Payment System

Technologies and
Functions:
Innovations and Developments
Masashi Nakajima
Reitaku University, Japan
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Library of Congress Cataloging-in-Publication Data

Nakajima, Masashi, 1958-

Payment system technologies and functions: innovations and developments / by
Masashi Nakajima.
p. cm.
Includes bibliographical references and index.
Summary: “This book analyzes the evolutionary trends, functions and
mechanisms of payment systems and presents an in-depth explanation of how
these trends led to the reduction of settlement risk and the importance of
such mechanisms that have contributed to the evolutionary progress of payment
systems”--Provided by publisher.
ISBN 978-1-61520-645-2 (hbk.) -- ISBN 978-1-61520-646-9 (ebook) 1. Check
collection systems. 2. Electronic funds transfers. 3. Clearinghouses
(Banking) 4. Payment. I. Title.
HG1692.N35 2011
332.1’78--dc22
2010040558

British Cataloguing in Publication Data

A Cataloguing in Publication record for this book is available from the British Library.

All work contributed to this book is new, previously-unpublished material. The views expressed in this book are those of the
authors, but not necessarily of the publisher.
Table of Contents

Foreword............................................................................................................................................... vii

Preface..................................................................................................................................................viii

Acknowledgment................................................................................................................................. xiv

Section 1
Basic Knowledge about Payment Systems

Chapter 1
Basics of Payment Systems.................................................................................................................... 1
Introduction.............................................................................................................................................. 1
Settlement and Payment System............................................................................................................... 2
Importance of Payment System................................................................................................................ 2
Several Aspects of Settlement................................................................................................................... 3
Paper-Based Payment Systems and Elecronic Payment Systems............................................................ 4
Actors in Payment Systems...................................................................................................................... 4
Banks as a Payment System..................................................................................................................... 5
Processes in Payment System.................................................................................................................. 6
Functions of Central Banks..................................................................................................................... 7
Network Externalities of Payment System............................................................................................... 8
Payment System as a Natural Monopoly................................................................................................. 8
Interdependencies of Payment Systems.................................................................................................... 9
References.............................................................................................................................................. 10
Endnote.................................................................................................................................................. 10

Chapter 2
Classifications of Payment System..................................................................................................... 11
Introduction............................................................................................................................................ 11
Operator of Payment System................................................................................................................. 12
Settlement Method.................................................................................................................................. 12
Frequency and Timing of Settlement...................................................................................................... 13
Payment Value........................................................................................................................................ 14
Settlement Date...................................................................................................................................... 14
Settlement Asset..................................................................................................................................... 15
References.............................................................................................................................................. 16
Endnote.................................................................................................................................................. 16

Chapter 3
Settlement Risk..................................................................................................................................... 17
Introduction............................................................................................................................................ 17
Origin of Settlement Risk....................................................................................................................... 18
Settlement Risk and Pre-Settlement Risk............................................................................................... 18
Classification of Settlement Risk............................................................................................................ 19
Magnitude of Loss Caused By Settlement Risk...................................................................................... 20
Actual Examples of Settlement Risk....................................................................................................... 21
Exposure of Settlement Risk................................................................................................................... 23
Reduction Measures of Settlement Amount............................................................................................ 23
Reduction Measures of Time-Lag.......................................................................................................... 25
References.............................................................................................................................................. 27
Endnotes................................................................................................................................................. 28

Section 2
Basic Payment Systems and Advanced Payment Systems

Chapter 4
DTNS System and RTGS System....................................................................................................... 30
Introduction............................................................................................................................................ 30
Two Basic Payment Systems.................................................................................................................. 31
Comparisons of Two Basic Payment Systems........................................................................................ 31
Risk Management Measures in DTNS System....................................................................................... 33
Risk Reduction by Introducing RTGS System........................................................................................ 36
Liquidity Management in RTGS System................................................................................................ 36
References.............................................................................................................................................. 41
Endnotes................................................................................................................................................. 41

Chapter 5
Hybrid System and Integrated System.............................................................................................. 42
Introduction............................................................................................................................................ 42
Hybrid System........................................................................................................................................ 43
Integrated System................................................................................................................................... 45
Mechanisms that Support Advanced Payment Systems......................................................................... 49
References.............................................................................................................................................. 54
Endnote.................................................................................................................................................. 54
 Section 3
Innovations in Payment Systems

Chapter 6
Evolutionary Trends of Payment Systems......................................................................................... 56
Introduction............................................................................................................................................ 57
Transision From DTNS System to RTGS System................................................................................... 57
Introduction of Hybrid Systems.............................................................................................................. 62
Introduction of Integrated Systems........................................................................................................ 63
Evolutionary Process of Payment Systems............................................................................................ 64
Multi-Currency Payment Systems and Offshore Payment Systems....................................................... 65
Linkage With CSD.................................................................................................................................. 70
Financial Edi Capability........................................................................................................................ 72
References.............................................................................................................................................. 73
Endnotes................................................................................................................................................. 73

Chapter 7
Driving Forces for Innovations in Payment Systems........................................................................ 75
Introduction............................................................................................................................................ 76
Rapid Growth of Settlement Values and Settlement Risks...................................................................... 76
Enlightenment by the BIS....................................................................................................................... 76
Competition between Payment Systems................................................................................................. 84
Technological Progress.......................................................................................................................... 86
References.............................................................................................................................................. 87
Endnotes................................................................................................................................................. 88

Chapter 8
Critical Issues on Payment Systems................................................................................................... 89
Introduction............................................................................................................................................ 90
Governance Structure of Payment Systems........................................................................................... 90
Legal Issues on Payment Systems.......................................................................................................... 91
Operational Reliability of Payment Systems.......................................................................................... 92
Efficiency Issues of Payment Systems.................................................................................................... 93
References.............................................................................................................................................. 94
Endnote.................................................................................................................................................. 94

Section 4
Developments of Payment Systems in Selected Countries

Chapter 9
Payment Systems in US....................................................................................................................... 96
Introduction............................................................................................................................................ 97
Fedwire.................................................................................................................................................. 97
CHIPS.................................................................................................................................................. 103
ACH..................................................................................................................................................... 118
References............................................................................................................................................ 129
Endnotes............................................................................................................................................... 129

Chapter 10
Payment Systems in EU..................................................................................................................... 130
Introduction.......................................................................................................................................... 131
From TARGET to TARGET2................................................................................................................ 131
TARGET2............................................................................................................................................. 135
Retail Payment Systems In EU............................................................................................................. 151
References............................................................................................................................................ 166
Endnotes............................................................................................................................................... 167

Chapter 11
Payment Systems in Japan................................................................................................................ 168
Introduction.......................................................................................................................................... 169
BOJ-NET.............................................................................................................................................. 169
Transition of BOJ-NET to RTGS System............................................................................................. 171
FXYCS.................................................................................................................................................. 182
Zengin System...................................................................................................................................... 183
References............................................................................................................................................ 189
Endnotes............................................................................................................................................... 189

Chapter 12
CLS Bank............................................................................................................................................ 190
Introduction.......................................................................................................................................... 190
Background of CLS Bank..................................................................................................................... 191
Outline of CLS Bank............................................................................................................................ 193
Funding and Settlement Procedures of CLS Bank............................................................................... 198
Risk Management of CLS Bank............................................................................................................ 204
Liquidity for CLS Settlement................................................................................................................ 206
Counter-Measures for Pay-In Failure................................................................................................. 207
Impact of CLS Bank............................................................................................................................. 208
Extention of Business Areas by CLS Bank........................................................................................... 210
References............................................................................................................................................ 211
Endnotes............................................................................................................................................... 212

About the Author............................................................................................................................... 213

List of Abbreviations.......................................................................................................................... 214

Index.................................................................................................................................................... 219
 vii

Foreword

It is fair to say that payment systems have become one of the most vibrant areas of reform, be it in terms
of policy, technology or products. This is shown by the rapid pace of change we observe in national and
international payment systems around the world.
One of the reasons for this reform process is the realisation – not so long ago – of the importance
of the financial market infrastructure, of which payment systems are an important part, for a safe and
sound financial system. In fact, robust payment systems are widely considered to be a key requirement
in maintaining and promoting financial stability. This was illustrated by the recent financial crisis where
many things in the financial markets went wrong, but the payment systems – even at the worst moments
when some of the markets froze – turned out to be resilient.
The main reason that the financial markets managed to avoid serious problems at the level of the
market infrastructure can be found in the substantial efforts made by many stakeholders in the financial
system over the past years. More precisely, during the decade preceding the recent crisis, the financial
sector as a whole spent a great deal of effort on enhancing the market infrastructure, mainly by removing
unnecessary counterparty risk from the financial system, both at the domestic level and at the global level.
This book provides an extensive overview of the world of payment systems. It starts by presenting the
basic concepts and risks, describes traditional and advanced payment systems, provides useful insights
in the trends and innovations in the payments landscape and ends with a description of the developments
in a number of important currency areas, including the role played by CLS Bank in the settlement of
foreign exchange transactions.
The attention paid to innovations in this book is, in my view, very important for a good understand-
ing of the evolution taking place in payment systems. Technological progress contributed substantially
to innovations in payment systems. Arguably, technology was the main driver behind the single most
important innovation to enhance the soundness of payment systems: the introduction of real-time pro-
cessing and settling of payments. The rationale behind this was simple: whereas net settlement systems
settle at the end of the day, real-time gross settlement systems allow for the final and irrevocable settle-
ment of each payment at the time of it being entered into the system. There is no longer the need to wait
until the end of the day to be sure that a payment received that day has successfully settled. In a sense,
this conceptually small step made possible a whole series of changes that fundamentally changed the
risk profile of payment systems.
In this book, the reader will find all the information needed to understand the way payment systems
function and will gain a better understanding of the current transformation taking place in this field.

Marc Hollanders.
Special Adviser on Financial Infrastructure Former Head of Secretariat, .
Committee on Payment and Settlement Systems Bank for International Settlements
viii

Preface

Payment systems are the indispensable infrastructure for financial markets and business activities. A
payment system is a mechanism that facilitates the smooth transfer of funds between financial institu-
tions.
Every commercial trade and financial transaction is finalized only when the final settlement is made
through a payment system. If operational failures were to happen in a payment system, which prevented
smooth transfers of funds, national economies and financial markets would be thrown into extreme
confusion and seriously damaged. Therefore, the safety and efficiency of payment systems is incredibly
important for national economies and financial systems to function effectively.

FEATURES OF THIS BOOK

The first feature of this book focuses on the evolutionary trends of payment systems. During the past
two decades, payment systems have evolved drastically from simple settlement methods to more highly-
sophisticated ways of handling payments. One of major factors in causing such an evolution was the
progress of information technology (IT). This book analyzes the evolutionary trends of payment systems
and presents an in-depth explanation of how these trends led to the reduction of settlement risk and the
improvement of settlement efficiency. The background and driving forces for such innovations are also
thoroughly discussed.
The second feature of this book puts a spotlight on the functions and mechanisms of payment systems.
The functions of payment systems have become very sophisticated and complicated with the help of
technological progress. Some mechanisms were invented to support such advanced payment systems,
which include frequent netting, offsetting, matching facility and advanced queue management. This book
tries to cast light on the importance of such mechanisms that contributed to the evolutionary progress
of payment systems.
The third feature of this book comprehensively covers the basic knowledge about payment systems,
which includes some definitions concerning payment and settlement, classifications of payment sys-
tems, and origins and reduction measures of settlement risk. In addition, the cases study analyses of
payment systems in US, EU and Japan as well as the CLS Bank are provided in the second half of the
book. These basic and concrete examples are particularly useful for beginners who want an overview
of payment systems.
As a whole, this book will hopefully provide a valuable tool for those interested in learning about
payment systems (i.e., academics and researchers, graduate and undergraduate students, relevant parties
of authority and central banks, and professionals in payment business who need to get a full understand-
ing of payment systems).
 ix

It is my hope that this book will make an intellectual contribution to promoting a better understanding
of payment systems for a wide range of interested people, and open up the way to make further progress
on enhancing the safety and efficiency of payment systems.

ORGANIZATION OF THE BOOK

The book is organized into four parts and twelve chapters. A brief description of each chapter follows:

Section 1: Basic Knowledge about Payment Systems

Chapter 1 gives an explanation of the basics of “payment systems.” Payment systems are an essential
part of financial infrastructure. The chapter sets up the basic knowledge of payment systems to help
the reader understand the discussions in the later chapters. The background knowledge includes several
aspects of settlements, actors in payment systems, banks as a payment system, the process of payment
systems, and the functions of central banks. It also identifies the economic natures of payment systems,
such as network externalities, natural monopoly and interdependencies of payment systems.
Chapter 2 presents some classifications of payment systems. Classifications are made from the fol-
lowing standpoints. The first point is the operator of a payment system. Some payment systems are
managed by central banks and others are operated by private sectors. The second point is the settlement
method. Some payment systems make settlements on a net basis and others settle payments on a gross
basis. The third point is the frequency and timing of a settlement. Some payment systems execute settle-
ments only at designated times, and other payment systems make in real-time. The fourth point is the
payment value. Some payment systems are mainly for large-value payments and others are for small-
value payments. The fifth point is the settlement date. In some payment systems, payments are settled
on the same day the payment orders are submitted to the system. In other payment systems, payment
orders are not settled until the next day, where overnight settlement risk resides. The last point is the
settlement asset. Some payment systems use “central bank money” as a settlement asset and others make
use of “commercial bank money.” These classifications are useful to understand basic payment systems
as well as advanced payment systems which are discussed in the later chapters. Needless to say, these
classifications are not mutually exclusive. Instead, one can use a combination of these classifications in
order to describe a payment system.
Chapter 3 discusses “settlement risk.” During the process from trade to its settlement, there is a risk
that the settlement will not take place as expected. This is the settlement risk which may cause a liquid-
ity problem and/or loss to the party involved in the settlement. First, the source of settlement risk is
identified in two kinds of settlements; simple settlements and exchange-for-value settlements. Second,
the differences are clarified between the settlement risk and the pre-settlement risk. Third, it gives the
classifications of settlement risk, which includes credit risk, liquidity risk, systemic risk, legal risk and
operational risk. Fourth, it makes clear the difference between the principal risk and replacement cost
risk. Fifth, it gives actual examples, in which settlement risk turned into reality. They include the Her-
statt Bank incident, the BCCI incident and the Bearing incident. Finally, after identifying the exposures
of settlement risk, reduction measures of the settlement amount and time-lag are discussed. Several
mechanisms, such as netting, Payment versus Payment (PVP), and Delivery versus Payment (DVP) are
of significant importance in reducing settlement risk.
x

Section 2: Basic Payment Systems and Advanced Payment Systems

Chapter 4 provides comparisons between the two basic payment systems, the Designated- Time Net
Settlement (DTNS) system and the Real-Time Gross Settlement (RTGS) system. Those comparisons are
indicative of the difference between the two systems and highlight the characteristics of each system.
The DTNS system and the RTGS system have their own advantages and drawbacks. The RTGS system
is far superior to the DTNS system from the viewpoint of the reduction of settlement risk. Conversely,
the DTNS system has an advantage on the aspect of liquidity required for a settlement. In sum, this
chapter shows that there is a trade-off between the DTNS system and the RTGS system, or more con-
cretely between safety and efficiency in payment system. This is the essential starting point to review
the development of the advanced payment systems in the later chapters.
Chapter 5 takes an analytical approach to two advanced payment systems; the “Hybrid system” and
the “Integrated system.” The Hybrid system is a system which combines the liquidity-savings features
of the DTNS system with the immediate finality of the RTGS system. The Hybrid system is character-
ized by frequent net settlements during the day. The Integrated system is a payment system which has
both the RTGS mode and the Hybrid mode. The participants of an Integrated system can use the RTGS
mode for urgent payment and utilize the Hybrid mode for non-urgent payment. These advance payment
systems are supported by several sophisticated mechanisms achieved through the progress of information
technology. The chapter gives an explanation of such mechanisms, which include (i) frequent netting and
continuous processing, (ii) partial netting, (iii) offsetting, (iv) searching and matching facility, (v) queue
management function, (vi) pre-funding account, and (vii) multiple functions in a single payment system.

Section 3: Innovations in Payment Systems

Chapter 6 presents an analysis about the evolutionary process of payment systems. Payment systems
showed remarkable changes in the past two decades. The first evolutionary trend was the transition
from the traditional DTNS systems to the RTGS system. A technology diffusion analysis of the RTGS
technology across the world is also presented. The next step in the evolution of payment systems was the
introduction of the Hybrid system. Several Hybrid systems in Europe and the US are discussed in detail.
The third trend was the introduction of Integrated system. Emergence of some Integrated systems are
discussed, which include the LVTS in Canada, the PIS in France, the MEPS+ in Singapore, the TARGET2
in EU and the Next Generation BOJ-NET in Japan. And then, a hypothesis on the typical evolutionary
pattern from the simple DTNS system to a more sophisticated system is proposed.
The chapter also reviews another line of evolutionary trends, including “Multi-Currency Payment
Systems” and “Offshore Payment Systems,” and the linkage between a payment system and a Securities
Settlement System (SSS). It also gives an explanation about the adoption of Financial EDI capability,
which is the scheme that enables the processing of the remittance information with payment instructions
in the payment system.
Chapter 7 makes an analysis of the driving forces leading to the evolutionary progress of payment
systems, as mentioned above. The first driving force was the growing recognition of settlement risk. As
the values of payments over payment systems increased dramatically in the past two decades, the central
banks worried about the substantially-increased settlement risk. It was one of the biggest motivations in
improving payment systems in each country. Second, several reports by the Bank for International Settle-
ments (BIS) triggered the reforms on payment systems in each country. Such reports include the “Core
 xi

Principles Report,” the “RTGS Report,” and the “Lamfalussy Report.” Third, the competition between
payment systems played a role. The competition between the CHIPS and the Fedwire in US was typical
case. Lastly, the progress of IT played a critical role. Enhanced computer capacity, improved communi-
cation networks and reduced technology costs contributed greatly to the innovation in payment systems.
Chapter 8 discusses the public policy matters which should be considered in designing and evaluat-
ing the payment systems. First, the governance structures of payment systems are discussed. Governing
approaches essentially affect the way payment systems are managed, including participation rules, risk
management schemes and the efficiency of the system. Second, the legal issues with payment systems
are reviewed. It goes without saying that a payment system should have a well founded legal basis. The
third point of public policy matters is operational reliability of payment systems. As payment systems
become increasingly dependent on computers and networks, the operational reliability of the system
is a key element in preventing operational risk. The last point discussed is the efficiency of payment
systems. As payment systems enjoy a monopoly situation in many countries, there are no market forces
urging payment systems to achieve the cost-efficiency. Therefore, it is important for payment system
operators to make the cost-efficiency of a system their own initiative.

Section 4: Developments of Payment Systems in Selected Countries

Chapter 9 provides a case study on the payment systems in the US. The Fedwire and the CHIPS are the
Large-value payment systems in US which handle interbank payments for the money market, govern-
ment bond market, and FX market. The Fedwire is a central bank payment system, owned and operated
by the Federal Reserve. The CHIPS is a private payment system, owned and operated by TCH Payments
Co. The Fedwire is operated as a RTGS system. The CHIPS belongs to the Hybrid system, where net
settlements are made continuously during the day. The new settlement method of the CHIPS (i.e., the
“CHIPS Finality”) is scrutinized closely in the chapter.
The chapter also describes the Retail payment system in the US, the Automated Clearing House
(ACH). The ACH is a nationwide electronic file transfer mechanism that processes retail transfers
between customer accounts. The functions of FedGlobal ACH and Financial EDI in the ACH network
are also discussed.
Chapter 10 provides detail on the payment systems in the EU. The landscape of payment systems in
the EU was changed drastically by the introduction of a single currency, the “Euro” in January 1999.
As for the Large-value payment system, the TARGET was introduced in 1999, which was a distrib-
uted system that linked the national RTGS systems with an interlinking network. The TARGET2 was
introduced in 2007-2008 to replace the first-generation TARGET. The TARGET2 is a centralized system
with a single platform and has a series of sophisticated mechanisms. The EURO1 is another Large-value
payment system operated by the EBA CLEARING.
The Retail payment systems in EU are still fragmented, which means that each country has its own
Retail payment system. In order to overcome such a situation, the European Central Bank (ECB) and
European Commission have promoted the Single Euro Payment Area (SEPA) project. The detail of the
SEPA project is described in this chapter.
Chapter 11 takes a close look at the payment systems in Japan. There are three payment systems in
Japan: the BOJ-NET, the FXYCS and the Zengin System. The BOJ-NET is the equivalent of the Fedwire
in the US, and the TARGET2 in Europe. It was operated as a RTGS system and then enhanced into an
Integrated system in 2008. The Next-Generation RTGS (RTGS-XG) project is described in detail in
this chapter.
xii

The FXYCS is a payment system that handles the JPY-leg payments for FX transactions. In this
sense, the FXYCS is the equivalent of the CHIPS in the US. The Zengin System is a national fund
transfer network for retail payments, which is the equivalent of the ACH in the US. The Zengin System
is planned to be upgraded to a sixth generation system in 2011. The details of the new mechanisms of
the six generation system are described in the chapter.
Chapter 12 focuses on the CLS Bank. CLS Bank was established in 1999 to eliminate settlement risk
associated with settling FX transactions in different time zones. Although CLS Bank was established
as a private bank in the US, its function is dedicated to providing a multi-currency settlement service.
Thus, CLS BANK should be regarded as one of the payment systems. This chapter elaborates on the
mechanism of CLS Bank, which includes the organization, the shareholders, the eligible currencies, and
the accounts used for CLS settlements. The funding and settlement procedures and risk management
schemes of CLS Bank are discussed in greater detail. In addition, the impact of CLS Bank on FX settle-
ments and the FX market is also analyzed.

REFERENCES

Allsopp, P., Summers, B., & Veale, J. (2009, February). The Evolution of Real-Time Gross Settlement:
Access, Liquidity and Credit, and Pricing. Financial Infrastructure Series: the World Bank.
Bank for International Settlements. (2001, July). A Glossary of Terms Used in Payments and Settlement
Systems.
Bank for International Settlements. (2003, April). Payment and Settlement Systems in Selected Countries
(the Red Book).
Bank for International Settlements. (2009, March). Statistics on Payment and Settlement Systems in
Selected Countries: Figures for 2007.
Fry, M. (1999). Payment Systems in Global Perspective. Routledge International Studies in Money &
Banking. doi:10.4324/9780203279991
Haldane, A., Millard, S., & Saporta, V. (2008). The Future of Payment Systems. Routledge.
Hollanders, M. (2007). Issues Shaping the Future of Payment Systems. SPEED, 1(3), Winter.
Humphrey, D. B. (1995). Payment Systems – Principles, Practice, and Improvements. The International
Bank for Reconstruction and Development.
Khiaonarong, T., & Liebenau, J. (2009). Banking on Innovation: Modernisation of Payment Systems.
Physica-Verlag Heidelberg.
Manning, M., Nier, E., & Schanz, J. (2009). The Economics of Large-value Payments and Settlement:
Theory and Policy Issues for Central Banks. Oxford University Press.
Nakajima, M. (2009). All about SWIFT. Toyo Keizai Inc.(in Japanese)
Nakajima, M., & Shukuwa, J. (2005). All about Payment Systems (2nd ed.). Toyo Keizai Inc.in Japanese
 xiii

Nakajima, M., & Shukuwa, J. (2008). All about Securities Settlement Systems (2nd ed.). Toyo Keizai
Inc.in Japanese
Pringle, R., & Robinson, M. (2002). E-money and Payment Systems Review. Central Banking Publica-
tions Ltd.
Rambure, D., & Nacamuli, A. (2008). Payment Systems: From the Salt Mines to the Board Room. Pal-
grave Macmillan.
Summers, B. (Ed.). (1994). The Payment System: Design, Management, and Supervision. International
Monetary Fund.
xiv

Acknowledgment

This book was mostly inspired by the experiences when I worked in the Bank of Japan (BOJ) for more
than two decades. For much of that period, I was involved in the financial stability side rather than in
the monetary policy side. There, the payment system was one of the main issues of concern. My supe-
riors and colleagues guided me in the right direction.
From 2003 to 2005, I had the chance to work for the Bank for International Settlements (BIS), my
colleagues at the Committee on Payment and Settlement Systems (CPSS) gave me some invaluable
advice and innovative ideas.
As a member of Secretariat of CPSS, I met several CPSS members who were directors of central
banks in charge of payment system. Through the discussion with these thoughtful central bankers, I
could get several new perspectives on payment systems.
The following is the list of people whom I am particularly grateful to. Without their direct and indirect
effect and contributions, this book would not come out.

Alan Taylor, EBA Clearing

Daniela Russo, European Central Bank

Dieter Becker, European Central Bank

Esmond Lee, Hong Kong Monetary Authority

Hansjörg Nymphius, Deutsche Bank

Hans-Jürgen Friederich, Deutsche Bundesbank

Iwao Kuroda, Chuo University (former BOJ)

Jean-Michel Godeffroy, European Central Bank

Jeffrey Marquardt, FRB

Jochen Metzger, Deutsche Bundesbank

John Trundle, Bank of England

Jonathan Butterfield, CLS Group

Lawrence Radecki, Federal Reserve Bank of New York

 xv

Lawrence Sweet, FRB

Marc Hollanders, BIS

Patrick Parkinson, FRB

Robert Lindley, BIS

Tommaso Padoa-Schioppa, European Central Bank

Vincent De Santis, CHIPS

Yoshiharu Oritani, Meiji University (former BOJ)

Yvon Lucas, Bank of France

Finally, I am grateful to Ms. Julia Mosemann of IGI Global for her continuing and professional support.
 Section 1
Basic Knowledge about
Payment Systems
 1

Chapter 1
Basics of Payment Systems

ABSTRACT
This chapter gives an explanation of the basics of “payment systems.” To begin with, it is necessary
to know what a payment is and what a payment system is. A “payment” usually describes a transfer
of monetary value between two parties, (e.g., the seller and the buyer). Thus any organized arrange-
ment for transferring monetary value between parties can be defined as a “payment system.” Payment
systems are an essential part of the financial infrastructure and their importance cannot be overstated.

This chapter sets up the basic knowledge of payment systems to help the reader understand the discussions
in the later chapters. The background knowledge includes the several aspects of settlement, actors in
payment systems, banks as a payment system, process of payment systems, and functions of central banks.

The economic natures of payment systems, such as the network externalities, natural monopoly and
interdependencies of payment systems are also discussed in this chapter.

INTRODUCTION seller is discharged. This act of discharging ob-

When a trade of goods or services is made, the
buyer should pay “money” to the seller in exchange
for them. In some cases, the money would take the
form of banknotes and coins, and in other cases,
the deposit money is used. This process is usually
called “payment.” When a payment is successfully
made, the obligation between the buyer and the
DOI: 10.4018/978-1-61520-645-2.ch001
ligations is described as “settlement.” “Payment
system” is a mechanism that enables such kind of
settlement or a smooth transfer of funds between
buyers and sellers, and/or between banks.
In the modern society, no economic activities
are possible without payments and settlements.
In this sense, it could probably be said that pay-
ment systems are one of the most imperative and
significant social infrastructures.

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

As payment systems are directly supported by
only a limited number of professionals in central
banks and commercial banks, the general public
seldom or never notices the role and importance
of payment systems. For this reason, the manage-
ment of payment systems has sometimes been
regarded as the “behind-the-scenes activities”,
which are actually not seen by many people.
Similarly, payment systems are even compared
to the plumbing. That is to say, payment systems
are extremely important, but their operation is
carried out underground and out of sight.
But the times have changed, and a lot of atten-
tion is currently focused on payment systems. The
background of the attention is threefold. First, the
volume of fund transfers handled through payment
systems has increased dramatically. That means
“settlement risk” which arises when a payment is
not made as expected, has also increased. Large
risk is always a cause of concern for the authorities
and central banks. Second, a remarkable evolu-
tion of the payment system continues due to the
development of Information Technology (IT). The
progress of IT has enabled the advancement of
payment processing and created some enhanced
payment systems. Third, the business aspects of
payment have received greater recognition. Pay-
ment related businesses, like clearing businesses
and custody businesses are becoming more and
more attractive for financial institutions.
SETTLEMENT AND
PAYMENT SYSTEM
Definition of Settlement
“Settlement” is defined as “an act that discharges
obligations in respect of funds between two or
more parties” (BIS, 2001). More plainly, settle-
ment is an act to make payments in compensation
for purchases of goods or services, and complete
the business process.
2
Basics of Payment Systems
Any economic activities, including the mail-
order, B2B transactions, internet auctions, trading
of equities and government bonds, and foreign
exchange trading, ultimately require a settlement.
In other words, settlement is indispensable to
credit-based business transactions in the modern
world.
Definition of Payment System
“Payment System” is a mechanism that enables
such kind of settlement or funds transfer smoothly
between the buyer and seller, and/or between the
banks. According to the definition of the Bank
for International Settlements (BIS), “a payment
system consists of a set of instruments, banking
procedures and, typically, interbank funds transfer
systems that ensure the circulation of money”
(BIS, 2001).
IMPORTANCE OF PAYMENT SYSTEM
Payment System as an Infrastructure
A payment system plays a pivotal role in circulating
funds all over the economy. If some malfunctions
were to happen to a payment system and hinder
the flow of funds, the impact would be extraor-
dinary and disruptive. The economic activities
and functions of financial markets would become
completely paralyzed. You can easily imagine
such a disastrous situation where no one can make
payments and no one can receive money from
others, and that all the flow of funds between
banks stopped dead.
Therefore, we can conclude that payment
systems are social infrastructures that support all
economic activities, including the commercial
activities and transactions in financial markets. A
safe and efficient payment system is an important
mechanism that props up the functions of financial
markets and the financial system.
Basics of Payment Systems
Greenspan’s Concern
An episode involving Alan Greenspan highlights
the importance of payment system. When the
chairman of the Federal Reserve Board (at that
point) heard of the September 11 attack in 2001,
his immediate concern was not the inflation rate
or the industrial production of the US economy,
but the “Fedwire,” the electronic payment system
in the US. He worried that a shutdown of the
Fedwire would lead to the collapse of financial
markets and financial systems not only in the US
but across the globe.
The possible economic crises were all too evident.
The worst, which I thought highly unlikely, would
be a collapse of the financial system. The Federal
Reserve is in charge of the electronic payment
systems that transfer more than $4 trillion a day
in money and securities between banks all over
the country and much of the rest of the world.
We’d always thought that if you wanted to cripple
the U.S. economy, you’d take out the payment
systems. Banks would be forced to fall back on
inefficient physical transfer of money. Business
would resort to barter and IOUs, the level of
economic activity across the country could drop
like a rock. (Greenspan, 2007)
SEVERAL ASPECTS
OF SETTLEMENT
An act of a “settlement” takes various forms.
Cash Settlement
For instance, individuals and corporates can make
settlements directly without the involvement of
banks. In these cases, the banknotes are widely
used, and this process is called “cash settlement.”
Bank-Related Settlement
On the other hand, settlements are often made
with the involvement of banks. Settlements with
banks include the paper instruments like the checks
and bill payable, bank transfer of deposits, and
direct debit.
As for a bank-related settlement, if the payer
and payee have their own bank accounts at the
same bank, the settlement is completed with an
account transfer within one bank. This process on
the book of a single bank is referred to as “internal
settlement” (see Figure 1a).
However, in the case that the payer and payee
use different banks, the involved banks need to
exchange the payment order and fund settlement
through a payment system (see Figure 1b). The
settlement of commercial trade is usually dealt
with through a “retail payment system.” That is
the exact reason why a payment system is required.
Supposing a case where only one bank exists in
a country like the “monobank system” in social-
ist countries, there is no need for a payment
system, as the internal settlement can handle all
the domestic payments.
A settlement encompasses the fund transfer of
much larger amounts between banks. A “Large-
Value Payment System” (LVPS) handles this kind
of settlement. Payment system is also inevitable
for interbank settlement.
FX Settlement
When foreign currency is involved in the fund
settlement, which is referred to as a “foreign ex-
change (FX) settlement.” Delivering of the USD
and euro after the USD/euro deal is the typical
case of foreign exchange settlement.
Securities Settlement
In addition, the concept of settlement includes
“securities settlement,” which means the transfer
of securities after a trade of equities, government
3

Figure 1. Internal settlement and settlement through payment system
bonds, or corporate bonds. However, the securities
settlement is nearly out of the scope of this book.
This book concentrates on the schemes of fund
settlement. Payment system plays an essential
role in this arena and is sometimes referred to as
“interbank funds transfer system.”
PAPER-BASED PAYMENT
SYSTEMS AND ELECRONIC
PAYMENT SYSTEMS
Paper-Based Payment Systems
In the early days, the payments among the banks
used to be made by exchanging the paper payment
instructions. But, as the number of payments in-
creased substantially, it became quite difficult to
transfer funds smoothly with the paper instructions
and manual handling.
Therefore, people tried to utilize Information
Technology (IT) in the payment system. This
endeavor resulted in developing the “electronic
payment systems” which were equipped with the
computer systems and networks.
4
Basics of Payment Systems
Electronic Payment Systems
In an electronic payment system, the host comput-
ers of payment system are linked to the terminals or
computers of the participants via networks. These
systems originally used to be called “electronic
payment systems,” but the name became obsolete
soon. Then, these systems came to be called sim-
ply as “payment systems,” that was because most
major payment systems became electronic and
there was no need to add the word to distinguish.
ACTORS IN PAYMENT SYSTEMS
The main actors of interbank funds transfer in-
clude the payment systems, central banks, and
commercial banks. The division of roles among
these actors is as follows.
Payment Systems
A payment system is a system or an organization
which conducts the funds transfer. Some payment
systems are managed by private companies and
called a “private payment system,” and others
Basics of Payment Systems
are managed by central banks and referred to
as a “central bank payment system.” In many
countries, those two payment systems co-exist
and share the roles.
Usually, a payment system covers one jurisdic-
tion (or country) and one currency. In several cases,
however, a payment system covers more than one
country or more than one currency. There is also
a case with several payment systems interlinked
with each other.
Payment systems take on a public nature, as
they handle a huge amount of payments from
many individuals, corporations and banks all over
the country. Thus some conditions are required
for a payment system. First, a payment system
should be managed efficiently by a sound business
method. Second, the operator of payment system
should manage settlement risk strictly in order to
minimize the effect when defaults happen.
Central Banks
Historically, central banks have played an active
role in payment system. Central banks inherently
have the function as “the bank for banks,” where
almost all banks hold accounts. Central banks can
provide the settlement assets with finality, which
is called the “central bank money.” Therefore, as
a part of their function, central banks operate a
payment system and provide settlement service
for financial institutions, typically banks.
Central banks are also the active participants
in payment systems for conducting open market
operations. It means that the central bank uses its
payment system to implement monetary policy.
Hence, it is widely recognized that a sound pay-
ment system is a precondition for the successful
conduct of monetary policy (Bech, 2008).
The extent to which central bank is involved
in the payment system varies from country to
country. It is generally the case that central banks
tend to support the interbank payment system,
which handles large-value payments. Some other
central banks are also involved in the operation
of retail payment systems. The typical case is the
Federal Reserve in the US.
Some central banks also offer a settlement
service for the private payment systems. More
concretely, a private payment system calculates
the positions to be settled among the participants,
and then the actual transfers of funds take place
in the central bank system.
Another important role of central banks is
to provide the liquidity to the participants of a
payment system. The payment system requires a
certain amount of intraday liquidity for a smooth
settlement. As a provider of central bank money,
only a central bank can carry out this responsibility
(discussed in more detail later).
Banks
Banks are major participants of payment systems.
They use payment systems to settle their own ob-
ligations in the money market, securities market
and FX market. They also use payment systems
on behalf of their customers, e.g. individuals and
corporations.
BANKS AS A PAYMENT SYSTEM
Internal Settlement
As mentioned above, banks can execute “internal
settlement,” when the payer and the payee have
their bank accounts at the same bank. This kind of
transaction is referred to as an “on-us” transaction
or “book transfer.”
In this sense, a bank can be regarded as a
kind of payment system itself. That is because
they can make settlements with their books, even
in a small scale. The more they make internal
settlements, the more they take on the nature of
payment system. When it comes to the transfer of
funds between accounts held at different banks,
the payment system comes into play and handles
the settlement between the two banks.
5

