Norges Bank's oversight of payment systems -- authorisation and supervision.

• Author: Lund, May Helle

Throughout the 1990s a number of international recommendations on risk reduction in payment systems have been drawn up. The most recent recommendations were issued by the Bank for International Settlements (BIS) in the report "Core Principles for Systemically Important Payment Systems" from the Committee on Payment and Settlement Systems (CPSS), consisting of representatives of the G-10 countries. The principles are supplemented by recommendations on the responsibilities of central banks in this area. The new Norwegian Act of December 1999 relating to Payment Systems is in accordance with these recommendations. The Act introduces authorisation and supervision of payment systems, assigning responsibility for interbank systems to Norges Bank. The Act also establishes requirements concerning the organisation of payment systems and risk management, and it incorporates the EEA Settlement Finality Directive in Norwegian law. This article describes Norges Bank's oversight responsibility for payment systems on the basis of the Act relating to Payment Systems.

1. International recommendations on risk reduction

   For several years there has been a broad international focus on payment system risk, and a number of international recommendations on risk-reduction measures have been put forward. One central recommendation is that participation in payment systems should have a well-founded legal basis. It was partly on the basis of this recommendation that the EU began work on the Directive on Settlement Finality in Payment and Securities Settlement Systems (Settlement Finality Directive). The most important recommendations and the main content of the Settlement Finality Directive are described in brief in the following section, providing a background for a more detailed expose of recent developments in the Norwegian payment system.

   1.1 The BIS and the EU

   In 1990, the BIS issued the "Report of the Committee on Interbank Netting Schemes of the Central Banks of the Group of Ten Countries". This report, known as the Lamfalussy Report, made recommendations concerning requirements for multi-currency, cross-border private netting systems in order to reduce risk. These recommendations were followed up by the Committee of Governors of the Central Banks in the European Union, which recommended that they should also apply to national payment systems. The Lamfalussy Report set the pattern for central banks' work on risk-reduction measures in national payment systems, and laid the basis for subsequent recommendations in the area.

   In addition, the European Monetary Institute (EMI), the precursor of the European Central Bank, drew up a report in 1994 on minimum standards for the functioning of domestic payment systems, with the aim of achieving greater harmonisation of national payment systems in the EU. The report recommends, among other things, that systems should be based on transparent and objective criteria for participation and that the operating hours of systems should be harmonised. The EMI also recommended that national gross settlement systems be established.

   1.2 Core Principles for Systemically Important Payment Systems

   Partly as a result of the problems in the wake of the Asian crisis in the late 1990s, the BIS produced a report entitled "Core Principles for Systemically Important Payment Systems". The report sets out ten principles that should be applied to systemically important payment systems (see separate box), including how the principles should be interpreted and implemented. As at July 2000 the report was available in a consultative report edition. The final version is expected to be published by the beginning of 2001.

   The report was drawn up by a task force consisting of payment system experts from 23 central banks, as well as the IMF and the World Bank, and therefore reflects a broad international consensus on the requirements for important payment systems. The report is written in such a way that it can be used by countries at different stages of development, including emerging markets. However, this does not imply that the report is of less relevance for countries with highly developed payment systems, such as Norway. The purpose of the report is to help strengthen the international financial infrastructure, as safe and efficient payment systems are important for ensuring financial stability.

   The BIS Core Principles are largely based on the recommendations of the 1990 Lamfalussy Report. The original six Lamfalussy recommendations have, however, been augmented by four new principles, namely numbers 4, 6, 8 and 10 in the box below. In addition, the most recent BIS report contains four recommendations on how central banks, in line with their oversight responsibility, should apply these principles. Moreover, the report applies to all systemically important payment systems, including national systems, whereas the recommendations in the Lamfalussy Report were originally confined to multi-currency, cross-border private netting systems. The most recent report also places greater emphasis on the need to balance the considerations of efficiency and risk reduction in payment systems. The report emphasises that the systems must meet stringent risk control requirements, while it is also important to limit costs, as this is necessary in order to be able to offer efficient payment services.

   On the whole, the Core Principles are more flexible than the Lamfalussy recommendations, particularly with regard to accepting various approaches to reducing and managing risk. This must be viewed in the light of the experience gained in developing "hybrid systems", such as netting systems with several settlements through the day, which have reduced risk and require lower liquidity than gross settlement systems.

   1.3. Settlement Finality Directive

   The Settlement Finality Directive contributes to safeguarding the legal basis for payment and securities settlement systems. The objective of the directive is to reduce the legal risk associated with participation in these systems, to promote financial stability and to strengthen the internal market within the European Economic Area (EEA), not least through provisions on settlement finality and choice of jurisdiction. The directive is also intended to facilitate implementation of the European Central Bank's monetary policy. The directive relates to both domestic and cross-border payment and securities settlement systems, but is confined to systems established within the EEA which have been notified to the European Commission or the EFTA Surveillance Authority, ESA. Member states are required to "satisfy themselves as to the adequacy of the rules of the system prior to notification". The directive does not specify how comprehensive this approval must be, but it provides for the introduction of fully developed authorisation and supervision arrangements. The most important provisions of the directive have been implemented in Chapter 4 of the new Norwegian Act relating to Payment Systems on legal protection and security (section 2.5).

   In 1998, the Nordic Council of Ministers appointed a Nordic task force to maximise harmonisation of the implementation of the directive in Nordic law. All the Nordic countries have now implemented the directive in their national legislation.

2. The Norwegian Payment Systems Act -- why do payment systems need regulation?

   2.1 Risks in payment systems

   When a customer uses a bank card to pay for goods in a shop, and the shop has an account at a different bank from the customer, this generates in reality at least three funds transfers. First, the customer's bank debits the customer's account for the sum in question. Second, the shop's bank credits the shop's account with the same amount. Third, the same amount is transferred from the customer's bank to the shop's bank.

   The number of card payments and other types of payment effected by banks on behalf of their customers in the Norwegian payment system can reach several million transactions per day. Participants in the payment systems may incur considerable risk in connection with the obligations which arise from these transactions should anything unforeseen occur. However, it is not card payments which give rise to the greatest risk in the payment system. The greatest exposure arises as a result of interbank trading in securities and foreign exchange and money market transactions. Most claims are settled via transfers between the banks' accounts at a settlement bank, referred to as interbank settlement. In order to handle smaller transfers more efficiently, banks have established procedures for calculating each bank's total net claim or net obligation vis-a-vis other banks, instead of settling each transaction individually. This process is known as netting. Payments where the time factor is crucial and transfers of large amounts are processed separately in the Real Time Gross Settlement (RTGS) system. Norges Bank is the ultimate settlement bank both for the RTGS system and for settlement of netted positions in the central retail netting system. These systems thus comply with BIS Core Principle no. 6 stating that assets used for settlement should preferably be a claim on a central bank. Some private banks also undertake settlement of retail transactions for smaller banks. The chart in the box provides a graphic illustration of transactions between participants in payment systems.

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   The daily turnover in the Norwegian payment system may reach several hundred billion Norwegian kroner. The bulk of...