Payment Systems

In 1998 the infrastructure behind the joint European payment system, TARGET, was finalised. TARGET came into force on 1 January 1999 on the introduction of the euro. The infrastructure behind the real-time gross-settlement system DEBES (the Danish part of TARGET), the correspondent central bank model for cross-border provision of collateral, and the possibility of euro-denominated settlement in the Danish Securities Centre were also realised in 1998.

There are prospects of further internationalisation of the infrastructure, including potential Nordic cooperation on settlement of securities, and the establishment of global cooperation between the largest banks in order to reduce the settlement risk on foreign-exchange trading.

The development in the danish payment systems

Discontinuation of the uncollateralised overdraft facility
The banks' access to uncollateralised intraday credit from the Nationalbank has been gradually phased out since 1995.

This discontinuation makes high demands of the banks' intraday liquidity management. In 1995 the Nationalbank therefore announced a long transition period to allow the banks to adjust to the new situation. The last remaining elements of the uncollateralised credit facility with the Nationalbank were dismantled at the end of September 1998. The Nationalbank is thus now in line with the other EU central banks, which all only offer intraday credit against collateral.

Collateral right
In connection with the transition to intraday credit against full provision of collateral the use of collateral has been made more flexible. A new function, the collateral right, has been developed in the Danish Securities Centre, VP. The function presents two advantages in relation to ordinary pledging of collateral whereby a pledged paper may not be traded again until the loan is redeemed. With the collateral right it is not the individual paper, but the collateral-right account as such which determines the size of a bank's allowed overdraft. For as long as the account has a value exceeding the overdraft the bank may freely transfer securities to and from the account. If the overdraft is not redeemed in due time, the lender (the Nationalbank) may transfer the pledged assets to its own account. Moreover, the banks may already use purchased securities as collateral in the settlement run during which the securities are transferred. In the case of ordinary pledging to the Nationalbank the securities may not be used as collateral until they have been transferred. The banks thus achieve a substantial liquidity saving.

It was the original plan that the collateral right would come into force before the end of 1996, but problems with its implementation led to postponement until 30 July 1998. Besides Denmark only France has a scheme similar to the collateral-right system.

Euro-denominated payment systems in Denmark

Non-euro area member states may be connected to the joint European payment system, TARGET⁽⁸⁾. In cooperation with the financial sector the Nationalbank has therefore built up a payment structure for euro. Systems have also been established for euro-denominated settlement of securities and retail payments.

TARGET
TARGET is a real-time gross-settlement system (RTGS), cf. Box 4, which allows large euro-denominated amounts to be transferred rapidly and safely within the euro area. TARGET came into force on 1 January 1999. In addition to monetary-policy transactions TARGET may be used for commercial transfers between banks within the EU. TARGET is based on national RTGS systems which are interlinked across national borders. The Danish part of TARGET is called DEBES, Danmarks Euro BEtalingsSystem. The Nationalbank has discussed the design of the system on an ongoing basis with representatives of the banks.

A total of 34 banks have registered as direct DEBES participants, while around 70 have registered as indirect participants. To be a direct participant a bank is required to hold a euro-denominated main account with the Nationalbank. Indirect participants do not themselves hold main accounts with the Nationalbank, but send and receive funds via a direct participant. At EU level more than 5,000 banks are direct participants and around 40,000 are indirect participants in TARGET. It is thus possible to transmit euro-denominated payments via TARGET to most banks within the EU.

Box 4 TYPES OF PAYMENT SYSTEMS

Payment systems for transfer of funds between banks can be divided into two categories: real-time gross-settlement systems and net settlement systems. In a real-time gross-settlement system (RTGS) the banks send their payment orders to e.g. the Nationalbank on a continuous basis. Each payment is settled immediately and finally via the banks' accounts with the Nationalbank. In a net settlement system the banks on an ongoing basis send their payment orders to a clearing centre (e.g. PBS or VP). One or several times a day the latter calculates the net position of each bank. The banks then settle their accounts, e.g. via accounts with the Nationalbank. There are both advantages and drawbacks in both systems. In a net settlement system the payments are not final until clearing and settlement have taken place. On the other hand, the liquidity requirement and thereby costs are higher in a gross-settlement system. A bank which in the course of one day is to send and receive three payments each of kr. 50 million will have no liquidity requirement in a net system, whereas in a gross system it might require up to kr. 150 million. In Denmark as of 4 January 1999 there are two real-time gross-settlement systems: DEBES in euro and the DN Inquiry and Transfer System in kroner. The retail clearing (settlement of retail payments, including cheques and Dankort) is an example of a net settlement system.