Tiered Structure of Payment System
As is often the case, the operators of payment
systems admit indirect participants as well as direct
participants as a participation method. “Direct
participant” has an account with the settlement
agent and can directly exchange payment orders
with other participants in the system. On the other
hand, “Indirect participant” usually does not have
an account, cannot send payment order directly to
the payment system, and has to make settlements
through direct participants. Indirect participant
(the second-tier participant) makes arrangement
with direct participant (the first-tier participant)
who make settlements on behalf of the indirect
participant.
This kind of approach is called a “tiered struc-
ture” or “tiered membership” in a payment system.
Some payment systems adopt the tiered structure
with indirect participants and others allow only
the direct participants. For example, the CHAPS
in the UK is famous for a highly tiered structure,
with only 18 direct participants out of around 350
commercial banks in the UK. On the contrary,
the BOJ-NET admits only the direct participants.
Clearing Bank and Quasi
Payment System
In the tiered structure, the direct participant who
widely accepts the responsibility of settlement for
indirect participants is referred to as “Clearing
Figure 2. Processes of payment system
6
Basics of Payment Systems
Bank.” A Clearing Bank can internalize many
settlements in its own books. This process is called
the “internalization” of payment. This is a situation
where payments are settled between the accounts
of the same Clearing Bank internally, without being
processed through the payment system.
If the internalization advances, one Clearing
Bank can settle a substantial amount of payments
in-house. In this case, the bank starts to have a
public nature like payment system, and is some-
times referred to as a “Quasi Payment System.”
A Clearing Bank or Quasi Payment System is
required to secure higher level of risk management
than the ordinary participants of payment systems.
PROCESSES IN PAYMENT SYSTEM
The stage of processing in payment system can
be conceptually divided into three processes:
payment, clearing and settlement (see Figure 2).
Payment
The first process is called “payment.” In the pro-
cess of payment, the participants of a payment
system send payment orders to the system, and
receive them from the system. A “payment order”
is a message to the payment system requesting the
transfer of funds to the payee, and is also called
“payment instruction” or “payment message.”
Basics of Payment Systems
There are two kinds of payment orders. One
is the “credit transfer order,” which requests the
funds to be moved from the payer’s (originator’s)
account to the payee’s (beneficiary’s) account.
The other is the “debit transfer order,” which is
the debit collection orders made or authorized by
the payer to move funds from (the bank of) the
payee to (the bank of) the payer and result in a
charge (debit) to the account of the payer. Most
large-value payment systems are only for the
credit transfer orders, and most of retail payment
systems support both the credit transfer and debit
transfer orders.
Clearing
The second process is called “clearing.” The
clearing process is to aggregate all the payment
orders and calculate the “net credit/debit position”
of each participant. The net position is the sum of
the value of all the transfers it has received less
the value of all transfers it has sent. If the differ-
ence is positive, the participant has a “net credit
position” and will receive the net amount. If the
difference is negative, the participant is in a “net
debit position” and obliged to pay the net amount.
Settlement
The third process is “settlement.” In this process,
each participant should pay the net debit position
and receive the net credit position. An actual funds
transfer is made at this stage, and the settlement
becomes final.
When a system is dedicated to facilitate the
settlement of the transfer of funds, it is sometimes
called a “settlement system.” However, the term
of “payment system” is more commonly used to
indicate an overall funds transfer system, includ-
ing a settlement system. To be precise, “payment
and settlement system” would be an all-round
expression including both systems.
As described later, a “net payment system” has
all three of these processes. In contrast, a Real-
Time Gross Settlement (RTGS) system does not
have the clearing process, and the payment process
is directly connected to the settlement process.
FUNCTIONS OF CENTRAL BANKS
Central banks have the multiple functions in
payment systems. First, central banks provide
the settlement asset with finality. Second, central
banks can provide the liquidity to the participant
of a payment system necessary for a smooth settle-
ment. Third, central banks conduct the oversight
for private payment systems. Simply put, central
banks play a very significant role for payment
systems.
Providing Finality
The first function of central bank is to provide
the finality to the payment system. “Finality” or
“settlement finality” is an important concept for
payment systems. Finality means that a transfer
of funds becomes irrevocable and unconditional.
In a condition the finality is not confirmed, the
business process is not completed and there is
still a risk of it not being settled. Accordingly, it
is quite important to affirm when the settlement
become final.
There are only two payment instruments
with finality in the world. One is the banknotes.
When paying with the banknotes, the obligation
is discharged at the moment of handover. On the
contrary, if payment is made by check, there is
still a risk of dishonor in the later stage and the
situation cannot be regarded as final.
The other payment instrument with finality
is the deposit balance with central bank, which
is often referred to as the “central bank money.”
When a fund transfer is made between the two
accounts at a central bank, it becomes final and
irrevocable immediately after the transfer is made.
Even when a payment system is a private one, the
7

settlement has finality if the final settlement is
made at the accounts of a central bank.
Providing Liquidity
“Liquidity” is a synonym for funds, and frequently
used when discussing a payment system. Providing
liquidity to the participants of a payment system
is another function of central bank. This liquidity
is usually lent to the participant during the day-
time in order to facilitate the early payment and
smooth progress of settlement. These funds are
called “intraday liquidity” and participants should
repay the funds by the end of the day. Especially,
the RTGS system requires large liquidity to carry
out the settlements, many central banks provide
the intraday liquidity to the participants by the
method of the intraday overdraft or intraday repo
transaction (to be discussed below).
Conducting Oversight
In addition to trying to enhance the safety and
effectiveness of their own payment systems,
central banks conduct the oversight on private
payment systems. This oversight is made from
the perspective of financial stability. If a private
payment system contains some risks, any defaults
could have disruptive influence on many banks as
well as financial market. That is the background
rationale that central banks should conduct the
oversight on payment systems.
NETWORK EXTERNALITIES
OF PAYMENT SYSTEM
“Network Externalities” are defined as a change
in the benefit that a user derives from a service
when the number of other users of the same ser-
vice changes. This is also known as a “network
effect.” “Positive network externalities” exist if
the benefit of a user increases when the number
of other users increases.
8
Basics of Payment Systems
As with a telephone network or fax network,
payment system has the strong positive network
externalities. The more participants (i.e. financial
institutions) that join a payment system, the more
value the system has, since a participant can send
payments to more participants and more customers
of the new participants.
PAYMENT SYSTEM AS A
NATURAL MONOPOLY
A payment system tends to be a natural monopoly
in a single currency area. A “natural monopoly”
occurs when the economies of scale predominate
in an industry and the maximum efficiency of
production and distribution is achieved through
a single supplier. Natural monopoly tends to arise
where the fixed costs are enormous but the mar-
ginal (variable) costs of supplying to additional
users are very small.
This holds true with payment system, since it
requires a huge investment when building a new
system but the additional costs for new partici-
pants are marginal. Therefore, a certain type of
payment system (e.g. large-value payment system
or retail payment system) tends to be a monopoly
in a country by its nature. It is unlikely that more
than one payment system for the same kind of
payments compete against each other in a single
currency zone.
It is a well-known fact that a monopoly tends to
entail several problems. The most classic problem
of monopoly is inefficiency. The monopoly institu-
tion tends to set a higher price than the marginal
cost of payment service. Another problem is the
abuse of political power. The monopoly institu-
tion could use its profit and power to influence
the arbitrary management of payment system.
If a payment system is mutually-owned by its
users, the monopoly problems could be mitigated
to some extent. However, the regulators and
overseers of payment systems should pay much
attention to prevent the abuse of a monopoly in
Basics of Payment Systems
setting the usage fee and criteria for participa-
tion, especially in the case of a privately-owned
payment system.
INTERDEPENDENCIES OF
PAYMENT SYSTEMS
Each payment and settlement system does not
always exist completely independently. They are
growing more interconnected with each other
and becoming more interdependent. As a result,
the smooth functioning of an individual payment
system often depends on the smooth functioning
of other related systems. This fact requires the
system operators, financial institutions, service
providers and regulators to have adequate under-
standing of the nature of risk and appropriate risk
management under an interdependent situation.
There are several forms of interdependencies
among payment and settlement systems (see
Figure 3).
System-Based Interdependencies
In some cases, the interdependencies arise from
the direct relationships among payment and
settlement systems. For example, Large-Value
Payment Systems (LVPSs) and Central Securities
Depository (CSD) may have technical links1 or an
account relationship to provide Delivery versus
Figure 3. Forms of interdependencies (Source: BIS (2008))
Payment (DVP) settlement of funds and securities.
Another example is CLS Bank, which depends on
the account relationship that CLS Bank holds at
each central bank of eligible currencies to provide
the Payment versus Payment (PVP) settlement
of FX trades (see Chapter 12 for more details).
These kinds of direct cross-system relationships
are called “System-based Interdependencies”
(BIS, 2008).
Institution-Based Interdependencies
The interdependencies can take the form of more
indirect ways. Large financial institutions may
have multiple relationships with many payment
and settlement systems. In this case, common
participation of a financial institution in two or
more systems creates indirect interdependencies
among the systems. In some cases, large financial
institutions are not just the common participants,
but also serving as the liquidity providers, settle-
ment banks or custody banks. If such a financial
institution makes a liquidity trouble in one sys-
tem, the disruption may have a direct impact on
another system.
These kinds of interdependencies arising from
the activities of one financial institution in two
or more systems are called “Institution-based
Interdependencies” (BIS, 2008).
9

Environmental Interdependencies
Interdependencies can arise from the indirect rela-
tionships between multiple systems, which depend
on a common reliance on the same service provider.
Such common reliance includes the IT provid-
ers, network providers, and common elements
of physical infrastructure (power, water, etc). A
typical example is the reliance of the financial
industry on the “Society for Worldwide Interbank
Financial Telecommunication” (SWIFT). SWIFT
provides the financial messaging services more
than 9,500 financial institutions as well as offers
the network services for more than 100 payment
and settlement systems. If by any chance, the
SWIFT network would have disturbance, many
payment and settlement systems would be affected.
These kinds of interdependencies arising from
common factors, including the use of a common
service provider are referred to as “Environmental
Interdependencies”(BIS, 2008).
10
Basics of Payment Systems
REFERENCES
Bank for International Settlements. (2008, June).
The Interdependencies of Payment and settlement
Systems.
Bech, M. (2008). The Diffusion of Real-time
Gross Settlement. In Haldane, A., Millard, S., &
Saporta, V. (Eds.), The Future of Payment Systems.
Routledge.
Greenspan, A. (2007). The Age of Turbulence.
The Penguin Press.
Nakajima, M., & Shukuwa, J. (2005). All about
Payment Systems (2nd ed.). Toyo Keizai Inc.in
Japanese
Nakajima, M., & Shukuwa, J. (2008). All about
Securities Settlement Systems (2nd ed.). Toyo
Keizai Inc.in Japanese
ENDNOTE
1
Payment systems and securities settlement
systems which have technical links with
central bank-owned payment systems are
sometimes called “ancillary systems.”
 11

Chapter 2
Classifications of
Payment System

ABSTRACT
This chapter presents some classifications of payment systems. Classifications can be made from various
standpoints, such as the following.

Some payment systems are administered by central banks and others are operated by private sectors.
Some payment systems make settlements on a net basis and others settle payments on a gross basis.
Some payment systems are mainly for large-value payments and others are for small-value payments.
Some payment systems execute the settlements at designated times, and the settlements take place in
real-time in other payment systems. Some payment systems use the central bank money as a settlement
asset and others make use of the commercial bank money.

These classifications are not mutually exclusive. Rather, one can use a combination of these classifi-
cations in order to describe the feature of a payment system. For example, a payment system may be
managed by a central bank, make settlements on a gross and real-time basis, and be mainly used for
large-value payments.

INTRODUCTION learning. However, taxonomy is sometimes very

Taxonomy is the practice and science of classi-
fication. In many cases, taxonomy is somewhat
tedious. It could lead beginners to a labyrinth of
DOI: 10.4018/978-1-61520-645-2.ch002
useful. It can be a very powerful tool to under-
stand the whole picture. When classifying the
whole thing into the separate parts according to
the several standpoints, it brings out the reality
of things.

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

In what follows is the classification of payment
systems made by the operator, settlement method,
frequency and timing, payment value, settlement
date and settlement asset.
OPERATOR OF PAYMENT SYSTEM
Payment systems can be classified into the “cen-
tral bank payment system” and “private payment
system” on the basis of the operator of the system.
In many countries, these two payment systems
co-exist and share the roles.
Central Bank Payment System
The “Central bank payment system” is a payment
system which central bank owns and operates.
The Fedwire in the US, TARGET2 in EU, and
BOJ-NET in Japan are the examples of this cat-
egory. Generally, the central bank payment system
consists of deposit accounts at a central bank and
a funds transfer system.
The degree of involvement of each central
bank in payment systems is different from coun-
try to country. For instance, the US is a typical
example of deep involvement. To be more pre-
cise, the Federal Reserve System (Fed) operates
the Fedwire for large-value funds settlement and
government bond settlement as well as operates
the Automated Clearing House (ACH) for retail
payments. In the UK and Canada, on the other
hand, payment systems are mainly owned and
operated by the private sector and the involvement
of central banks is rather limited.
Private Payment System
The “Private payment system” is a payment system
owned and operated by private sector. Typically,
the operator is an association of banks or a user-
owned company, which is sometimes called “clear-
ing house”. Though, due to the public nature of
payment system, it is fairly rare that the operator
12
Classifications of Payment System
is a pure business corporation for profit-taking. In
many cases, the private sector operator tries to take
on a public nature by adopting various measures
in ownership and decision-making structure. Such
measures include admitting membership to the
central bank, giving a seat on the board of direc-
tors to the public sector, and making the central
bank the shareholder.
The CHIPS in the US, EURO1 in EU, and
Zengin System in Japan are the examples of
private payment systems.
Clearing System and
Settlement System
According to the three stages of processes in
payment systems mentioned in Chapter 1, the
private payment systems are sometimes called
the“clearing systems,” and the central bank sys-
tems are referred to as the “settlement systems.”
This is because the private payment systems cover
the clearing process and the settlement process is
carried out by the central bank payment systems
in many cases.
SETTLEMENT METHOD
Payment systems can be classified into the “net
settlement system” and “gross settlement sys-
tem” on the basis of settlement method. In the
former system, settlement is made based on a
“net position”, which is calculated by the sum of
the received amount less the sum of the paying
amount. In the latter system, settlement is made on
the gross amount of the individual payment order.
Net Settlement System
“Net Settlement System” is a payment system in
which payment orders are settled on a net basis.
In this system, a net credit or net debit position
for each participant is calculated. “Net position” is
the sum of the value of all the payments received
Classifications of Payment System
less the value of all payments sent. If the differ-
ence is positive, the participant is in a “net credit
position,” and will receive the net amount. If the
difference is negative, the participant is in a “net
debit position” and should pay the net amount.
An arrangement, in which a net position is
calculated between two parties, is called “bilateral
netting.” Meanwhile, an arrangement, in which
a net position is calculated between a participant
and the rest of the participants in the payment
system, is called “multilateral netting.” The net
credit or debit position at the settlement time is
called the “net settlement position.”
Gross Settlement System
“Gross Settlement System” is a payment system
in which the settlement of funds occurs individu-
ally on a gross basis. In this system, no netting is
made and settlement is made on the instruction
value (gross value) of each payment instruction
in the order of arrival.
FREQUENCY AND TIMING
OF SETTLEMENT
Payment systems fall into three categories on the
basis of frequency and timing of settlement: the
“designated-time settlement system,” “real-time
settlement system” and “continuous settlement
system”.
In the first system, settlement is made only at
a certain time. In the second system, settlement
is made in real-time when the system receives the
payment order. In the third system, settlement is
made continuously when a payment order meets
the condition for settlement.
Designated-Time Settlement System
“Designated-Time Settlement System” is a pay-
ment system in which settlement is made only at a
designated-time, one time or several times in a day.
A classic example of this system is to make a
settlement only one time at the end of the busi-
ness day. This is called the “end-of-day settlement
system.” In the end-of-day settlement system,
the net settlement positions are settled from the
net debtors to the net creditors. This is to say, the
end-of-day settlement system is usually operated
in conjunction with the net settlement system.
Real-Time Settlement System
“Real-Time Settlement System” is a payment
system in which settlement is made immediately
in real-time. This means that the processing of
payment order is carried out at the time when the
system receives it rather than at some later time.
In a Real-time Settlement System, settlement is
made individually at real-time during the operat-
ing hours of the system.
Continuous Settlement System
“Continuous Settlement System” is a payment
system in which settlement is made continuously
when a payment order meets the condition for
settlement. Different from a Real-Time Payment
System, payment orders go into the checking
process before the settlement process. When and
only when a payment order satisfies the settlement
condition, the payment order is processed for
settlement. To take one example of a settlement
condition, the balance of the related accounts
should be positive (above zero) and below the
upper limit after the processing of the payment
order. The processing could be gross settlement
or net settlement, depending on the settlement
mechanism.
The Continuous Settlement System falls into
an intermediate category between the Desig-
nated-Time Settlement System and Real-Time
Settlement System. If a payment order passes
the settlement condition immediately, the order
is processed in no time. In this case, the continu-
ous settlement system is more like the Real-Time
13

Settlement System. But if not the case, there is
a possibility that the payment order may have to
wait in the queue possibly for hours.
PAYMENT VALUE
Payment systems can be classified into the “Large-
Value Payment System” and the “Retail Payment
System” on the basis of payment value. The for-
mer system is mainly for large-value payments,
of which a typical example is an interbank fund
transfer. The latter system is mainly for small-value
payments, which are made up of the payments of
individuals and corporations.
Large-Value Payment System
“Large-Value Payment System” (LVPS) is a pay-
ment system mainly for the large-value payments.
It is also called “large-value funds transfer sys-
tem.” Usually, no floor limit (minimum amount)
is set, and participants can send a payment order
of any amount. Therefore, this naming does not
mean that this system is exclusive for large-value
payments, but suggests that this system handles
mainly payment orders with large values.
A major target of the Large-value payment
system is the transactions in financial markets,
including the money markets, government bond
markets, and foreign exchange markets. The BIS
(2005) pointed out the characteristics of payments
processed through a Large-value payment system
as follows.
• They are exchanged among financial
market participants (so-called wholesale
payments);
• They are usually urgent and require timely
settlement (time-sensitive);
• They are related to important financial
market activities such as money markets
14
Classifications of Payment System
or foreign exchange transactions as well as
many commercial transactions.
Hence, payments processed in a Large-value
payment system include important payment or-
ders both for financial institutions and financial
markets as just described, and are usually regarded
as a “Systemically Important Payment System11”
(SIPS).
To give actual examples, the Fedwire and
CHIPS in the US, TARGET2 and EURO1 in EU,
CHAPS in the UK, and BOJ-NET in Japan fall
within this category.
Retail Payment System
“Retail Payment System” is a payment system
mainly for small-value payments, which are
primarily made by individuals and corporations.
Payments for the mail-orders, internet shopping,
salary payments, or utility bill payments are the
typical examples of this payment system.
Since a Retail payment system handles a vast
range of trading, it processes a huge number of
payments in a day. Payments for the business-to-
business (B2B) transactions, business-to-consum-
er (B2C) transactions, and consumer-to-consumer
(C2C) transactions go to a Retail payment system
for settlement.
To cite the concrete examples, the ACH in
the US, STEP1 and STEP2 in EU, BACS in the
UK, and Zengin System in Japan fall within this
category.
SETTLEMENT DATE
Payment systems can be classified into the “same-
day payment system” and “next-day payment
system” on the basis of settlement date. In the
former system, payments are settled on the same
day when payment orders are submitted to the
system. In the latter system, payment orders are
Classifications of Payment System
not settled until the next day of submitting pay-
ment and so the overnight settlement risk resides.
Same-Day Payment System
All Large-value payment systems in major in-
dustrialized countries are the same-day payment
systems. That is to prevent the emergence of
overnight settlement risk. Needless to say, the
RTGS system and the continuous settlement
system are included in the same-day payment
system by definition.
Many of the Retail payment systems have
become the same-day payment systems to reduce
settlement risk. Such systems include the STEP1
in EU and Zengin System in Japan.
Next-Day Payment System
In some payment systems, the submitting pay-
ment orders (payment process) and calculating
net positions (clearing process) are performed on
the same day. But the actual settlement of the net
settlement position (settlement process) is carried
out on the next day. In this case, settlement risk
exists overnight.
To name a few, the ACH in the US and STEP2
in EU fall within this category.
SETTLEMENT ASSET
In a settlement system, the settlement is per-
formed by exchanging “settlement asset” at the
settlement institution. Settlement asset is defined
as “an asset used for the discharge of settlement
obligation” (BIS, 2001) and more concretely, it
indicates a deposit balance at the central bank
or a commercial bank. A settlement institution
is the organization which keeps the records of
participants’ accounts in order to achieve settle-
ment within the settlement system. Generally, the
settlement institution is a commercial bank or a
central bank. Settlement asset is an asset for the
participants of the system, and at the same time,
it is a liability for the settlement institution.
Payment systems can be classified into the
“payment system with central bank money” and
“payment system with commercial bank money”
on the basis of a settlement asset.
It should be noted that a settlement asset is a
different criteria from the operator of a payment
system. Some private payment systems operated
by the private sector use the central bank money
as a settlement asset. Thus, it means that those
two criteria are not mutually-exclusive.
Payment System with
Central Bank Money
When a payment system uses the deposits at a
central bank as settlement asset, it is called the
“payment system with central bank money.” In
this system, funds are transferred between the
participants’ accounts at a central bank.
Central bank money has superiority in the
safety, liquidity and finality; because a central
bank never goes bankrupt and never faces a lack
of liquidity because of its money creation power.
This is the reason why many Large-value payment
systems use central bank money as settlement as-
set. It is also worth noting that global standards
recommend that the Systemically Important Pay-
ment Systems (SIPSs) should use the central bank
money as settlement asset.
Payment System with
Commercial Bank Money
When a payment system uses the deposits at a
commercial bank as settlement asset, it is called the
“payment system with commercial bank money.”
In this system, the settlement institution is a
private company, which is not completely safe
from bankruptcy. If by any chance the settle-
ment institution runs into default, the settlement
would fall into chaos. Therefore, some protection
measures should be taken to avoid such confu-
15

sion. And participants of such a system should
pay adequate attention to the credit risk of the
settlement institution.
REFERENCES
Bank for International Settlements. (1989, Feb-
ruary). Report on Netting Schemes (the Angell
Report).
Bank for International Settlements. (1997, March).
Real-Time Gross Settlement Systems (the RTGS
Report).
Bank for International Settlements. (2001, Janu-
ary). Core Principles for Systemically Important
Payment Systems.
16
Classifications of Payment System
Bank for International Settlements. (2003, Au-
gust). The Role of Central Bank Money in Pay-
ment Systems.
Bank for International Settlements. (2005, May).
New Developments in Large-Value Payment
Systems.
ENDNOTE
1
A Systemically Important Payment Sys-
tem (SIPS) is a payment system where, if
the system were insufficiently protected
against risk, disruption within it could trig-
ger or transmit further disruptions amongst
participants or systemic disruptions in the
financial area more widely (BIS, 2001).
 17

Chapter 3
Settlement Risk

ABSTRACT
This chapter discusses the issues concerning “settlement risk.” During the process from a trade to its
settlement, there is a settlement risk, which is the risk that settlement would not take place as expected.
Settlement risk may cause a liquidity problem and loss to the party who was supposed to receive the fund.

First, the source of settlement risk is identified in two kinds of settlements; the “simple settlement” and
“exchange-for-value settlement.” Second, the differences are clarified between “settlement risk” and
“pre-settlement risk.” Third, the classifications of settlement risk is explained, which include “credit risk,”
“liquidity risk,” “systemic risk,” “legal risk” and “operational risk.” Fourth, the differences are made
clear between “principal risk” and “replacement cost risk.” Fifth, the actual examples are described,
in which settlement risk turned into reality. They include the famous “Herstatt Bank incident,” “BCCI
incident” and “Bearing incident.” Finally, the measures how to reduce settlement risk are discussed
after identifying the exposures of settlement risk. Several mechanisms to reduce the risk, such as the
netting, Payment versus Payment (PVP), and Delivery versus Payment (DVP), are described in detail.

INTRODUCTION was supposed to receive the funds from the other

“Settlement risk” is the risk that a settlement does
not take place as expected, which may cause a
liquidity problem and/or loss to the party involved
in the settlement. If this risk becomes reality in the
interbank fund transfer system, the bank which
DOI: 10.4018/978-1-61520-645-2.ch003
banks would suffer serious troubles.
When designing or analyzing payment sys-
tems, how to reduce settlement risk is the most
important point. In order to reduce settlement risk,
as a first step, you should know its origin, and its
various types and nature. Then, you can examine
some tools and measures to reduce or eliminate it.

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

ORIGIN OF SETTLEMENT RISK
A settlement is classified into two types. The first
one is the “simple settlement,” in which funds are
simply transferred from the payer to the payee.
The second type is called the “exchange-for-value
settlement,” in which funds are exchanged with
other financial assets, such as foreign currencies
or securities.
The origin of settlement risk differs according
to the type.
Simple Settlement
“Simple Settlement” is a settlement in which funds
are simply transferred from the payer to the payee.
In this settlement, the delivery of equivalent value
of the transferred funds, such as goods or services,
are conducted in a different dimension from
payment system. More simply put, if you order
a shirt on the internet, the shirt will be delivered
by a delivery service, like DHL. Then you will
make a payment to the internet company using a
payment system. At that time, the delivery service
and payment system bear no relation.
In this simple settlement, the payment lag is
the origin of settlement risk. “Payment lag” is a
time-lag between the initiation of the payment
order and its final settlement. In order to reduce
settlement risk in this context, the time-lag should
be shortened as much as possible.
Exchange-for-Value Settlement
“Exchange-for-Value Settlement” is a settlement
in which funds are exchanged with other financial
assets, such as foreign currencies or securities.
In this settlement, both a transfer of funds and
delivery of assets take place. For example, the
delivery of currency A and Currency B occurs
in a foreign exchange (FX) settlement, and the
transfer of funds and delivery of securities are
executed in the securities settlement.
18
Settlement Risk
In the exchange-for-value settlement, a
settlement lag is the origin of settlement risk.
“Settlement lag” is a time-lag between a funds
settlement and delivery of a financial asset. Such
a situation could happen, in which a transfer of
funds are made but cannot receive the counter
financial asset, and vice versa. A mechanism in
which the transfer of funds and delivery of assets
are conducted simultaneously is quite useful in
order to prevent such an awkward situation. These
mechanisms are called “Delivery versus Payment”
(DVP) for securities settlement and “Payment
versus Payment” (PVP) for FX settlement (both
will be discussed later).
SETTLEMENT RISK AND
PRE-SETTLEMENT RISK
Settlement Risk
Usually, “settlement risk” is a general term to des-
ignate the risk that a settlement will not take place
as expected. Meanwhile, this term is sometimes
used in a narrow sense. This usage means that a
party cannot fulfill the settlement obligations on
the due date. When the term of “settlement risk”
is used in this narrow sense, the point is that the
default will take place on the settlement date. As
the settlement process is the final stage, the pay-
ment instructions are executed on the settlement
date. In the case of an interbank payment, if the
payer bank cannot transfer the funds as expected
by the deadline of a payment system, the recipient
bank will not receive the expected funds, which
causes a liquidity shortage and unreasonable loss.
Pre-Settlement Risk
“Pre-settlement risk” is a contrary term in respect
to settlement risk. This term is frequently used in
the exchange-for-value settlement, such as FX
settlement or securities settlement. This is the
risk that the counterparty of such a trade will be
Settlement Risk
unable to settle the obligation on the future due
date. In short, a feature of the pre-settlement risk
is that it takes place before the settlement date.
Another feature of this risk is that the resulting
loss is limited to the cost of replacing the original
transaction at current market prices, which is
known as “replacement cost risk” (discussed later
in this chapter). In other words, if the counterparty
of a trade goes into bankruptcy before the settle-
ment date, the buyer cannot receive the required
foreign currency or securities.
CLASSIFICATION OF
SETTLEMENT RISK
“Settlement risk” (as a general term) is classified
into several categories as follows on the basis of
the cause and nature of the risk.
Credit Risk
“Credit risk” is defined as “the risk that a coun-
terparty will not settle an obligation for full value,
either when due or at any time thereafter” (BIS,
2001). For example, suppose that Bank A made
a trade with Bank B in a financial market such as
money market, FX market, or government bond
market. If Bank A becomes bankrupt before/on
the settlement date, Bank B, the counterparty of
the trade, cannot receive the funds, foreign cur-
rencies or government bonds. In this case, Bank
B cannot receive the obligation on the settlement
date or even at a future date, because Bank A
already became insolvent. If Bank B can receive
anything in the liquidation proceedings, it is not
the full value of the trade. This is the typical case
when a credit risk breaks out.
Liquidity Risk
“Liquidity Risk” is defined as “the risk that a
counterparty will not settle an obligation for
full value when due” (BIS, 2001). In the case of
liquidity risk, the settlement of debt obligation
is temporarily unable to be executed and will be
fulfilled at a future date. There is a big difference
between credit risk and liquidity risk in this respect.
Liquidity risk does not imply that the counter-
party becomes insolvent; it occurs when a mistake
in cash position management or computer trouble
causes a temporary lack of funds at a solvent in-
stitution. The loss is limited because a bank can
receive the obligation in the future, but even so,
the bank suffers if it cannot receive the funds in
a timely manner. In other words, it would cause
a shortage of funds for itself.
Systemic Risk
“Systemic risk” is the risk that the failure of one
participant in a financial market to settle its re-
quired obligation will cause a chain-reaction of
settlement failures, which could cause a serious
turmoil in the financial market. Such a chain of
failures may cause a broad range of significant
credit and liquidity problems and, as a result,
might threaten the stability of the financial market.
Since payment system is a network which links
a lot of participants in a financial market, it could
be a transmission channel for such chain-reaction
failures and cause systemic risk.
Systemic risk is the risk that the failure of one
participant spills over to other participants in the
payment system through debtor-creditor relation-
ships in the process of payment and settlement and,
as a result, might paralyze the payment system
as a whole. Central banks, who are responsible
for financial stability, give their full attention to
prevent such risk.
Legal Risk
“Legal risk” is defined as “the risk of loss because
of the unexpected application of a law or regulation
or because a contract cannot be enforced” (BIS,
2001). To give an example, when the default of
a bank takes place, and the counterparty regards
19

its obligation as protected legally, but in fact, it is
not the case. In this case, the couterparty suffers
a loss because of legal uncertainty.
Each country’s legal system is closely related
to this risk, which includes the collateral law,
bankruptcy law and contract law. Especially, the
“zero hour rule1” in the insolvency law might be a
cause of concern for payment system participants.
Operational Risk
“Operational Risk” is “the risk of human error or
a breakdown of some component of the hardware,
software or communications system that are cru-
cial to settlement” (BIS, 2001). A bank facing a
shortage of funds due to a mismanagement of a cash
position manager is the typical case of operational
risk. A breakdown of a computer system preventing
a bank from sending/receiving payment orders to/
from the payment system is another example of
operational risk. Financial crimes, illicit activities,
natural disasters, and terrorist attacks also might
be the cause of operational risk. In recent years,
payment systems depend heavily on computer and
network systems, so the countermeasure for system
failure is becoming more and more important.
After the September 11 terrorist attack in 2001,
the importance of “business contingency plan”
(BCP) gained a lot of attention, and many pay-
ment systems implemented appropriate measures,
including developing the crisis scenarios, identi-
fying the priority operations, and strengthening
backup systems.
MAGNITUDE OF LOSS CAUSED
BY SETTLEMENT RISK
Settlement risk can be classified into two types
on the basis of the magnitude of loss arising from
settlement risk. The first one is the “principal risk,”
in which the loss is the full value of the financial
transaction. The second one is the “replacement
cost risk,” in which the loss is a fraction of the
20
Settlement Risk
full value of the transaction, namely the differ-
ence between the original transaction price and
current market price.
Principal Risk
“Principal Risk” is “the credit risk that a party will
lose the full value in a transaction” (BIS, 2001).
This term is typically used with the exchange-for-
value settlement when there is a time-lag between
the fund-leg and another leg (e.g. securities-leg
or foreign currency-leg).
Principal risk occurs when the settlement
process starts and one party of the transaction
delivers the funds, securities or foreign currency.
In this case, this party has the risk that it cannot
receive the counter value, even if it delivers the
leg of one-side.
In the case of a securities settlement, the risk
is that the seller of the securities delivers the se-
curities but cannot receive the funds, or that the
buyer of the securities makes payment but cannot
receive the securities.
Replacement Cost Risk
“Replacement cost risk” is the risk arising from
price fluctuations. If the seller of the securities
becomes bankrupt before the settlement date,
the buyer of the securities becomes unable to
receive the securities. If the buyer still needs the
securities, it should go into the market and buy the
same securities. On this occasion, there is a risk
that the market price is higher than the original
contract price. In the case of the seller, it suffers
a loss when the market price is lower than the
original transaction price.
In this situation, the risk arising from the
difference between the current market price and
the original contract price is called “replacement
cost risk.”
This risk only pertains to the case where the
solvent party does not yet make payment or de-
livery to the bankrupt party. Thus, this is the risk
Settlement Risk
before the settlement process starts and is also
called “pre-settlement risk.” Once the solvent party
conducts a payment or delivery and is unable to
cancel it, the pre-settlement risk is transformed
into the principal risk.
Replacement cost risk is a kind of “market
risk,” arising from the fluctuation of market
price. Therefore, the larger the market volatility,
the larger this risk becomes. And the longer the
time-lag between the trade date and settlement
date, the higher this risk grows.
The magnitude of replacement cost risk is
rather limited compared to that of principal risk.
If the price movement between an original trade
and a replacement trade is just 1% of the securi-
ties price, the replacement cost is a matter of 1%
of a trade. As the loss of principal risk is 100%
of securities price, the magnitude of the principal
risk is 100 times that of the replacement cost risk
in this case.
Usually, the replacement cost is just a small
percentage of the principal. However, if the mar-
ket price fluctuates dramatically, the risk might
become quite considerable. For instance, it is
reported that during the financial crisis of Black
Monday in 1987, the stock prices of the NY stock
exchange dropped around 25 to 35 percent between
the trade date and the settlement date.
ACTUAL EXAMPLES OF
SETTLEMENT RISK
There were several incidents, in which settlement
risk turned into reality. Here are some examples
of such incidents.
Herstatt Bank Incident (1974)
In 1974, Herstatt Bank (Bankhaus Herstatt in
German), which was a small bank in Germany,
suffered an excessive loss by a series of failures
in FX trade. Becoming aware of that, German
banking authorities withdrew its banking license
and ordered the liquidation of the Bank. The
order was issued at 3:30 p.m. on 26 July 1974 in
Frankfurt when the interbank payments system
finished the settlement in Germany.
Prior to the closure order of Herstatt Bank,
several of its counterparties had paid Deutsche
Marks to the Bank on that day through the German
payment system. These counterparties anticipated
to receive the counter value in the US dollars later
on the same day in New York.
Against those expectations, as the closure order
was issued at 10:30 a.m. in New York, the cor-
respondent bank of Herstatt Bank suspended the
outgoing US dollar payments from the account of
the Bank. Because of this, the counterparties could
not receive the counter value in the US dollars.
As the Bank was an active player in the FX
market, the default amount of the Bank was beyond
$200 million as a whole, which caused a large
number of banks to suffer a loss and there was a
big disruption in the international financial market.
As a consequence of this incident, the FX
settlement risk caused by the international time
differences was named “Herstatt risk.” Ironically,
the Herstatt Bank was reduced to dust, but the
name of the Bank remains in the payment system
terminology today.
Bank of New York Incident (1985)
The Bank of New York (BONY) was one of two
clearing banks for government bonds in the US,
which offered clearing and settlement services for
a large number of securities dealers.
One day in November 1985, the BONY became
unable to send the delivery orders of govern-
ment bonds to the Fedwire in the daytime due
to computer trouble. This resulted in one-sided
transactions of receiving of huge amounts of
government bond, coupled with the payment of
a large amount of funds to other participants of
the Fedwire. This situation led the BONY to incur
an immense overdraft from the Federal Reserve
Bank of New York.
21

As a result, the BONY borrowed $3 billion in
intraday overdraft and $2.3 billion in overnight
lending. With the vast amount of overdraft and
lending, the BONY managed to get through the
day and was able to avoid the crisis of default.
New York’s Blackout Incident (1990)
In August 1990, there was a huge blackout in
New York City including the downtown centers.
This caused the malfunctions of computers of
financial institutions as well as the disruptions
in the financial markets and payment systems
for a few days.
Some financial institutions suffered shut downs
of the computer systems, which obstructed the
payment business. The market rate showed terrible
ups and downs because some major participants
could not take part in the market.
The Federal Reserve Bank of New York man-
aged to continue the operation of the Fedwire with
a private electronic generator.
BCCI Incident (1991)
On July 5th 1991, the banking supervisors in
Europe ordered the closure of the Bank of Credit
and Commerce International (BCCI). The BCCI
was a major international bank of Arab origin,
registered in Luxembourg, and was suspected of
committing fraud on a massive scale. This closure
order was issued at 1:00 p.m. London time on that
day (8:00 a.m. in New York).
The UK and Japanese banks suffered a principal
loss by this closure. They were the counterparties
of the BCCI in FX trades which were due to settle
on July 5th. As for a USD/sterling FX transac-
tion, the sterling payment was made through the
Clearing House Automated Payments System
(CHAPS) in the morning of that day, but the USD
payment was cancelled before its processing in
the Clearing House Interbank Payments System
(CHIPS). Therefore, the BCCI’s counterparty lost
22
Settlement Risk
the principal amount of the FX deal, which was
not a small amount.
A major Japanese bank also suffered a principal
loss for the USD/yen deal. The yen payment was
duly made through the Foreign Exchange Yen
Clearing System (FXYCS) on July 5th of Japan
Standard Time. However, the assets of the BCCI
in New York were frozen before the settlement of
the USD leg of the transaction took place.
This is another example of Herstatt risk, caused
by the time differences.
Bearings Incident (1995)
Baring Brothers was the oldest merchant bank in
London, until it collapsed at the end of February
1995 due to the unauthorized trading by its de-
rivatives trader in Singapore, Nick Leeson. This
collapse caused a crisis of making the end-of-day
settlement in the ECU clearing nearly unable to
be completed. The ECU clearing was the clearing
system of the European Currency Unit2 (ECU)
operated by the ECU Banking Association (the
current Euro Banking Association).
Concretely, on Friday, February 24th, one clear-
ing bank sent an ECU payment to Baring Brothers
due on Monday, February 27th. On Sunday, Febru-
ary 26th, the bank recognized the appointment of
administrator in bankruptcy to Barings and tried
to cancel the payment instruction. But the rules
of the ECU clearing did not permit this kind of
cancellation. The net position of the bank on
Monday happened to be negative and the bank
had to pay the net debit amount, which included
the payment to Barings, at the end of the day.
Fortunately, the bank finally agreed to pay the net
position and the settlement between the 45 clearing
banks was duly completed in the timely manner.
However if, the sending bank had not eventually
agreed to pay the net debit position, the end-of-
day settlement would have failed, which had led
to the unwinding of all the payments. The failure
of final settlement could have had very serious
Settlement Risk
consequences with the systemic impact on all the
banks as well as the ECU market.
EXPOSURE OF SETTLEMENT RISK
There are two factors that decide the scale of
settlement risk, namely, the settlement amount and
time-lag. The exposure of settlement risk, which
means the amount at risk, is defined as a product
of the settlement amount and time-lag. In other
words, the larger the settlement amount becomes
and the longer the time-lag becomes, the higher
settlement risk grows (see Figure 1).
Settlement Amount
In a gross settlement system, the settlement amount
is the principal amount of a transaction. Meantime,
the net positions are the object of concern in a net
settlement system.
Time-Lag
Time-Lag in a Simple Settlement
In a simple settlement, settlement risk is the risk
for the receiver of the funds. It arises when a trade
is executed, and disappears when the receiver
confirms the receipt of the funds. The time-lag
between the execution of the transaction and the
completion of confirmation is of concern.
Figure 1. Exposure of settlement risk (conceptual
diagram)
Time-Lag in a FX Settlement
Foreign exchange (FX) settlement is a sort of
exchange-for-value settlement, in which one
currency is exchanged with another currency. A
time-lag between the completion of the two legs of
the transaction (i.e. one currency leg and another
currency leg) is of particular concern.
This risk disappears when the counterparty
confirms the receipt of the currency purchased.
The difference from a simple settlement is the tim-
ing when the risk arises. The FX settlement risk
starts when a payment instruction for the currency
sold can no longer be cancelled. At this stage, the
bought amount is clearly at risk. Until the pay-
ment instruction becomes unable to cancel, the
bank does not face the settlement risk exposure,
even though it faces a possible pre-settlement risk.
REDUCTION MEASURES OF
SETTLEMENT AMOUNT
As mentioned above, settlement risk represents
the products of settlement amount and time-lag.
In order to reduce settlement risk, either settle-
ment amount or time-lag, or both of them should
be reduced.
“Netting” is often used as a measure in order to
reduce the settlement amount. Netting is defined
as “an agreed offsetting of positions or obligations
by trading partners or participants” (BIS, 1992).
Netting reduces a large number of individual
positions or obligations to a smaller number of
positions. Netting can be classified into the several
categories on the basis of a number of concerned
parties and legal grounds.
Classification of Netting According
to the Number of Concerned Party
The netting can be classified into two major
categories; “bilateral netting” and “multilateral
netting.” This classification depends on whether
23

