confidence in, the UK financial system, or (b) to have serious consequences for business or other interests throughout the United Kingdom. 32

33 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-IV 185 Recognition criteria//continued (2) In considering whether to specify a system the Treasury must have regard to (a) the number and value of the transactions that the system presently processes or is likely to process in the future, (b) the nature of the transactions that the system processes, (c) whether those transactions or their equivalent could be handled by other systems, (d) the relationship between the system and other systems, and (e) whether the system is used by the Bank of England in the course of its role as a monetary authority. 33

34 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-V 186 Procedure (1) Before making a recognition order in respect of a payment system the Treasury must (a) consult the Bank of England, (b) notify the operator of the system, and (c) consider any representations made. 34

35 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-VI 188 Principles (1) The Bank of England may publish principles to which operators of recognised interbank payment systems are to have regard in operating the systems. (2) Before publishing principles the Bank must obtain the approval of the Treasury. 189 Codes of practice The Bank of England may publish codes of practice about the operation of recognised inter-bank payment systems. 35

36 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS-VII 190 System rules (1) The Bank of England may require the operator of a recognised inter-bank payment system (a) to establish rules for the operation of the system; (b) to change the rules in a specified way or so as to achieve a specified purpose; (c) to notify the Bank of any proposed change to the rules; (d) not to change the rules without the approval of the Bank. (2) A requirement under subsection (1)(c) or (d) may be general or specific. 36

37 UK Banking Act PART 5 INTER-BANK PAYMENT SYSTEMS- VIII 191 Directions (1) The Bank of England may give directions to the operator of a recognised inter-bank payment system. (2) A direction may (a) require or prohibit the taking of specified action in the operation of the system; (b) set standards to be met in the operation of the system. 37

38 What is Financial Stability? A stable financial system is one in which financial intermediaries, markets and market infrastructure facilitate the smooth flow of funds between savers and investors and, by doing so, help promote growth in economic activity. Conversely, financial instability is a material disruption to this intermediation process with potentially damaging implications for the real economy Source: RBA The ability of the financial system to withstand stresses and strains and continue to provide financial services P. Jenkins and G. Thiessen, Reducing the Potential for Future Financial Crises: A Framework for Macro-Prudential Policy in Canada Commentary No. 351(Toronto: C.D. Howe Institute, May 2012) 38

39 Terminology: Key Concepts The elimination or control of systemic risk is tantamount to financial stability Macro-prudential supervision and regulation is designed to control (if not eliminate altogether) systemic risk so as to lead to financial stability. 39

40 Systemic Risks Risks to the financial system that cumulate across institutions, markets, and even countries to levels that could have serious effects on the real economy. They are of two types: Resiliency risks reflect a concentration of risk that can arise at a point in time because the interconnectedness and similar exposures of financial institutions and markets reduce the resiliency of the financial system to shocks and stresses. Procyclical risks, in contrast, are those that cumulate over time and reflect the tendency of the financial system to procyclical behaviour [rapid credit expansion contributing to unsustainable booms during economic upswings] that exacerbates economic booms and busts. 40

41 Macroprudential An orientation or perspective of regulatory and supervisory arrangements, calibrating them from a system-wide or systemic perspective, rather than from that of the safety and soundness of individual institutions on a standalone basis. It is an inductive rather than deductive perspective that follows a top-down approach, working out the desirable safety standard for the system as a whole and, from there, deriving that of the individual institutions within it. It takes explicitly into account the fact that drivers of risk depend on the collective behaviour of financial institutions. * *C. Borio, Implementing a Macroprudential Framework: Blending Boldness and Realism (BIS, 2010) at p. 2 41

42 Macro-prudential policy Macro-prudential policy seeks to augment the existing regulatory framework by focusing on systemic risk. Systemic risk can be broadly defined as risks to the stability of the whole or a large part of the financial sector. The purpose is to look beyond setting specific regulatory requirements aimed at ensuring the safety and soundness of individual firms [ micro-prudential regulation ], in order to identify desirable safety standards for the financial system as a whole. Macro-prudential regulation is an important addition to existing micro-prudential (or firm-specific) financial regulation. Source: UK New Approach Feb