The fees for using DEBES are fixed so as to cover all costs. A further requirement was that the system would be available for widespread use. The fee structure therefore includes a connection fee and a monthly charge which both increase with the size of the bank, as well as transaction fees, which are the same for all participants.

The fee for cross-border TARGET transactions declines with the number of transactions. The fee for the first 100 transactions per month is 1.75 euro, for the next 900 transactions 1 euro, and for the following transactions 0.80 euro.

TARGET will be open daily from 7.00 a.m. to 6.00 p.m., except weekends, Christmas Day and New Year's Day. The long opening hours ensure that the system is open concurrently with payment systems in e.g. the USA and Japan. This can help to reduce the settlement risk on foreign-exchange trading, cf. Box 5.

It is difficult to estimate the scale on which TARGET will be used in the future. In addition to monetary-policy transactions and settlement of various net systems in euro, the central banks wish the system to be used for large payments. Smaller payments are best made via the net systems, as is also the case at national level.

TARGET terms for non-euro area member states
EU member states outside the euro area participate in TARGET on more restrictive terms than the euro area member states. While euro-area participants have access to unlimited intraday liquidity against provision of collateral, participants from the non-euro area member states may only obtain liquidity on the basis of deposits by the country's central bank to a central bank in the euro area. The Nationalbank therefore before 8.00 a.m. each morning deposits 1 billion euro with a central bank in the euro area. This deposit is withdrawn at around 5.00 p.m. each evening. There is thus an upper limit of 1 billion euro to the liquidity which can be made available to the Danish participants within one day. If the banks' total liquidity requirement exceeds 1 billion euro the Nationalbank distributes the liquidity to the participants according to the same distribution key as is used for the connection fee and the monthly charges. The costs of the deposits are collected from the Danish participants and distributed on the banks in proportion to the liquidity they receive. For the 1st quarter of 1999 the costs are fixed at 0.08 per cent p.a.

Furthermore, after 5.00 p.m. non-euro area member states may only transact payments on the basis of a positive balance. In case of failure to cover an overdraft by 5.00 p.m. the participant must pay an interest premium to the Nationalbank. If the overdraft is not covered by 6.00 p.m. the participant must pay a further interest premium to the Nationalbank and the ECB. Apart from the interest premium to the ECB this generally corresponds to the practice in the Nationalbank's krone-denominated payment system, and is not expected to present problems for the Danish participants. Overall the terms for Danish banks' participation are acceptable.

The Nationalbank uses government bonds and mortgage-credit bonds as the collateral basis for both euro-denominated intraday credit and for krone-denominated credit. For technical reasons it is not possible to use certificates of deposit as collateral for euro-denominated credit. In order to cover the market-value risk it has been determined that the value of the collateral must exceed the amount of the loan by at least 3 per cent.

The correspondent central bank model
In order to facilitate the provision of collateral in e.g. TARGET the EU central banks and the ECB have built up the correspondent central bank model (CCBM) for cross-border provision of collateral. The principle is that the central banks will not extend credit of any kind without collateral. Cross-border collateral is provided by the central banks acting as each other's correspondent banks. A bank within the EU may use securities placed in another EU member state as collateral vis-à-vis its national central bank. A bank in Germany requiring credit from the Bundesbank may e.g. deposit securities held in the Netherlands to a safekeeping account with the Dutch central bank. The latter informs the Bundesbank that it holds the securities, and the Bundesbank then provides the credit to the German bank.

Danish banks with branches in a participating country may obtain euro-denominated liquidity against Danish securities as collateral, provided that the Danish securities are accepted as collateral. The central banks of France, the Netherlands, Finland, Luxembourg and Germany have stated that they accept Danish securities.

In the longer term it is possible that cross-border intra-EU collateral will be provided by transferring securities between securities centres, cf. below concerning ECSDA.

Settlement of securities and retail payments denominated in euro
In the Danish Securities Centre euro-denominated settlement, like krone-denominated settlement, takes place at night in order to be in harmony with the settlement in the international securities centre Euroclear. Euro settlement takes place in kroner, since, as stated above, the Nationalbank may only make euro-denominated liquidity available during the day. The krone amounts are converted to euro on the following morning.

While the retail clearing on the krone side takes place at night, the euro-denominated retail clearing is settled in the morning. This gives participants time to obtain euro-denominated liquidity, and to relinquish it again. The euro-denominated retail clearing may only be used for account-to-account payments and not for PBS transfers, e.g. direct debits. The euro retail clearing is expected to be ready in May 1999.

In order to prepare participants for the new euro-denominated systems, in cooperation with VP and the Danish Bankers Association the Nationalbank has held seminars on settlement and payment systems denominated in euro. Approximately 350 people attended. Moreover, the Nationalbank has provided staff training for DEBES participants.