Figure 2. Bilateral netting and multilateral netting
the netting is made between two parties or among
more than two parties (See Figure 2).
Bilateral Netting
“Bilateral netting” is an arrangement between
two parties to net out their bilateral obligations.
In other words, two parties offset their credit ob-
ligations and debt obligations for a certain period
of transactions in a one-to-one relationship, and
the amount of difference, which is often called
“net position,” is settled.
Multilateral Netting
“Multilateral netting” is an arrangement among
three or more parties to net out their obligations,
where the netting is arithmetically achieved by
summing each participant’s bilateral net positions
with the other participants to make a multilateral
net position. The multilateral netting of payment
obligations normally takes place in the context
of a multilateral net settlement system. Multilat-
24
Settlement Risk
eral netting is often conducted through a central
counterparty (CCP) that is legally substituted as
the buyer to every seller and the seller to every
buyer. Although the relation between the CCP and
each participant is bilateral, the netting effect is
similar to that of multilateral netting.
Classification of Netting
According to the Legal Notion
The netting can also be classified into three cat-
egories; “payment netting,” “obligation netting”
and “close-out netting.” This classification is on
the basis of a legal view point.
Payment Netting
“Payment netting” is a method of settling all
gross obligations due on the same date in the
same currency by the payment of net amount.
In this netting, as the subject of netting is only
the payment instructions, the credit obligations
and debt obligations still exist on a gross basis.
In other words, the netting has no impact on the
obligation of the original contract. The payment
netting only brings about a reduction in the number
of payment instructions and settlement amount.
It should be noted, however, if the settlement
of net position is not executed in this netting for
any reason, there is still a possibility that the
settlement of gross obligation might be required.
Obligation Netting
“Obligation netting” is a method to offset obliga-
tions due on the same future value date in the same
currency and replace them by new obligations, i.e.
net positions. In this netting, the original obligation
on a gross basis no longer exists and is replaced
by a new net position. “Novation” is the legal
term which means the replacement of obligation
with agreement from the concerned parties. Thus,
this netting is also called “netting by novation.”
Settlement Risk
In this netting, the magnitude of risk is reduced
to the net amount when the netting is made. It is
the merit of this netting that there is no return of
obligation on a gross basis, even if the settlement
of net position is not executed for any reason.
Close-Out Netting
While the two netting schemes noted above are
the netting that are conducted under normal cir-
cumstances, “close-out netting” is a special form
of netting which comes into effect when some
predefined events, such as a default, occurs.
More concretely, when a predefined event oc-
curs, such as the appointment of liquidator or the
commencement of bankruptcy procedures, all the
existing contracts of concerned parties are offset
and a net position is calculated by computing the
present value of the future obligations.
The close-out netting looks similar to the
obligation netting in respect that obligations are
novated into a new obligation. However, the close-
out netting is different from the obligation netting
in several respects. First, the novation is put into
motion only by special events, such as default
or bankruptcy. Second, the novation covers not
only the obligations due on the same value date
in the same currency, but also the obligations due
on the different value date and/or in the different
currency. Third, all the obligations of the default
counterparty are considered due when the netting
is executed. In short, the close-out netting is the
netting scheme for the very special cases and has
much stronger power than the obligation netting.
Setting Transaction Limits
To set transaction limits is also a useful tool for
each financial institution to put restrictions on
settlement amounts. Some payment systems
impose a “debit cap” or “credit limit” to each
participant of the system to limit the risk exposure
of a participant vis-à-vis another participant or the
risk exposure to the payment system as a whole.
As a self-imposed risk management tool, some
financial institutions set limits on the unsettled
amount with other financial institutions. These
limits are set separately for each of counterparty
depending on the risk-based evaluation. The limit
is sometimes called “Daily Settlement Limit”
(DSL).
REDUCTION MEASURES
OF TIME-LAG
Moving Up Settlement Time
One approach to reduce the time-lag on a settle-
ment is to move up the day and time of the settle-
ment. In the Designated-time settlement system,
if the settlement time is moved up from the next
day to the same day when payment instructions
are submitted to the system, the overnight settle-
ment risk is diminished.
Moreover, if the End-of-day settlement system
is changed to the Continuous settlement system,
in which settlement is made continuously during
the day, the time-lag between the submission of
payment instructions and the execution of settle-
ment, would shorten further.
The ultimate form of this approach is to adopt
the Real-Time Gross Settlement (RTGS) system.
In this system, once the payment order is sent to
the payment system, the instructions are processed
in real-time and the settlement is made immedi-
ately. The time-lag is practically nil in the RTGS
system, which means the settlement risk arising
from the time-lag is completely eliminated. That
is the reason why the RTGS system has been
introduced in many countries.
Early Reconciliation
Settlement risk for each financial institution
extinguish when the “reconciliation” is made.
Reconciliation means to confirm the outcome
of settlement, including the status of payment
25

instructions and the balance of account. Individual
institutions can reduce the time-lag between the
sending out of payment instructions and recon-
ciliation by moving up the reconciliation time.
In order to achieve the early reconciliation, it is
necessary to improve the operational procedures
as well as to reform the internal system. In the
case the settlement process is outsourced, it is
also required to develop a close relationship with
the outsourcing partner, such as a correspondent
bank or settlement agent, to obtain early notices
and advice.
Transition to a Synchronous
Settlement
As mentioned above, the time-lag between one
payment leg and another delivery leg is the ori-
gin of settlement risk in the exchange-for-value
settlement.
It is quite useful to adopt “Synchronous
Settlement” in order to accommodate this risk.
Synchronous settlement is a mechanism in which
the settlement of one payment leg and another
delivery leg is executed simultaneously. By execut-
ing the settlement of two legs at the same time,
the time-lag becomes nil and the settlement risk
arising from the time-lag is eliminated.
Figure 3. The concept of payment versus payment (PVP)
26
Settlement Risk
“Payment versus Payment” (PVP) in FX settle-
ment and “Delivery versus Payment” (DVP) in
securities settlement are two typical examples of
synchronous settlement.
Payment versus Payment (PVP)
“Payment versus Payment” (PVP) is a scheme to
prevent such situations as “euro delivered, but the
US dollars not received” or “the US dollars paid,
but Japanese Yen not received” in the settlement
of FX trade.
To be more precise, PVP is a mechanism which
ensures that a final transfer of one currency occurs
if and only if a final transfer of the other currency
takes place (see Figure 3). In this scheme, the
payment of one currency always goes hand-in-
hand with the payment of another currency, and
there is no principal risk caused by the time-lag
of the two legs.
Delivery versus Payment (DVP)
“Delivery versus Payment” (DVP) is a scheme
that links a Delivery, i.e. a securities transfer and
a Payment, i.e. a funds transfer. By this linkage,
DVP ensures that delivery of securities occurs if,
and only if, a funds transfer occurs (see Figure 4).
Settlement Risk
Figure 4. The concept of delivery versus payment (DVP)
DVP can prevent such situations as “the secu-
rities delivered, but no counter value received”
or “the payment made, but the securities not re-
ceived.” That is the reason why global standards
on securities settlement such as the Group of
Thirty (G30) or International Securities Services
Association (ISSA) recommended adopting the
DVP mechanism for all the securities settlement.
Three Models of DVP
There are three DVP models, which were identi-
fied in the “DVP report” of BIS (BIS, 1992). This
classification is based on whether the fund transfer
and the delivery of securities are made on a gross
basis or on a net basis.
DVP Model 1
DVP Model 1 is a mechanism that makes a
settlement of both securities and funds on a gross
(trade-by-trade) basis. DVP Model 1 conducts the
simultaneous settlement of an individual securities
transfer and an associated funds transfer. By its
nature, DVP Model 1 is also called “Gross-Gross
Type DVP.”
DVP Model 2
DVP Model 2 is a mechanism where the delivery
of securities is executed on a gross basis, but the
funds transfer is executed on a net basis. Usually,
in DVP Model 2, securities transfers are settled
on a trade-for-trade (gross) basis during the day,
while funds transfers are settled on a net basis at
the end of the day. Focusing on its nature, DVP
Model 2 is also called “Gross-Net Type DVP.”
DVP Model 3
DVP Model 3 is a mechanism that makes a settle-
ment of both securities and funds on a net basis.
Settlements may occur once a day or at several
times during the day. DVP Model 3 is also called
“Net-Net Type DVP.”
REFERENCES
Bank for International Settlements. (1992, Sep-
tember). Delivery versus Payment in Securities
Settlement Systems.
27

Bank for International Settlements. (1993, Sep-
tember). Central Bank Payment and Settlement
Services with Respect to Cross-Border and Multi-
Currency Transaction (the Noël Report).
Bank for International Settlements. (1996, March).
Settlement Risk in Foreign Exchange Transactions
(the Allsopp Report).
Bank for International Settlements. (1997, March).
Real-Time Gross Settlement Systems (the RTGS
Report).
Bank for International Settlements. (1998, July).
Reducing Foreign Exchange Settlement Risk: A
Progress Report.
Bank for International Settlements. (2001, Janu-
ary). Core Principles for Systemically Important
Payment Systems.
Bank for International Settlements. (2007, July).
Progress in Reducing Foreign Exchange Settle-
ment Risk.
Goodhart, C. (2008, February). Liquidity Risk
Management. Financial Stability Review. Banque
de France.
Harrison, S., Lasaosa, A., & Tudela, M. (2005,
December). Tiering in UK Payment Systems:
Credit Risk Implications. Financial Stability Re-
port, Bank of England.
Manning, M., Nier, E., & Schanz, J. (2008a).
System Design and Sources of Credit Risk in
Large-value Payment and Settlement Systems.
In Manning, M. (Eds.), The Economics of Large-
value Payments and Settlement. Oxford University
Press.
Manning, M., Nier, E., & Schanz, J. (2008b).
Liquidity Risk in Large-value Payment Sys-
tems. In Manning, M. (Eds.), The Economics of
Large-value Payments and Settlement. Oxford
University Press The Payments Risk Committee.
(2000, April). Intraday Liquidity Management in
the Evolving Payment System.
28
Settlement Risk
ENDNOTES
1
“Zero hour rule” is a provision in the bank-
ruptcy law whereby the transactions of a
closed institution that have taken place
after midnight on the date when the institu-
tion is ordered closed may be retroactively
rendered ineffective. If this rule is applied
to a payment system, all the settlements that
the closed institution made after 12:00 a.m.
of the closing day, which were regarded to
have settlement finality, become invalid. In
this case, all the settlements are cancelled
and the net positions should be recalculated,
which might cause systemic risk. In the Eu-
ropean Union (EU), the Settlement Finality
Directive (98/26/EC) was introduced in 1998
in order to keep away zero hour rules from
payment systems. It ensures that “transfer
orders cannot be revoked after a moment
defined by the rules of the system.” More-
over, it clearly states that “transfer orders
and netting shall be legally enforceable and,
even in the event of insolvency proceeding
against a participant, it shall be binding on
third parties, provided that such transfer
orders were entered into the system before
the start of such insolvency proceedings.”
In addition, there are no zero hour rules in
Japan.
2
The European Currency Unit (ECU) was
a basket of the currencies of the European
Community member states, used as the unit
of account for the European Community as
well as in international financial transactions
before being replaced by the euro in January
1999.
 Section 2
Basic Payment Systems and
Advanced Payment Systems
30

Chapter 4
DTNS System and RTGS System

ABSTRACT
This chapter provides comparisons between the “Designated-Time Net Settlement” (DTNS) system and
“Real-Time Gross Settlement” (RTGS) system. Those comparisons clarify the differences between the
two systems and highlight the features of each system.

The DTNS system and RTGS system have their own advantages and drawbacks. The RTGS system is
superior in reducing settlement risk. On the other hand, the DTNS system has an advantage on the level
of liquidity required for settlement. This means that there is a trade-off between the two systems in terms
of risk and efficiency. With knowledge of the pros and cons of the two systems, the most appropriate
system should be adopted according to the feature of payments which are processed in the system.

INTRODUCTION easy to develop the DTNS systems and difficult

There are two types of basic and traditional pay-
ment systems. One is the “Designated-Time Net
Settlement” (DTNS) system, and the other is the
“Real-Time Gross Settlement” (RTGS) system.
In the early days when payment systems became
computerized, most payment systems were the
DTNS systems. That was because it was rather
DOI: 10.4018/978-1-61520-645-2.ch004
to implement the RTGS functions with the level
of Information Technology (IT) at that time.
In the course of the 1990s, the RTGS systems
became widely used in many countries. Since
the RTGS system has the decisive advantage in
mitigation of settlement risk, many central banks
introduced the RTGS system.
As the DTNS and RTGS system have their
own merits and demerits, these two systems are
used in parallel in many countries.

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
DTNS System and RTGS System
TWO BASIC PAYMENT SYSTEMS
Designated-Time Net
Settlement (DTNS) System
In a DTNS system, payment orders which par-
ticipants submit over the course of a day are ac-
cumulated in the system. At the end of the day,
the “netting” takes place and the “net position” of
each participant is calculated. The net positions are
informed to each participant and then, the settle-
ments of the net positions are executed, typically
once, at the end of the day. To be more precise,
the net debtors are required to pay-in the net debt
amount to the system account, and upon receipt
of all these funds, the system makes pay-outs the
net credit amount to the net creditors.
The netting brings about the reduction of the
number and overall value of payments. However,
the finality of settlement is only achieved at the
end of the day. The DTNS system is also called
“Deferred Net Settlement” (DNS) system, em-
phasizing the late settlement.
According to the classifications in Chapter
2, the DTNS system is “Net settlement system”
and “Designated-Time settlement system.” It is
often adopted in “Private payment system.” Some
DTNS systems may be “Large-value payment
systems” and others may be “Retail payment
systems.” Some of DTNS systems are “Same-
day payment systems” and others are “Next-day
payment systems.”
Real-Time Gross Settlement
(RTGS) System
In a RTGS system, each payment order is settled
individually in the full amount of the payment order
(i.e. on a gross basis). If the payer has sufficient
balances (or credit availability) in its account, each
payment order is settled immediately on arrival
in the system (i.e. on a real-time basis).
When the payer’s account balance is insuf-
ficient to process the payment order, the order
is typically queued in the system, or sent back
to the payer as an error order. The RTGS system
has the advantage that payments become final as
soon as the order is sent to the system, so that the
intraday risk exposure does not build up. On the
other hand, the downside of the RTGS system
is that it requires a higher level of liquidity for
settlement compared to the DTNS system.
According to the classification in Chapter 2,
the RTGS system is “Gross settlement system” and
“Real-Time settlement system.” It is often adopted
in “Central bank payment system” and “Payment
system with central bank money.” Usually, it is
“Large-value payment system” and “Same-day
payment system” by definition.
COMPARISONS OF TWO
BASIC PAYMENT SYSTEMS
With these features of the DTNS and RTGS
system in mind, the comparisons of two systems
can be made as follows, from the aspects of (i)
settlement risk, (ii) required liquidity and (iii)
operational burden.
Comparison from the Perspective
of Settlement Risk
In a RTGS system, payment orders are settled
individually at the account of the central bank.
Accordingly, a payment order becomes final and
settlement risk disappears when the payment order
is processed on a real-time basis.
On the other hand, in a DTNS system, there
is a long gap of time between when the payment
order is sent to the system and when the net posi-
tion is finally settled. Until the final settlement, the
unsettled amounts accumulate further and further
during the day. The finality of settlement is only
achieved at the end of the day and thus there is
no certainty of settlement until then. If one of the
participants fails to meet its payment obligation
at the settlement time, there is a possibility that
31

all the payment orders could be unwound1. This
would lead to a disturbance on the liquidity situ-
ation of other participants and possibly bring on
another resulting default.
Therefore, the RTGS system is far superior to
the DTNS system from the viewpoint of reduc-
ing settlement risk. The RTGS system achieves
finality earlier, which reduces credit and liquidity
risk. On top of this, there is no systemic risk in
the RTGS system.
Comparison from the Perspective
of Required Liquidity
Another aspect of comparison is “liquidity,” which
means the required amount of funds for settle-
ment, or the outstanding amount in the settlement
account. Each participant in a payment system
required to have enough liquidity for payment
processing.
In a RTGS system, a participant should have
the liquidity equivalent to or more of each payment
order to be processed. If a participant sends some
payment orders of sizable amount, it should hold
an aggregate amount of liquidity in its account,
which might be a heavy burden on the payer. If
the liquidity is not enough, the payment order is
put in the queue and the settlement is not executed
on a real-time basis.
On the other hand, the necessary liquidity for
each participant is just a “net debit position” (i.e.
difference between the paying amount and the
receiving amount to/from other participants) in
a DTNS system. Usually the net amount is much
lower than the aggregate gross amount. Moreover,
the participants with “net positive position” (i.e.
the participants whose receiving amount is larger
than the paying amount) need no liquidity for
the final settlement, since such participants only
receive the funds from other participants.
Therefore, the DTNS system has an advantage
on the aspect of liquidity required for settlement.
That is to say, the DTNS system is superior to the
RTGS system in terms of “efficiency.” In other
32
DTNS System and RTGS System
words, the RTGS system can eliminate credit risk,
but it does so at the expense of requiring a much
higher level of liquidity than the DTNS system.
Because of this characteristic, it is often said
that the RTGS systems are “liquidity hungry”
relative to the DTNS systems. Central banks can
mitigate the liquidity cost of participants in the
RTGS system by providing intraday liquidity at
low cost (to be discussed later).
Comparison from the Perspective
of Operational Burden
The third aspect of comparison is operational
burden. The “cash position manager” who is re-
sponsible for the settlement function in a financial
institution should monitor the processing situation
of payment orders and manage the liquidity in the
settlement account for smooth settlement.
In a DTNS system, the only thing the manager
should do is prepare the fund for the net position
(much smaller than the gross amount of pay-
ments) before the settlement time, usually at the
end of the day.
In a RTGS system, the manager should manage
the liquidity in its account on a real-time basis
during the day. In this case, the operational bur-
den is much heavier than that of a DTNS system.
When the RTGS system is introduced, how-
ever, many banks (especially large-scale banks)
introduce the system which automatically man-
ages the release of payment orders according to
the liquidity situation of the bank. These “release
control systems” reduce the operational burden
of cash position managers.
Trade-Off between Safety
and Efficiency
As explained above, there is a trade-off between
the DTNS and RTGS system, or more concretely
between safety and efficiency in a payment system.
The DTNS system has an advantage in efficiency,
but is inferior in safety. That is, the DTNS system
DTNS System and RTGS System
Figure 1. Trade-off between safety and efficiency in payment systems
requires only small liquidity for settlement, but
cannot achieve the intraday finality. On the other
hand, the RTGS system is superior in safety, but
has a disadvantage in efficiency (see Figure 1).
A great deal of effort has been made to strike
the right balance between safety and efficiency
in payment systems, which has lead to the evolu-
tion of payment systems (see Chapter 5 and 6 for
more details).
RISK MANAGEMENT MEASURES
IN DTNS SYSTEM
As mentioned above, the DTNS system has a
drawback in terms of settlement risk. Thus, how
to manage the settlement risk is an important issue
for the DTNS system.
There are two methods to cope with the is-
sue. The first one is to set a “limit” (or “cap”) on
the paying amount or receiving amount of each
participant. This is a risk management measure to
confine the risk among the participants, or between
the system and each participant.
The second one is to introduce a “Loss-Sharing
Rule,” which stipulates the allocation of any loses
arising from the default of participant in the system.
Setting a Limit
It is rather common that the DTNS system adopts
risk management measures, such as a Net Credit
Limit or Net Debit Cap. When these measures
are adopted, such a system is generally called
“Protected DTNS system,” which has a high level
of security. Without these measures, the system is
called “Unprotected DTNS system,” in which the
risk management needs to be improved.
Bilateral Net Credit Limit
“Bilateral Net Credit Limit” is a limit on the credit
exposure a participant incurs vis-à-vis another
participant as a result of the payments received
that have not yet been settled. This Limit is on
a “Net Credit Position” between two parties,
which is calculated by subtracting the sum of the
“payments sent” from the sum of the “payments
received” between the two participants.
By setting the “Net Credit Limits” for each
participant bilaterally, a participant can confine
the risk exposures to other participants within the
upper limit because the system blocks the payment
orders which make the net position go above the
limit. This limit is also called “Net Receiver Limit.”
If a participant sets a Net Credit Limit at very
lower level, it can reduce the bilateral risk exposure
substantially, but it may make it difficult to receive
33

payments due to the limit restraint. Therefore, not
only the level of credit risk of each participant, but
also the smooth operation of its own is a factor to
be considered when each participant decides the
limit for other participants.
Multilateral Net Debit Cap
“Multilateral Net Debit Cap” is a limit on the
funds transfer activity of individual participants
to a payment system. While the Net Credit Limit
is set bilaterally, the Net Debit Cap is set mul-
tilaterally. This Cap intends to reduce the risk
exposure of the system as a whole below a certain
level by limiting the sum of payments sent from
each participant.
In general, the Net Debit Cap of a participant
is calculated by multiplying the sum of the Net
Credit Limits which the participant gets from the
other participants by the “system-wide rate.” Thus,
the larger the participant’s Net Credit Limits total
become, the larger the participant’s Net Debit Cap
becomes. The system-wide rate ranges from 3 to
5%, depending on each payment system.
Loss-Sharing Rule
Definition of the Loss-Sharing Rule
In a “Protected DTNS system” which adopts
the risk management measures described above,
the settlement risk is limited to a certain level.
In spite of these risk reduction measures, one or
more participants of payment system may possi-
bly fail to meet their obligation on the same day.
The Loss-Sharing Rule is an arrangement that
stipulates how the loss will be shared among the
parties concerned in such a case. This is also called
the “Loss-Sharing Agreement.” In the case of de-
fault, the Loss-Sharing Rule finalizes a settlement
by sharing the loss among participants without
unwinding of all the settlements in the system.
Depending on the Rule, even a participant
that has no transaction with the defaulter could
34
DTNS System and RTGS System
be requested to share some losses. Therefore,
each participant should fully understand the Loss-
Sharing Rule and probability of loss-sharing.
Classifications of the Loss-Sharing Rule
The Loss-Sharing Rule can be classified into
three categories, namely, (i) defaulters pay, (ii)
survivors pay, and (iii) third parties pay.
Defaulters Pay
“Defaulters Pay” is a loss-sharing arrangement
where the defaulting party (or parties) itself bears
the whole loss. To achieve this arrangement, each
participant is required to provide the collateral
in advance for the possible maximum exposure
it may create for the other participants. In a pay-
ment system with Defaulters Pay, each participant
should decide the Net Debit Cap and pledge the
collateral for equivalent amount of the Cap before
the start of the settlement day.
If the arrangement is solid enough, the partici-
pants other than the defaulters can complete the
settlement without suffering any losses, regardless
of the number of the defaulters.
This arrangement has an advantage that the
risk is mitigated sufficiently for all the partici-
pants. On the other side of the coin, the collateral
burden is rather heavy on all the participants in
this arrangement.
Survivors Pay
“Survivors Pay” is a loss-sharing arrangement
where the survivors, i.e. the participants other
than the defaulting parties, bear a loss jointly. In
the event of a participant’s inability to settle, this
arrangement requires losses to be borne by the
surviving participants according to some prede-
termined formula.
The DTNS system tends to adopt this loss-
sharing arrangement. This is because the collateral
burden is so heavy in the Defaulters Pay that it
DTNS System and RTGS System
almost cancels out the efficiency merit of the
DTNS system.
To achieve this arrangement, each participant
is requested to set Bilateral Net Credit Limits
with the other participants. If a participant falls
into default, the survivors should bear the loss
on a “pro-rata basis” of Net Credit Limits for the
defaulting party. Accordingly, if a participant
admitted a large limit to the defaulter, it should
bear a large share of the loss. Usually, each par-
ticipant is required to provide collateral which is
equivalent to the largest limit out of the limits it
admitted to the other participants.
The initial merit of this arrangement is that the
collateral burden is much less than the Defaulters
Pay, because the losses are paid jointly by all the
participants other than the defaulter.
The second merit is that this arrangement
tends to promote mutual monitoring among the
participants in the payment system and serve as
an incentive to take appropriate risk management.
That is because the sharing of loss will be propor-
tional to the Net Credit Limit of each participant
to the defaulting party. If a participant does not
appropriately monitor the other participants and
admits an excessive limit, there is a risk of bearing
the excessive loss-sharing.
On the other hand, this arrangement has a
weakness in risk management in exceptional
circumstances. More specifically, in the event of
two or more major participants defaulting, there is
a possibility that the total losses cannot be covered
by the survivor’s collateral which was originally
intended for a single default.
To avoid such a serious situation, some DTNS
systems introduce the collateral schemes which
brace for the default of the largest two participants
in the system.
Third Parties Pay
“Third Parties Pay” is a loss-sharing arrangement
in which a third party, i.e. other than the defaulters
or survivors, bears the loss. Usually, this arrange-
ment is not a main scheme of loss-sharing but
rather adopted as a mechanism to complement
the Defaulters Pay or Survivors Pay.
A typical example of a third party is a central
bank. For instance, the Bank of Canada is stipulated
to bear a loss if the collaterals of participants are
insufficient to cover the loss in the Large Value
Transfer System (LVTS).
Depending on the content of the Rule, this
arrangement may create a “moral hazard” in the
participants. That is to say, if the central bank bears
a large extent of the loss, each participant will
not pay much attention to its risk of loss-sharing.
The loss-sharing of a central bank in this ar-
rangement can be regarded as the role of a “Lender
of Last Resort” (LLR), which constitutes as a
“safety net” for financial stability.
The central bank’s involvement can be consid-
ered as a scheme similar to the insurance, which
is provided in cases of extremely low probability,
like the simultaneous defaults of multiple major
participants. Without the involvement of the cen-
tral bank, a heavy burden of collateral would be
enforced on all the participants in preparing for
any such extreme events.
Role of Liquidity Providers
In the loss-sharing arrangement mentioned above,
the collateral is generally provided in the form
of securities, mainly in government bonds. The
collateral must be sold in order to raise the funds
needed to cover the defaulter’s obligation. Since
it takes time to sell the securities in the market,
the deadline of settlement cannot be met.
For this reason, “Liquidity Providers” are set up
in some DTNS systems. Each Liquidity Provider
sets a “Commitment Line” to a payment system for
a rainy day. A Commitment Line is an agreement
under which an operator of a payment system can
borrow funds up to a predetermined amount when
a default breaks out. When a default occurs, the
Liquidity Providers provide the required funds im-
mediately to cover the obligation of the defaulter
35

in accordance with the agreement. With the funds
from the Liquidity Providers, the operator of the
payment system is enabled to complete the settle-
ment in a timely manner.
Generally, the Liquidity Providers are major
private banks which have a strong fund-raising
capacity in the market. And sometimes a central
bank may act as a Liquidity Provider. The loans
from the Liquidity Providers are repaid with the
funds raised from selling the collateral in the
market at a later date.
RISK REDUCTION BY
INTRODUCING RTGS SYSTEM
Reduction of Credit and
Liquidity Risk
To introduce a RTGS system makes a great con-
tribution to the reduction of settlement risk. As
payment orders are processed continuously during
the day and settlements became final immediately
in the RTGS system, it eliminates the credit and
liquidity risk among the participants during the
process of settlement.
More concretely, the RTGS system shortens
the period of duration substantially for the expo-
sure to credit and liquidity risk. Provided there
is sufficient liquidity for a payment order in the
payer’s account, the payment lag is practically
zero and the cause of risk is removed.
Elimination of Systemic Risk
Introducing a RTGS system is also a powerful
measure to take away systemic risk for the fol-
lowing reasons.
First, the RTGS system reduces the exposure
among participants during the day, which elimi-
nates the possibility of loss or liquidity shortage
arising from the default of other participants.
36
DTNS System and RTGS System
Second, the RTGS system never executes the
unwinding, which is the main cause of systemic
risk in the DTNS system.
Third, the settlement time is not fixed in a RTGS
system, and a participant can make a settlement
with finality at any time of the day. If a temporary
shortage of liquidity takes place during the day,
a participant can cope with such a situation with
time to spare, by taking measures of fund-raising
from the market or waiting for the incoming pay-
ments from other participants.
Fourth, the RTGS system can be a basic infra-
structure for the DVP and PVP mechanism. With
the linkage to other systems, the RTGS system
can contribute to the risk reduction for securities
settlement and FX settlement.
LIQUIDITY MANAGEMENT
IN RTGS SYSTEM
Liquidity management is an important factor in
the RTGS system. As the RTGS system is a gross
settlement system, there is no netting executed and
payment orders are processed individually with
a gross amount. As a result, the level of liquidity
required in the RTGS system is much higher than
that in the DTNS system.
At the same time, because the RTGS system
is a real-time settlement system, a settlement with
finality is made continuously, as far as there is suf-
ficient liquidity in the payer’s account. In short, a
participant can secure the intraday finality as long
as the payer has sufficient liquidity.
Source of Liquidity
Generally speaking, the market liquidity as a whole
is provided to the financial market by a central
bank, and the supplied liquidity is distributed
among the participants through a payment system.
DTNS System and RTGS System
Four Kinds of Sources of Liquidity
When the payer seeks to make payments in the
RTGS system, there are four kinds of sources of
liquidity.
The first source of liquidity is the outstanding
balance in the payer’s settlement account. By
the reserve requirements, the banks are required
to keep certain level of a reserve balance in the
current account at the central bank. Normally, the
settlement account in the RTGS system is, at the
same time, the account for the required reserves.
When the settlement day starts, this reserve de-
posit at the end of the previous day is the origin of
liquidity to be used for the settlement of the day.
The second source is the incoming payments
from other participants in the payment system. The
incoming payments are created as a result of the
securities trades, FX trades as well as customer
payments.
The third source is the funds raised from the
money market. The participants of the RTGS
system usually participate in the money market
and can borrow funds from other banks, in case
of necessity.
The fourth source is the liquidity provided by
a central bank. A central bank supplies liquidity
when necessary to the participants of the RTGS
system by means of intraday overdraft or intraday
repo transaction.
Supply and Distribution of Liquidity
The market liquidity as a whole is provided by the
central bank to the financial market through the
open market operations. Since the settlement of
the RTGS system takes place through the transfer
of funds among the participants’ accounts at a
central bank, the liquidity is provided in the form
of “central bank money.”
Once provided, the liquidity is distributed
among the participants through the payment
system. Liquidity distribution is made by the
incoming and outgoing payments in the payment
system as well as the money market transactions.
Intraday Liquidity
Demand for Intraday Liquidity
As mentioned above, the RTGS system requires a
large quantity of liquidity for settlement. Because
of this, it is rather inevitable for central banks to
provide intraday liquidity to the participants of a
RTGS system. “Intraday Liquidity” is provided
by central banks to the participants of the system
during the day to process payments, and the bor-
rowed funds are to be repaid by the end of the
settlement day. If the borrower is unable to repay
the funds by the deadline, it must pay the penalty
rate which is much higher than the market rate.
The Intraday Liquidity is solely for facilitating a
smooth settlement in the system during the day, and
the character of the liquidity is extremely different
from that of overnight lending by a central bank.
Two Methods for Providing
Intraday Liquidity
The two main methods to provide Intraday Li-
quidity are “Intraday Overdraft” and “Intraday
Repo transaction.”
Intraday Overdraft
“Overdraft” (O/D) is an agreement that central
bank allow the financial institutions to withdraw
funds exceeding deposit balance, which means the
account balance become temporarily negative (i.e.
below zero). When an overdraft is admitted only
during the day, it is called “Intraday Overdraft”
(Intraday O/D).
In this case, the account balance should be
restored to be positive (i.e. above zero) by the end
of the day. In concrete terms, the borrower of an
Intraday O/D should repay the intraday loan by
the end of the day. If unable to do so, the situation
is called the “spillover” of intraday credit to the
37

overnight credit. In this case, the borrower should
pay a penalty rate on the overnight credit.
When admitting Intraday O/D, many central
banks require collateral for the temporary lend-
ing. That is to mitigate credit risk of the central
bank arising from a possible default of the bor-
rower. In this case, the possible borrower should
provide collateral to the central bank in advance,
and can make overdrafts within the limits of the
collateral value. Intraday O/D with collateral is
usually provided at no charge. In other words,
the borrower does not have to pay any interest
rate on the O/D.
The US is a sole exception on this point. The
Federal Reserve provides Intraday O/D to the
participants of the Fedwire without collateral.
Meanwhile, the Intraday O/D is subject to charges,
which are imposed on a minute-by-minute basis.
Intraday Repo Transaction
“Repo transaction” is a financial transaction where
the seller commits to buy back the securities from
the buyer at a specified price at a designated future
date. It is also known as “Repurchase Agreement.”
Even though it takes the form of selling and buy-
ing back of securities, the underlying nature of
the transaction is collateralized short-term lending
from the buyer to the seller.
“Intraday Repo transaction” means that the
selling and buying back of securities is executed
on the same day, which is mainly used by central
banks in Europe. As a repo is economically similar
to a secured loan, a central bank becomes the buyer
and provides funds while receiving securities as
collateral to protect against the possible default
of the seller. As this is an intraday transaction, the
seller (i.e. financial institution) should buy back
the securities by the end of the day and repay the
fund to the central bank.
In general, Intraday Repo transaction is made
with no charge, which means that the prices of
selling and buying back are identical. In sum, the
nature of the Intraday Repo transaction is similar
38
DTNS System and RTGS System
to Intraday O/D which is made with collateral
and no charge.
Opportunity Cost of Intraday Liquidity
In both the Intraday O/D and Intraday Repo trans-
actions, with the exception of the Federal Reserve,
central banks provide intraday liquidity with no
charge. Therefore, there is no explicit cost for
intraday credit from the central bank. However,
it does not mean that there is no cost entailed for
the intraday liquidity.
This is because many central banks require
“full collateralization” of intraday liquidity. This
greatly reduces the credit risk of the central bank,
but imposes an implicit cost of posting collateral.
The hidden cost caused by holding securities
as collateral is known as “opportunity cost” in
economics.
Illiquidity
What is Illiquidity?
When a participant’s central bank account balance
is smaller than the amount of the payment order
in the RTGS system, such a situation is called
“illiquidity” or lack of funds.
In this situation, the payment order is not ex-
ecuted in the RTGS system until the participant
comes up with the funds. That is, the “delay risk”
takes place due to the shortage of funds. In this
situation, the participant needs to obtain funds from
the market or the central bank as soon as possible.
Impact of Illiquidity
Nonetheless, the situation of illiquidity does not
necessarily bring a severe impact immediately in
the RTGS system.
The degree of impact depends on the urgency
of payment order. If the payment order is non-
urgent, the risk implication is rather limited. On
DTNS System and RTGS System
the contrary, if the payment order is highly urgent,
the delay risk has a material impact.
Gridlock
What is Gridlock?
“Gridlock” is a situation where the failure of some
payment instructions to be executed prevents a
substantial number of other instructions of other
participants from being executed in a payment
system. These chain-reaction consequences lead
to a temporary stop of recycling of liquidity in
a payment system. The initial cause of this cir-
cumstance might be a shortage of liquidity. And
higher cost of liquidity will encourage banks to
delay their payments.
For example, Bank A is holding back a payment
order to Bank B, waiting for the payment from
Bank C, while Bank B is holding back a payment
order to Bank C until the receipt of the payment
from Bank A. And Bank C is also holding back
a payment to Bank A, waiting for the payment
from Bank B (see Figure 2).
This is a typical situation of gridlock, where
each participant is waiting for the payment from
others. If this kind of situation arises, the settle-
ments would be stuck and the circulation of liquid-
ity in the system would be blocked. As a result of
this defensive strategy taken by many participants,
Figure 2. Gridlock situation (example)
the settlements in the payment system cannot
make the slightest progress.
System-Wide Liquidity and
Liquidity Distribution
The gridlock situation tends to take place espe-
cially when the “system-wide liquidity” is insuf-
ficient, which means that there are not enough
funds in the market as a whole. However, even
when the system-wide liquidity is sufficient, if
the distribution among the participants does not
work well and an extremely uneven distribution
of funds takes place, the gridlock situation may
also emerge.
Furthermore, if each participant has a tendency
to delay as much as possible sending outgoing
payments intentionally in order to save its own
liquidity, the gridlock situation is prone to oc-
cur. If the liquidity costs are considerably-high
reflecting the central bank’s policy on providing
intraday liquidity, the banks would have a strong
incentive to delay payments as late as possible2.
Preventive Measures against Gridlock
To avoid such a situation, some payment sys-
tems introduced a “Gentlemen’s Agreement” or
a “Throughput Guideline” that obliges all the
participants to send out certain percentage of pay-
39

ment orders of the day (on a volume basis and/or
a value basis) by a certain time.
Other systems use an “Incentive Pricing
Policy” to promote the sending out of payment
instructions during the early hours of the day.
That is to say, a “timing-based fee structure”
was introduced to promote an early submission
of payment orders. For instance, the surcharge is
imposed on the late payment orders sent after a
fixed time. Or on the contrary, the lower charge
is applied to the payment instructions sent early
in the morning.
In addition, some payment systems adopt off-
setting mechanisms to solve the gridlock situation
(to be addressed later).
Queuing Mechanism
What is a Queue?
“Queue” is a mechanism where payment orders
are held pending by the system until the pre-
defined conditions are met. In the DTNS system,
the limitation of a Bilateral Net Credit Limit and
a Multilateral Net Debit Cap are considered as
required conditions for processing.
As for the RTGS system, by contrast, suffi-
cient liquidity in the payer’s account is the only
and decisive condition. Payment order is held in
the queue until the sufficient funds are available
in the payer’s account. In some cases, the credit
availability from the central bank may be taken
into account to judge the sufficiency of liquidity.
Central Queue and Distributed Queue
It is rather common that a queuing facility is
built in the central processing system of a pay-
ment system, which is called “Central Queue.”
The queue also can be built in the system of an
individual financial institution, which is called
“Distributed Queue.”
Meanwhile, some RTGS systems do not have
a central queuing mechanism. In such a system,
40
DTNS System and RTGS System
when the account balance of the payer is insuffi-
cient, the payment order is rejected by the system
and returned to the payer.
Central Queuing Facilities
as a Global Trend
To have a central queuing facility is a growing
trend of RTGS systems. According to the 2008
Global Payment Systems Survey of the World
Bank, the majority of RTGS systems worldwide
(83 out of 98 systems, or 85%) have centralized
queuing facilities and allow payment orders to
wait in a queue until all required conditions for
the processing of such payment orders are met.
Queue management mechanisms have made
impressive progress in recent years, which led to
more advanced and sophisticated payment systems
(to be addressed in the next chapter).
Structural Factors
Influencing Liquidity
The liquidity situation in a payment system is
influenced by some structural factors of the
participants.
Number of Participants
First of all, the number of participants in a system
has some effects on the liquidity situation. In a
system with rather a limited number of partici-
pants, the “internalization” plays an important role,
which means that a larger number of customer
payments are processed internally in major banks.
In this case, the payment orders processed by
the payment system as interbank settlements get
fewer. As a result, the intraday liquidity necessary
for a settlement tends to be reduced.
Difference in the Size of Participants
The difference in the size of the participants in
the system also has some impact on the liquidity
DTNS System and RTGS System
situation. More concretely, Intraday Liquidity
required for a payment system with both large
scale banks and small-and medium-sized banks
and that of a system with only uniformly-sized
banks are possibly different.
Generally speaking, the large scale banks tend
to have the same scale of inflow and outflow
payments especially for customer payments, and
the required liquidity for outgoing payments is
frequently covered by incoming payments. On
the other hand, the small-and medium-sized banks
deal with a limited number of payment orders
and tend to be one-sided, i.e. excess in payment
or in receipt.
Difference in the Specialized
Field of Participants
It is rational to assume that a system with many
specialized banks and a system with homogeneous
banks have diverse patterns of payments and dif-
ferent requirements for intraday liquidity.
Net Positions of Other
Payment Systems
The net positions of other payment systems also
affect the liquidity requirement of a RTGS system.
Such payment systems include the Bill and Check
Clearing Systems, Retail payment systems, and
Securities Settlement Systems. The net positions
of these systems are usually settled through the
RTGS system, or settled at the central bank ac-
count which the RTGS system also uses. That has a
direct effect on the liquidity situation of the RTGS
system. That is one aspect of interdependencies of
payment systems already mentioned in Chapter 1.
REFERENCES
Bank for International Settlements. (1989, Feb-
ruary). Report on Netting Schemes (the Angell
Report).
Bank for International Settlements. (1990, No-
vember). Report of the Committee on Interbank
Netting Schemes of the Central Banks of the Group
of Ten Countries (the Lamfalussy Report).
Bank for International Settlements. (1993, Sep-
tember). Central Bank Payment and Settlement
Services with Respect to Cross-Border and Multi-
Currency Transaction (the Noël Report).
Bank for International Settlements. (1997, March).
Real-Time Gross Settlement Systems (the RTGS
Report).
Bank for International Settlements. (2001, Janu-
ary). Core Principles for Systemically Important
Payment Systems.
ENDNOTES
1
“Unwind” or “unwinding” is a procedure
when a default occurs in the net settlement
system. If a participant fails to settle, some
or all the provisional transfers involving
the default participant are deleted from the
system and the settlement obligation from the
remaining payments are then recalculated.
2
This is one of the major reasons that many
central banks have not charged interest on
the intraday credit.
41
42

Chapter 5
Hybrid System and
Integrated System

ABSTRACT
This chapter takes an analytical approach to two types of advanced payment systems, namely the “Hybrid
system” and “Integrated system.” The Hybrid system is a combination of the best features of the DTNS
system and RTGS system. The Hybrid system is characterized by the frequent net settlement during the
day. The Integrated system is defined as the payment system which has both the RTGS mode and Hybrid
mode. The participants of Integrated system can use the two modes depending on the urgency of the
payments.