43 Macroprudential policy toolkit Tools addressing the resilience risk involve the adjustment of capital base, pertain to governance and managerial incentives, and purport to increase transparency to enhance market discipline Addressing procyclicality requires the inducement of a build-up of cushions in good times so that they could be drawn down in bad times, thereby acting as stabilizers. -- the development of an effective framework to address procyclicality raises some questions that are familiar from the development of fiscal and monetary policy. BIS Annual Report

44 Objectives and use of Powers Payment systems - a key area for the use of central bank s responsibilities for financial stability and for the implementation of monetary policy Key aim of monetary stability: control of inflation through open market(om) operations; Key aim of financial stability: control of systemic risk- through OM operations, oversight and regulation Financial stability a land-between monetary policy and supervision 44

45 Financial Market Infrastructure ( FMI ) Payment systems* Central securities depositories Securities settlement systems* Central counterparties* Trade repositories *Settlement Systems 45

46 BANK OF England Act A Financial Stability Objective (1) An objective of the Bank shall be to protect and enhance the stability of the financial system of the United Kingdom (2) In pursuing the [this objective] the Bank shall aim to work with other relevant bodies (including the Treasury, the Financial Conduct Authority and the Prudential Regulation Authority). 11 Objectives In relation to monetary policy, the objectives of the Bank of England shall be (a) to maintain price stability, and (b) subject to that, to support the economic policy of Her Majesty s Government, including its objectives for growth and employment. 46

47 2013 Institutional changes in UK Financial Regulation -I First, a new Financial Policy Committee (FPC) [was]established in the Bank of England, with responsibility for macro-prudential regulation, or regulation of stability and resilience of the financial system as a whole; Second, micro-prudential (that is, firmspecific) regulation financial institutions that manage significant risks on their balance sheets [are]carried out by an operationally independent subsidiary of the Bank of England, the Prudential Regulation Authority (PRA); and Source: UK New Approach Feb

48 2013 institutional changes in UK Financial Regulation II Third, responsibility for conduct of business regulation [was]transferred to a new specialist regulator [to act as] consumer protection and markets authority. The name of this body [is] the Financial Conduct Authority (FCA); the FCA will have responsibility for conduct issues across the entire spectrum of financial services. Source: UK New Approach Feb

49 New Architecture for UK Financial Regulation 49

50 EUROPEAN SYSTEMIC RISK BOARD (ESRB) Responsible for macro-prudential oversight in the EU in order to contribute to the prevention or mitigation of systemic risks. ESRB Membership Voting members: NCB s Governors; ECB Vice President; European Commission Member; Chairs of three EU supervisory authorities: banking; insurance, and securities. Non-voting members: Reps pf national supervisors; President of Economic and Finance Committee. 50

51 Dodd- Frank Act SEC. 112 (1) (a): General PURPOSES AND DUTIES OF THE Financial Stability Oversight Council (FSOC) (A) to identify risks to the financial stability (B) to promote market discipline, (C) to respond to emerging threats to the stability of the United States financial system. 51

52 Title VIII of Dodd-Frank Act (ss ): Payment, Clearing and Settlement Supervision-I Sec. 804: designation by FSOC of systemic importance of financial market utilities [clearing houses] or payment, clearing or settlement activities Sec. 805: Risk management standards for such utilities and activities are to be set by the Fed. in consultation with the FSOC and supervisors. 52

53 Title VIII of Dodd-Frank Act (ss ): Payment, Clearing and Settlement Supervision-II- Sec 806 (a) Board may authorize a FRB to establish and maintain an account for a designated financial market utility (DFMU)... (b) Board may authorize a FRB to provide to DFMU discount and borrowing privileges only in unusual or exigent circumstances 53

54 Conclusion: The Economist, February 19 th -25 th 2011 at 77 The West s financial crisis has shaken public confidence in its leading central banks, and yet has also led to an expansion of their duties and powers. This has happened against the background in which central banking is becoming a more complicated game. On one hand, [the] old monetary policy tasks are not getting any easier to perform. On the other hand, in taking on more responsibility for the supervision of banks and the stability of the financial system central banks are taking more risks: Financial stability is politically a more treacherous mission that price stability. It requires new macroprudential policies and a new set of skills. Particularly, it may be more difficult if not impossible to insulate the attainment of financial stability from political considerations as well as interference by politicians. 54