Internationalisation of the settlement structure

The number of cross-border transactions has increased steadily in recent years. To support this development a number of initiatives have been taken in the securities and currency settlement areas.

Securities settlement
As described on p. 62, the securities depositories of Denmark (VP), Sweden (VPC) and Norway (VPS) have initiated cooperation to support closer Nordic cooperation in the stock-exchange area and to prepare for wider European cooperation in the future. In the longer term the vision is to create a joint Nordic clearing and settlement company called S4 (Scandinavian Securities Settlement System).

S4 will be designed to be in harmony with a future joint European securities settlement infrastructure. In the short term the cross-border provision of collateral within the EU takes place via CCBM. In the longer term the intention is for the securities depositories to establish links among themselves which are similar to those existing today between VP and Euroclear. This will be achieved via ECSDA (European Central Securities Depositories Association), which is an alternative to CCBM. Securities may be transferred between countries via ECSDA.

Settlement of foreign-exchange trading
Major changes are also being prepared in the area of currency settlement. Currency settlement and securities settlement are similar in that two different claims are exchanged. However, with regard to currency settlement there are no institutions to ensure simultaneous settlement of the two claims and thereby reduce the settlement risk. One of the problems related to foreign-exchange trading is that the exchange is often between countries in different time zones. There can therefore be a long delay between the ingoing and outgoing payments in a foreign-exchange transaction. The parties to a foreign-exchange transaction in practice hold a credit risk on each other for the period from the irrevocable release of their currency until they receive currency from the counterparty.

In July 1998 the major industrialised countries, G10, published a report on foreign-exchange trading risks⁽⁹⁾. The report follows up on an equivalent report from 1996. In the 1996 report G10 recommended action at three levels: bank, sectoral and central-bank levels. Banks were to improve their risk management systems so as to reduce the duration of the settlement risk. The banking sector was encouraged to accelerate the establishment of clearing centres where settlement risks are limited by netting or are eliminated by PvP (Payment versus Payment), i.e. by simultaneous settlement of both legs of a foreign-exchange transaction. The central banks were to work for the RTGS systems of different countries to be open at the same time to provide for simultaneous settlement of the two legs of a foreign-exchange transaction, and the central banks were to contribute to building up international cooperation.

Box 5 CLS BANK

Continuous Linked Settlement, CLS, is a private bank established to reduce the risk on foreign-exchange transactions. The original initiative was taken by 20 of the world's largest commercial currency traders, but later the group of shareholders has been expanded to include approximately 60 shareholders who have each contributed $3.5 million. Den Danske Bank and Unibank are among them. The shareholders will be the only direct participants. The system is planned to start in mid-2000 for the most liquid currencies (dollar, euro, yen and a few others). The krone will not be included until the second wave, probably around the turn of the year 2000/2001. Between one third and half of global currency trading is expected to take place via the system. The principle behind CLS is Payment versus Payment, PvP. Both parties in a foreign-exchange transaction must pay in their part of the deal to the CLS Bank, a subsidiary of CLS. Only then will the CLS Bank exchange the payments. This avoids a bank assuming a risk before it receives the currency. A currency may only be settled in CLS if the country's RTGS system is open between 7.00 a.m. and 12.00 CET, so that payments can be exchanged. Although in principle the system is very simple, in practice it will be very complicated. This is because - to save liquidity - the deals will to a great extent be settled by netting without funds being paid in. The necessary procedures should a bank not be able to fulfil its commitments will also have to be in place.

The 1998 report concludes that progress has been made on all fronts. Banks have improved their risk management systems. At the sectoral level a number of large banks have commenced the establishment of the CLS Bank, cf. Box 5. Finally, TARGET entails considerable opportunities for simultaneous settlement of foreign-exchange transactions via PvP.

The framework for payment systems⁽¹⁰⁾

The Payment Card Act
In autumn 1998 the Ministry of Business and Industry submitted a draft bill to amend the Payment Card Act. The bill entails the rescinding of Section 20 of the Payment Card Act which prohibits the banks from imposing fees on retail traders for their Dankort transactions. Initially this applies only to payments via the Internet. In three years' time the banks may also impose fees on the retail sector if real competition has been established in the area.

Further development of the payment technology will be of benefit to banks, the retail sector and consumers alike. However, Section 20 implies that some elements of the costs may not be imposed on the retail sector. To some extent this reduces the banks' incentive to develop the technology further.

The Nationalbank has traditionally supported the establishment of a common payment systems infrastructure. The common infrastructure must be regarded as a considerable advantage. The objective must therefore be a liberalisation of the Payment Card Act without at the same time destroying the core of the common infrastructure.

Footnotes