These advanced payment systems became possible through the progress of Information Technology (IT).
The progress of IT enabled to achieve several mechanisms to support the sophisticated payment systems.
This chapter gives the explanation of such mechanisms, which include (i) the frequent netting and con-
tinuous processing, (ii) partial netting, (iii) offsetting, (iv) searching and matching facility, (v) queue
management function, (vi) pre-funding account, and (vii) multiple functions in a single payment system.

INTRODUCTION 1990s, the new types of payment systems emerged.

In the 1990s, it was a worldwide trend of payment
systems to make the transition from the DTNS
system to the RTGS system. And from the late
DOI: 10.4018/978-1-61520-645-2.ch005
The first one was called “Hybrid system.” In the
Hybrid system, net settlements are executed many
times a day, while the traditional DTNS system
executes a net settlement only once, at the end
of the day.

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
Hybrid System and Integrated System
The second one was called “Integrated system.”
The characteristic of the Integrated system is that
this type has two processing modes of payment
instructions. One is the RTGS mode and the other
is the Hybrid mode.
Payment systems in advanced nations have
evolved from the two basic payment systems, i.e.
the DTNS system and RTGS system to the two
advanced payment systems, i.e. the Hybrid system
and Integrated system. With the introduction of
the advanced payment systems, the classical type
RTGS system tends to be called the “pure RTGS
system,” suggesting that the function is rather
limited and old-fashioned.
HYBRID SYSTEM
Feature of Hybrid System
“Hybrid” is a word which means a thing made
by combining two different elements. In the pay-
ment system area, the “Hybrid system” means a
combination of the advantages of the DTNS and
RTGS system. To be more precise, this system
combines the liquidity-savings features of the
Figure 1. Characteristics of hybrid system
DTNS system with the immediate finality offered
by the RTGS system in order to improve the risk-
efficiency trade-off.
The Hybrid system is a logical extension of
the DTNS system, where the final settlement
takes place only once at the end of the day. The
characteristic of the Hybrid system is derived
from the fact that the net settlements are made at
frequent intervals or continuously. And the net
settlements become final at the time of frequent
settlements. These frequent net settlements suc-
ceeded in combining the liquidity-saving features
and immediate finality.
The DTNS system has a disadvantage that
the transfer of funds become final only at the
end of the day, even though it has an advantage
that settlement can be made with small liquidity
only for the net position. With the frequent net
settlement, the Hybrid system realizes the merit
of the RTGS system, that is early finality and free
from systemic risk. At the same time, being a net
settlement system, the Hybrid system still keeps
the merit of the DTNS system, i.e. the settlement
capability with small liquidity. The combination
of the merits of the two systems is achieved by
this means (see Figure 1).
43

That is the reason why this system is called
“Hybrid system.” This system is also sometimes
referred to as “Continuous Net Settlement” (CNS)
system, compared to the DTNS system.
Development of Hybrid Systems
EAF2 as the First Hybrid System
The first Hybrid system in the world emerged in
Germany, which was called “EAF2.” In March
1996, it became a Hybrid system from the DTNS
system. In the EAF2, the bilateral net settlements
were made every twenty minutes in the morning
session. It was a true milestone, considering that
net settlement was executed only once a day in
the traditional DTNS system.
In addition to the frequent bilateral net settle-
ments in the morning session, two multilateral
netting settlements were made in the afternoon
session. This was for the payment instructions
unsettled in the morning session. The settlements
became final at each net settlement. It was a small
invention, but a breakthrough innovation in the
history of payment systems.
Subsequent Hybrid Systems
Following the EAF2, the Paris Net Settlement
(PNS) in France, and the Clearing House Interbank
Payments System (CHIPS) in the US became the
Hybrid systems, transformed from the DTNS
system successively during 1999-2001.
The new feature of these systems was that
the net settlement was made continuously based
on settlement events, instead of at regular time
intervals as in the EAF2. It can be recognized that
the Hybrid system took another step forward. The
settlement events include the receipt of incoming
payments and the addition of liquidity up to the
settlement amount.
44
Hybrid System and Integrated System
CHIPS as the Most Advanced
Hybrid System
Under the existing circumstances, the CHIPS in
the US is the latest and the most advanced Hy-
brid system. The settlement engine of the CHIPS
judges the capability of net settlement for each
payment instruction, and the net settlement is
made continuously, if possible. A system, which
is called the “balanced release engine,” selects the
processing mode from three types: “Individual
release,” “Bilateral release” and “Multilateral
release,” according to the available balance of the
payer and payee and the incoming and outgoing
payment situation.
Individual release is a simple transfer of funds
of a single payment order. Bilateral release is the
bilateral net settlement between the two partici-
pants. Multilateral release is the multilateral net
settlement among three or more participants (see
Chapter 9 for more detail).
It is incredibly amazing that the automatic
selection of processing mode is possible almost
in real time, considering that the traditional DTNS
system made the simplest form of net settlement
only once a day. By adopting continuous settle-
ment, the frequency of the settlement increased
drastically compared to the only one-time settle-
ment in the DTNS system.
As you can see, even belonging to the same
category as Hybrid system, the processing method
of payments has made substantial progress,
which was largely supported by the technologi-
cal progress.
Hybrid System and Trade-
off in Payment System
As mentioned in the previous chapter, there is a
trade-off in payment systems between safety and
efficiency. Safety means that settlement risk is
reduced and efficiency means that the required
liquidity for settlement is small. As explained in
Chapter 4, the DTNS system has an advantage on
Hybrid System and Integrated System
Table 1. Trade-off between safety and efficiency
Safety Efficiency
DTNS system Low High
RTGS system High Low
the liquidity required for the settlement, which
means its efficiency is “High.” However, the
DTNS system is vulnerable to settlement risk,
including the possibility of systemic risk, which
means its safety is “Low.”
On the other hand, the RTGS system requires
larger liquidity to process settlements, which
means the “Low” efficiency. But the RTGS has
an advantage for the reduction of settlement risk,
which means its safety is “High” (see Table 1).
With the presence of this trade-off relationship,
the RTGS and DTNS systems are to be found on
the same “indifference curve.” This means by
improving the safety, the efficiency will be de-
creased, and if the efficiency is enhanced, the
safety will be degraded. When the efficiency
comes first, the DTNS system is chosen, and when
priority is placed on the safety, the RTGS system
is selected in the traditional world with only two
choices.
Figure 2. Indifference curve and payment systems
However, the Hybrid system made it possible
for early finality and settlement capability with
small liquidity at the same time. This is more than
just the middle point of the two systems. This
combination of merits from two systems realized
the higher utility for the participants of the system,
which meant an upward shift of the ‘indifference
curve’ or ‘trade-off curve’ (see Figure 2). Thus,
it can be concluded that the Hybrid system was
a true innovation that achieved an enhancement
of utility in the payment system.
INTEGRATED SYSTEM
Feature of Integrated System
The next evolution of payment systems was the
transition to Integrated system. An Integrated
system is defined as the payment system which
has both the RTGS mode and Hybrid mode.
Participants of an Integrated system can use both
modes as the situation demands. More concretely,
participants can use the RTGS mode for the urgent
and time-critical payments, while they can use
the Hybrid mode for the non-urgent payments.
The Hybrid mode performs the continuous or
frequent settlement with netting effect and is often
45

referred to as “Liquidity-Saving mode,” because
participants can execute their payment with a
small balance in their accounts and can save the
liquidity (see Figure 3).
Usually, a participant can use the RTGS mode
and Liquidity-Saving mode from a single liquid-
ity, i.e. single account, in an Integrated system. If
the RTGS mode and Hybrid mode were two in-
dependent systems, a participant should manage
the two liquidities during the day separately, which
might be a heavy burden on the participant. So,
it was a logical advancement to integrate the two
functions into one payment system, which allows
participants to manage liquidity in a single ac-
count.
Development of Integrated Systems
LVTS in Canada
The pioneer of the Integrated system was the Large
Value Transfer System (LVTS) in Canada. The
LVTS started operation in February 1999. The
LVTS has two functions for processing of pay-
ment instructions. One function is called “Tranche
1,” which is the RTGS mode. The other is called
“Tranche 2,” which is the Liquidity-Saving mode.
Participants can select either Tranche 1 or Tranche
Figure 3. The concept of Integrated system
46
Hybrid System and Integrated System
2, and send their payment instruction through the
selected Tranche.
PIS in France
The second Integrated system was the Paris
Integrated System (PIS) in France. In 1999,
France had two large-value payment systems for
euro. One was the Paris Net Settlement (PNS),
which became the Hybrid system from the DTNS
system in April 1999, operated by Centrale des
Règlements Interbancaires (CRI: The Interbank
Settlement Center). The other was the Transferts
Banque de France (TBF), which was the RTGS
system, operated by the Banque de France.
In April 1999, the CRI developed a “liquidity
bridge” between the TBF and PNS. The liquidity
bridge is a scheme allowing participants to transfer
liquidity between the two payment systems at any
time of the day. By this means, the PNS and TBF
became closely linked.
Even though these were two independent pay-
ment systems, they looked like a single combined
payment system from the viewpoint of partici-
pants. Therefore, these two systems were called
“Paris Integrated System” (PIS) as a whole, and
regarded as one of the Integrated systems (see
Figure 4).
Hybrid System and Integrated System
Figure 4. The Concept of Paris Integrated System (PIS)
RTGSplus in Germany
The RTGSplus in Germany was the third Integrated
system, which started operation in November
2001. The RTGSplus had two modes; the “EX pay-
ment mode” and “Limit payment mode.” The EX
payment mode was an RTGS settlement for high
priority payment. The settlement was executed
only if there was enough liquidity in the payer’s
account.
On the other hand, the Limit payment mode
was a Liquidity-Saving mode with the continuous
Figure 5. Settlement Scheme of RTGSplus
offsetting functionality. When payment instruc-
tions were sent to the system, a special algorithm
searched the central queue to see if another set
of payment instructions might offset each other.
Once such a set of payment instructions was found,
these instructions were settled by offsetting (see
Figure 5).
“Offsetting” meant the simultaneous booking
of the outgoing and incoming payment. Offsetting
was considered as a gross settlement, but the ef-
fect was quite similar to the netting. In the Limit
Payment mode, participants were able to set the
47

Sender Limits bilaterally or multilaterally to
control their own liquidity. Participants could
manage their liquidity in a single liquidity pool
and used two modes according to the priority of
the payment.
TARGET2
When euro was introduced in January 1999, the
“TARGET” (Trans-European Automated Real-
time Gross settlement Express Transfer system)
started its operation. The TARGET was a decen-
tralized system which linked the RTGS systems
of the countries that introduced euro. It was a
useful payment system that deals with the cross-
border euro payment within EU. However, the
TARGET had some inefficiency because it was
constructed by connecting a number of RTGS
systems in EU. Some functions were somewhat
different and each central bank still operated each
system individually.
The Eurosystem (the ECB and national central
banks) decided to upgrade the TARGET by in-
troducing the Single Shared Platform (SSP). The
new payment system was called “TARGET2.”
The TARGET2 is a centralized system with single
platform and the fee and service became uniform
throughout the euro area.
The TARGET2 started its operation in Novem-
ber 2007. Advanced features of the RTGSplus, new
BI-REL (in Italy) and PIS were transplanted into
the TARGET2. To be more precise, the TARGET2
was built as an Integrated system with the RTGS
mode and the Liquidity-Saving mode. In addition,
the new features were introduced in the TARGET2,
including the liquidity control with sender limits,
prioritization of payments, and liquidity reserva-
tion for urgent payment. Thus, the TARGET2 is
the one of the most advanced Integrated systems
(see Chapter 10 for more details).
48
Hybrid System and Integrated System
MEPS+ in Singapore
The MEPS+ is an Integrated system in Singapore,
which started its operation in December 2006.
The MEPS+ was the first Integrated system in
the Asia-Pacific region. The previous system, the
MEPS, was a pure RTGS system. By adding the
Liquidity-Saving mode, it became an Integrated
system.
Next Generation RTGS of the BOJ-NET
The BOJ-NET in Japan also used to be a pure
RTGS system. In 2006, the Bank of Japan (BOJ)
published a plan to enhance the BOJ-NET into an
Integrated system. The project was called “Next
Generation RTGS Project” (RTGS-XG project).
The main point of the RTGS-XG was to add the
Liquidity-Saving Feature (LSF) and centralized
queuing function. And the Bilateral and Multilat-
eral Offsetting functions which are similar to those
of the RTGSplus were also introduced.
By this means, the BOJ-NET joined the family
of Integrated systems. The only thing that was
different from other Integrated systems was that
the BOJ-NET adopted a two-account system: the
current account for the RTGS settlement and the
LSF account for the Liquidity-Saving function
(see Chapter 11 for more details).
Share of Advanced
Payment Systems
According to the calculation1 in Bech et al. (2008),
only 3% of wholesale payments by value were
settled over the Hybrid and Integrated systems in
G10 countries in 1999. By 2005, the percentage had
risen to 32%. This figure has continued to rise, as
the Hybrid systems and Integrated systems were
introduced in several more countries since 2005.
Hybrid System and Integrated System
MECHANISMS THAT SUPPORT
ADVANCED PAYMENT SYSTEMS
Advanced payment systems, such as the Hybrid
systems and Integrated systems, are supported by
several sophisticated mechanisms. The progress
of IT has facilitated the achievement of such
mechanisms at a reasonable cost.
Such mechanisms that contribute to the evo-
lutionary progress of payment systems include (i)
the frequent netting and continuous processing,
(ii) partial netting, (iii) offsetting, (iv) searching
and matching facility, (v) queue management func-
tion, (vi) pre-funding account, and (vii) multiple
functions in a single payment system.
Frequent Netting and
Continuous Processing
When the DTNS system was developed, most
systems executed netting only at the end of the
day, due to the constraint of computer capacity.
Furthermore, in some systems, it took such a
long time to calculate the netting positions of all
participants that they could not make the final
settlement on the same day, and the final settle-
ment of the net position was made on the next day.
In recent years, thanks to the enhanced process-
ing capability of the computers and other technical
Figure 6. Full Netting and Partial Netting
progress, “Frequent Netting” became possible,
which led to the emergence of the Hybrid system.
The form of frequent netting progressed from
the netting with regular intervals to the netting
of continuous processing. The latter processing
executes netting when some settlement events
happen, such as the addition of liquidity, a new
payment order or the change of sender limit.
Partial Netting
“Full Netting” is executed in the DTNS system,
which means that all the payment orders of all the
participants are incorporated into the calculation
of net positions.
Due to the progress of IT, “Partial Netting”
became possible, which executes netting only the
payments of a limited number of participants (see
Figure 6). Partial netting includes the “Bilateral
Partial Netting” between two participants and
“Multilateral Partial Netting” among three or
more participants. The Liquidity-Saving mode was
realized thanks to the capability of partial netting.
In some systems, the Bilateral and Multilat-
eral Partial Netting are treated separately. For
example, the Bilateral Netting is regarded as a
main function of processing and is up and running
during the operating hours. While, the Multilat-
eral Netting is regarded as a supplemental
49

method, and is executed only at scheduled times
of the day or when a gridlock situation happens.
Offsetting
What is Offsetting?
“Offsetting” means a simultaneous booking of
the outgoing payment and incoming payment. As
with the netting, there is “Bilateral Offsetting” and
“Multilateral Offsetting.” Bilateral Offsetting is a
simultaneous processing of payments between two
participants. Multilateral Offsetting is a simulta-
neous processing of payments among more than
three participants, typically all the participants
of the system.
Offsetting and Netting
In Offsetting, each payment is regarded to be ex-
ecuted on a gross basis. However, the result of the
processing is exactly the same as the netting. For
instance, assuming that Bank A sends a payment
of 40 to Bank B, and Bank B sends a payment
of 100 to Bank A. In the case of netting, the net
positions (+60 for Bank A and -60 for Bank B)
are calculated and the positions are put on each
account, which leads to the increase of 60 on
Bank A’s account and the decrease of 60 on Bank
Figure 7. Offsetting and Netting
50
Hybrid System and Integrated System
B’s account. In the case of Bilateral Offsetting,
two payments between Bank A and Bank B are
processed simultaneously. As a result, Bank A’s
account will increase by 60, and Bank B’s account
will decrease by 60 (see Figure 7). No difference
is found between the two outcomes.
The Offsetting concept was adopted by the
RTGSplus in Germany for the first time ever in the
world. That was in order to avoid the netting
concept, because only the RTGS system could
connect to the TARGET and once one of the
functions is judged to be the netting, the RTGSplus
could not link to the TARGET. Later on, other
payment systems implemented Offsetting facili-
ties. It was because the netting-like effect could
be materialized in the RTGS system by adopting
the Offsetting facilities. This led to more substan-
tial progress in payment systems.
Searching and Matching Facility
Technological progress made it possible to search
for appropriate pairs of payment instructions in a
waiting queue, based on the payment and liquid-
ity conditions of the concerned parties. Such
conditions include the liquidity situation and the
Sender Limit of the sender, the Credit Limit of
the receiver and so on. The search engine can find
Hybrid System and Integrated System
out and match the appropriate pair of payments
to be netted or offset.
In addition, the searching and matching facili-
ties can process a large number of payments in
the queue as quick as a flash. This capability of
high-speed searching and matching resulted in
inventing the Liquidity-Saving function.
Queue Management
“Queue” is a scheme whereby payment instruc-
tions are held pending according to certain rules
until the instructions meet some conditions. Most
RTGS systems and advanced systems have the
central queuing mechanisms for the better con-
trol of payment flows. By holding the unsettled
payments in the queue, the system is capable of
combining some payment instructions and netting
(or offsetting) them. A participant also can control
its payment flow and liquidity by managing the
payment instructions in the queue.
In recent years, the queue management
techniques have made amazing progress, which
played a key role in the evolutionary progress of
payment systems.
Table 2. The basic queue processing rule
FIFO Payments are placed in the queue in the order of arrival to the system. Processing is done on a first-in first-out basis,
which means from the top payment in the queue.
by-pass FIFO When the first payment in the queue cannot be processed, the second payment would be tried.
FAFO Regardless of the orders in the queue, processing is made as much as possible with the available liquidity.
Table 3. Queue processing rule of selected payment systems
FIFO
ELLIPS (Belgium), LVTS (Canada),
TBF (France), PNS (France),
RTGSplus (Germany), HKD CHATS (HK),
USD CHATS (HK), Euro CHATS (HK),
BI-REL (Italy), TOP (Netherlands),
K-RIX (Sweden), E-RIX (Sweden),
SIC (Switzerland), euroSIC (Switzerland)
Note: Some of these payment systems were closed or consolidated into the TARGET2 at a later date.
Source: BIS (2005)
Basic Queue Processing Rule
The payment instructions in a queue are processed
in accordance with the prescribed rule. The basic
queue processing rules include the following (see
Table 2).
First-In, First-Out (FIFO)
The most basic rule of queue processing is the
“First-In, First-Out” (FIFO). In the FIFO rule,
the payments are waiting in the queue by arrival
sequence to the system, and the processing would
be tried in sequence from the top payment in the
queue.
Bypass FIFO
“Bypass FIFO” is a variation of the FIFO rule. In
the Bypass FIFO, when the top payment in the
queue does not satisfy the condition of settlement,
the second payment would be tried to be processed.
In the RTGSplus of Germany, the strict FIFO
rule was adopted for the EX Payment mode and
the Bypass FIFO rule was applied to the Limit
Bypass FIFO
ELLIPS (Belgium)
PNS (France)
RTGSplus (Germany)
BI-REL (Italy)
K-RIX (Sweden)
E-RIX (Sweden)
51

Payment mode. Other payment systems in Europe
also adopted the Bypass FIFO rule (see Table 3).
First-Available, First-Out (FAFO)
“First-Available, First-Out” (FAFO) is the rule
that tries to execute as many payments as possible
to settle, regardless of their order in the queue. In
some systems, the FAFO rule takes over the FIFO
rule at the end of the day, in order to process as
many unsettled payments as possible.
Advanced Queue
Management Functions
It is the tendency of newly designed payment
systems to add the queue management functions
which allow the participants to actively control
payment orders in the queue. These advanced
queue management functions include (i) priori-
tization, (ii) reordering, (iii) timed payments, and
(iv) optimization.
These queue management functions heavily
depend on the real-time capability of monitoring
and controlling of payments in the queue by the
participants, which are made possible by interac-
tive network services.
Prioritization
“Prioritization” is a function to add a priority code
to each payment to assign its priority. Until the
Table 4. Prioritization and reordering capability in selected payment systems
Payment system with Prioritization
ELLIPS (Belgium), TBF (France),
RTGSplus (Germany), HKD CHATS (HK),
USD CHATS (HK), Euro CHATS (HK),
BI-REL (Italy), TOP (Netherlands),
SIC (Switzerland), euroSIC (Switzerland),
CHAPS Euro (UK), CHAPS Sterling(UK)
CHIPS (US)
Note: Some of these payment systems were closed or consolidated into the TARGET2 at a later date.
Source: BIS (2005)
52
Hybrid System and Integrated System
payments with high priority are processed and
deleted from the queue, the payments with low
priority will not start to be processed. In some
systems, the Prioritization is set at two levels,
e.g. “urgent” and “normal.” In other systems, the
Prioritization is set at three levels, such as “high,”
“normal” and “low” priority. More sophisticated
way of Prioritization is also possible.
Reordering
“Reordering” is a function of changing the order
of payments in a queue. For example, when the
strict FIFO rule is applied, and a large payment is
at the top of the queue and blocks all the process-
ing, it is possible to promote the processing of the
other payments by relocating the top payment to
the lower order temporarily (See Table 4).
Timed Payment
“Timed Payment” is a function to appoint the
execution time of each payment order. This func-
tion includes the “Till Payment” function which
appoints the completion time of settlement, and
the “From Payment” function which appoints the
starting time of execution. The Timed Payment is
useful especially for the time-critical payments.
Payment system with Reordering
RTGS (Germany), HKD CHATS (HK),
plus
USD CHATS (HK), Euro CHATS (HK),
BI-REL (Italy), TOP (Netherlands),
K-RIX (Sweden), E-RIX (Sweden),
SIC (Switzerland), euroSIC (Switzerland),
CHAPS Euro (UK), CHAPS Sterling(UK)
CHIPS (US)
Hybrid System and Integrated System
Optimization
“Optimization” is a mechanism which promotes
the processing of unsettled payments in the queue,
typically when a gridlock situation arises. When
this mechanism is executed, the FIFO rule is
usually substituted by the FAFO to promote the
processing of as many payments as possible,
regardless of the order in the queue.
In the process of Optimization, the method of
offsetting is often used to process payment orders
waiting in a queue. In this case, the Multilateral
Offsetting is more commonly used than the Bi-
lateral Offsetting, because it is suitable to match
payments as much as possible.
Optimization is put in motion at a fixed time,
at odd intervals, or only when necessary. In some
systems, its Optimization is done manually by
the system operator when the operator confirms
necessity based on its monitoring of the system.
In other systems, Optimization is done automati-
cally by the system in a specific interval of time
or based on other parameters.
Pre-Funding Account
It is often the case that the advanced payment
systems have special accounts for settlement.
In this case, the participants have to make “Pre-
funding,” which means to put the funds in their
accounts for the settlement of that day at the
beginning of the day.
The DTNS system is based on the concept of
“pay later,” in which participant should pay the
net debit position at the end of the day. The DTNS
system requires some risk mitigation arrangements
including setting a Sender Limit and pledging
collateral, because there are some possibilities of
default in the pay-later scheme. In the Pre-funding
system, as the payment orders are processed using
the fund paid in advance, there is no need for a
risk mitigation arrangement, which reduces the
risk management burden on the participants.
However, it should be noted that the Pre-
funding scheme is workable only in a payment
system which has a considerable high speed of li-
quidity circulation in the system. If the Pre-funding
scheme is introduced to a payment system with
inefficient liquidity circulation, a huge amount
of funds must be paid in advance, which is the
big burden on the participants. For example, in
the CHIPS, the settlement amount of the day is
500 to 600 times of the initial funding amount.
Thus, the Pre-funding and efficient circulations
of liquidity are closely connected to each other.
Multiple Functions in a
Single Payment System
Historically, it was quite common that one payment
system adopted only one method of processing,
such as the RTGS mode or the DTNS mode. Be-
cause it was quite difficult to realize the multiple
payment processing modes in one system from
the perspective of system development. In addi-
tion, the risk management scheme was another
reason, which varied considerably according to
the processing mode.
The rapid progress of IT has enabled two modes
to exist in a single payment system, which has
paved the way for the Integrated system. Adopting
the Offsetting concept has helped to combine two
functions in one system by avoiding the netting
concept which requires a different risk manage-
ment scheme.
Future Trends
The BOJ-NET became an Integrated system in
2008. But, ahead of BOJ-NET, the Monetary
Authority of Singapore (MAS) successfully imple-
mented the “MEPS+” in December 2006. The
MEPS+ was the first Integrated System in Asia,
which replaced the previous national interbank
payment system, the MEPS.
The Managing Director of MAS mentioned that
the changes in the financial landscape had led to
53
 Hybrid System and Integrated System

a need for more efficient liquidity management, Bech, M., Preisig, C., & Soramäki, K. (2008,
improved risk management and more streamlined June). Global Trends in Large-Value Payments.
payment flows, and the MEPS+ was designed FRBNY Economic Policy Review.
to meet these needs. If market demand works in
European Central Bank. (2006, August). The
the same way, it is highly possible that payment
Evolution of Large-Value Payment Systems in
systems will continue to evolve progress with the
the Euro Area. ECB Monthly Bulletin.
aid of technological innovation in order to meet
the market needs. Martin, A. (2005). Recent Evolution of Large-
Shortly after the RTGS system was invented, Value Payment Systems: Balancing Liquidity
only a handful country adopted this innovative and Risk. Economic Review, First Quarter 2005.
system, even though it was quite effective in Federal Reserve Bank of Kansas City.
reducing settlement risk. However recently, it is
McAndrews, J. & Trundle, J. (2001, December).
reported that more than 100 countries had adopted
New Payment System Designs: Causes and Con-
the RTGS system. Therefore, one can predict
sequences. Financial Stability Review. Bank of
that those “Advanced Systems” would gradually
England.
become the prevalent systems throughout most
of the world. It is worth noting that the RTGS
system took more than 20 years to become the
most prevailing system in the world. ENDNOTE
1
In their calculation, the Hybrid and Integrated
REFERENCES systems include PNS, LVTS, CHIPS and
RTGSplus.
Bank for International Settlements. (2005, May).
New Development in Large-Value Payment Sys-
tems.

54
 Section 3
Innovations in Payment Systems
56

Chapter 6
Evolutionary Trends of
Payment Systems

ABSTRACT
This chapter presents an analysis about the evolutionary process of payment systems. Payment systems
showed remarkable changes in the past two decades. The first evolutionary trend was observed in the
central bank payment systems. That was the transition from the traditional DTNS system to the RTGS
system. A technology diffusion analysis of the RTGS technology across the world is also presented. The
second step in the evolution of payment systems was the introduction of the Hybrid system. Several Hybrid
systems in Europe and the US are discussed in detail. The third trend was the adoption of the Integrated
system. Emergence of some Integrated systems are discussed, which include the LVTS in Canada, PIS
in France, MEPS+ in Singapore, TARGET2 in EU and Next Generation BOJ-NET in Japan. And then,
a hypothesis on the typical evolutionary pattern from the simple DTNS system to more sophisticated
systems is proposed.

This chapter also reviews another line of evolutionary trends, including the “Multi-Currency Payment
Systems” and “Offshore Payment Systems,” and the linkage between payment system and “Securities
Settlement System” (SSS). It also gives an explanation about the adoption of “Financial EDI” capabil-
ity, which is the scheme that enables the processing of remittance information with payment instructions
in the payment system.

DOI: 10.4018/978-1-61520-645-2.ch006

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
Evolutionary Trends of Payment Systems
INTRODUCTION
During the past twenty years, payment systems
have evolved in step with the progress of Infor-
mation Technology (IT). In the early days, the
payment systems could make a net settlement only
once a day and process payment instructions in
only a very simple manner. Gradually, the payment
systems have become capable to carry out the
real-time settlements and continuous processing,
and handle payments based on the sophisticated
algorithms. Such progress has brought about a
reduction in settlement risk and improvement in
settlement efficiency.
The evolutionary trends of payment systems
include (i) the transition from the DTNS systems
to RTGS systems, (ii) introduction of the Hybrid
systems and Integrated systems, (iii) emergence
of the Multi-Currency Payment Systems and
Offshore Payment Systems, (iv) linkage between
payment system and Securities Settlement Sys-
tem (SSS), and (v) adoption of Financial EDI
capability.
TRANSISION FROM DTNS
SYSTEM TO RTGS SYSTEM
The first evolution was observed in the payment
systems operated by central banks. The evolution-
ary growth was the transition from the DTNS
system to the RTGS system.
DTNS System and RTGS System
In many countries, when the electronic payment
systems were first introduced, they were the
Designated-Time Net Settlement (DTNS) systems.
DTNS system is a net settlement system, thus
the settlement of funds occurs on a net basis. In
concrete terms, a net position of each participating
bank is calculated, which is defined as the sum
of the value of all the transfers a participant has
received up to a particular point in time minus the
value of all transfers it has sent. DTNS system
is a designated-time settlement system, in which
the final settlements take place at a certain time,
typically once, at the end of the day. In short, the
final settlement of net positions occurs at the end
of the day in DTNS system.
On the other hand, the Real-Time Gross Settle-
ment (RTGS) systems have two features. The first
feature is that the settlement of funds occurs on a
gross basis, which means payment instructions are
processed on a one-by-one basis without netting.
The second feature is that the final settlement is
made on a real-time basis during the day. Thus
the settlements become final immediately.
Merits of RTGS System
As mentioned in the previous chapters, the RTGS
system is superior in reducing settlement risk
compared to the DTNS system. Settlement risk is
the risk that a participant of a payment system will
suffer a liquidity problem and/or loss because the
other party does not make payments as expected.
Settlement risk includes the credit risk, liquidity
risk, legal risk, operational risk and systemic risk
(see Chapter 3 for more detail).
The DTNS system tends to be vulnerable
to settlement risk. First, the unsettled payment
instructions accumulate until the end of the day
in the DTNS system. Therefore, until the final
settlement is completed at the end of the day,
settlement risk stays around. On the other hand,
the RTGS system processes each payment instruc-
tion one-by-one and makes them final during the
daytime. Thus, the RTGS system can effectively
reduce settlement risk.
Second, “systemic risk” is the keyword. This is
the risk that the failure of one participant to meet its
required obligations will cause other participants
to be unable to meet their obligations when due.
Such a failure may cause widespread liquidity or
credit risk problems and, as a result, might threaten
the stability of financial markets. As overseers of
payment systems and financial markets, central
57
 Evolutionary Trends of Payment Systems

banks are particularly concerned with systemic industrialized countries, which include the “RIX”
risk. The DTNS system has a potentiality of sys- in Sweden (1986), “SIC” in Switzerland (1987),
temic risk, because if one participant is unable to and “EIL-ZV” in Germany (1988).
settle its net debit position, the payment system
has to recalculate a new set of net positions for Changeover to RTGS System in EU
each of the remaining participant by deleting all
the payments involving the defaulted participant. In the European Union (EU), the RTGS system
This procedure is called “unwinding.” Unwinding spread rapidly in the late 1990’s. It was because
can lead to the unexpected changes in the net posi- the TARGET system was planned to prepare for
tions of the remaining participants, which could introducing the single currency euro. The TAR-
cause a “knock-on effect” or “cascade effect” of GET was the payment system for the whole euro
settlement failures. Specifically, other participants area and was developed by connecting the payment
could fail to meet their obligations, which would systems of each member country.
generate a “contagious default.” The worst thing A decision was made that only the RTGS
of unwinding is that a bank’s net position may system would link to the TARGET system. Since
be adversely affected by the failure of another the settlement method and risk management of
bank even if it had no direct transactions with the RTGS system were completely different from
the failed bank. those of the DTNS system, it was impossible to
On the other hand, the RTGS system has no link the two different types of systems. Because of
possibility of systemic risk, because each transfer
of funds becomes final instantly when processed.
As there is no netting in the RTGS system, there Table 1. Introduction of RTGS system in selected
is no unwinding risk. countries
Hence, the RTGS system is more robust than
Country RTGS System1 Timing of
the DTNS system in terms of settlement risk. introduction
However, the elimination of risk comes at the Denmark DN Inquiry and Transfer System 1981
cost of an increased demand for intraday liquid- US Fedwire 1982
ity. This is the only demerit of the RTGS system. Sweden RIX 1986
To cover such liquidity demand, central banks Switzerland SIC 1987
usually provide intraday credit to the participants
Germany EIL-ZV 1988
in RTGS system. Even if intraday credit is pro-
Korea BOK-Wire 1994
vided without a fee, the intraday liquidity is not
Thailand BAHTNET 1995
free, because usually collateral is required for the
UK CHAPS 1996
intraday credit, which causes a collateral cost.
Belgium ELLIPS 1996
Hong Kong CHATS 1996
Global Trend toward RTGS System
France TBF 1997
Italy BI-REL 1997
Early Adopters of RTGS System
Netherlands TOP 1997

As of 1985, there were only two RTGS systems Australia RITS 1998

observed; namely, the “Fedwire1” in the US and Singapore MEPS 1998

“DN Inquiry and Transfer System” in Denmark EU TARGET 1999

(see Table 1). From the late 1980’s, the number of Japan BOJ-NET 2001
RTGS systems increased gradually, especially in 1 The name when the RTGS system was introduced.

