1. 1 The role of central bank money for large value payment systems Robert Lindley Deputy Head, CPSS Secretariat Regional workshop on reforming payment and securities settlement systems for the Middle East and North Africa Bahrain, Wednesday 16 March 2005 1

2. 2 Overview 1. Some stylised facts about central bank money 2. Who must use central bank money 3. Who can use central bank money 4. Services on central bank accounts

3. 3 Importance of money Almost every economic transaction involves money Economic agents free to choose means of payment Most money is “fiat” money – so acceptance depends on trust Key role of central bank is to maintain trust in money – both its value (monetary policy) and its circulation (payment systems) 1. Some facts about central bank money

4. 4 Money, money, money …. Type of money Cash (banknotes and coins) Deposits (current/sight) E-money 1 X not now limited access X not yet? Type of issuer Central bankCommercial banks 1 Coins are usually issued by the Ministry of Finance (this complication is ignored in the rest of the presentation)

5. 5 Central bank cash Central bank has monopoly But universal “access” – everyone can use cash Why? Cash is a bearer instrument Safe and convenient for users to have central bank monopoly – no need to worry about the riskiness of the issuer A monopoly? Inefficient? Cost may not be too high.

6. 6 Central bank deposits Central bank and commercial banks both issue deposit money but access to central bank deposit money is usually very limited (eg mostly banks and government). Why?

7. 7 Architecture of deposit money Central bank Central bank and commercial bank money AD CB A D CB “Free” banking More efficient but less safe? A balance between safety and efficiency Monobanking Safe but less efficient? Central bank Efficient - competition between banks (more important than with cash) Safe – banks (and customers) indifferent about where payments come from

8. 8 Advantages and disadvantages of settling in central bank money Advantages for banks Safety (credit and liquidity risk, business continuity) Liquidity (routine and emergency) Efficiency (single settlement institution) Neutrality (central bank is not usually a competitor) Other perceived benefits (safety net) Disadvantages for banks No interest paid Regulatory costs

9. 9 “The singleness of the currency” Originally a result of central bank monopoly of cash … … and, for deposit transfers, interbank settlement at the central bank More recently also supported by: deposit insurance banking supervision which mean we worry less about bank failures One dollar is one dollar is one dollar … regardless of whose liability it is.

10. 10 Three issues Who must use central bank money – who must have a central bank account? Who can use central bank money – who is allowed to have a central bank account? What services should the central bank provide on the accounts? AD CB

11. 11 Payment systems 1 Systemically important payment systems “Assets used for settlement should preferably be a claim on the central bank; where other assets are used they should carry little or no credit or liquidity risk” Core principles for systemically important payment systems (SIPS) Reason: safety In practice, almost all SIPS do settle in central bank money Main exceptions: foreign currency systems (nb: CLS as key example) 2. Who must use central bank money

12. 12 2 Other payment systems? Usually allowed to settle in central bank money but do not have to In practice, most usually do Efficiency and neutrality particularly important Sometimes discouraged (particularly if system includes non-banks as participants)

13. 13 Individual banks? Central bank BE DC Single-tier structure F A B Central bank C A D Two-tier structure E F Second tier banks (indirect participants) First tier banks (direct participants)

14. 14 Tiering Extent of tiering depends partly on costs Partly on tradition Partly on cartels (especially in the past) … but rarely forbidden. (NB Hong Kong.) Usually central banks leave it up to individual banks to decide. Why? Big banks typically do use central bank money Efficiency benefits may outweigh safety costs Difficult to enforce But ……

15. 15 Concentration …… Central bank BE DC Single-tier structure B Central bank C A D Two-tier structure F A E F Is this a quasi- system? Flows via central bank: A↔B A↔C A↔D A↔E A↔F B↔C B↔D B↔E B↔F C↔D C↔E C↔F D↔E D↔F E↔F Flows via central bank: A↔B A↔F B↔C B↔D B↔E B↔F C↔F D↔F E↔F

16. 16 Quasi-systems Central banks still considering what (if anything) to do Unlikely to lead to limits on tiering May lead to oversight of quasi-systems (ie some payment system standards applied to Bank A) Practical issues (eg how big do you have to be to be a quasi-system) Cooperation with banking supervisors likely

17. 17 Who can have access? Always or almost always OftenSometimes Never or almost never Banks Non-bank securities firms Other non-bank FIs General public Central banks and IFIs Remote access banks Corporates Central government Other government Central bank staff Key:increasing trendno changedecreasing trend 3. Who can use central bank money

18. 18 Increasing trend (1) Non-bank securities firms and other non-bank financial institutions May be similar to banks – the border line is not always clear Advantages of allowing access systemic risk? competitive disadvantage? central bank neutrality? Disadvantages of allowing access moral hazard? disintermediation? risk to central bank? AD CB

19. 19 USD United States Hong Kong Germany Bank Increasing trend (2) Remote access Main issue is risk (especially if credit is available) Is there demand? NB CLS as key example

20. 20 Decreasing trend Government (central and other), central bank staff, general public, corporates Advantages of allowing access “Experience” for the central bank Neutrality (for government) Disadvantages of allowing access Unfair advantage? (re general public and corporates) No particular advantage – better to have a competitive tender (re government)

21. 21 Services on accounts Credit –Account may be of little benefit without it –Risk to central bank (so collateral, limits, fees) Reducing credit costs –System design (eg hybrids) –Wider range of collateral Technical changes –Standards –Easier connectivity Operating hours –CLS as an example 4. What services should central banks provide?

22. 22 CLS: a key example USD BANK A ZURICH BANK B BAHRAIN JPY Continuous Linked Settlement is an example of settlement in commercial bank money, remote access, and the need for longer opening hours (1) A foreign exchange deal

23. 23 (2) The current settlement method BANK A ZURICH Bank A's USD correspondent Bank B's USD correspondent USD payment system USD Bank A's JPY correspondent Bank B's JPY correspondent JPY payment system JPY BANK B BAHRAIN X

24. 24 (3) Under CLS CLSBANKCLSBANK Bank A’s USD corresp- ondent USD Bank B’s USD corresp- ondent USD JPY Bank A’s JPY corresp- ondent JPY Bank B’s JPY corresp- ondent JPY BANK A ZURICH BANK B BAHRAIN CLS BANK NEW YORK Settlement is on the books of CLS Bank (ie not central bank money) CLS has remote access to RTGS systems around the world to receive and make these payments … … and needs all systems to be open at the same time …

25. 25 “Core” CLS hours (7 to 12 CET) 061218 24 6 12 Japan Switzerland USA (NY) (4) Payment system hours First day (in Japan) Second day (in Japan) Day 1 Day 2 1622410 16 22 4 1016224102216 Time in Japan Time in Switz. Time in USA

26. 26 Conclusion A mixture of central bank and commercial bank money is important to achieve a balance between safety and efficiency. But there are no clear rules about who can or must use central bank money. It is a matter of judgement about where the best balance lies. AD CB