Payment systems--a potential source of risk. The need for oversight and supervision.

• Author: Haare, Harald
• Position: Norway. Central Bank of Norway

Since the early 1990s, there has been increased attention on the risk banks incur through their role in the payment system. The primary focus has not been on the individual bank's risk exposure but on the possibility of problems spreading from one bank to another through the payment system. This type of domino effect is called systemic risk and can at worst threaten financial stability. Central banks oversee the payment system in order to limit this risk. This article explains the concepts oversight and supervision as well as the performance of Norges Bank's tasks in this area.

1. Introduction

   On an ordinary day, the Norwegian payment system processes more than three million payment transactions. On some days, for example the last days before Christmas, the number of transactions can be far higher. The average value of all transactions is approximately NOK 300 billion per day. This means that in less than one week, turnover in the Norwegian payment system is comparable to mainland GDR

   Most payment transactions are between individuals and public or private enterprises. For example, when an individual pays rent by credit transfer or purchases goods by payment card, the transaction will result in an obligation for the payer's bank to withdraw the amount from the payer's account and transfer it to the payee's bank, which in turn must credit the same amount to the payee's bank account. Therefore, an ordinary payment transaction results in a settlement between the payer's and payee's banks. This is accomplished by debiting and crediting the two banks' accounts in a settlement bank.

   Most retail payments involve small amounts and it is not efficient to send these transactions individually to settlement. Instead, they are totalled and netted in a clearing house. The clearing house calculates the result of all payments to and from customers in the participating banks. The result is a sum per bank either a net obligation or a net receivable from all the other banks. The individual banks or their data processing centres send payment information to the Norwegian Interbank Clearing System (NICS) which is responsible for netting. NICS has subcontracted this operation to the processing centre BBS (Banking and Business Solutions). The netting result is then sent to the settlement bank. In Norway, retail payments of this kind are settled twice daily, in the morning and in the afternoon.

   If netting results are to be settled, all participating banks must have cover in their accounts at the settlement bank, either in the form of deposits or drawing rights. The settlement will not be completed as expected if there is insufficient cover. Because the settlement comprises many individual transactions between many banks, insufficient cover at one bank will have consequences for all other participating banks. If a bank expects to receive a substantial amount in the settlement, and it fails to be settled, the impact on the bank's liquidity could be considerable. This liquidity shortage can also spill over to other banks, which in turn expected to receive liquidity from the bank that did not receive settlement.

   In order to reduce the risk of such spillover effects due to a failure to settle, the largest transactions will not be included in this type of netting but will be sent individually to settlement. The large-value transactions may for example relate to securities or foreign exchange transactions between financial institutions.

   Norges Bank is the most important settlement bank in terms of the total amount settled. The majority of banks do not settle their transactions directly at Norges Bank but use private settlement banks. The most important of these is DnB NOR Bank ASA, which operates an authorised system and acts as the settlement bank for more than 100 small and medium-sized banks. Sparebank 1 Midt-Norge provides settlement services for almost 20 savings banks. Total obligations and receivables from each of these settlement banks and from the banks whose transactions they settle are sent to NICS for netting and subsequent settlement at Norges Bank. The participating banks receive settlement from the private settlement bank after final settlement at Norges Bank.

   [ILLUSTRATIONS OMITTED]

   Systems for clearing and settlement of interbank payment transactions are called interbank systems. The customer-oriented part of the payment system is called the system for payment services (see Chart 1).

   In addition to the transactions from NICS, Norges Bank receives netted transactions from the securities settlement at the Norwegian Central Securities Depository (VPS) and from the financial derivatives settlement at VPS Clearing ASA (see Chart 2). Banks can send individual transactions to Norges Bank directly or via NICS.

   In their quest for customers, banks have strong incentives to offer safe, swift and user-friendly payment solutions at a reasonable price. Such solutions also benefit the economy as a whole. Problems at one bank can spill over to other banks through the payment system. Individual banks do not have the same incentives to cover the costs of limiting systemic risk. This is an important reason for central bank oversight of the payment systems. Because the payment system plays a very important role in the economy, it is essential that interbank systems are operative even if one or more participating banks encounter problems. Central bank oversight will place emphasis on identifying and containing systemic risk in the interbank systems.

2. Norges Bank and payment systems in Norway

   Norges Bank has played a key role in the payment system since the Bank was established in 1816. In the early years, Norges Bank provided ordinary banking services such as payment services in addition to its primary function of issuing banknotes and coins. The number of private banks increased sharply in the course of...