58
Evolutionary Trends of Payment Systems
this, it became a prerequisite to become a member
of the Economic and Monetary Union (EMU) to
have a RTGS system.
Therefore, the concerned central banks were
obliged to implement the RTGS system by January
1999, the target date of introducing euro, to meet
the requirement. In this way, the central banks
which planned to introduce euro reconstructed
their payment systems into the RTGS system one
after another during 1996-1997.
Introduction of RTGS System
in Other Countries
Influenced by these movements, some Asia-Pa-
cific countries also introduced the RTGS systems
in late 1990s, which included the “BOK-Wire”
in South Korea (1994), “BAHTNET” in Thailand
(1995), “CHATS” in Hong Kong (1996), “RITS” in
Australia (1998) and “MEPS” in Singapore (1998).
The use of RTGS systems also grew outside
the industrialized countries. Some countries in
Eastern Europe, Latin America, Middle East,
and Africa were similarly introduced the RTGS
systems. In South America, Uruguay was the first
country to adopt the RTGS system in 1995. Saudi
Arabia (1997) was the first country in the Middle
Figure 1. Number of countries that adopted the RTGS System (Source: Bech and Hobijn (2007))
East, and South Africa (1998) was the first comer
in Africa. Some of these countries constructed
their electronic payment systems from scratch
as RTGS systems.
According to the survey of the Federal Reserve
Bank of New York, 90 out of 174 countries in the
world had adopted a RTGS system by the end of
2006 (Bech & Hobijn, 2007). By this means, the
adoption of RTGS system has become the global
trend of payment systems (see Figure 1). It can
be observed that the RTGS system has became
the de facto standard in the central bank payment
systems.
Global Situation toward RTGS System
According to the “Global Payment System Survey
2008” conducted by the World Bank, 112 coun-
tries2 out of 142 (or 79%) were using the RTGS
system as of December 2006. With regard to the
timing of introducing the RTGS system, the survey
shows 45 systems were implemented in 1997 or
before, 31 systems in 1998-2001, 24 systems in
2002-04, and 12 systems in 2005-06. In summary,
about 70% of the RTGS systems in the world were
introduced before 2001 (see Table 2).
59
 Evolutionary Trends of Payment Systems

Table 2. The year of implementation of the RTGS system

Year of Implementation 1997 or before 1998-2001 2002-04 2005-06 Total

number of systems 45 31 24 12 112
share 40% 28% 21% 11% 100%
Source: The World Bank (2008)

Among the 112 countries which use the RTGS
system, the central bank is the operator of the
RTGS system in 108 countries3. And in all cases
of the 112 countries, the central bank is the settle-
ment agent for the RTGS system. This result shows
that central banks assume a key role for RTGS
systems as both the operators and settlement
agents.
Adoption of RTGS System in Japan
The adoption of the RTGS system in Japan was
rather special. When the Bank of Japan (BOJ)
developed the BOJ-NET in 1988, the BOJ-NET
had two modes; the DTNS mode and the RTGS
mode. Some argued that the RTGS system was
introduced in the BOJ-NET at this point (Bech
& Hobijn, 2007). But actually, this was not the
case. The RTGS mode was seldom used4 by the
participants due to the high liquidity cost, and
we should conclude that the characteristic of the
old BOJ-NET was basically a DTNS system at
that point. The BOJ changed the BOJ-NET into
a RTGS system by abolishing the DTNS mode
in January 2001. At that time, the BOJ-NET was
transformed from the de facto DTNS system into
the genuine RTGS system.
Technology Diffusion in
the Case of RTGS
General Theory on Diffusion
of Innovations
General theory on diffusion of innovations tells
us that the rate of adoption follows a predictable
pattern. The rate of adoption of a new technology
is slow at first. Then, adoption rate becomes high
until a substantial share of members (or agents) has
adopted the technology. After that, the adoption
rate levels out and eventually falls off.

Figure 2. S-shaped curve and bell-shaped curve of technology adoption

60
Evolutionary Trends of Payment Systems
This pattern makes a “S-shaped diffusion
curve,” which indicates the share of adopters over
the course of time (see Figure 2).
It is also a well-known fact that the adopter
distributions make a “bell-shaped curve” for a
successful innovation. Rogers (1995) divided this
bell-shaped curve into five categories. The first
2.5% of adopters are named “innovators.” The
following 13.5% are labeled “early adopters.”
The next 34% of adopters up to the median are
called “early majority,” while the 34% above the
median are labeled “late majority.” And the re-
maining 16% of adopters are called “laggards”
(see Figure 2).
It is extremely interesting to know that the
adoption pattern of the RTGS technology by cen-
tral banks follows an S-shaped diffusion curve,
almost identical to that observed in other technolo-
gies (see Figure 3). It is amazing that central banks
follow the general pattern of technology adoption,
even though their principles of behavior are quite
different from that of the private sector.
Diffusion of RTGS Technology
Bech and Hobijn (2007) examined the diffusion
of the RTGS technology across the world’s 174
central banks. They concluded that the central
Figure 3. Actual and fitted adoption rates of RTGS (Source: Bech and Hobijn (2007))
banks can be divided into five categories accord-
ing to Roger’s classification.
• The central banks that adopted RTGS prior
to 1987 are considered to be “innovators.”
• Central banks that adopted RTGS before
1998 are “early adopters.”
• Central banks that adopted RTGS dur-
ing1998-2004 are the “early majority.”
• Central banks that adopted after 2004 are
the “late majority.”
According to this classification, the Federal
Reserve System was an innovator; Bank of Eng-
land was an early adopter; Bank of Japan was
part of the early majority; and National Bank of
Romania was part of the late majority.
Bech and Hobijn (2007) made an analysis to
identify the determinants of RTGS adoption and
found the following results.
• (i) real GDP per capita, (ii) population, (iii)
education, and (iv) the investment price
has a positive impact on the adoption.
• As for the spillover effect from one central
bank to other central banks, the bilateral
trade relationships have the strong effect
on the adoption.
61

These results suggest that larger countries
(reflected by population), with a higher standard
of living (reflected by real GDP per capita), and
a high level of human capital (reflected by educa-
tion), seemed to be more likely to adopt the RTGS
system than others. Moreover, countries with a
relatively low price of capital (reflected by the
investment price) also are more likely to adopt.
On the other hand, the spillover effect seems to
play a significant role in the adoption. Trade re-
lationships seem to have a strong impact on the
spillover effect from one central bank to another.
This implies that if country A has a strong rela-
tionship with Country B in trade, they also have
a significant relationship in financial transactions.
INTRODUCTION OF
HYBRID SYSTEMS
The second evolutionary step in payment systems
was the emergence of Hybrid systems (see Table
3). As mentioned in the previous chapter, the
Hybrid system is the combination of the best
features of the DTNS and RTGS system.
Feature of Hybrid System
The Hybrid system derived from the DTNS sys-
tem in which final settlement takes place only
once, usually at the end of the day. In the Hybrid
system, the net settlements are made at frequent
intervals or continuously and the transfer of funds
becomes final at the time of these settlements. The
traditional DTNS system has a disadvantage which
Table 3. Introduction of Hybrid System in selected
countries
Country Hybrid System Timing of
introduction
Germany EAF2 March 1996
France PNS April 1999
US CHIPS February 2001
62
Evolutionary Trends of Payment Systems
the transfer of funds becomes final only at the end
of the day; even though it has an advantage that
settlement can be made with small liquidity for
a net position. With the frequent net settlement,
the Hybrid system keeps the merit of the DTNS
system, i.e. the settlement capability with small
liquidity, and in addition realizes the merit of the
RTGS system, which is the early finality. That is
why this system is called “Hybrid system.” It is
also sometimes referred to as “Continuous Net
Settlement” (CNS) system, when compared to
the DTNS system.
The emergence of the Hybrid system was
to overcome the trade-off between safety and
efficiency, stated differently, risk reduction and
liquidity cost.
Emergence of Hybrid Systems
EAF2 in Germany
The first Hybrid system in the world was the
“EAF2” in Germany. Before becoming a Hybrid
system in March 1996, the old EAF was a typical
DTNS system, which executed the final settlement
at the end of the day. In the EAF2, the netting was
made at regular intervals. Bilateral net settlements
were made every twenty minutes in the morning
session and two multilateral netting settlements
were made in the afternoon session. The settle-
ments became final at each net settlement. This was
the most elementary form of the Hybrid system.
PNS and CHIPS
Following the EAF2, the “PNS” in France, and
“CHIPS” in the US became the Hybrid system
during 1999-2001 (see Table 3). In these systems,
the net settlements were made continuously based
on the settlement events, like the receipt of a new
payment order and addition of liquidity, instead
of at regular intervals.
The CHIPS is the latest and the most advanced
Hybrid system, where the system judges the
Evolutionary Trends of Payment Systems

Table 4. Introduction of Integrated System in

capability of net settlement for each payment
selected countries
instruction, and net settlement is made continu-
ously, if possible. The system, which is called the Country Integrated System Timing of introduction
“balanced release engine,” selects the processing Canada LVTS February 1999
mode from the three types: Individual Release, France PIS(PNS and TBF) April 1999
Bilateral Release and Multilateral Release, accord-
Germany RTGS plus
November 2001
ing to the available balance of the payer and payee
Italy new BIREL April 2004
and the incoming and outgoing payment situation.
Singapore MEPS + December 2006
Bilateral Release is just like bilateral net settle-
EU TARGET2 November 2007
ment between the two participants. Multilateral
Japan BOJ-NET(RTGS-XG) October 2008
Release is a kind of multilateral net settlement
among the three or more participants.

No Hybrid System in Asia-Pacific Emergence of Integrated Systems

For some reason or other, no Hybrid system ap- LVTS in Canada

peared in the Asia-Pacific region, including Japan
and Singapore. In the case of these two countries,
the RTGS system jumped to the Integrated system,
without going through a Hybrid system phase.
INTRODUCTION OF
INTEGRATED SYSTEMS
Feature of Integrated System
The earliest adopter of Integrated system was the
“Large Value Transfer System” (LVTS) in Canada,
which started its operation in February 1999. The
LVTS has two modes of payment; Tranche 1 and
Tranche 2. Tranche 1 is the RTGS mode, which
is suitable for urgent payments. Tranche 2 is the
Liquidity-Saving mode, which is suitable for
non-urgent payments and has the merit of small
liquidity settlement capability.

The next step in the evolution of payment systems PIS in France

was the transition to the Integrated System (see
The “Paris Integrated System” (PIS) in France was
Table 4). The Integrated System is defined as
the second to come. In April 1999, a “Liquidity
the payment system which has both the RTGS
Bridge” was established between the Paris Net
function and Hybrid function. Participants of the
Settlement (PNS), a Hybrid system and Transferts
Integrated System can use both functions as the
Banque de France (TBF) which is a RTGS system.
situation demands. For example, the participants
The Liquidity Bridge allowed the participants
can use the RTGS function for urgent payments
to transfer the liquidity freely between the PNS
and time-critical payments, whereas they can use
account and TBF account. With this integrated
the Hybrid function for non-urgent payments. The
management, these two systems were collectively
Hybrid function performs continuous or frequent
referred to as “Paris Integrated Systems” (PIS).
settlement and is often referred to as “Liquidity-
The PIS is also regarded as one of the Integrated
Saving mode,” because participants can execute
systems.
their payment with small liquidity.

63

RTGSplus in Germany and
new BIREL in Italy
The third one was the “RTGSplus” in Germany,
which started operation in November 2001.
The RTGSplus also had two payment modes; EX
payment mode and Limit payment mode. The
EX payment mode is a RTGS mode, which is
suitable for high priority payments. The Limit
payment mode is a Liquidity-Saving mode with
the continuous offsetting settlement.
Just like the RTGSplus, the Bank of Italy added
the Liquidity-Saving mode to the BIREL, a pure
RTGS system in April 2004. The new system,
called the “new BIREL,” was another Integrated
system with two payment modes.
MEPS+ and BOJ-NET
The Integrated system was spread to the Asia-
Pacific region. The first one was the “MEPS+” in
Singapore. By adding the Liquidity-Saving mode
to the MEPS, the pure RTGS system, the MEPS+
became the integrated system in December 2006.
The second one was the “BOJ-NET” in Japan.
The project to enhance the BOJ-NET was called
“Next-Generation RTGS” (RTGS–XG) project.
The important aspect of the project was to add
a Liquidity-Saving Feature (LSF) to the pure
RTGS mode of the BOJ-NET. At the completion
of the project, the BOJ-NET became an Integrated
system in October 2008 (see Chapter 11 for more
details).
TARGET2
In Europe, the TARGET2 began operation in No-
vember 2007. The TARGET2 was an enhancement
made from the TARGET. It is interesting to note
that the enhancement project, called “next genera-
tion project,” was exactly the same project name
used in Japan. The biggest feature of the project
was the transition from the decentralized structure
to the centralized structure with a Single Shared
64
Evolutionary Trends of Payment Systems
Platform (SSP). However, that was not all. The
TARGET2 has the advanced features which were
derived from the RTGSplus, new BIREL and PIS.
That is to say, the TARGET2 has the Liquidity-
Saving mode as well as the RTGS mode, which
means that it is one of the Integrated systems.
Currently, the advanced feature of the TARGET2
is available all across the euro area (see Chapter
10 for more details).
EVOLUTIONARY PROCESS
OF PAYMENT SYSTEMS
From Basic to Advanced
Payment Systems
As mentioned above, payment systems evolved
from the basic payment systems to the advanced
payment systems. They progressed from the simple
DTNS system to the RTGS system, and then to
the Hybrid system and Integrated system.
With the emergence of such sophisticated
and elaborated systems, the conventional forms
of the RTGS system and DTNS system tend to
be called “pure RTGS system” and “pure DTNS
system” respectively, with the implicit meaning
of a simple payment system.
Typical Evolutionary Pattern
The typical evolutionary pattern from the simple
DTNS system to the sophisticated system can be
described as below5 (see Figure 4).
• In the first stage, a central bank and a pri-
vate sector operate each DTNS system in a
country, respectively.
• In the second stage, the central bank en-
hances its system to a RTGS system, be-
cause it tends to focus on the reduction of
settlement risk and the RTGS system has
an advantage in this aspect.
Evolutionary Trends of Payment Systems
Figure 4. Evolution process of payment systems (typical case)
• In the third stage, the private payment sys-
tem becomes a Hybrid system in order to
obtain intraday finality with the continuing
merit of net settlement.
• In the final stage, the RTGS mode and the
Hybrid mode are integrated in order to col-
lectively manage the liquidity, which leads
to the Integrated system.
In some cases, the process of a Hybrid system
is skipped, and the RTGS system and/or DTNS
system would jump directly into the Integrated
system.
Driving Forces
The evolution and sophistication of payment sys-
tems have been pushed by some driving forces,
which include the rapid growth of settlement
values and settlement risk, the global standards
for reducing settlement risk and the competition
between payment systems (to be described in
Chapter 7).
In addition, the progress of Information Tech-
nology (IT) has paved the way for enabling the
payment processing in a complicated way and
facilitated the evolution of payment systems.
MULTI-CURRENCY PAYMENT
SYSTEMS AND OFFSHORE
PAYMENT SYSTEMS
Traditionally, a payment system processes the
payment instructions of the national currency in
a country. Recently, some payment systems come
to deal with payment orders in multi-currencies,
and others are operated outside of the country
where the currency is issued. These systems
were invented mainly in order to reduce foreign
exchange (FX) settlement risk.
Emergence of Multi-Currency
Payment Systems
A typical example of a multi-currency payment
system is “CLS Bank,” which started its operation
65

in September 2002. CLS Bank was established in
order to reduce the foreign exchange (FX) settle-
ment risk arising from time-zone differences. It
was established as a bank in the US, but it serves
as a payment system for multi-currencies. It settles
seventeen currencies, including the US Dollar
(USD), euro, UK Pound, Japanese Yen (JPY),
Swiss Franc, Canadian Dollar, Australian Dollar,
Singapore Dollar, and others.
To give an example, when Bank A and Bank
B make a USD/JPY transaction, the delivery of
USD and JPY are made simultaneously in the
form of Payment versus Payment (PVP) in CLS
Bank. Through this scheme, the Herstatt Risk,
which means FX settlement risk caused by the
time differences, is eliminated (see Chapter12
for more detail).
Emergence of Offshore
Payment Systems
Offshore Payment Systems
in Hong Kong
There are typical examples of Offshore Payment
Systems in Hong Kong.
Three Offshore Payment
Systems in HK
The Hong Kong Monetary Authority (HKMA) has
operated6 the “Clearing House Automated Trans-
fer System” (CHATS) since 1996. The CHATS
is the RTGS system for Hong Kong dollar and is
sometimes referred to as “HKD-CHATS.”
Table 5. Payment systems in Hong Kong
Payment System Currency
CHATS HK Dollar
USD-CHATS US Dollar
EUR-CHATS euro
RMB-CHATS RMB
66
Evolutionary Trends of Payment Systems
In addition to the payment system of domestic
currency, the HKMA started the operation of the
“USD-CHATS” in August 2000, which is the
payment system for the US dollar. In addition, it
also started the operation of the “Euro-CHATS” in
April 2003, which is the payment system of euro.
On top of this, it launched the “RMB-CHATS”
in June 2007, which is the payment system for
the Chinese currency, Renminbi (See Table 5).
As these payment systems are for the foreign
currencies operated in Hong Kong, they are re-
garded as “Offshore Payment Systems.”
The reason why the HKMA established these
systems is to meet the needs of financial institu-
tions to make settlements in the PVP scheme in
these currencies in the time zone of Asia. Another
incentive is to make Hong Kong a regional hub
of financial transactions in Asia.
Since these systems are established as a
complete “replica” (an exact copy) of the HKD-
CHATS, these systems are operated as RTGS
systems just as the CHATS.
The settlement institutions are not the HKMA,
but private banks; the Hong Kong and Shanghai
Banking Corporation (HSBC) for the USD-
CHATS, Standard Chartered Bank for the Euro-
CHATS and Bank of China for the RMB-CHATS.
The participants of each system open an
account in each currency at each settlement in-
stitution. The settlement is executed by the fund
transfer among the accounts at each settlement
institution. Intraday liquidity is not given by the
central bank (HKMA), but by the settlement
institution, if necessary, depending on the com-
mercial decision. Therefore, these are the typical
Settlement Institution Time of launch
HKMA December 1996
HSBC August 2000
Standard Chartered Bank April 2003
Bank of China June 2007
Evolutionary Trends of Payment Systems
examples of payment system with “Commercial
Bank Money.”
PVP Linkages and DVP Linkages
The four systems (CHATS, USD-CHATS, Euro-
CHATS and RMB-CHATS) are linked with each
other, and therefore the Payment versus Payment
(PVP) settlement is possible for each pair of the cur-
rencies: USD/HKD, USD/EUR, USD/RMB, EUR/
HKD, EUR/RMB and HKD/RMB (see Figure 5).
Additionally, the USD-CHATS has PVP links
with the “BI-RTGS,” Rupiah payment system in
Indonesia, and the “RENTAS” (Real Time Trans-
fer of Funds and Securities), Ringgit payment
system in Malaysia. And three systems (CHATS,
USD-CHATS and Euro-CHATS) have payment
links with the “China’s Domestic Foreign Cur-
rency Payment System,” which is another Offshore
Payment System in mainland China and covers
eight foreign currencies.
On the other hand, the CMU (Central Money-
markets Unit), which is the bond settlement system
in Hong Kong, has linkages with the four payment
systems (CHATS, USD-CHATS, Euro-CHATS
and RMB-CHATS). And the CCASS (Central
Figure 5. Overview of Payment Infrastructure in Hong Kong (Source: HKMA, modified)
Clearing and Settlement System), which is the
equities settlement system in Hong Kong, has
the linkages with the CHATS and USD-CHATS.
Through these linkages, the Delivery versus
Payment (DVP) settlement is possible between
securities and funds in each denominated currency.
Offshore Payment Systems
in a Global Context
According to the “Global Payment Systems Survey
2008” of the World Bank, a total of 15 countries
indicated that their RTGS system handles trans-
actions both in local currency and in at least one
foreign currency.
These are: Argentina, Armenia, Bolivia, Costa
Rica, Denmark, Estonia, Guatemala, Indonesia,
Jordan, Kenya, Peru, Philippines, Sweden, United
Kingdom7 and Uruguay. In addition, Poland has
a designated foreign currency system (for euro).
They are regarded as Offshore Payment Systems.
The euroSIC in Switzerland
Another example of an Offshore Payment Sys-
tem is the “euroSIC” in Switzerland. The “SIX
67

Interbank Clearing” has operated the euroSIC
interbank payment system for transactions in
euro on behalf of Swiss banks since 1999. As
Switzerland is a non-EU member state, euro is a
foreign currency for Swiss banks. The euroSIC
was established to allow Swiss banks to send and
receive euro payments under this circumstance.
The euroSIC was established as a replica of the
“Swiss Interbank Clearing” (SIC), the payment
system for the Swiss franc, and has been operating
as a RTGS system.
The settlement institution of the euroSIC is the
“Swiss Euro Clearing Bank” (SECB), which was
established jointly by Swiss banks as a special
purpose bank in Germany. Participants of the
euroSIC open an euro-denominated accounts at
the SECB, and the euro settlement is executed by
transferring the euro funds between the partici-
pants’ accounts at the SECB.
The euroSIC has two interfaces. One is the
“remoteGATE,” which enables financial institu-
tions outside of Switzerland to access the euroSIC
as well as the SIC. Financial institutions around
the world can access the two Swiss RTGS systems
via the international network of SWIFT. In other
words, the remoteGATE allows the “remote ac-
Figure 6. The euroSIC and its two interfaces (Source: SIX Interbank Clearing, modified)
68
Evolutionary Trends of Payment Systems
cess” to banks from outside of Switzerland (see
Figure 6).
The second interface is the “swisseuroGATE,”
which links the euroSIC with TARGET2 for
large-value payments with the banks in the euro-
zone countries. As for retail payments, the euroSIC
has a connection to the EMZ8 and STEP2 (see
Figure 7).
Through these schemes, the euroSIC provides
interbank Euro settlements between Swiss banks
as well as cross-border euro payments between
Swiss banks and banks in eurozone countries. The
euroSIC is operated in Switzerland, which is
outside of the eurozone, and can be regarded as
an Offshore Payment System.
The Tokyo Dollar Clearing in Japan
The Tokyo Dollar Clearing (TDC) is a book trans-
fer system for banks located in Japan to settle the
US dollars (USD) during Tokyo operating hours.
The TDC is a service provided by JPMorgan
Chase. JPMorgan Chase Tokyo is the settlement
institution, where each participant has their own
USD account.
Evolutionary Trends of Payment Systems
Figure 7. The euroSIC and its connections to the EU (Source: SIX Interbank Clearing, modified)
All settlements are executed by funds transfers
among the participants’ USD accounts at JPMor-
gan Chase Tokyo (see Figure 8). The TDC provides
finality of settlement in USD in Japan with the
provisions of the account condition agreement.
That is, the settlements at JPMorgan Chase Tokyo
become final when processed. The account at
JPMorgan Chase Tokyo is closely linked with the
account at JPMorgan Chase NY. The remaining
balance of the Tokyo account is linked with the
NY account balance. Participants can pay out the
excess funds from the JPMorgan Chase Tokyo
account to the JPMorgan Chase NY account.
On the other hand, when a participant wants
to increase the Tokyo balance, it can make a request
to JPMorgan Chase NY for granting credit in the
Figure 8. The book transfer on the TDC (Source: JPMorgan Chase, modified)
form of an intraday overdraft. When the overdraft
is extended, the participant is able to transfer the
funds in the USD from the NY account to the
Tokyo account during Tokyo operating hours. The
cover payment to repay the overdraft will be made
later to JPMorgan Chase NY during NY operating
hours.
With a usual correspondent banking service, a
Japanese bank and its customer can confirm the
receipt of the USD only on the next day of the
payment, due to the time differences. By using
the TDC service, a bank and the customer can
affirm payment and receipt of USD on the day
of settlement. This is the major merit of the TDC.
The operation of the TDC started in 1986 and has
a long history of more than 20 years.
69
 Evolutionary Trends of Payment Systems

The TDC is the settlement system operated
in Japan for banks in Japan to process the USD
payments. Therefore, it is supervised and moni-
tored both by the Fed and the Bank of Japan. It is
particularly worth noting that the TDC is a purely
private scheme, where the settlement service is
provided by a private financial institution.
LINKAGE WITH CSD
Role of CSD
“Central Securities Depository” (CSD) is an
institution that provides a settlement service of
securities, including the government bonds, cor-
porate bonds, equities and money market instru-
ments. The CSD manages securities accounts in
an electronic form, and processes settlements by
means of book entries. For the electronic transfer
of securities, the CSD operates a computer system,
which is sometimes called the “securities settle-
ment system” (SSS9).
Every country has a CSD / CSDs which pro-
vides the settlement of securities issued in the
country (See Table 6). In this case, the CSD is called
“National Central Securities Depository” (NCSD).
Some NCSDs deal with all the securities issued in
a country. And other NCSDs provide settlement
service only for a limited scope of securities, so
two or more NCSDs share the responsibility for
all the securities issued in a country.

Table 6. Central securities depositories in selected countries

The name of CSD Scope of Securities

Government Equities Other Securities
Bond
US Fed ○ × ×
DTC × ○ ○
Canada CDS ○ ○ ○
UK Euroclear UK & Ireland ○ ○ ○
France Euroclear France ○ ○ ○
Germany Clearstream Banking Frankfurt (CBF) ○ ○ ○
Italy Monte Titoli ○ ○ ○
Switzerland SIS ○ ○ ○
Spain IBERCLEAR ○ ○ ○
ICSD Euroclear Bank ○ ○ ○
ICSD Clearstream Banking Luxembourg (CBL) ○ ○ ○
Japan Bank of Japan ○ × ×
JASDEC × ○ ○
Hong Kong CMU ○ × ○
CCASS × ○ ×
Singapore MAS ○ × ×
CDP × ○ ○
Australia Austraclear ○ × ○
ASX × ○ ×
(Note1) ○: The CSD provides settlement service of these securities.
×: The CSD does not basically provide service of these securities.
(Note2) Other securities include the corporate bond, commercial paper, certificate of deposit and so on.

70
Evolutionary Trends of Payment Systems
Meanwhile, there is a CSD which settles inter-
national securities or cross-border transactions of
domestic securities. Such a CSD is called “Inter-
national Central Securities Depository” (ICSD).
Well-known ICSDs are the Euroclear Bank and
the Clearstream Banking Luxembourg (CBL).
Linkage between Payment
System and SSS
In some countries, the operator of a payment
system also acts as a CSD for securities, espe-
cially for government bonds. In such a case, the
operator holds and manages both the fund account
and securities account (see case (a) of Figure 9).
For example, the Fed operates the Fedwire,
which is the payment system for the USD as well
as the settlement system for government bonds.
The Bank of Japan (BOJ) operates the BOJ-Net,
which is the fund transfer system and government
bond book-entry system at the same time. Fur-
thermore, the European Central Bank (ECB) is
planning to handle all euro securities settlements
with the TARGET2. The project, which will make
the TARGET2 a securities settlement system, is
called “TARGET2-Securities” (see Chapter 10
for more detail).
On the other hand, in other countries, the CSD
has been developed separately from payment sys-
tems (see case (b) of Figure 9). In this case, it is
the global trend that the linkage is built between
the payment system and CSD.
Figure 9. Payment system and CSD
Merits of Linkage
Such a linkage between the payment system and
CSD has two merits to be pointed out. The first
merit is to attain Delivery versus Payment (DVP).
By linking the fund settlement system and securi-
ties settlement system, a scheme is possible that
links the delivery of securities and transfer of
funds. As mentioned in Chapter 3, the DVP is a
useful method to eliminate settlement risk arising
from the time-lag between the delivery of securi-
ties and transfer of funds.
A typical example of DVP function in such
a linkage is as follows. At the first setout, the
“Provisional Settlement” of securities is executed
in the CSD, and the notice is sent to the payment
system. Responding to the notice of Provisional
Settlement sent from the CSD, the transfer of
funds corresponding to the securities settlement
is executed in the payment system, and the notice
is sent back to the CSD. Receiving the notice of
fund settlement, the “Final Settlement” of securi-
ties then takes place (see Figure 10).
The second merit is to make it possible to
deliver the coordination between the fund and
collateral. If a payment system and a CSD system
are closely linked, borrowing funds from a central
bank and making a pledge of collateral, and repay-
ing funds and returning collateral can be made in
synchronization.
In more advanced systems, the buyer of se-
curities can pledge the bought securities to the
71

Figure 10. DVP settlement by means of linkage
central bank, obtain intraday overdraft with the
collateral, and make payment to the seller of
securities with the funds just obtained from the
central bank. These three processes are executed
at the same time. Such a mechanism is called
“self-collateralization” or “In-Transit Collateral.”
FINANCIAL EDI CAPABILITY
Concept of Financial EDI
Recently, exchanges of information on business
trades are often made electronically through the
Figure 11. The concept of financial EDI
72
Evolutionary Trends of Payment Systems
network. Electronic ordering has become widely
used, instead of paper-based or telephone-based
ordering in business communities. This process
is called “Electronic Data Interchange” (EDI).
When the upstream of the trade processes,
like ordering, delivering and invoicing, become
electronic, there is the need that the downstream
processes of trade should be electronic too. As the
most downstream of trade is the payment process,
there is a growing need that commercial data,
including invoice data, should be processed hand-
in-hand with payment instructions electronically.
The scheme that enables the processing of
remittance information with payment instructions
Evolutionary Trends of Payment Systems
is called “Financial EDI.” It is a great benefit for
the company (especially for the seller) because
if it can receive funds with the detailed data in-
cluding an invoice number, name of the buyer,
date of delivery, order number, and total amount
charged, the seller can streamline the reconciliation
process of their accounts receivable substantially
(see Figure 11).
EDI Capability in Payment Systems
Against this background, payment systems tend
to be capable of Financial EDI. That is to say, the
payment system can carry the remittance data with
payment instructions.
In the US, the Automated Clearing House
(ACH) introduced the Financial EDI service
in the early 1990s, and the volume of EDI has
been growing substantially year by year. And the
CHIPS and Fedwire are planning to introduce the
same kind of service to the large-value payment
systems in 2011.
The EU is trying to establish the Single Euro
Payments Area (SEPA). In this project, the stan-
dard form of credit transfer, the “SEPA Credit
Transfer” (SCT), requires that all payment orders
should be able to carry 140 characters of EDI
information. That means that all the banks in the
EU will have EDI capability in the near future.
In Japan, the Zengin system, the retail pay-
ment system of Japan, is planned to be upgraded
in 2011. The old Zengin system has very limited
EDI capability in its fixed-length message format
of up to only 20 characters, which is seldom used.
The new Zengin system will adopt a flexible XML
format and have adequate EDI capability.
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New Developments in Large-Value Payment
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Bech, M. (2008). The Diffusion of Real-time
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Saporta, V. (Eds.), The Future of Payment Systems.
Routledge.
Bech, M., & Hobijn, B. (2007). Technology Dif-
fusion within Central Banking: The Case of Real-
Time Gross Settlement. International Journal of
Central Banking, 3(3).
Bech, M., Preisig, C., & Soramäki K. (2008, Sep-
tember). Global Trends in Large Value Payments.
Federal Reserve Bank of New York Economic
Policy Review.
Fry, M. (1999, February). Risk, Cost and Liquidity
in Alternative Payment Systems. Bank of England
Quarterly Bulletin.
Millard, S., & Saporta, V. (2005, December). The
Future of Payments. Financial Stability Review.
Bank of England.
Nakajima, M. (2003). March). Global Trends in
Payment Systems and Their Implications for Ja-
pan. Forum of International Development Studies,
Nagoya University. (in Japanese)
Rogers, E. (1995). Diffusion of Innovations. The
Free Press World Bank. (2008). Payment Systems
Worldwide, a Snapshot: Outcomes of the Global
Payment Systems Survey 2008.
ENDNOTES
1
The origin of Fedwire can date back to 1918
when the Federal Reserve inaugurated a
network of wire communications among
the individual Reserve Banks. The Fedwire
system migrated to a fully computerized
platform, and became a real RTGS system
in the early 1970s (Bech, 2008).
2
In this survey, the Central Bank of West
African States (BCEAO) and the Eastern
Caribbean Central Bank (ECCB) are counted
73

as 8 different countries for each, even though
only one RTGS system is used in both cases.
That is one of the reasons that the number
of countries in this survey is larger than that
in the Fed’s survey.
3
The four exceptions are Canada, Hong Kong,
Iceland and Switzerland.
4
In September 2000, only 0.1%, in terms of
amount, was processed by the RTGS mode,
the rest was handled by the DTNS mode.
5
It is needless to say that there are other pat-
terns of evolutionary progress depending
on the individual situation of each country.
For example, the RTGS is the only payment
system in some countries.
6
The computer operator of CHATS is the
“Hong Kong Interbank Clearing Limited”
74
Evolutionary Trends of Payment Systems
(HKICL). The HKICL is a private company
jointly owned by the HKMA and the Hong
Kong Association of Banks (HKAB).
7
The CHAPS Euro clearing system was closed
in May 2008 after nine years of service. The
system began operation in January 1999,
and used the same settlement mechanisms
as the CHAPS Sterling.
8
Abbreviation of Elektronischer Massenzah-
lungsverkehr. The EMZ is a retail payment
system in Germany.
9
This is the definition of SSS in a narrow
sense. In a broad sense, the SSS means the
full set of institutional arrangements for
confirmation, clearance and settlement of
securities trades and safekeeping of securi-
ties.
 75

Chapter 7
Driving Forces for Innovations
in Payment Systems

ABSTRACT
This chapter makes an analysis of the driving forces that advanced the evolutionary progress of payment
systems, as mentioned in the previous chapters.

The first driving force was the growing recognition of settlement risk. As financial transactions grew,
the settlement values over payment systems increased dramatically throughout the 1980s, 1990s and
2000s, which was accompanied by substantially-increased settlement risk. It was self-evident that the
larger settlement risk becomes, the higher the need increases to control it. Especially, the central banks
became worried about the greater risk, which was the strongest motivation to improve the payment
systems in each country.

The second driving force was the role of the Bank for International Settlements (BIS), which should not
be underestimated. The BIS published several reports which explained the theory and practice of pay-
ment systems, including the cause of settlement risk and the protective measures for it. The BIS reports
included some global standards with which the targeted payment systems should comply. Each country
made great efforts to meet the goals of minimum standards presented in the reports.

The third driving force was the competition between the payment systems. In a situation where the pay-
ment systems compete with each other, the system has a strong incentive to make it more efficient and
safer by improving its settlement mechanism. This was the bright side of market mechanism, which could
not be observed in a natural monopoly situation.

Fourth, the progress of Information Technology (IT) also played a critical role. Enhanced computer
capacity, improved communication networks and reduced technology cost contributed greatly to the
innovation of payment systems.

DOI: 10.4018/978-1-61520-645-2.ch007

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
 Driving Forces for Innovations in Payment Systems
INTRODUCTION
As mentioned in Chapter 6, payment systems
evolved from the DTNS system to the RTGS
system, and further to the Hybrid system and
Integrated system. It can be pointed out that it
was a great revolutionary era of payment systems
during the past two decades. However, the great
transformation of payment systems did not arise
spontaneously or automatically. There were some
driving forces behind the evolutionary process of
payment systems. Some of them are discussed in
more details below.
RAPID GROWTH OF SETTLEMENT
VALUES AND SETTLEMENT RISKS
Fast-Growing Settlement Values
First, the settlement values of payment systems in
industrialized countries have increased at a very
rapid pace, which has been higher than that of
economic growth. Figure 1 shows the settlement
values of payment systems in eleven developed
countries and the euro area (from 1999). This
chart tells us that the settlement amount became
more than double during the past fifteen years.
The progress in globalization and liberalization
of financial transactions has had a direct impact
on the drastic increase on settlement amounts.
Settlement Values Relative to
Nominal GDP
Table 1 and Figure 2 show the settlement values
of payment systems relative to the nominal GDP
in thirteen industrialized countries. In most coun-
tries, this ratio is between 40 and 100 times1 the
annual nominal GDP (see Table 1 and Figure 2).
The average ratio is 75.3 times in 2007.
This fact means that a one-week settlement
amount of a payment system is larger than the
annual nominal GDP of the nation. In other words,
76
a payment system settles the nominal amount of
annual GDP in only three or four days. With this
knowledge in mind, you can imagine the tremen-
dous social impact there would be if there were
to be a malfunction with a payment system. It is
needless to say that larger settlement values are
accompanied with larger settlement risk.
Recognition of Settlement Risk
Increased settlement values indicate the greater
potential risk inherent in payment systems. The
risk comes out if settlements are not made properly
due to the default of a participant or something.
It should be noted that potential risk does not
always remain dormant. Actually, settlement risk
sometimes became a reality and caused huge
losses. Some examples are shown in Chapter 3,
which include the Herstatt Bank incident, Bank
of New York incident, BCCI incident and Bear-
ings incident.
The rise of awareness on the increased potential
risk encouraged a sweeping reform on payment
systems. Moreover, the awareness that settlement
risk is not an imaginary risk but a “real risk” is a
strong driving force for the reform of the payment
systems in each country. Especially, the central
bank in each country became concerned about the
inherent risk in the payment systems.
ENLIGHTENMENT BY THE BIS
The Bank for International Settlements (BIS)
published several important reports on payment
systems and reduction measures of settlement risk.
These educational campaigns of the BIS success-
fully increased the awareness for settlement risk
across the globe.
With the growing recognition of settlement
risk, the operators and overseers of payment sys-
tems have started to actively work on the reduction
of settlement risk. Such active movements have led
Driving Forces for Innovations in Payment Systems
Figure 1. Settlement values of selected payment systems (Source: statistics on payment and settlement
systems in selected countries, BIS, each year)
to the evolutionary progress of payment systems
as well as the improvement of risk management.
Role of the CPSS
The Committee on Payment and Settlement Sys-
tems (CPSS) played the pivotal role in publishing
the reports on payment systems.
History, Function and
Organization of the CPSS
Originally, a “Group of Experts on Payment Sys-
tems” was set up in 1980 by the Governors of the
central banks of the Group of Ten (G10). After a
detailed review of payment system developments
in the G10 countries and several analytical works
on payment systems, the Group was reorganized
into the CPSS in 1990 in order to extend the
activities of the Group. The CPSS was set up as
one of the permanent central bank committees2,
which reports to the Central Bank Governors of
the countries of the Group of Ten.
The functions of the CPSS are to monitor
and analyze developments in domestic payment,
settlement and clearing systems as well as in cross-
border and multicurrency systems. The CPSS
also focuses on the standard-setting activities.
The CPSS cooperates with other international
groups, including the International Organization
of Securities Commissions (IOSCO), the Basel
Committee on Banking Supervision (BCBS) and
the Financial Stability Board (FSB) to address
issues for common concern.
Members of the CPSS are senior officials re-
sponsible for the payment and settlement systems
in each central bank. The CPSS had consisted of
the representatives of the central banks from Bel-
gium, Canada, the European Central Bank (ECB),
France, Germany, Hong Kong, Italy, Japan, the
77
 Driving Forces for Innovations in Payment Systems

Table 1. Settlement values of payment systems relative to nominal GDP .

(As of 2007)
--- Times

Country Payment System Settlement values relative to Nominal GDP 1

Belgium ELLIPS 79.5
Canada LVTS 30.0
France TBF 76.7
PNS 8.6
Germany RTGS plus
95.9
Hong Kong HKD CHATS 134.2
Italy BIREL 27.4
Japan BOJ-NET 57.2
FXYCS 10.9
Netherlands TOP 68.9
Singapore MEPS 62.8
Sweden RIX 2 48.9 4
Switzerland SIC 102.1
UK CHAPS 3 65.9 4
US Fedwire 48.6
CHIPS 35.2
Total --- 75.3
Note1: Settlement value (annual) / Nominal GDP (annual)
Note2: RIX = K-RIX + E-RIX
Note3: CHAPS = CHAPS Sterling + CHAPS Euro
Note4: Sweden and UK are figures of 2006.
Source: BIS (2009)

Figure 2. Settlement values of payment systems relative to nominal GDP (As of 2007) Source: BIS (2009)

78
Driving Forces for Innovations in Payment Systems

Table 2. Membership of the CPSS

Netherlands, Singapore, Sweden, Switzerland, the
United Kingdom, and the United States. In July The Existing Members The New Members from
2009, the emerging market economies joined the July 2009
activities of the CPSS when the CPSS broadened Belgium Australia
Canada Brazil
the membership to include the central banks of the European Central Bank China
Australia, Brazil, China, India, Mexico, Russia, (ECB) India
Saudi Arabia, South Africa and South Korea (see France Mexico
Germany Russia
Table 2). Hong Kong Saudi Arabia
Italy South Africa
Japan South Korea
CPSS Reports the Netherlands
Singapore
Sweden
The CPSS reports encompass a broad range of Switzerland
issues on payment systems, which include the the United Kingdom
the United States
large-value payment systems, retail payment
Source: CPSS
instruments and systems, and foreign exchange
settlement. In addition, the reports covered the
area of the securities settlement systems and the
The Lamfalussy Standards
clearing and settlement arrangements for deriva-
tives transactions, both of which are unfortunately
The Lamfalussy Standards
outside the scope of this book.
as a Global Standard
Among them, some reports are regarded as
important ones, which had major impact on the
The “Lamfalussy Standards” were derived from
payment system reforms. Such reports include
the “Report of the Committee on Interbank Net-
the “Core Principles Report,” “RTGS Report,”
ting Schemes of the Central Banks of the Group
“Lamfalussy Report,” “Angell Report,” “Allsopp
of Ten Countries” (Lamfalussy Report) in 1990.
Report” and “Noël Report.” Some reports were
The Standards were set forth originally as the
named after the chairman of the working group
minimum standards for a cross-border and multi-
that prepared the report. Table 3 shows the list of
currency payment system with a netting scheme.
important reports concerning payment systems.
Later on, the Standards became regarded as the
Having heavily affected by a series of these
standards for the net settlement systems in general.
reports, the central banks across the globe pro-
Currently, the standards are regarded as a global
moted the introduction of the RTGS system. On
standard with which the DTNS systems should
the other hand, the DTNS systems improved their
strictly comply.
risk management, and the private banks tightened
the management of settlement risk. Furthermore,
Six Standards of Lamfalussy Standards
the reports on the foreign exchange settlement
were conduced to the establishment of CLS Bank
The Lamfalussy Standards are made up of six
by private sector.
standards (see Table 4). Of which, two standards
In what follows, this section describes the
are particularly important. One is standard III,
Lamfalussy Standard and Core Principles, both
which represents that the limits should be placed
of which are particularly important in designing
on the maximum level of credit exposure that
and evaluating payment systems.
can be produced by each participant. Another
important one is standard IV, which requires the

79
 Driving Forces for Innovations in Payment Systems

Table 3. List of the CPSS reports on payment systems

date of publication the name of the report

1. Payment Systems: General Issues
June 2008 The Interdependencies of Payment and Settlement Systems
January 2006 General Guidance for National Payment System Development
May 2005 Central Bank Oversight of Payment and Settlement Systems
August 2003 The Role of Central Bank Money in Payment Systems
2. Large-value Payment Systems
January 2006 Cross-border Collateral Arrangements
May 2005 New Developments in Large-value Payment Systems
January 2001 Core Principles for Systemically Important Payment Systems (Core Principles Report)
March 1997 Real-time Gross Settlement Systems (RTGS Report)
November 1990 Report of the Committee on Interbank Netting Schemes of the Central Banks of the Group
of Ten Countries (Lamfalussy Report)
February 1989 Report on Netting Schemes (Angell Report)
3. Retail Payment Instruments and Systems
January 2007 General Principles for International Remittance Services
March 2004 The Survey of Developments in Electronic Money and Internet and Mobile Payments
March 2003 Policy Issues for Central Banks in Retail Payments
November 2001 Survey of Electronic Money Developments
September 2000 Clearing and Settlement Arrangements for Retail Payments in Selected Countries
May 2000 Survey of Electronic Money Developments
September 1999 Retail Payments in Selected Countries: A Comparative Study
August 1996 Security of Electronic Money
4. Foreign Exchange Settlement
May 2008 Progress in Reducing Foreign Exchange Settlement Risk
July 1998 Reducing Foreign Exchange Settlement Risk: A Progress Report
March 1996 Settlement Risk in Foreign Exchange Transactions (Allsopp Report)
September 1993 Central Bank Payment and Settlement Services with respect to Cross-border and Multi-
currency Transaction (Noël Report)
Source: CPSS

capability of ensuring the timely completion of
daily settlements, even if the participant with the
largest single net debit position is unable to settle.
As well as being compliant with other stan-
dards, if the maximum debit position for each
participant is fixed (standard III), and the maxi-
mum amount is covered by collateral or other
measures (standard IV), the system is regarded
as compliant with the Lamfalussy Standards.
When a net settlement system complies with these
six standards, such a system is generally called
“Lamfalussy-compliant system” or “Secured net
settlement system3.”
Lamfalussy-Compliant System
During the 1990s, many net settlement systems
became the Lamfalussy-compliant systems, by set-
ting the net debit cap, stipulating the loss-sharing

80
Driving Forces for Innovations in Payment Systems

Table 4. The Lamfalussy standards

I. Netting schemes should have a well-founded legal basis under all relevant jurisdictions.
II. Netting scheme participants should have a clear understanding of the impact of the particular scheme on each of the financial risks
affected by the netting process.
III. Multilateral netting systems should have clearly-defined procedures for the management of credit risks and liquidity risks which
specify the respective responsibilities of the netting provider and the participants. These procedures should also ensure that all parties
have both the incentives and the capabilities to manage and contain each of the risks they bear and that limits are placed on the maximum
level of credit exposure that can be produced by each participant.
IV. Multilateral netting systems should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of
an inability to settle by the participant with the largest single net-debit position.
V. Multilateral netting systems should have objective and publicly-disclosed criteria for admission, which permit fair and open access.
VI. All netting schemes should ensure the operational reliability of technical systems and the availability of back-up facilities capable of
completing daily processing requirements.
Source: BIS (1990)

rule, and introducing the collateral scheme for the
maximum debit amount.
At the first setout, the CHIPS in the US be-
came Lamfalussy-compliant by introducing the
loss-sharing rule and collateral scheme in 1990. In
Europe, the EAF in Germany and PNS in France
also became the Secured net settlement systems
in late 1990s. In Japan, the FXYCS became com-
pliant with the Standards by introducing its risk
reduction measures in 1998.
Lamfalussy-Plus System
“Lamfalussy-plus system” is a net settlement
system with a stronger form of risk prevention
measures than the Lamfalussy-compliant system.
More concretely, the system can assure the final
settlement in a timely matter, even in the event
of more than one participant failing.
In other words, if more than one participant
becomes unable to settle, and the total default
amount is more than the largest net debit position
of single participant, the Lamfalussy-plus system
assures the certainty of settlement.
Lamfalussy Plus One System
system is called “Lamfalussy plus One system.”
The BIS requires achieving Lamfalussy plus One
for the Systemically Important Payment Systems
(SIPSs) as a best practice.
The CHIPS in the US was the first in the world
to achieve Lamfalussy plus One in January 1997.
It achieved it by introducing the procedures that
would cover the simultaneous failure of any two
participants with the largest net debit positions.
At the same time, by taking these measures, the
CHIPS could stand for the simultaneous failure of
the twenty-five smallest participants. This means
that the CHIPS would still be able to settle, even
if, although practically impossible, one-quarter
of all the CHIPS participants failed on the very
same day.
In Japan, the Zengin system achieved Lam-
falussy plus One in May 2002, and the FXYCS
in March 2004.
The Core Principles
The “Core Principles” derived from the Report
on “Core Principles for Systemically Important
Payment Systems,” which was published by the
CPSS in January 2001.

When a net settlement system can ensure the timely The Core Principles and the SIPS
completion of daily settlement, even if the top
two participants with the largest net debit position The Core Principles are applied to “Systemically
would be unable to pay at the same time, such a Important Payment Systems” (SIPSs). Payment

81
 Driving Forces for Innovations in Payment Systems
system is regarded as SIPS, if a disruption within
the system could trigger or transmit further disrup-
tions amongst participants or systemic disruptions
in the financial area more widely. Systemic impor-
tance is judged mainly by the size and/or nature of
the individual payments or their aggregate value.
Therefore, large-value payment systems would
normally be considered to be SIPSs. A SIPS does
not necessarily handle only high-value payments.
Some SIPSs can handle both high-value and low-
value payments. The critical point is whether the
system has a possibility to trigger or transmit
disruption by virtue of certain segments of its
traffic. The SIPSs may be owned and operated
by central banks, by the private sector, or jointly
by public and private agencies. In some cases, the
boundary between SIPS and non-SIPS is not clear
enough, and the central bank should determine it
with careful consideration.
The Core Principles were drawn up with the
intention of being used as universal guidelines to
encourage the design and operation of safer and
more efficient SIPSs worldwide. The Core Prin-
ciples are being applied not only to the developed
countries but also to the emerging economies.
The Scope of the Core Principles
The Core Principles are made of ten principles
and cover a much wider range than the Lamfa-
lussy Standards (see Table 5). More concretely,
they include the recommendations on the legal
basis　(Principle I), understanding financial
risks (Principle II), management of financial risks
(Principle III), prompt final settlement (Principle
IV), settlement in multilateral netting systems
(Principle V), settlement assets (Principle VI),
security and operational reliability (Principle
VII), efficiency (Principle VIII), access criteria
(Principle IX), and governance (Principle X).
The Core Principles have some points which
are not covered by the Lamfalussy Standards,
such as follows. A SIPS should preferably use
central bank money as settlement asset. A SIPS
82
should have contingency arrangements as well as
a high degree of security and operational reli-
ability. A SIPS should maintain efficiency in
designing and operating a system. A SIPS should
disclose the criteria for participation.
Minimum Standard and Best Practice
Principle IV and V have double standards, namely,
“minimum standard” and “best practice.” The
minimum standard is the lowest standard to be
achieved by the emerging countries and the best
practice is a higher standard meant for the devel-
oped countries.
Principle IV: Prompt Final Settlement
Principle IV defines the daily settlement timing
under normal circumstances. The Principle re-
quires the final settlement to be provided by the
end of the day as a minimum standard. Normally,
the DTNS system for large value payments ex-
ecutes the final settlement at the end of the day.
In this case, the system is considered to meet the
minimum standard.
For the developed countries, Principle IV
requires more prompt settlement during the day.
To adopt a RTGS system is a common way to
accomplish the intraday finality. Hybrid system
and Integrated system also can provide a simi-
larly prompt settlement during the day. Even the
DTNS system could meet the higher standard, if
it executes several settlements in the course of an
operating day, instead of only a one-time settle-
ment at the end of the day.
This higher standard is deemed to be desirable
particularly when the payment system handles
large volumes of high-value payments and the
country has a well-developed financial market.
Driving Forces for Innovations in Payment Systems

Table 5. Core principles for systemically important payment systems

I. The system should have a wellfounded legal basis under all relevant jurisdictions.
II. The system’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the
financial risks they incur through participation in it.
III. The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respec-
tive responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those
risks.
IV.* The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the
day.
V.* A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settle-
ments in the event of an inability to settle by the participant with the largest single settlement obligation.
VI. 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 risk and little or no liquidity risk.
VII. The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely
completion of daily processing.
VIII. The system should provide a means of making payments which is practical for its users and efficient for the economy.
IX. The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.
X. The system’s governance arrangements should be effective, accountable and transparent.
* Systems should seek to exceed the minima included in these two Core Principles.
Source: BIS (2001)

Principle V: Settlement in standard, the Principle requires such types of

Multilateral Netting Systems secured systems.

Principle V is applied only to the systems that Use of Core Principles in

settle on a multilateral net basis, and is not rel-
evant to the RTGS system. Multilateral netting
can create the risk that, if a participant is unable to
meet its settlement obligations, other participants
will face unexpected credit and liquidity risks.
As a minimum standard, the Principle requires
multilateral netting systems to ensure the timely
completion of daily settlement, even if a participant
with the largest net debit obligation is unable to
settle. Reduced to its simplest terms, the Principle
requires the Lamfalussy-compliant System at
minimum, where the maximum debit position
for each participant is fixed, and the maximum
amount is covered by collateral, credit lines or
other measures.
As a best practice, the Principle requires that a
payment system can still operate in the case that
more than one institution might be unable to settle.
A more adverse case includes two participants
with the largest individual settlement obligations
being unable to settle. Only the Lamfalussy-plus
system and more preferably the Lamfalussy Plus
One system can meet this requirement. As a higher
International Community
The Core Principles are included in “12 Key
Standards for Sound Financial Systems” published
by the Financial Stability Board4(FSB). As a part
of Key Standards, the Core Principles are used
in the “Financial Sector Assessment Programme”
(FSAP) and the “Reports on the Observance of
Standards and Codes” (ROSC), conducted jointly
by the International Monetary Fund (IMF) and
World Bank.
In concrete terms, the staff of the IMF and
World Bank would visit each country every few
years and check whether or not the payment sys-
tem is compliant with the Core Principles. This
might be a systematic pressure for action to be
compliant with the Principles in the international
community.

83
 Driving Forces for Innovations in Payment Systems
COMPETITION BETWEEN
PAYMENT SYSTEMS
The competition between payment systems is
another factor which encourages the evolutionary
progress of payment systems. As is often the case,
a payment system has the tendency to be a natural
monopoly in a domestic market. This means that
there tends to be only one payment system oper-
ated for specific payments in a country. However,
occasionally, there are cases that multiple pay-
ment systems compete with one another in the
same payment market in the same currency. The
competition arises from the currency integration
or homogenization of the plural payment systems.
Where there is a competition among pay-
ment systems, each payment system makes
all-out efforts to get ahead of the competition,
which includes improving functionality, allow-
ing widespread participation both from home
and abroad, and reducing settlement fees. If one
payment system enhances the functionality and
gets an advantage, the other system devotes itself
to catch up and hopefully get ahead of the front
runner. In the process of such competition, some
striking innovations were brought out and the new
schemes of processing payments were developed.
What follows are examples of a competition
that was a driving force to encourage the innova-
tion of payment systems.
Competition by European
Monetary Union
Coexistence of Multiple Payment
Systems in Euro Area
The single currency euro was introduced in 1999.
Before the introduction of euro, there was a single
payment system in each country, i.e. in national
currency area. For example, German mark pay-
ments were settled through the German payment
system and French franc payments were settled
through the French payment system. That is to
84
say, the natural monopoly was firmly established
in each national currency area. However, this
situation changed drastically, because the pay-
ment systems of the legacy currencies (including
German mark, French franc) became the payment
systems of the euro in one stroke. As a historical
fact, there were fifteen RTGS systems and four
DTNS systems that coexisted in single currency
area when the euro was introduced. Especially, the
competition was very fierce between the German
payment system and the French payment system,
since both countries were filled with ambition to
take the initiative in the integration process of the
euro payment market.
Evolution of the EAF
It is noteworthy that the competition started far in
advance of the introduction of the euro in January
1999. First, the German payment system, the EAF
enhanced its settlement mechanism drastically in
1996 and transformed from the DTNS system into
the Hybrid system. It was the very first Hybrid
system in the world. Additionally in 1998, the
EAF allowed the “remote access,” which per-
mitted foreign financial institutions to access the
EAF from abroad. The indirect access (indirect
participation) was also admitted for the first time
in the EAF. The transaction fee was reduced from
0.40 DM to 0.30 DM per payment order.
In January 1999, the EAF changed its German
name (“Electronischen Abrechnung Frankfurt”)
to an English name (“Euro Access Frankfurt”),
with an aim to make foreign banks feel a sense
of affinity. At the same time, the EAF made two
important changes to its service. First, the multi-
lateral netting was added to the previous bilateral
netting in the phase I (in the morning session).
Second, the “Liquidity Bridge” was established
between the EAF special account and the Bundes-
bank account which was used for the settlement
of the ELS (the German RTGS system). Through
this Liquidity Bridge, the participants were able
to transfer liquidity between the two accounts,
Driving Forces for Innovations in Payment Systems
i.e. between the two payment systems. The con-
venience and flexibility in liquidity management
was improved with these changes. However, the
function was still limited and the transfer of funds
was possible only once every hour.
Evolution of the PNS
Observing the development of German payment
system, the French payment system started its
own innovation. The PNS, the French DTNS
system changed its settlement scheme in April
1999 from the net settlement once a day to the
continuous settlement during the day, which made
the PNS into a Hybrid system, just like the EAF.
At the same time, the PNS changed its name from
its French name (“Système Net Protégé”) to an
English name (“Paris Net Settlement”), keeping
the abbreviation unchanged.
The processing scheme of the PNS was quite
similar to that of the EAF, which was the combi-
nation of bilateral optimization and multilateral
optimization with a bilateral sender limit. Here,
the “optimization” meant the same kind of pro-
cessing as the netting. The Liquidity Bridge was
also established between the PNS and the TBF
(the French RTGS system). Through this Bridge,
the participants could transfer the liquidity freely
between the two payment systems at anytime dur-
ing the operating hours. In this respect, the PNS
was superior to the EAF.
The combination of the PNS and the TBF was
called “Paris Integrated System” (PIS), as they
looked like an integrated and consistent payment
system. With this enhancement, the PNS caught
up to the EAF and had a lead over the German
payment system in terms of flexible liquidity
transfer with the RTGS system.
Introduction of the RTGSplus
After the French payment system caught up,
the German payment system stepped forward
further. The Deutsche Bundesbank built a new
payment system “RTGSplus” and started operation
in November 2001. The RTGSplus was developed
by integrating the EAF, a hybrid system, and the
Euro Link System (ELS), a RTGS system. The
RTGSplus had two processing modes, which were
the “Express Payment” and “Limit Payment.”
The Express Payment was a RTGS mode, where
the processing was made on a gross and real time
basis, just like the ELS. The Limit Payment was a
Liquidity-Saving mode, where continuous offset-
ting was made with the function of a sender limit.
“Offsetting” meant the simultaneous booking of
an incoming payment and an outgoing payment,
and the outcome of the processing was exactly
the same as the netting. The RTGSplus was the first
Integrated system in the world. By introducing
the cutting-edge system, the German payment
system got a long lead on the French payment
system again.
Introduction of the new BIREL
Stimulated by the innovation of the German and
French payment systems, the Italian payment
system also moved forward. The Bank of Italy
renovated the RTGS system BIREL and built the
“new BIREL.”
The new BIREL was built by adding the
Liquidity-Saving mechanism to the RTGS mode
of BIREL. The functionality of the new BIREL
was almost identical to that of the RTGSplus. This
meant that the new BIREL was another Integrated
system.
Development into the TARGET2
As described above, several payment systems
coexisted in parallel in a single currency area and
were placed in a very competitive situation after the
introduction of euro. Such competition encouraged
each payment system to take evolutionary and
innovative measures. The evolutionary process
created the advanced payment systems, such as
the Hybrid system and Integrated system. It can
85
 Driving Forces for Innovations in Payment Systems
be concluded that the competition was a major
driving force for the enhancement of payment
systems especially in euro area.
In 2007, the TARGET2 was introduced instead
of the TARGET. The TARGET2 was built by
combining all the functions of the PIS, RTGSplus
and new BIREL. Thereby, the euro area countries
could broadly enjoy the benefits of the excellent
functioning of an advanced payment system.
Probably, a re-evaluation should be made about
the importance of these advanced systems as the
groundbreakers in the evolutionary process of
payment systems.
Competition between Two
Payment Systems in the US
In the US, the competition between the Fedwire
and CHIPS was a driving power to promote in-
novation in the payment systems.
Sharing Roles between
the Two Systems
Until the mid-1990s, the US banks used to handle
the domestic payments and foreign exchange re-
lated payments in separate divisions. At that time,
the domestic payments were sent to the Fedwire,
and the foreign exchange related payments were
sent to the CHIPS automatically.
However, from the late 1990s, the US banks
tended to integrate the payment operations into
one division as a cost-cutting measure. By this
integration of business, the same division could
handle both domestic and international payments,
which meant that any payments could be sent to
either the Fedwire or CHIPS, if the receiving bank
was a participant of these payment systems. To sum
it up, the customers were given options to choose
between the two payment systems when submit-
ting payment orders. In this way, the competition
between the Fedwire and CHIPS was kicked off.
86
Introduction of CHIPS Finality
At this stage, the Fedwire had an advantage of
being able to provide the intraday finality, since
the Fedwire was a RTGS system and payments
were processed on a real-time basis. As the CHIPS
was a DTNS system, where the final settlement
took place only at the end of the day, there was
still remained settlement risk. For this reason,
some customers who wanted one-hundred percent
certainty of the completion of their payment had a
tendency to choose the Fedwire. Especially large
companies, who had a large volume of payments,
had a strong tendency to prefer the Fedwire. This
meant that the CHIPS was losing a large volume
of payments due to the lack of intraday finality.
Against this background, the CHIPS intro-
duced the “CHIPS Finality” in 2001. The CHIPS
Finality is a scheme that continuously matches,
makes netting and settles payment orders. By this
continuous processing, the CHIPS could provide
the intraday finality, which is nearly a real-time
finality.
This was an endeavor for the CHIPS to try to
catch up with the Fedwire in respect of intraday
finality. This was another example of how the
competitive situation led to the innovation in
payment systems.
TECHNOLOGICAL PROGRESS
The progress of Information Technology (IT) also
made significant contributions to the enhance-
ment of functionality in payment systems. With
the progress of IT, payment systems became
enabled to make the frequent netting, execute the
continuous offsetting and handle payments with
the sophisticated algorithms.
Enhanced Computer Capacity
Due to the tremendous increase in processing
power of computers, it became possible to execute
Driving Forces for Innovations in Payment Systems
the frequent netting or the continuous offsetting
during the operating hours. The partial netting also
became possible. In the early days, only the full
netting was possible, and the netting processing
was possible only once a day mainly due to the
constraint of computer capacity.
In addition to that, the increased processing
capability of computers enabled the process of pay-
ments with highly sophisticated algorithms. That
led to payments processing with the elaborated
rules and advanced queue management, such as
the prioritization, reordering, and timed payment.
Based on these functions, the Hybrid system and
the Integrated system became feasible.
Improved Communication Network
Improved communication networks also made
a great contribution to the evolution of payment
systems. High-speed lines and interactive mes-
saging services became available at reasonable
costs. With enhanced network functionality, the
payment-related messages could be sent between
payment system and participant at the speed of
light.
With this network capability, it became possible
to do a real-time monitoring of the account bal-
ance, situation of settlement and status of payment
instructions in the queue. It was also possible to
change the debit cap or credit limit and to change
the order of payments in the queue in real-time
and in an interactive way.
Reduced Technology Cost
No less important is the fact that the cost of utiliz-
ing advanced technology has reduced drastically.
Widespread use of software package in system
development instead of custom-ordered develop-
ment is one of the reasons of such cost reduction.
This means that investment costs were sub-
stantially reduced for establishing new payment
systems. The reduced technology cost encouraged
the adoption of advanced technology, and the fruit
of technological innovation was smoothly intro-
duced to the new systems. In sum, the advanced
technology became available at a reasonable
cost, which led to the remarkable innovation in
payment systems.
REFERENCES
Bank for International Settlements. (1989, Feb-
ruary). Report on Netting Schemes (the Angell
Report).
Bank for International Settlements. (1990, No-
vember). Report of the Committee on Interbank
Netting Schemes of the Central Banks of the Group
of Ten Countries (the Lamfalussy Report).
Bank for International Settlements. (1992, Sep-
tember). Delivery versus Payment in Securities
Settlement Systems.
Bank for International Settlements. (1993, Sep-
tember). Central Bank Payment and Settlement
Services with Respect to Cross-Border and Multi-
Currency Transaction (the Noël Report).
Bank for International Settlements. (1996, March).
Settlement Risk in Foreign Exchange Transactions
(the Allsopp Report).
Bank for International Settlements. (1997, March).
Real-Time Gross Settlement Systems (the RTGS
Report).
Bank for International Settlements. (1998, July).
Reducing Foreign Exchange Settlement Risk: A
Progress Report.
Bank for International Settlements. (1999, Sep-
tember). Retail Payments in Selected Countries:
A Comparative Study.
Bank for International Settlements. (2000, Sep-
tember). Clearing and Settlement Arrangements
for Retail Payments in Selected Countries.
87
 Driving Forces for Innovations in Payment Systems
Bank for International Settlements. (2001, Janu-
ary). Core Principles for Systemically Important
Payment Systems.
Bank for International Settlements. (2003a,
March). Policy Issues for Central Banks in Retail
Payments.
Bank for International Settlements. (2003b,
August). The Role of Central Bank Money in
Payment Systems.
Bank for International Settlements. (2005, May).
Central Bank Oversight of Payment and Settle-
ment Systems.
Bank for International Settlements. (2006a, Janu-
ary). Cross-border Collateral Arrangements.
Bank for International Settlements. (2006b, Janu-
ary). General Guidance for National Payment
System Development.
Bank for International Settlements. (2007, July).
Progress in Reducing Foreign Exchange Settle-
ment Risk.
Bank for International Settlements. (2009, March).
Statistics on Payment and Settlement Systems in
Selected Countries.
88
ENDNOTES
1
The difference of ratio may mainly come
from the volume of financial transactions
in each currency.
2
The other permanent committees of the BIS
include the Basel Committee on Banking
Supervision (BCBS) and the Committee on
the Global Financial System (CGFS).
3
When a net settlement system does not
comply with the Lamfalussy Standards,
such a system is called the “Unprotected
net settlement system” or “Unsecured net
settlement system.”
4
The FSB was established to coordinate,
at the international level, the work of na-
tional financial authorities and international
standard setting bodies and to develop and
promote the implementation of effective
regulatory, supervisory and other financial
sector policies. The FSB is comprised of the
representatives from central banks, national
regulators on financial institutions and in-
ternational institutions.
 89

Chapter 8
Critical Issues on
Payment Systems

ABSTRACT
This chapter discusses the public policy matters which should be considered to design and evaluate
payment systems.

First, the governance structure of payment systems is discussed. Some payment systems are managed
by central banks and others are operated by private sectors. The division of labor between the central
banks and private sectors varies considerably from country to country. Governing approaches essentially
affect the way the payment systems are managed, including the participation rules, risk management
schemes and efficiency of the system.

Second, the legal issues concerning payment systems are reviewed. Needless to say, a payment system
should have a well founded legal basis. It is conceivable that the insolvency law may have an adverse
impact on the settlement finality of a payment system. Thus, careful considerations are necessary to
confirm the validity of settlement in a payment system under the laws of the jurisdiction.

Third, the operational reliability of payment systems is discussed. Modern payment systems are the
“electronic payment systems” and are comprised of computers and networks. It is absolutely imperative
to ensure the operational security of a payment system by securing the reliability of hardware, software,
telecommunication networks, power supplies and staff. It is particularly desirable to ensure the opera-
tional reliability for the “systemically important payment systems”(SIPSs).

Fourth, the efficiency of payment systems is discussed. Since a payment system provides a service with
public nature, the operator should take the cost-effective way to manage the system. The cost of a payment
system includes the processing cost of the system and the internal processing costs of the participants. It
also includes the liquidity cost of participants, which means how much liquidity the participants should
hold in order to process payments.

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Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.

INTRODUCTION
Public policy matters of payment systems should
be considered when making a system’s design. A
number of factors of payment systems relate to
public policy matters including the processing
mechanisms, risk management schemes, partici-
pation rules, fee structures, and so on.
Public policy matters can also be used as cri-
teria for evaluating payment systems by public
authorities. In many countries, the central bank
is responsible for oversight of private payment
systems, and some central banks publish the re-
sults as an oversight report regularly. As criteria
of assessment for oversight, these public policy
matters are useful for making evaluations.
Actually, the Core Principles for Systemically
important Payment Systems (Core Principles),
which is the global standard for payment sys-
tems published by the Committee on Payment
and Settlement Systems (CPSS) of the Bank for
International Settlements (BIS) in 2001, provides
some suggestions on these matters. Core Principle
I is about the “legal basis,” and Core Principle VII
handles the matter of “security and operational
reliability.” In addition, Core Principle VIII deals
with the “efficiency” and Core Principle X is about
the “governance.”
GOVERNANCE STRUCTURE
OF PAYMENT SYSTEMS
Ownership of Payment Systems
Governance structures of payment systems vary
widely between countries. This fact is intimately
related to the form of ownership of each payment
system.
The ownership of payment systems can be
divided into three main categories.
90
Critical Issues on Payment Systems
• Central bank-owned systems. Some pay-
ment systems are owned and operated by
central banks. It is usually the case that the
central bank operates the RTGS system
which has a close linkage with the cen-
tral bank accounts. In this case, the central
bank determines the regulations and proce-
dures of the system, and discloses informa-
tion about the system.
• Privately-owned systems. On another
front, other payment systems are owned
and operated by the private sector. In most
cases, the payment system operators are
organized as the member-owned co-op-
eratives. In some countries, however, the
operator takes the form of a stock company
owned by shareholders. In this case, it is
more common that a majority of share-
holders are the participants of the system,
but there is a chance that some non-users
could be included.
• Jointly-owned systems. In some cases, the
central bank and the private sector own and
operate the infrastructure jointly or sepa-
rately own the various parts of the system
which make up the whole system.
Required Condition for Governance
of Payment Systems
Core Principle X requires the systemically im-
portant payment systems to have the effective,
accountable and transparent governance. That is
because there are normally only a very few pay-
ment systems in a country and participants have
no freedom of choice.
First, the governance arrangements should
be clearly specified and publicly available. And
the objectives of a payment system should be
disclosed to the owners, participants and public
authorities. Even taking the form of a stock com-
pany, the main objective of the company should
not be profit-making.
Critical Issues on Payment Systems
The key component of governance is the
composition of the board which makes important
decisions on the system. The board should have
the composition which reflects the interest of
various participants, including the large users and
small-scale users. And the board should contain
members who have the necessary expertise in the
payment business.
The reporting lines between management
team and board member is another key factor.
The reporting line should be clear and direct.
The reporting line of risk management and audit
functions should be independent from the line of
day-to-day operations.
Public disclosure of governance structure is
a requisite for the transparency of the payment
system.
LEGAL ISSUES ON
PAYMENT SYSTEMS
Legal Basis for Payment Systems
A specific area of legal structure is deeply involved
with the validity of settlement in a payment sys-
tem. Such legal structure includes the contract
laws, insolvency laws, banking laws, and laws of
secured interests. Thus, the operator of a payment
system should clarify the relationship between the
system rule and relevant laws.
In this regard, Core Principle I states:
• The system should have a well founded
legal basis under all relevant jurisdictions.
A well founded legal basis provides a frame-
work as for the rights and obligations of the
participants and operator. It also gives a clear
definition when the finality of settlement is en-
sured in the system.
When the netting scheme is adopted, the pay-
ment system should have a robust legal base that
ensures the enforceability of netting arrangements.
A crucial risk might come from an insolvency
law. In some countries, the “zero hour rules” are
stipulated as a provision of insolvency law. The
rules may have the adverse effect on the settlements
of payments which are completed in the payment
system. If the zero hour rules are applied, all trans-
actions by a bankrupt institution from midnight
on the date of bankruptcy become retroactively
rendered ineffective. The effect could be reverse
payments that have apparently already been settled
and were thought to be final. This situation would
cause a grave legal risk to the participants of the
payment system.
When a legal framework in a jurisdiction is
not clear enough, it is recommendable that the
operator takes legal opinions in order to protect
the operator and participants from the legal dis-
putes in the future.
Legal Issues in International Context
In cases where a payment system is operated in
an international context, the operator should en-
sure that the system rules are legally valid in all
relevant jurisdictions. Such a situation includes
the case that a payment system admits the remote
participation and/or collateral from abroad.
The operator should clearly decide the appli-
cable law for each aspect of the payment activities.
It is also necessary for the payment system opera-
tor to address the possibility of conflicts of laws.
OPERATIONAL RELIABILITY
OF PAYMENT SYSTEMS
Operational Failures of
Payment Systems
As payment systems become increasingly de-
pendent on computer and network systems, the
operational reliability of these systems is a key
element to prevent operational risk. The defect
and malfunction of a central computer or network
91

of payment systems could lead to the systemic
risk implication.
If such operational failures were to happen
in a payment system, it would lead to a serious
situation. At first, the operational failure would
cause on late or failed settlements of interbank
transactions, which would lead to the confusion
in the money, FX and securities markets. Second,
the customer payments would not be settled in a
timely manner, which would cause another dis-
order affecting the whole market economy. The
customer claims would result in huge business
losses and degrading of bank reputations. In short,
an operational failure of a payment system would
lead to significant adverse effects on the financial
markets and economic activities of the nation.
Measures to Ensure
Operational Reliability
A primary response in order to minimize the op-
erational failure is to make a “full duplication” of
the system and network. Each component of the
system (including hardware, software, network,
power supply, and staff) should be duplicated in
case anything goes wrong.
The backup facilities are a functional neces-
sity in cases where a major accident occurs at the
main computer site. At least one backup system
should be immediately available (so-called “hot
backup”), which is usually used in combination
with a “cold backup” system(s). It should be
kept in mind that only a backup system is not
enough. The backup system should be operated
by an adequate number of well trained staff and
personnel. It should also be remembered that the
staff requires the office space to work.
It is not very wise to build a back-up site near
the primary site. It should be built as far away from
the primary site as necessary to avoid being subject
to the same set of risks as the primary location. It is
a minimum condition that the back-up sites do not
rely on the same infrastructure components (e.g.,
92
Critical Issues on Payment Systems
transportation, telecommunications, water supply,
and electronic power) used by the primary site.
A secondary response is to prepare a well-
conceived “Business Contingency Plan” (BCP).
The payment industry took an increasing interest
in the BCP after the September 11 incident in
2001. The BCP is the preparation and testing of
measures that protect business operations and also
provide the means for recovery of technologies
in the event of any damage or failure of facilities.
Such events include the building fires, earth-
quakes, terrorist attacks and pandemic diseases.
As a first step, a BCP requires the analysis of the
threats and business impact from the disruption.
Then, a disaster recovery plan should be designed
and implemented, which should be followed by
sufficient training.
The timely recovery of operations is especially
significant for payment systems. In the interagency
paper1, the FRB, OCC and SEC in the US recom-
mend that core clearing and settlement organiza-
tions should develop the capacity to recover and
resume clearing and settlement activities “within
the business day” on which the disruption occurs.
And the paper recommends that the overall goal
should be set that recovery and resumption can be
made “within two hours” after an event.
EFFICIENCY ISSUES OF
PAYMENT SYSTEMS
The efficiency of transactions in a market economy
is to a large extent determined by the efficiency
of the payment system. Thus, the efficiency is
largely a matter of social welfare.
Cost-Efficiency of Payment Systems
Recommendation 15 of the Recommendations
for Securities Settlement Systems (RSSS) (BIS,
2001) describes the efficiency as follows;
Critical Issues on Payment Systems
• While maintaining safe and secure opera-
tions, securities settlement systems should
be cost-effective in meeting the require-
ments of users.
The words of “securities settlement system”
should be replaced by “payment systems” here in
the context of this book. It is difficult to assess the
efficiency of a particular payment system in any
definitive manner. The cost of a payment system
should be carefully balanced with the requirement
of participants and the safety and security of the
system. The first priority of a payment system
is to assure the payments of participants will
be consistently settled in a timely manner with
absolute safety. Thus, only the efficiency should
not be overstressed by itself.
In many countries, however, there is only
one or very few payment systems, and therefore
it enjoys a monopoly situation. Without sound
competition, the market forces cannot induce a
payment system to achieve the cost-efficiency
automatically.
In addition, the member-owned co-operatives,
as is often the case with privately-owned payment
systems, tend to fall into the “collective action
problems.” According to this theory, participants
in any group attempting collective action will have
incentives to “free ride” on the efforts of others.
And this would be true especially when the group
is working to provide public goods, like payment
system service. Such problems can potentially
lead to inefficiency in payment systems.
That is why several global standards about pay-
ment systems set independent recommendations
about efficiency and try to draw people’s attention
to the cost-efficiency of the system.
Overall Costs of Payment Systems
When analyzing the efficiency of a payment sys-
tem, the overall costs should be evaluated. The
overall costs include both the “direct costs” and
“indirect costs.” The direct costs are the processing
costs of payments, which are reflected in fees and
charges. Initial setup costs for participants to join
the payment system are also included.
The indirect costs are the “liquidity costs” for
participants. If the system’s design requires each
participant to hold a high level of liquidity in order
to process its payments, the system’s liquidity cost
is regarded as high. Liquidity cost also depends
on the central bank’s policy on intraday liquid-
ity. If a central bank provides intraday liquidity
to each participant easily and at low rates, the
liquidity cost of the system becomes low. It is
common that the intraday facility of central bank
requires collateral; the opportunity cost of holding
the collateral should be taken into account when
considering the overall cost.
REFERENCES
Bank for International Settlements. (2001, Janu-
ary). Core Principles for Systemically Important
Payment Systems.
Bank for International Settlements and IOSCO.
(2001, November). Recommendations for Securi-
ties Settlement Systems.
Bank for International Settlements and IOSCO.
(2004, November). Recommendations for Central
Counterparties.
Manning, M., Nier, E., & Schanz, J. (2008a).
Market Failure in Payment and Settlement Sys-
tems. In Manning, M. (Eds.), The Economics of
Large-value Payments and Settlement. Oxford
University Press.
Manning, M., Nier, E., & Schanz, J. (2008b). Own-
ership, Governance and Regulations of Payment
Systems. In Manning, M. (Eds.), The Economics
of Large-value Payments and Settlement. Oxford
University Press Khiaonarong, T., & Liebenau J.
(2009). Banking on Innovation: Modernisation
of Payment Systems. Physica-Verlag Heidelberg.
93
 Critical Issues on Payment Systems

ENDNOTE
1
“Interagency Paper on Sound Practices to
Strengthen the Resilience of the U.S. Finan-
cial System,” FRB, OCC, and SEC, April
2003.

94
 Section 4
Developments of Payment
Systems in Selected Countries
96

Chapter 9
Payment Systems in US

ABSTRACT
This chapter provides a case study on the payment systems in the US. In general, each country has
Large-value payment system(s) and Retail payment system(s).

In the case of the US, the “Fedwire” and the “CHIPS” are the Large-value payment systems which
process the large-value funds transfer, such as the interbank payments for the money market, govern-
ment bond market, and FX market. The Fedwire is a central bank payment system, owned and operated
by the Federal Reserve. While, the CHIPS is a private payment system, owned and operated by the
TCH Payments Co. From the viewpoint of the settlement method, the Fedwire is a Real-Time Gross
Settlement (RTGS) system. On the other hand, the CHIPS belongs to the Hybrid system, where the net
settlements are made continuously during the day. The new settlement method of the CHIPS, i.e. the
“CHIPS Finality,” is scrutinized closely.

As for the Retail payment system, the “Automated Clearing House” (ACH) handles small value payments
in the US. The ACH is a nationwide electronic file transfer mechanism that processes the retail credit
and debit transfers between the customer accounts. The Federal Reserve is the largest ACH operator
in the US. Meanwhile, the TCH Payments Co. is a private-sector operator of ACH. As for the ACH pay-
ments, the settlements are made between the sending banks and receiving banks only on the next day of
the processing on a net-basis. That means that the ACH is a Designated-Time Net Settlement (DTNS)
system. The function of the “FedGlobal ACH” and “Financial EDI” capability on the ACH network
is also discussed.

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Payment Systems in US
INTRODUCTION
The US is the largest economy in the world as
well as having one of the world’s biggest financial
markets. In addition, the US dollar (USD) still
has its dominant role as a key currency, which
is widely used in the international trade, global
finance and investment, and as a reserve currency.
This situation leads the massive flow of funds in
the USD domestically and internationally.
For this reason, the US payment systems handle
such a massive fund transfers of the USD within
the nation and also between the US and foreign
countries. Therefore, it is extremely important to
obtain a detailed knowledge about how the USD
payments are settled.
FEDWIRE
Outline of Fedwire
Status of Fedwire in US
Payment Systems
The “Federal Reserve’s wire transfer system” (the
Fedwire) is a Large-value payment system, owned
and operated by the Federal Reserve (the Fed).
There are two Large-value payment systems in
the US, namely the Fedwire and the CHIPS. The
Fedwire mainly handles the domestic payments
between the US banks. And the CHIPS mainly
processes the international payments, such as the
foreign exchange transactions. In addition to these
Large-value payment systems, the Automated
Clearing House (ACH) is a retail payment system,
which handles the fund transfers of small values.
The Fedwire offers two kinds of services to
the banking sector in the US. One is a secure
and reliable service of handling large-value and
time-critical payments. This is often referred to
as the “Fedwire Funds Service.” The other is a
book-entry securities transfer service for mainly
government bonds, which is usually called the
“Fedwire Securities Service.” These two services
are collectively known as the “Fedwire Services.”
The Fedwire Funds Service is mainly described
in this section.
Characters of Fedwire
The Fedwire transfers the funds between the
“Federal Reserve accounts” which each financial
institution holds at the Federal Reserve Banks.
The Fedwire Funds Service is generally used to
make large-value and time-critical payments, such
as the federal funds transactions and government
bond transactions.
The Fedwire is a credit transfer system. Par-
ticipants (the depository institutions) originate a
funds transfer by instructing a Federal Reserve
Bank to debit the funds from its own account
and credit it to the account of another participant.
The Fedwire is a Real-Time Gross Settlement
(RTGS) system. Thus, payment orders are settled
individually on a gross basis. And if and only if
the payer bank has a sufficient balance in its ac-
count, a payment order is settled immediately on
a real-time basis. With this RTGS function, the
participants are able to send and receive time-
critical payments for themselves or on behalf of
their clients.
The funds transfers on the Fedwire become
final and irrevocable immediately when the pay-
ments are processed1.
Settlement Volumes of Fedwire
Figure 1 shows the volumes and values of the
Fedwire. The average daily volume of transfers
was 495 thousand in 2009. And the average daily
value was $2,504 billion in the same year. These
figures are indicative of the importance of the
Fedwire in the US payment market.
The average value per transfer was $5.1 mil-
lion, which was very large amount. The average
daily volume and value of transfers demonstrate
97

Figure 1. Volumes and values of the Fedwire (Source: the Federal Reserve)
showed a sharp decrease in 2009 after the long-
term upward trend.
Only depository institutions (and certain other
financial institutions) can hold an account with a
Federal Reserve Bank, and are eligible to partici-
pate in the Fedwire. In 2009, approximately 7,300
participants used the Fedwire for funds transfer. In
fact, large banks use the Fedwire quite extensively,
and the top 50 banks account for approximately
80% of settlement value of the Fedwire.
The Fedwire handles both the “interbank pay-
ments” which are the funds transfer for bank’s
own account, and the “customer payments” which
are made on behalf of their clients. The customer
payments account for about 80% in volume, and
about 40% in value.
Access to Fedwire
The participants make an online access to the
Fedwire by the “FEDNET,” which is the dedicated
communication network for the Fedwire. The
FEDNET is a nationwide high-speed network
which connects between the participants and
Federal Reserve Banks.
98
Payment Systems in US
The large-sized Banks tend to connect to the
Fedwire through the “computer interface connec-
tion,” in other words, the compute-to-computer
connection. While the medium-sized banks use
the “Fedline,” which is the dedicated terminal to
send payment orders to the Fedwire.
The very small-sized banks are exceptionally
admitted to have the “off-line connection,” where
participants can make payment instructions by
telephone.
Almost 90% of the participants have online
connection, either through the compute-to-com-
puter connection or the Fedline. And these online
participants account for almost every transactions
(99%) of the Fedwire.
Intraday Liquidity at Fedwire
Method of Providing Intraday Liquidity
Since the RTGS system requires a lot of liquidity
to execute the settlement, it is a common practice
that a central bank provides intraday liquidity to
the participants of the RTGS system. There are
two methods in providing intraday liquidity.
Payment Systems in US
Table 1. Providing methods of intraday liquidity in selected countries (Source: Nakajima & Shukuwa,
2005)
Intraday Repo Transaction Intraday Overdraft
(collateralized, free of charge)
France Belgium
Hong Kong Germany
Switzerland Italy
UK Japan
Netherland
Sweden
One is a “daylight overdraft” that central bank
admits the participants to have the negative bal-
ance in the account at the central bank during
the daytime. This temporal credit is only for the
daylight usage and should be repaid by the end
of the day. Another method is an “intraday repo
transaction” that central bank buys securities from
the participants with repurchase agreement by the
end of the day.
In the case of the daylight overdraft, “collateral
is necessary but free of charge” is the common
style of providing intraday liquidity. But the US
is the only exception in major countries. This is
because the Federal Reserve provides intraday
liquidity without collateral but charges a fee on
daylight overdraft (See Table 1).
Payment System Risk (PSR) Policy
As the Federal Reserve Banks are exposed to credit
risk by the uncollateralized intraday overdraft,
the Federal Reserve has its Payment System Risk
(PSR) policy. The policy provides a guideline to
manage their risk on the daylight overdraft, as
follows.
First, the “net debit cap” is set for each par-
ticipant according to its financial condition. The
net debit cap means the upper limit of daylight
overdraft, which each institution are not allowed
to exceed. There are two kinds of caps. The “single
day cap” is the maximum allowable overdraft on
any day. And the “two-week average cap” is the
Intraday Overdraft
(Uncollateralized, with fee)
USA
maximum allowable average of the peak daily
overdrafts in a two-week period.
Second, the Federal Reserve charges the
daylight overdraft fees to the participants. The
calculation of the fee depends on the usage of
negative balance of the Federal Reserve account
on a minute-by-minute basis. This minute-by-
minute counting system is intended to encourage
the participants to repay the overdraft as soon as
possible.
Third, if the overdraft is not repaid by the end
of the business day, the high penalty is imposed.
Besides, if an institution will fall into such a situ-
ation in a repetitive manner, the institution will
be prohibited from using the intraday overdraft.
The Federal Reserve monitors the usage of
intraday overdraft of each participant every min-
ute, using the “Daylight Overdraft Reporting and
Pricing System” (DORPS).
Revision of PSR Policy
In December 2008, the Federal Reserve Board
decided to revise its Payment System Risk (PSR)
policy. This revision was mainly designed to
improve the intraday liquidity management and
payment flows for the banking system. But it is
also targeted to mitigate the credit exposures of
the Federal Reserve Banks caused by the daylight
overdraft.
The main point of the revised PSR policy is
to approve a “voluntary collateral regime.” This
new approach was taken in order to encourage
99

the pledging of collateral to cover the daylight
overdrafts. The fee for the collateralized daylight
overdrafts is set to be zero, as with other major
central banks. On the other hand, the fee for the
uncollateralized daylight overdrafts is raised in
order to promote the collateralization.
The revised PSR policy took effect in March
2011. With the revision, the way of providing
intraday liquidity of Federal Reserve moved a
few steps closer to the method of other major
central banks.
Operating Hours of Fedwire
Extensions of Operating Hours
The operating hours of the Fedwire Funds Service
has been extended in several times. In December
1997, the operating hours was extended from
10 hours (from 8:30 a.m. to 6:30 p.m., Eastern
Standard Time <EST>) to 18 hours (from 0.30
a.m. to 6:30 p.m.).
Then, in May 2004, the Federal Reserve
brought forward the starting time of the Fedwire
to 9:00 p.m. of the previous day, which extended
the operating hours to 21 hours and 30 minutes.
Usually, a central bank payment system is
operated during the daytime, when transactions
are actively made in the financial market of the
country. The reason why the Federal Reserve ex-
tended the operating hours was to take measures
against the foreign exchange (FX) settlement risk.
Each currency is settled in the payment system
of the currency-issuing country, which inevitably
leads to the differences of settlement time. Where
Table 2. Operating hours of the Fedwire funds service (Source: Federal Reserve Financial Services, 2006)
On-line Participants
Opening 9:00 p.m.
Cut-off for customer payments 6:00 p.m.
Cut-off for interbank payments 6:30 p.m.
Note: All the time is in US Eastern Time (ET).
100
Payment Systems in US
there is a time difference in the exchange-for-value
settlement, there is settlement risk. The risk is
known as the “Herstatt risk” in the FX settlement
(see Chapter 3 for more detail).
Therefore, if the overlapping time of payment
system is established between the US and Asia-
Pacific countries, the USD and the Asia-Pacific
currencies could be settled in the same time zone.
That means that the FX settlement risk arising from
the time differences could be eliminated. Since
the USD is the key currency widely used in the
international trades and financial transactions, and
the time differences are biggest between the US
and the Asia- Pacific countries, the overlapping
time between the two areas is most beneficial.
The ultimate solution for this purpose must be
the “24-hour Fedwire,” which had been discussed
for a long time in the central banking society. The
current situation is not exactly 24 hours but very
close to it.
Current Operating Hours of Fedwire
The operating hours of the Fedwire Funds Service
begin at 9:00 p.m. (EST). During the three hours
from 9:00 p.m. to 0:00 a.m. (EST), the value date
of the settlement is regarded as the next day. As
9:00 p.m. in EST is 6:00 p.m. in Pacific Time
Zone, the payment instructions in San Francisco
after 6:00 p.m. (in Pacific Time) are handled as
the next day value payments.
The cut-off time for customer payments is set
at 6:00 p.m. And only the interbank payments
are available for the time zone from 6:00 to 6:30
p.m. (see Table 2). More specifically, only the
Off-line Participants
9:00 a.m.
5:30 p.m.
6:00 p.m.
Payment Systems in US
“settlement payment order” is possible from 6:00
p.m. to 6:30 p.m. A settlement payment order is
a payment order in which the originator and the
beneficiary are each other (i) a bank subject to the
reserve requirement of the Federal Reserve, or
(ii) a participant in a net settlement arrangement
approved by a Reserve Bank.
The operating hours for the off-line participants
are still limited from 9:00 a.m. to 6:00 p.m.
Other Services of Fedwire
National Settlement Service (NSS)
The Federal Reserve also provides the “National
Settlement Service” (NSS). The NSS allows
participants in the private-sector clearing arrange-
ments to exchange and settle transactions on a
multilateral basis through the designated “master
accounts” held at the Federal Reserve Banks.
There are approximately 40 clearing arrange-
ments using the NSS, including the check clearing
house associations, Automated Clearing House
(ACH) networks, and credit card processors.
The NSS provides an automated mechanism
for submitting the “Settlement Files” to the
Federal Reserve Banks. This scheme improves
operational efficiency and reduces settlement risk
Figure 2. Settlement scheme of national settlement service (NSS)
for participants by granting the settlement finality
on the day when the File is sent.
The NSS business day begins at 8:30 a.m. and
ends at 5:00 p.m. EST, Monday through Friday.
In this service, the “Settlement Agent” who is
the operator of clearing arrangement, calculates
the debit and credit balances as a result of the
clearing activities, and sends the balances as a
“Settlement Files” to the Reserve Bank.
When the Federal Reserve Bank receives a
Settlement File, it processes each “Debit Balance”
to the “Master Account” of the “Settler” who is
a participant of clearing activities and has an ac-
count at Reserve Banks.
The Debit Balances are debited from the Master
Accounts of the Settlers and the same amounts
are immediately credited to the “Settlement Ac-
count,” which is an account at Reserve Bank that
is used during the settlement processing to hold
funds temporarily until the settlement process is
completed.
Once all the debit processing is completed and
the Settlement Account has been fully funded, the
“Credit Balances” are debited from the Settlement
Account, and the same amounts are immediately
credited to the Master Accounts of the Settlers
with credit balance (See Figure 2). When the
settlement processing is finished, the balance of
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 Payment Systems in US

Table 3. Eligible securities for Fedwire securities service (Source: Federal Reserve Financial Services,
2009)

Type of Issuer Issuer

U.S. Treasury
Federal Government Agencies
Government Sponsored Enterprises
International Organization
Treasury Bills, Treasury Notes, Treasury Bonds
Department of Veteran Affairs, Financing Corporation, Tennessee Valley Authority (TVA), Resolution
Funding Corporation
Federal Home Loan Banks, Fannie Mae, Freddie Mac, Ginnie Mae, Farm Credit Bank, Farmer Mac,
Sallie Mae
African Development Bank, Asian Development Bank, Inter-American Development Bank, World Bank

the Settlement Account becomes zero. The credit
and debit processing is final and irrevocable when
processed.
The NSS is similar to the service that the
Federal Reserve has provided to the CHIPS. The
NSS was implemented in March 1999, by extend-
ing the local settlement sheet service provided by
each Reserve Bank. Since the NSS is a nationwide
service, the debit and credit processing among
multiple Federal Reserve Banks are also possible.
The average daily number of Settlement Files
was 60, and the average daily settlement value (dol-
lar value of debits only) was $66 billion in 2009.
Fedwire Securities Service
The Federal Reserve provides the “Fedwire Se-
curities Service” as well as the Fedwire Funds
Service. The Fedwire Securities Service consists
of a safekeeping function and a book-entry securi-
ties transfer function.
The safekeeping function involves an elec-
tronic storage of securities records in custody
accounts, that is to say, in a book-entry form. The
securities transfer function involves transfers and
settlements of securities between the securities
accounts of participants.
The Fedwire-eligible securities include the
securities issued by the US Treasury, other federal
agencies, Government-Sponsored Enterprises
(GSE), and certain international organizations,
such as the World Bank (see Table 3).
In this service, the business day begins at 8:30
a.m. and ends at 3:15 p.m. EST, Monday through
Friday. During these hours the participants can
originate online securities transfers.
The securities transfers can be made both in
the form of “free of payment” or “Delivery versus
Payment” (DVP). For the sake of safety, however,
most securities settlements are made in the DVP.
In the DVP settlement, the funds and securities
are exchanged simultaneously. Since the Fedwire
is a RTGS system, the Fedwire Securities Service
provides a real-time delivery-versus-payment
function that enables the participants to transfer
securities to other participants and simultaneously
receive funds for such securities. Once processed,
the securities transfers are final and irrevocable.
The Fedwire is a securities settlement system
as well as a fund settlement system. Some may
feel odd that central bank provides the securities
settlement service. As for the government bond,
however, it is not unusual that central bank pro-
vide the settlement service. Several central banks
in Asia including Japan offer the same kind of
securities settlement service. Moreover, many
European central banks provided the settlement
service for the government bond until late 1990s.
The central banks are involved in the government
bond settlement because the fund and government
bond is tightly linked each other. That is, the
government bond is the most suitable collateral
for the central bank money.
In 2009, approximately 2,300 participants
made the Fedwire securities transfers. The average

102
Payment Systems in US
daily volume of the transfers was 83 thousand,
and the average daily value of the transfers was
$1,173 billion in 2009. The average value per
transfer was $14 million in the same year.
CHIPS
The “Clearing House Interbank Payments System”
(CHIPS) is the Large-value payment system in the
US, along with the Fedwire. The CHIPS used be a
Designated-Time Net Settlement (DTNS) system,
where the settlements are made only at the end
of the day on a net-basis. In February 2001, the
CHIPS made a drastic change in the settlement
method. In the new scheme, the net settlements
are made continuously during the day. This new
scheme is known as the “CHIPS Finality,” and
the CHIPS became the Hybrid system as a con-
sequence of the reform.
In what follows, the outline of the CHIPS is
given, and after that, the way how this Hybrid
system works is discussed in detail.
Outline of CHIPS
Operator of CHIPS
The CHIPS started its operation in April 1970.
At that point, the operator was the “New York
Clearing House” (NYCH). In March 1998, the
Figure 3. Transition of Operator of the CHIPS
“Clearing House Interbank Payments Company
LLC” (CHIPCo) was established as an operating
company of the CHIPS, as an affiliated company
of the NYCH.
The NYCH was the oldest clearing house in the
US, established in 1853. The NYCH was originally
established in order to simplify the daily check
exchanges in New York City. Later it moved on to
the electronic funds transfer service, the CHIPS.
In November 2003, the NYCH merged with the
Chicago Clearing House, and changed its name to
“The Clearing House” (TCH). Then, the CHIPCo
became the subsidiary of the TCH.
In July 2004, the TCH published the stream-
lining plan, in which the TCH and five affiliated
companies2 were merged into a single payments
company with a single governing board. The name
of the new company was “The Clearing House
Payments Company LLC” (TCH Payments Co.).
The company is sometimes referred to as the
“TCH” or the “PaymentsCo” in short. The CHIPCo
became a part of the company. After the lengthy
past background mentioned above, the CHIPS is
now owned and operated by the TCH Payments
Co. (See Figure 3).
The TCH Payments Co. is owned by 19 private
banks which are primary users of the CHIPS. The
Board of the Company consists of 15 senior ex-
ecutives of the owner institutions. The Board of
TCH Payments Co. makes the strategic decision
of the company.
103

Payments Processed by CHIPS
The CHIPS processes the international USD pay-
ments, including the foreign trade transactions, the
FX transactions and the cross-border securities
transactions. Needless to say, most of them are
the large-value payments.
The CHIPS is the main channel of cross-
border payments in the USD. Over 95% of the
USD cross-border payments are processed by the
CHIPS. Recently, the Asia-related payments have
been growing, and the transactions to, from, or
within Asia represent 41% of the CHIPS volume
as of the end of 2009.
In the meantime, more and more domestic
payments are also becoming to be processed by
the CHIPS. This means that the homogenization
is going on between the CHIPS and the Fedwire.
Settlement Volumes of CHIPS
The CHIPS processed 337 thousand payments
average per day in 2009. The settlement volume
is on a scale of about 70% of the Fedwire.
The average daily value of transfer in the
CHIPS was $1,446 billion in the same year. The
Figure 4. Volumes and Values of the CHIPS (Source: TCH)
104
Payment Systems in US
settlement value is approximately 60% of the
Fedwire. Judging from these figures, the CHIPS
is the largest private payment system in the world.
The average value per transfer was $4.29
million in 2009. The average dollar amount per
payment is decreasing year by year, from $6.48
million in 1994. This trend suggests that the CHIPS
is attracting more and more customer payments,
most of which are the retail payments.
The total settlement values showed the con-
secutive decrease from 1998 to 2000. One of the
backgrounds of the decline was the adverse impact
of the Asian currency crisis in 1998. Another rea-
son was the introduction of the single currency
“euro” in January 1999. Before the introduction of
the euro, the legacy European currencies (Mark,
Franc, Lira, Peseta, and the rest) were traded each
other using the USD as an intermediary currency:
e.g. Mark to the USD and the USD to Lira. But
the legacy currencies were merged into a single
currency, and then the demand for the USD as a
“vehicle currency” was dropped out. After these
decreases, the settlement values of the CHIPS
moved back into the upward trend again (see
Figure 4).
Payment Systems in US
Participants of CHIPS
When the CHIPS started operation in 1970, the
participants were just 9 banks. From there, the
participants increased year by year, and reached
142 banks in 1985. After that, however, the number
of participants came to decrease gradually.
The primary cause was a number of successive
mergers among the US banks, especially between
the big banks. In addition, some foreign banks
withdrew from the USD settlement business as
part of the rationalization and cease the direct
membership of the CHIPS.
Hitting the bottom as 44 banks in 2007, the
number of participants began to recover and
became 50 banks at the end of 2010 (see Figure
5). The main force of the recovery was Chinese
banks. Three big Chinese banks participated in
the CHIPS in 2009. This fact shows the rising
economic power of China.
The CHIPS participants include the US com-
mercial banks and the foreign banks with the
offices in the United States. The nationality of the
CHIPS participants ranges over 22 countries
worldwide.
Figure 5. Participants of the CHIPS (Source: TCH)
Access to CHIPS
There are two ways for the participants to make
access to the CHIPS. One is to use the CHIPS’s
own dedicated network. Another is to use the
SWIFTNet, which is provided by SWIFT. Most
participants use the dedicated network in practice.
Payment Message of CHIPS
A CHIPS participant sends a “payment message”
to the CHIPS in a structured, computer-readable
format. The payment message includes some
information, including the dollar amount, value
date, sending participant, receiving participant,
beneficiary, originator and intermediary bank (See
Table 4). Some information fields are mandatory
to fill in and the others are optional.
Upon receipt of a payment message from the
participant, the CHIPS carries out a format check.
Any payment messages will be rejected, if they
do not pass the format check. Once the check has
been completed, the system will move the pay-
ment message to a “waiting queue” where the
payment messages will stay until the processing
is made.
105
 Payment Systems in US

Table 4. Information in Payment Messages of the CHIPS (Source: TCH, 2007)

Item €€€€€Information
Amount and Date Dollar Amount
Value Date
Sending and Receiving Participant Sending participant’s CHIPS identification number
Receiving participant’s CHIPS identification number
Intermediary bank identification
Beneficiary and Originator Beneficiary’s bank identification
Beneficiary identification
Originator identification
Originator’s bank identification
Instructing bank identification

Operating Hours of CHIPS Comparison between

The operating hours of the CHIPS is from 9:00
p.m. to 5:00 p.m. EST. During these 20 hours, the
participants can send and receive the payments.
The payments received from 9:00 p.m. to 0:00 a.m.
EST is handled as the next day value payments
as in the Fedwire.
The starting time is identical to the Fedwire,
which was moved forward from 0:30 a.m. to 9:00
p.m. in May 2004. This extension was in tandem
with the extension of the Fed’s operating hour.
Fedwire and CHIPS
Table 5 shows the comparison between the Fedwire
and the CHIPS. These are both the Large-value
USD payment systems, but there are some dif-
ferences in the settlement method, the operator,
the number of participants, the main transactions
processed, and the settlement volumes.
Situation Before CHIPS Finality
Traditional Settlement Method

The CHIPS had been operated as a typical “Des-

ignated-Time Net Settlement” (DTNS) system

Table 5. Comparison between Fedwire and CHIPS

Fedwire CHIPS
Method of settlement RTGS System Hybrid System
Operator Federal Reserve TCH Payments Company
(central bank) (private sector)
Number of participants approximately 7,300 48
Settlement Area across the US New York
Main transactions processed Domestic payments in US International payments
Federal Funds transactions Foreign trade transactions
Government bond Transactions Foreign exchange transactions
Commercial Payments Cross-border securities transactions
Settlement Volume 495 thousand 337 thousand
(Daily average, in 2009)
Settlement Value (Daily average, in $2,504 billion $1,446 billion
2009)

106
Payment Systems in US
until February 2001. To be more precise, the
participants sent payment orders to the CHIPS,
and once received, the CHIPS calculated the net
position of each participant during the day. And at
the end of the business day, the CHIPS informed
each participant of the final net position of the day.
The participants with the net debit position
should pay-in the net debit amount to the “CHIPS
Account” at Reserve Bank of New York by a cer-
tain time. This process was known as the “funding
stage.” When all the participants finished making
the pay-in and the funding stage is completed, the
CHIPS paid out the credit amount to each par-
ticipant with the net credit position. This process
was called the “payment stage” (see Figure 6).
In other words, the CHIPS collected the net
debit amount from the participants with the net
debit position, and distributed the net credit amount
to each participant with the net credit position.
The DTNS system is a zero sum system, in which
the total of the net debit positions and net credit
positions are identical. Therefore, the balance of
Figure 6. Traditional Settlement Method of CHIPS (until February 2001)
the CHIPS account became zero after finishing
the funding and payment stage.
Strengthening of Risk Management
The CHIPS had taken some measures to improve
the risk management of the DTNS system step by
step (See Table 6).
Same-Day Settlement
First, the CHIPS was a next-day settlement system,
where the final settlements among the participants
were executed at the next morning of the day. In
1981, the CHIPS moved to the same-day settle-
ment system, where the settlements are made at
the end of the day. This measure was taken in
order to eliminate the overnight risk that the net
creditors had for the net debtors.
107
 Payment Systems in US

Table 6. Strengthen of Risk Management in CHIPS (Source: Nakajima & Shukuwa, 2005)

Strengthen measures of risk management Substances

Same-day Settlement (1981)
Bilateral Net Credit Limit (1984)
Sender Net Debit Cap (1986)
Settlement Finality by Loss-sharing Rule
and Collateral Scheme (1990)
Lamfalussy plus One system by reinforce-
ments of Sender Net Debit Cap and Col-
lateral Scheme (1997)
To changeover from the next-day settlement to the same-day settlement.
To introduce Bilateral Net Credit Limit, which is the limit on the net credit exposure a participant
incurs vis-à-vis another participant. This is to limit the net credit position between two parties.
To introduce Multilateral Net Debit Cap, which is a limit on the net debit amount a participant
can bear to the CHIPS. The Cap was set to be 5% of the sum of Net Credit Limit a participant
obtained from other participants. This is to reduce the risk exposure of the CHIPS as a whole.
To introduce the Loss-sharing Rule and Collateral Scheme in order to ensure the timely completion
of daily settlement, even if the participant with the largest single net debit position is unable to settle.
The Loss-sharing Rule stipulated that the surviving participant should bear the loss on a
pro-rata basis of net credit limit for the defaulting party. The loss-sharing amount was called
“Additional Settlement Obligation” (ASO). Each participant was obliged to pledge the collat-
eral equivalent to 5% of ASO to the collateral account at Federal Reserve Bank of New York.
The “Settlement Finality” was ensured by these two measures, even in case of the default of
the participant with the largest net debit position.
The system-side rate to calculate the Sender Net Debit Cap was reduced from 5% to
3%. While, the Collateral Scheme was reinforced by introducing the minimum collat-
eral amount of 10 million dollar, and by raising ASO calculating rate from 5% to 5.1%.
With these two reinforcements, the CHIPS became the Lamfalussy plus One system, which could
stand for the defaults of top two participants with largest net debit position on the same day.

Bilateral Net Credit Limit
Second, the CHIPS introduced the “Bilateral
Net Credit Limit” in 1984. Each participant was
obliged to set up the Limits on the net credit expo-
sure that it allowed vis-à-vis another participants.
The Limit was to confine credit risk bilaterally
between the participants.
Sender Net Debit Cap
Third, the “Sender Net Debit Cap” was introduced
in 1986. The Cap was a limit on the net debit
amount that a participant could hold vis-à-vis the
CHIPS. The Cap was set to be 5% of the sum of
the Bilateral Net Credit Limit a participant ad-
mitted from the other participants. This Cap was
introduced in order to confine the risk exposure
of the CHIPS to all the participants in total.
Achievement of Settlement Finality
Fourth, the “Loss-sharing Rule” and the “Col-
lateral Scheme” were introduced in 1990. These
two schemes were brought in to ensure the daily
settlements to complete in a timely manner, even
if the participant with the largest single net debit
position will become default.
The “Loss-sharing Rule” prescribed that the
“surviving participants,” i.e. the other participants
than the default participant, should bear the loss
jointly. The share of the losses is not equal among
the surviving participants, but on a “pro-rata basis”
which is based on the Net Credit Limit amount
each participant admitted to the defaulting party.
That meant that if a participant admitted the larger
Net Credit Limit to the defaulter, then it will bear
the larger shares of the losses.
The loss-sharing amount was called “Ad-
ditional Settlement Obligation” (ASO). In the
“Collateral Scheme,” each participant was obliged
to pledge the collateral which was equivalent to
5% of ASO. The collateral was to be provided to
the CHIPS’s “Collateral Account” at the Federal
Reserve Bank of New York.
With these two measures, the CHIPS achieved
the “Settlement Finality,” which means that the
settlement can be accomplished in a timely manner,

108
Payment Systems in US
even if the participant with the largest net debit
position will be unable to settle.
Advancement to Lamfalussy
Plus One System
Finally, the Sender Net Debit Cap and the required
collateral were tightened up in 1997. With these
measures, the CHIPS reached the minimum
standard of Lamfalussy standards and become
a “Lamfalussy Plus One System.” This meant
that the CHIPS could withstand the coincidental
defaults of top two participants with the largest
net debit positions on the same day (See Chapter
7 for more detail).
CHIPS Finality
Introduction of CHIPS Finality
In February 2001, the CHIPS changed the settle-
ment method drastically. This new method is
known as the “CHIPS Finality.” The remarkable
features of the CHIPS Finality are; the settle-
ment is made, (i) in real-time basis, (ii) with the
continuous matching, and (iii) on a net basis.
The most important outcome of these features
is that the payments have the “intraday finality”
during the day.
The main points which delivered the risk
reduction were as follows:
The first point was the scheme of “prefunding.”
In this scheme, each participant should pay-in
the amount necessary for the settlement of the
day to the CHIPS Account before the start of the
settlement processing. Second, the processing of
payments will be executed only within the balance
of each account, which means that any negative
balances are not permissible in the CHIPS.
In other words, the CHIPS Finality is the
payment system of prefunding type, where the
safety is ensured by paying-in the necessary fund
in advance. The prefunded funds are sometimes
referred to as the “security deposit” because the
fund is already secured in the system.
Initial Prefunded Balance
The CHIPS holds the “Prefunded Balance Ac-
count” at the Federal Reserve Bank of New York
(FRBNY). Each day, each CHIPS participant is
required to pay-in a predetermined amount (the
“opening position requirement”) to this account.
Once paid-in, the amount is recorded as the “Initial
Prefunded Balance” of each participant.
When an additional liquidity is necessary
for the smooth settlements, each participant can
make additional pay-ins of funds during the day
to increase the Prefunded Balance, which is called
the “Supplemental Funding.” There is no limit
on the amount of Supplemental Funding, and the
participants are able to add supplemental funds
throughout the day until the closing time of the
system.
On the other hand, when the liquidity is more
than enough, each participant can withdraw of
funds from the Initial Prefunded Balance during
the day, which is called the “Withdrawal.” The
amount of Withdrawal should be less than the
amount of the Supplemental Funding.
Available Balance
The “Available Balance” of each participant is
calculated by adding Initial Prefunded Balance
with all the incoming and outgoing payments, and
the Supplemental Funding and Withdrawal (see
Table 7). The Available Balance is also referred
to as the “Current Position” of each participant.
Table 7. The relationship between initial prefunded
balance and available balance
Available Balance
= Initial Prefunded Balance
+ Daytime Incoming and Outgoing Payments
+ Supplemental Funding and Withdrawal
109

The Available Balance is a record on the sys-
tem book of the CHIPS. When a participant makes
a pay-in for the Initial Prefunded Balance, the
balance is recorded as an “Opening Position” of
the participant. Following the recording of a
participant’s opening position, the CHIPS system
will change the Current Position of each partici-
pant to reflect all the processing of incoming and
outgoing payments throughout the day.
Pay-in to Prefunded Balance Account
The pay-in to the Prefunded Balance Account is
made through the Fedwire. That means the fund
is transferred from the participant’s account at the
Federal Reserve Bank to the Prefunded Balance
Account of the CHIPS. In case that a participant
does not have an account at the Federal Reserve
Bank, the participant can have the other bank to
pay-in on behalf of itself, which holds the account
at the Federal Reserve Bank.
The participant who makes pay-in by itself
is called the “Funding Participant.” And the
participant who outsources the pay-in procedure
to other bank is referred to as the “Non-funding
Participant.”
The required amount of the opening position
is recalculated by the CHIPS for each partici-
pant periodically at least once each month. The
calculation is based on the volume and value of
the sending payments of each participant. The
new Initial Prefunded Balance is calculated and
informed at the weekend and applied from the
beginning of the next week.
Unless all the participants complete the pays-in
of the required amounts to the Prefunded Balance
Account, the CHIPS will not start the processing
of payment orders. The pay-in to the Prefunded
Balance Account starts at 9:00 p.m. EST which
is the opening time of the Fedwire, and should
be completed by 9:00 a.m. (by 7:00 a.m. on the
day after holiday).
110
Payment Systems in US
Conditions for Processing of Payments
The CHIPS keeps a separate record of each
participant’s Current Position. When a payment
order is processed, an amount is deducting from
the sending participant’s Current Position and the
same amount is added to the receiving participant’s
Current Position. The deducting and adding are
deemed to be processed at the same time, which
is called the “Simultaneous Processing.”
There are two conditions which are necessary
to start the processing of payments. No payment
message will be processed, unless the situation of
both sending participant and receiving participant
meet these two conditions.
The first condition is that the Available Balance
of the sending participant will not become less
than zero after the processing of the payment. This
condition is called the “Minimum Position Limit.”
The second condition is that the Available Bal-
ance of the receiving participant will not exceed
an amount equal to twice of its opening position
(Initial Prefunded Balance) after receiving the
payment. This condition is called the “Maximum
Position Limit.”
The first condition is set in order to avoid
creating credit risk among participants, which the
ordinary net settlement systems inevitably retain.
The second condition is set in order to prevent
the situation of liquidity imbalance in the system,
which leads to deteriorate the settlement efficiency
of the CHIPS. More concretely, if a great deal
of liquidity in the CHIPS concentrates on only a
handful of participants, the other participants will
suffer from a lack of liquidity and the process-
ing of payments from these participants will be
hampered. This condition is set in order to avoid
such a situation of maldistribution of liquidity in
the system.
With these two conditions, the Available Bal-
ance of each participant changes from moment
to moment between zero and a twice of its Initial
Prefunded Balance (see Figure 7).
Payment Systems in US
Figure 7. Minimum Position Limit and Maximum Position Limit
Input of Payment Orders
In order to ensure the smooth processing of pay-
ments, each participant are obliged to input more
than 65% of payments of the day in volume, and
more than 55% of payments in value by 12:00 p.m.
A participant can send a pressing payment order
with two kinds of preference flags: the “urgent
flag” and “preferred flag.” The urgent payment
messages are processed before the preferred pay-
ment messages, and the preferred payment mes-
sages are released before the non-priority payment
messages. With the exception of the general rule,
the urgent and preferred payment messages can
be processed without consideration of Maximum
Position Limit of the receiving participant.
A participant is able to change the status of
payment message, e.g., from the non-priority to
the preferred payment, from the preferred to the
urgent payment and vice versa, only when the
payment is not yet processed. A participant also
can cancel the payment messages which are not
yet processed.
The “CHIPS Online Cash Management Tool”
allows each participant to know the Available Bal-
ance and payment messages waiting in the queue
in real time. With this Tool, a participant also can
assign and change the status of payment orders.
Three Processing Methods
of Payments
The core system for the CHIPS Finality is called
the “Balanced Release Engine,” which takes
charge of the matching, netting and processing
of payment orders.
When the CHIPS receives a payment order, it
is once stored in the “waiting queue.” Payment
orders which satisfy two conditions of the Maxi-
mum Position Limit and Minimum Position Limit
are picked up from the queue, which is called
“released,” and processed.
There are three processing methods to handle
the payment orders in the CHIPS Finality.
Individual Release
The first one is called the “Individual Release,” in
which a payment order is processed individually.
In this Release, the CHIPS decrease the Available
Balance of the sending participant and increase
the Balance of the receiving participant by the
amount of the payment order. The recording of
decrease and increase of each Balance is deemed
to be effective simultaneously. The way of pro-
cessing of Individual Release is quite similar to
that of the RTGS system.
111
 Payment Systems in US

Bilateral Release Concrete Descriptions of Three

The second method comes when the Individual
Release is not applicable, which means either
(or both) of the two conditions is not satisfied to
process a payment order individually.
In this case, the payment orders between the
two participants (e.g., the payments from Bank
A to Bank B, and the payments from Bank B to
Bank A) are picked up and netted. Then the net
amount, the “bilateral net balance,” is calculated.
If the processing of the bilateral net balance sat-
isfies the two conditions, the system makes the
debit and credit processing of the net amount to
each Available Balance. This processing method
is referred to as the “Bilateral Release.”
Multilateral Release
When both the Individual Release and Bilateral
Release are not applicable, the third method is
applied. In this case, the payment orders among
more than two participants (e.g., Bank A, Bank B
and Bank C) are picked up and netted. Then the
net amounts, the “multilateral net balances” are
debit and credit to the Available Balances of the
involved participants. This method is referred to
as the “Multilateral Release.”
Kinds of Releases
Some examples are given here as concrete descrip-
tions of three kinds of Release as mentioned above.
Example of Individual Release
Assume that the Available Balance of Bank A is
$10 million and the Balance of Bank B is $8 mil-
lion, and that Maximum Position Limit of each
bank is $20 million.
If Bank A sends a payment order of $3 million
to Bank B under this situation, the payment order
is processed immediately and individually because
the outcome of the Balances of both Bank A and
Bank B will fall within the Maximum Position
Limit and Minimum Position Limit. The Balances
after processing of the payment order become $7
million for Bank A and $11 million for Bank B
(see Figure 8).
Example of Bilateral Release
Assume that the Available Balances of participants
are close to the Maximum Position Limit. In the
example of Figure 9, the Balance of Bank B is
$25 million and close to the Maximum Position
Limit of $30 million. If the payment orders from
Bank A to Bank B are processed individually, the

Table 8. Three processing methods of CHIPS finality

Processing Method Contents

Individual Release A payment order is processed individually.
e.g., a payment order from Bank A to Bank B is processed individually.
Bilateral Release The payment orders between two participants are netted and the net balance is processed in a batch.
e.g., The payment orders between Bank A and Bank B are netted, and the “bilateral net balance” is
debit from and credit to each Available Balance.
Multilateral Release The payment orders among more than two participants are netted and the net balances are processed
in a batch.
e.g., The payment orders among Bank A, Bank B and Bank C are netted, and the “multilateral net
balances” are debit from and credit to each Available Balance.

112
Payment Systems in US
Figure 8. Example of individual release
Balance of Bank B will exceed the Maximum
Position Limit.
In this case, the payment orders from Bank A
to Bank B and the payment orders from Bank B
to Bank A are netted by the Bilateral Release, and
the “bilateral net balance” is processed in a batch.
In consequence, $1 million is debited from the
Balance of Bank A and $1 million is credited to
the Balance of Bank B simultaneously (see Figure
9).
Figure 9. Example of bilateral release
By using the bilateral netting method, the
exceedance of the upper limit of Bank B can be
avoided.
Example of Multilateral Release
Assume that the Available Balance of each par-
ticipant is rather low, and the Balance of sending
participant will become less than zero if payment
orders are processed individually or bilaterally
netted.
113

Figure 10. Example of multilateral release
In this case, the payment orders of more than
two participants (e.g., Bank A, Bank B and Bank
C) are picked up, and netted multilaterally. If the
“multilateral net balances” satisfies the two condi-
tions of the involved participants, the net balances
are debited from or credited to the Balance of each
participant (see Figure 10).
Real-Time Finality and High Efficiency
of Fund
By the combination of three processing methods
(Releases) mentioned above, almost all of the
payment orders are processed within 15 seconds
in the CHIPS. Therefore, the TCH Payments Co.
describes the way of settlement in the CHIPS as
the “Real-Time Netting.” And it explains that the
CHIPS settlement has the “real-time finality.”
However, it possibly will take more than several
hours to process a payment order, in the case of
liquidity shortage on the account of the sending
participant. Thus, strictly speaking, so-called the
“real-time finality” in the CHIPS is quite different
from that of the RTGS system.
In the CHIPS, the settlement value of the day
is around 600-700 times of the Initial Prefunded
Balance, the opening position. In concrete terms,
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Payment Systems in US
the CHIPS transfers an average total value of
about $2 trillion a day, with only $3 billion in
prefunding. This ratio of the opening position to
the daily settlement value is significantly better
than other payment systems. For example, this
figure is reported to be approximately 12 times
in the Fedwire.
This means the CHIPS achieves the high ef-
ficiency of funds, which is highly beneficial to
the participants. Stated another way, a participant
can make a large value of payments with a small
liquidity utilizing these three processing methods
of the CHIPS Finality.
End-of-Day Closing Procedure
As mentioned above, almost all of the payments
are processed in a very short time during the day.
However, some payments3 possibly continue to
stay in the queue until the cut-off time (5:00 p.m.)
of the system, mainly because of the liquidity
shortage of the sending participant.
In that case, the CHIPS carries out the “End-
of-Day Closing Procedure,” which intends to
process as many payment messages as possible.
The Closing Procedure is made in the following
four stages.
Payment Systems in US
First Stage: Remove the
Maximum Position Limit
When it becomes 5:00 p.m., the cut-off time, the
CHIPS closes the system for receiving payment
orders. At this time, the system tries to process
as many unsettled payment orders as possible by
lifting the Maximum Position Limit. In contrast,
the Minimum Position Limit is still valid.
Second Stage: Calculation
of Closing Positions
If any payment messages still remain in the queue
after the first stage, the CHIPS will calculate the
“multilateral net balance” as for the all the un-
settled payments in the queue. This is a kind of
provisional calculation, and no actual processing
of payments is executed.
The resulting multilateral net balance for each
participant will be combined with the participant’s
Available Balance to calculate the “Closing Po-
sition” (see Table 9). The CHIPS informs each
participant of the Closing Position with Initial
End-of-Day Balance Report. If the Closing Posi-
tion is negative (less than zero), the participants
are required to pay-in the funds to make up the
negative position, which is called the “Closing
Position Requirement.”
Third Stage: Final Prefunding
Each participant with a negative Closing Position
should pay-in the amount of its Closing Position
within 30 minutes from receiving the Balance
Report. This process is referred to as the “Final
Table 9. Example of closing position
Available Balance + Multilateral Net Position of Unsettled
|. Payments
$ 30 million
△ $ 50 million
Prefunding.” That is to say, the participant with
negative position should pay-in the funds to the
Prefunded Balance Account at the FRBNY.
Fourth Stage: Two Scenarios
Two scenarios are possible after the third stage
or the Final Prefunding.
If all the participants with the negative Closing
Position successfully make the required pay-in
within 30 minutes, all the unsettled payments in
the queue are processed and settled. This scenario
is known as the “Full Final Prefunding,” where
all the settlements are accomplished.
If one or more participants with the negative
Closing Position are unable to make the requested
fund transfer within 30 minutes, the system will
match, net and process as many payments in the
queue as possible, using the Available Balance
and Additional Funding. This scenario is called
the “Partial Final Prefunding.”
If there are any payment messages remained as
unsettled in the queue after the processing of Partial
Final Prefunding, these payments are treated as
“expired,” and the CHIPS notify the expiration
of the payments to the sending participant. If the
expiration of payments happens by any possibility,
the participant can re-route the payment through
the Fedwire or correspondent banking relationship.
The effect of expiration is quite limited because
only the limited number of payments could be
expired and they can be recovered by re-routing.
Furthermore, it is worth mentioning that there are
neither the unwinding nor loss-sharing in any case,
both of which are the system-wide incidents and
affect many participants of the system.
= Closing Position
|.
| △ $ 20 million
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Pay-Out Procedure
After all the payment orders have been processed
or have expired, the CHIPS makes a “pay-out”
procedure. That is to transfer the funds through
the Fedwire from the Prefunded Balance Account
to the participants’ accounts with the positive
closing position (greater than zero).
The total amount of pay-out is equal to the
final balance at the Prefunded Balance Account.
Eventually, the balance of the Prefunded Balance
Account becomes zero after all the pays-out.
CHIPS’s Schedule of the Day
Table 10 summarizes the CHIPS’s settlement
schedule of the day, as described above.
Merit of CHIPS Finality
By introducing the CHIPS Finality, the risk man-
agement of the CHIPS changed substantially. In the
traditional DTNS scheme, the un-settled payment
orders were accumulated during the day, which
lead to settlement risk. In order to reduce such
risk, the CHIPS had introduced several counter-
measures, such as the net credit limit, debit cap
and loss-sharing rule.
Table 10. CHIPS’s schedule of the day
Period of Time Processing
From 9:00 p.m. (of the previous day) to Pay-in
9:00 a.m.
From 9:00 a.m. to 5:00 p.m. Processing of Payments
From 5:00 p.m. End-of Day Closing Procedure
Around 5:30 p.m. Two Scenario
After the Final Prefunding Pay-out
(Note): Time is in US Eastern Time.
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Payment Systems in US
In the CHIPS Finality, however, settlements
are made continuously and in near real-time
basis, which will prevent the accumulation of
the unsettled payments. In the new scheme, the
intra-day finality became reality.
Therefore, with the introduction of the CHIPS
Finality, the CHIPS abolished the whole risk
management measures, including the Loss-sharing
Rule, Collateral Scheme, Bilateral Net Credit
Limit and Sender Net Debit Cap. The participants
became completely free from the burden of such
risk management measures.
Remittance Information
on Wire Transfer
Customer Transfer Plus (CTP)
The CHIPS is planning to introduce a new message
format to support business remittance information,
in tandem with the Fedwire. This new message
format is called the “Customer Transfer Plus”
(CTP) and will be implemented in November
2011. The key point of the CTP message is that
the participants of the CHIPS and the Fedwire can
add and send the remittance information with a
payment order.
Contents
Each participant are obliged to pay-in the required
amount to the Prefunded Balance Account.
Payments are processed by three methods with the limi-
tation of Minimum Position and Maximum Position.
1) Remove the Maximum Position Limit
2) Calculation of Closing positions
3) Final Prefunding
1) Full Final Prefunding: all the settlements are com-
pleted.
2) Partial Final Prefunding: some payments are treated
as expired.
The CHIPS transfer the funds to the participants with
positive closing position.
Payment Systems in US
The “remittance information” is the additional
details of fund transfer related to the underlying
commercial payment being settled. To send the
remittance information with a payment order
is referred to as the “Financial Electronic Data
Interchange” (“Financial EDI”).
The ultimate benefit of the Financial EDI is that
the beneficiary is able to know the details of the
payment. When getting the details of payments,
the suppliers (payees) can automatically reconcile
the payments received from the customers (pay-
ers). It will bring significant streamlining of rec-
onciliation process by introducing the automatic
reconciliation, which leads to the elimination of
data entry errors by manual handling.
Two Sequences of the
Payment Message
The new CTP message has two “Sequences,”
the groups of information: the Sequence A and
Sequence B. The “Sequence A” is for the core
payment messages which include the sending par-
ticipant, receiving participant, payment amount,
originator, beneficiary, and routing information.
The “Sequence B” is for the addenda information
up to 9,000 characters. The Sequence B is set to
support the remittance information4, such as the
contents of invoice or bill number.
The participants have an option whether or not
to use the new CTP message when sending pay-
ments. However, all the participants of the CHIPS
will be required to be able to receive the CTP
message and to ensure that the internal systems
can handle the new message format.
Data Elements of Financial EDI
The CHIPS (and also the Fedwire) basically sup-
ports the two data elements in the Sequence B:
the “EDI STP 820” and “ISO 20022.”
The “EDI STP 820” is an electronic file format
that establishes the data content of the payment
order/remittance advice transaction set within the
context of an EDI environment. This format was
developed by the Electronic Payments Network
(EPN), which was the operator of the “Automated
Clearing House” (ACH, to be described later).
Therefore, this format can be regarded as the US
national standard for remittance information.
On the other hand, the “ISO 20022” is a uni-
versal financial industry message scheme prepared
by the Technical Committee (TC) 68 of the Inter-
national Organization for Standardization (ISO).
The ISO 20022 standard provides the financial
industry with a common platform for the develop-
ment of messages in a standardized “eXtensible
Markup Language” (XML). The ISO 20022 coves
a wide range of financial services, including the
payments, securities, trade services, FX trades,
and cards. Of these, the customer credit transfer
standard which includes the structured remittance
information is used in the CTP message.
In addition to the two standard data elements,
several local formats are allowed to use in the
CTP message. These are the UEDI, the ANSI,
the IXML, the GXML, the NARR and the S820.
When using these local formats, the senders and
receivers should agree how to use the free text
of 9,000 characters in advance. The CHIPS (and
Federal Reserve Banks) will not be validating
against these standards.
Background of CTP
The Federal Reserve Banks and the TCH con-
ducted a research5 in 2006 to examine the corporate
demand for the structured remittance information
in the “wire transfer,” which means the CHIPS
and Fedwire.
From this comprehensive research, it was con-
cluded that the corporates had a clear preference
for including structured remittance information as
part of payment message in wire transfer in order
to eliminate the existing inefficiencies. The key
findings showed that 94 percent of respondents
said it was ‘valuable’ or ‘very valuable’ for the
117

wire transfer to include the remittance information
in the payment messages.
And, importantly, these companies are willing
to pay for such efficiencies. The findings showed
that 58 percent of the respondents said they were
willing to pay additional amount for the wire
transfers that include the remittance information.
On average, the respondents indicated that they
would be willing to pay additional $1.67 for pay-
ments that include the remittance information.
According to the estimate of the TCH and
Federal Reserve Banks, if only 2 percent of the
corporate check volume moved to the wire transfer,
the wire volume will increase by 47 percent. It
will be a remarkable increase of the wire transfer
business, if it will possibly happen.
Most corporates found the check payments
quite inefficient and have tended to move to the
ACH payment. However, there will be a potential
demand for some high-value items to move to the
wire transfer because of the speed and security
of the CHIPS and Fedwire. To add a capability
of remittance information is a way to meet such
a potential needs and to migrate the high-value
payments from the check payments to the wire
transfer. Being a project for the improvement of
convenience for the participants of the wire trans-
fer, this is a business decision under a competitive
environment between the ACH and wire transfer.
ACH
Outline of ACH
Role of ACH
The “Automated Clearing House” (ACH) is a retail
payment system in the US. The ACH payments
include the payroll, social security benefits, tax
refunds, and bill payments for utilities, mail order
and internet shopping, and business-to-business
payment. While the ACH handles huge volume of
payment orders, the average amount of which is
118
Payment Systems in US
rather small. More than 15,000 depository finan-
cial institutions originate and received 15.2 billion
ACH payments in 2009. The average amount of
ACH payment was about $2,000.
The ACH services include both a credit transfer
service and a debit transfer service.
There are two operators of the ACH in the
US: the Federal Reserve Banks (hereinafter
referred to as the FedACH) and “The Clearing
House Payments Company LLC” (hereinafter
TCH Payments Co.). The FedACH is operated
by the central bank and the TCH Payments Co.
is a private-sector operator.
The ACH is operated according to the operat-
ing rules established by the “National Automated
Clearing House Association” (NACHA). The
NACHA represents nearly 11,000 financial in-
stitutions through 18 regional payments associa-
tions and direct membership. The NACHA is a
non-profit association, established in 1974. The
NACHA provides the rules and guidelines, edu-
cational service, and member communications. It
also develops the new payment applications and
provides the marketing and promotion activities.
The settlement of ACH payments is executed
on the next morning of the day that the ACH re-
ceived the payment files, which means the ACH
is the Next-day settlement system (see Chapter
2 for more detail).
History of ACH
The concept of the ACH came up in the late 1960s,
when it seemed that the increasing volume of the
paper checks used by businesses and consumers
will exceed the processing capacity of financial
institutions.
The first ACH in the US was the “Calwest-
ern Automated Clearing House Association”
(CACHA) in California. The CACHA started
operation in October 1972, using the computer
processing service of the Federal Reserve Bank
of San Francisco. Following the CACHA, many
local ACH associations began ACH service with
Payment Systems in US
the help of local Federal Reserve Bank which
provided the facilities, equipment, and staff to
operate an ACH. At this stage, the ACH was the
local service among the depository institutions
in a specific area.
In 1974, the NACHA was formed by several
regional ACH associations to develop the uni-
form rules and standard formats to establish the
nationwide clearing network of ACH payments.
At an early stage, the ACH system relied on the
magnetic tapes and diskettes to exchange the ACH
files which contained a number of payments.
This file exchange method required the physical
transport of the tapes and diskettes between the
participants and ACH.
By the end of 1978, arrangements were made
between the New York Clearing House (NYCH,
became the TCH later), the NACHA and the Fed-
eral Reserve Banks to implement an inter-regional
exchange system. Then, the ACH became the
nationwide network.
In 1994, the Federal Reserve mandated that
all ACH payment files should be deposited elec-
tronically and all output files will be delivered to
the participants electronically. That is to say, all
depository institutions dealing with the Federal
Reserve directly were required to have an elec-
tronic link through the computers and networks.
Until 1996, the Federal Reserve integrated the
local ACH services into a nationwide service and
the computer center was also consolidated into a
single center.
Operators of ACH
As mentioned above, there are two ACH opera-
tors in the US.
Federal Reserve Banks
It is a distinctive characteristic of the US that
central bank is directly and deeply involved in
the retail payment. In other industrial countries,
central bank tends to leave the retail payment area
to the private sector and is not directly involved.
There was a historical background behind it.
When the establishment of the ACH was discussed
in the industry in the late 1960s, the Federal
Reserve participated in the early discussions and
offered to provide the computer systems and staff
necessary for the ACH service. Right from the
start, the Federal Reserve had a deep involvement
in the ACH operations.
The ACH service of the Federal Reserve is
referred to as the “FedACH.” All the government
payment is made through the FedACH. The Fe-
dACH handles approximately 70% of the ACH
payments in the US.
TCH Payments Co.
“The Clearing House Payments Company” (TCH
Payments Co.) is a sole private-sector operator
of the ACH6. It became the first private-sector
ACH operator in 1975. At this time, it was called
the “New York Automated Clearing House”
(NYACH) as an affiliated business of the New
York Clearing House (NYCH) which handled the
check clearing.
In March 1998, the “Small Value Payments
Company LLC” (SVPCo) was established to gov-
ern and operate small value payment. The SVPCo
carried on the electronic check presentment and
the ACH operation.
In April 1999, the NYACH changed its name
to the “Electronic Payments Network” (EPN). It
was a step to reconstitute as a national ACH from
the local ACH in NY area. In October 2000, the
“Electronic Payments Network LLC” (EPN LLC)
was established as a subsidiary of the SVPCo.
In July 2004, “The Clearing House Payments
Company LLC” (TCH Payments Co.) was es-
tablished, and the EPN LLC was merged into
the Company with other four affiliated company.
Through this streamlining process, the TCH
Payments Co. provides the ACH service, along
119

with the CHIPS service, check clearing, and
electronic check clearing.
Scheme of ACH
The ACH executes the batch-processing of files
which contains payment messages. As the files
are processed by the store and forward method, a
payment messages is not processed individually,
unlike the Large-value payment system.
This section gives an explanation about the
scheme of ACH in the case of the credit transfer
(see Figure 11).
1. The Originator and Receiver should make
an agreement beforehand that payments will
be made through the ACH.
2. The Originator sends the payment orders
in an electronic file to the “Originating
Depository Financial Institution” (ODFI).
3. The ODFI puts together the files from a
number of customers as the “ACH payment
file” and sends the file to the ACH. The
closing time of the FedACH is 14:15.
Figure 11. Scheme of the ACH (credit transfer)
120
Payment Systems in US
4. The ACH sorts out the payment orders to
create a separate “output file” for each de-
pository institution, and distributes the file
to each “Receiving Depository Financial
Institution” (RDFI). The FedACH sends the
file to each participant four times a day.
5. The RDFI receives the payment file from
the ACH, makes credit processing to the
Receiver’s account, and makes a credit
advice to the Receiver.
Transaction Volumes of ACH
Growth Rate of ACH Traffic
From 1990s, the transaction volumes of the
ACH kept the strong growth of more than 10%
consistently. It was followed by the sharp decline
during 2008-2009 (see Figure 12). The volume
of the network ACH transaction (excluding the
on-us volumes) in 2009 was 15.3 billion, which
was about 2.5 times of 2001.
Some of these transaction volumes were con-
sidered to be shifted from the paper check. Re-
flecting such a conversion, the paper check volume
Payment Systems in US

Figure 12. ACH transaction volume (Source: NACHA)

has declined significantly. According to the survey
of the Federal Reserve, the number of checks paid
in the US has fallen from 42 billion in 2001 to 37
billion in 2003, and to 30 billion in 2006.
It is worth mentioning that the growth rate of
ACH transactions in 2009 was only 2%, which
was the lowest in the last 20 years. It was because
of the overall slump of the US economy due to
the global financial crisis.
Debit and Credit Transfers in ACH
The credit transfers accounted for 36% of ACH
volume, while the debit transfer volumes made
up 64% in 2009. The proportion of debit transfers
Figure 13. Commercial and government payments
in ACH (Volumes in 2009) (Source: NACHA)

Commercial and Government

Payments in ACH

The commercial sector (companies and indi-

viduals) uses the ACH for the deposit of payroll,
payment for utility bill, loan payment, and so on.
The federal government also uses the ACH for the
social security benefits, pensions and payments
for public works. The government payments made
up 7.9% of the ACH network volume in 2009 (see
Figure 13). The rests, 92.1% of the volume are
the commercial payments.

121
 Payment Systems in US

Figure 14. Debit and credit transfers in ACH

has been increasing from 41 percent in 2001 (See
(Volumes in 2001 and 2009) (Source: NACHA)
Figure 14).

On-Us Payments in ACH

When both the originator and beneficiary have

the accounts at the same deposit institution, the
ACH-formatted payments remain within a single
institution and will not be sent to the ACH. This
kind of payments are known as the “on-us pay-
ments” and sometimes called the “off-network
payments.” The on-us payments are executed as
the internal settlements in a bank, and accounted
for 18.7 percent of all the ACH volume in 2009.

Concentration of ACH Usage

The top 50 originating institutions accounted for

88.3 percent of all the network ACH payments
in 2009. The top five originating institutions ac-
counted for 61.9 percent of all the ACH payments
(see Figure 15).
On the receiving side, the top 50 banks made
up 55.6 percent of payment volume. And the top
5 receiving institutions accounted for 31.1 percent

Figure 15. Concentration of ACH usage (Originating Institution, in 2009) (Source: NACHA)

122
Payment Systems in US
of the volume. The degree of concentration was
much higher in the originating side.
Both on the originating and receiving side,
the big banks have a sizable proportion, which
suggests the concentrated account structure of
the companies and individuals.
Basic Services of ACH
The basic services of the ACH are referred to as
the “Direct Deposit” and the “Direct Payment.”
The Direct Deposit is a credit transfer service.
And the Direct Payment is a debit transfer service,
especially for the recurring bill payment, such as
the telephone and utilities.
Direct Deposit
The “Direct Deposit” is a credit transfer service
which allows a company to credit the accounts
of its employees, customers, and beneficiaries
with funds due to them. Direct Deposit is often
used for the deposit of payroll. It is also used to
distribute funds of the healthcare, benefits and
pensions. In addition, a consumer can make bill
payments for the mail order shopping or internet
shopping through the Direct Deposit.
Direct Payment
The “Direct Payment” is a debit transfer service
which is typically used for a recurring bill pay-
ment. At the outset, a consumer should give the
originating depository institution or Originator
(e.g., mobile-phone company) an authorization
to debit his/her account on a regular basis. Then,
the funds are debited from the consumer’s account
automatically at a certain time (e.g., every month)
according to the authorization.
Typical payments of the Direct Debit include
the utility payments, mortgage/rent, automobile
loan payments, charitable contributions, insurance
premiums, membership dues, tuition payments,
and nonprofit organization fees. It is the most
convenient way for the Originator to collect funds
from a significant number of customers.
Settlement Procedures of
ACH Transactions
The interbank settlement regarding the ACH trans-
action is made among the accounts at the Federal
Reserve Banks. Unlike the CHIPS and Fedwire,
the ACH payments are processed on Day 1, but
the settlements for those payments are executed
on Day 2 or Day 3.
Settlement of FedACH Transactions
The settlements of the FedACH transactions are
carried out, as described below.
(i) Settlement of FedACH Credit
As for the “FedACH Credit,” an ACH credit file
is sent from the Originator to the ODFI. Then, the
ODFI processes the file and sends the transactions
to the Federal Reserve Bank. The Federal Reserve
Bank delivers the files containing the ACH credit
payments to the RDFIs. Those processing of the
ACH payments are made on the day that the
credit file is sent to the ODFI. This day is called
the “Day 1” or “Process Day.”
For the settlement of these payments, the
Federal Reserve Bank debit the ODFI’s account,
and credit the RDFI’s account. This settlement
is made on the following business day of the
Process Day, the “Day2” or the next day of Day
2, the “Day 3.” They are called the “Settlement
Day” (see Figure 16).
The credit and debit processing to the partici-
pant’s accounts are made at 8:30 a.m. eastern time
of the Settlement Day. These fund transfers become
final when posted to the participant’s accounts.
For the smooth settlements, the participants are
required to prefund for own ACH credit transac-
tions. This means that the ODFI are required to
have the adequate liquidity in its account at the
123

Figure 16. Settlement of FedACH credit (Source: Federal Reserve Financial Services, 2001)
Federal Reserve Bank before 8:30 a.m. of the
Settlement Day. This is called the “Settlement-day
Finality” for the ACH credit transfers, which was
introduced in 2001.
(ii) Settlement of FedACH Debit
Regarding the “FedACH Debit,” an ACH debit
file is sent from the Originator to the ODFI. Then,
the ODFI processes the file and sends the transac-
tions to the Federal Reserve Bank. The Federal
Reserve Bank delivers the ACH debit payments
to the RDFIs. Those processing of payments are
made on Day 1 (or the Process Day).
On Day 2 (or the Settlement Day), the Federal
Reserve Bank debits the RDFI’s account, and
credits the ODFI’s account. Then, the RDFI debit
the Receiver’s account, and the ODFI credits the
Originator’s account (see Figure 17).
As for the settlement of debit transfer, the
processing to the participant’s account is made at
11:00 a.m. eastern time of Settlement Day. But
these fund transfers do not have the finality until
the following day or Day 3. This is because the
debit transactions may be subject to the return,
124
Payment Systems in US
mainly due to insufficient funds at Receiver’s
account.
Settlement of TCH’s
ACH Transactions
As for the ACH service of the TCH Payments
Co., the settlements are made through the Na-
tional Settlement Service (NSS) of the Fedwire.
The TCH Payments Co. submits the settlement
file to the Federal Reserve Bank as a Settlement
Agent. The file contains the net positions of the
participants as a result of the ACH credit and debit
transactions. And the net positions are settled
among the participant’s settlement accounts at
the Federal Reserve Banks, utilizing the NSS
function. The credit and debit processing of the
net positions become final when posted to the
settlement account.
Settlement of Inter-Operator
ACH Transactions
When either an ODFI or a RDFI belongs to the
FedACH network, and the other belongs to the
Payment Systems in US
Figure 17. Settlement of FedACH debit (Source: Federal Reserve Financial Services, 2001)
TCH’s network, the payments file will be ex-
changed and the settlement is executed between
the Federal Reserve Bank and TCH Payments Co.
This kind of transaction is known as the “Inter-
Operator ACH transaction.”
FedGlobal ACH
Outline of FedGlobal ACH
The FedACH provide the cross-border payment
service, which is called the “FedGlobal ACH.”
With this service, a customer can make credit
payments to more than 35 countries and debit
payments from Canada.
To build this scheme, the Federal Reserve Bank
of Atlanta (Atlanta Fed) serves as a “Gateway
Operator” (GO) on the US side. The Atlanta Fed
appoints the “Foreign Gateway Operator” (FGO)
in each country, and closely works with the FGO
to make cross-border payments.
The cross-border payments are formatted using
the NACHA “Standard Entry Class” (SEC) code
of “International ACH Transaction” (IAT). The
header record of payment message contains the
information specific to cross-border payments,
including the FX related data, destination country,
and currency codes.
Options in FedGlobal ACH
The FedGlobal ACH allows some options in the
foreign exchange and the delivery of payment.
Foreign Exchange Options
The FedGlobal ACH allows three options for cur-
rency value exchange: (i) the “Fixed-to-Variable”
(FV) option, (ii) the “Fixed-to-Fixed” (FF) option
and (iii) the “F3X” option.
(i) FV Option
In the “FV option,” the USD amounts are converted
to a variable amount of destination currency based
on a competitive foreign exchange rate provided
as part of the payment flow. The settlements are
made in the USD between the participating US
financial institutions and the Federal Reserve
Banks.
125
 Payment Systems in US

(ii) FF Option (i) A2A Option

In the “FF option,” the payments are both trans-
ferred and received in the USD to the USD-de-
nominated accounts (the “USD to USD” option).
This option is applied to the countries that allow
the banks to provide the USD accounts to the
customers. The settlements are made in the USD
between the participating US financial institutions
and the Federal Reserve Banks.
(iii) F3X Option
The “F3X” is the option where payments are
both transferred and received in foreign currency
(the “foreign currency to foreign currency” op-
tion). The foreign exchange rate and settlement
is managed and processed by the participating
US financial institutions and the respective FGO
via their foreign correspondent banks. The settle-
ments are conducted outside of the ACH network
through a foreign correspondent.
Delivery Options
The FedGlobal ACH also offers the payment
delivery options in the selected countries: the
“Account-to-Account” (A2A) option and the
“Account-to-Receiver” (A2R) option.
In the “A2A option,” the funds are deposited to
the bank account of the receiver. This is a standard
option of payment delivery.
(ii) A2R Option
In the “A2R option,” the receiver can get paid in
cash at either a financial institution or at a trusted
third-party provider. When this option is used,
the supplemental information is required in the
payment message to identify the receiver prop-
erly. The additional information to identify the
receiver includes: (i) unique payment password,
(ii) Receiver’s date of birth, and (iii) Receiver’s
cell phone number.
Merit of FedGlobal ACH
The Federal Reserve explains the background of
the FedGlobal ACH that this service is to keep
pace with customers’ demand for the low-cost
and efficient cross-border payments.
Traditionally, the cross-border payments have
been handled by private banks through the cor-
respondent banking network. But there have been
complaints from the customers that the cross-
border payments are too expensive and take too

Table 11. Options of FedGlobal ACH (Source: Federal Reserve Financial Services)

FX Options Delivery Options

FF FV F3X A2A A2R
North America Canada ○ ○ ○ ○ ×
Mexico × ○ ○ ○ ○
Central & South Panama ○ × × ○ ×
America
Other 12 coun- ○ ○ × × ○
tries1
Europe 22 countries2 × ○ ○ ○ ×
○:Available, ×:Not Available
1. Argentina, Bolivia, Brazil, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Peru, Uruguay
2. Austria, Belgium, Cyprus, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, Malta, Netherlands,
Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, Switzerland, United Kingdom

126
Payment Systems in US
long. One of the reasons of the high-cost and the
delay is that the correspondent banking is based
on the bilateral relationship and may require dif-
ferent procedure for each transaction.
The justification is that the Federal Reserve
Banks tries to provide more low-cost and ef-
ficient service for the cross-border payments by
standardizing and streamlining the procedures.
With this service, the customers in the US can
send payments to overseas with lower cost and
in a shorter time frame. The FedGlobal ACH will
deliver the funds to the foreign receiving bank in
one day or two.
Financial EDI on ACH Network
In addition to the basic services mentioned above,
the ACH operators are actively promoting the
“Financial EDI” (Electronic Data Interchange).
The Financial EDI is a scheme that allows the
originator to send the remittance information
with a payment order to the receiver of the pay-
ments. This scheme is mainly used between the
buyer and the seller of business transaction. With
Financial EDI, the seller company (the receiver
Figure 18. Credit advice and remittance advice (traditional way)
of the fund) can make reconciliation on electronic
basis without the paper documents.
Benefits of Financial EDI
Under the circumstances without Financial EDI,
the buyer company (the payer) sends the payment
order to its bank, and delivers the remittance ad-
vice to the seller company (the payee) by mail or
through another network than the payment system,
e.g., the value-added network. For this reason, the
seller company receives the credit advice and the
remittance information separately, with the paper
documents or electronic file. These separations
lead to manual processing of reconciliation at
the seller company, which is costly and time-
consuming (see Figure 18).
By contrast, if the buyer and seller use the
Financial EDI, the seller company is able to receive
the remittance information along with the credit
advice from its bank. Getting the remittance in-
formation electronically, the seller company can
improve the reconciliation process substantially
and reduce the cost (see Figure 19).
Although the ultimate beneficiary of Financial
EDI is the corporate sector, the banking sector is
127
 Payment Systems in US

Figure 19. Credit advice and remittance information (with financial EDI)

able to improve the customer service and make
service fee revenue.
EDI Format on ACH Network
Two kinds of formats can be used for the Financial
EDI on the ACH network. One is the “CCD+”
(Corporate Credit or Debit +) and the other is the
“CTX” (Corporate Trade Exchange).
The CCD+ can carry only one addendum record
with 80 characters maximum. The “addendum
record” is a file which can contain remittance
information. The normal “CCD” format cannot
carry any addendum.
On the other hand, the CTX can carry up to
9,999 addenda records with up to 80 characters
each, which means almost 800,000 of total char-
acters, can be added per payment. That means the
enormous volume of data can be transferred on
the ACH network.

Figure 20. Financial EDI on ACH Network (Source: the NACHA)

128
Payment Systems in US
Usage of Financial EDI
on ACH Network
The transactions of Financial EDI are increasing
steadily year by year. In 2008, the payments with
addenda records were 311 million, 16 percent
increase from the previous year. The number of
addenda records was 1,004 million in 2008, which
was 13 percent increase over the previous year.
The average number of addenda records per
CTX was approximately 15, which was much
less than the maximum number of records to be
attached.
REFERENCES
CHIPS http://www.chips.org/
Federal Reserve Bank Services http://www.frb-
services.org/
Federal Reserve Financial Services. (2001, April).
Getting Started with FedACH Origination.
Federal Reserve Financial Services. (2006,
September). Federal Reserve Banks Operating
Circular No.6.
Federal Reserve Financial Services. (2009,
March). Fedwire Securities Service Guide.
NACHA http://www.nacha.org/
Nakajima, M., & Shukuwa, J. (2005). All about
Payment Systems (2nd ed.). Toyo Keizai Inc.in
Japanese
The Clearing House. (2007, November). Clearing
House Interbank Payment System (CHIPS): Self-
Assessment of Compliance with Core Principles
for Systemically Important Payment Systems.
The Clearing House http://www.theclearinghouse.
org/home.php
ENDNOTES
1
The finality of funds transfer on the Fedwire
is prescribed in Regulation J of the Federal
Reserve.
2
The five affiliated companies merged were
as follows: the Small Value Payments Com-
pany (SVPCo), Clearing House Interbank
Payments Company (CHIPCo), Electronic
Payments Network (EPN), Electronic Clear-
ing Services (ECS), and National Check
Exchange (NCE).
3
Usually, around 500-750 payment messages
may remain unreleased (TCH, 2007).
4
Cover payment information is also included
in Sequence B.
5
“Business-to-Business Wire Transfer Pay-
ments: Customer Preferences and Oppor-
tunities for Financial Institutions,” October
2006, The Clearing House and the Federal
Reserve Banks.
6
There used to be two other private-sector
ACH operators: the “American Clearing
House Association” (ACHA) and “Visa
ACH.” Due to the competitive pressure from
the EPN and FedACH, the ACHA ceased
operation in October 2002 and Visa ACH
left the network in March 2003. Those ces-
sations of business made the TCH Payments
Co. a sole private-sector ACH operator.
129
130

Chapter 10
Payment Systems in EU

ABSTRACT
This chapter provides details of the payment systems in the EU. The landscape of payment systems in
the EU was changed drastically by the introduction of the single currency “euro” in January 1999.

As for the large-value payment system, the “TARGET” was introduced in 1999, which was a distributed
system linking the national RTGS systems with the interlinking network. The “TARGET2” was intro-
duced in 2007-2008 instead of the first-generation TARGET. The TARGET2 is a centralized system with
a single platform. The “EURO1” is another payment system used for the large value transfer of funds
in euro. The EURO1 is a private payment system operated by the EBA CLEARING.

In preparation for introducing the euro, the evolutionary progress of payment systems has been observed
in the EU since the mid-1990s. The evolutions include the changeover from the RTGS System to the
Hybrid System and also to the Integrated System. These sophisticated systems included the “RTGSplus”
in Germany, the “PNS” and the “PIS” in France, and the “new BIREL” in Italy. The settlement mecha-
nisms of those advanced payment systems are also discussed in greater detail. It can be concluded that
these evolutions of payment systems in each country led to the successful development of the TARGET2.

The reforms of retail payment systems were also sought in response to the introduction of the euro.
However, the retail payment systems in the EU are still fragmented, which means that each country has
its own retail payment system. In order to overcome such a situation, the European Central Bank (ECB)
and European Commission have promoted the project of “Single Euro Payments Area” (SEPA). The
aim and situation of the SEPA project is described in detail. The cross-border retail payment systems,
i.e. the “STEP1” and “STEP2,” are also discussed in this chapter.

DOI: 10.4018/978-1-61520-645-2.ch010

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
Payment Systems in EU
INTRODUCTION
In January 1999, the Economic and Monetary
Union (EMU) started and the single currency
“euro” was introduced. And the “euro area,” the
single currency area, was born with the introduc-
tion of the European single currency.
Before the EMU, the payments in German
Mark were settled through the German payment
system, and the payments in French Franc were
settled in the French payment system. In this way,
there had been a “one to one relationship” between
the currency and the payment system.
However, the legacy currencies (Mark, Franc,
Lira, and the rest) were integrated into the euro,
and the payment systems for each national cur-
rency were converted to the payment systems for
euro. That brought about the co-existence situation
of the multiple euro payment systems in a single
currency zone.
It is rather common that different kind of pay-
ment systems co-exist with different purposes in a
country, for instance, the RTGS system and DTNS
system, and the large-value payment system and
retail payment system. But it is quite exceptional
that the multiple payment systems with the same
nature co-exist in a single currency area.
Just after the introduction of the euro, there
were fifteen RTGS systems and four DTNS sys-
tems as large-value payment systems. In addition
to that, there were more than twenty retail payment
systems in the euro area. The European Central
Bank (ECB) has been trying to improve such a
decentralized and distributed situation.
FROM TARGET TO TARGET2
TARGET
Nature of TARGET
When the euro was introduced in January 1999,
the TARGET started its operation for the euro
settlement in the EU. The “TARGET” stands
for Trans-European Automated Real-time Gross
settlement Express Transfer system.
The TARGET was composed of fifteen RTGS
systems in the EU countries, intended to make
the euro settlement across the EU area. The basic
concept was that the TARGET provided the euro
settlement service for the cross-border payments
as well as the domestic payments. As with the
RTGS system in each country, the TARGET was
the large-value payment system mainly for the
interbank fund transactions, FX transactions, and
securities transactions.
The TARGET was intended to integrate the
financial markets in the euro area through the
smooth settlements of the euro. Besides, it was
aimed to become an infrastructure for the Euro-
pean Central Bank (ECB) to pursue the monetary
policy in an efficient manner.
It is worth mentioning that the TARGET was
the first “cross-border RTGS system” in the world,
which provided the real-time and gross settlement
service across the borders.
The ECB laid out three main objectives to
develop TARGET as follows;
1. To provide a safe and reliable mechanism
for the settlement of euro payments on an
RTGS basis;
2. To increase the efficiency of inter-Member
State payments within the euro area;
3. To serve the needs of the monetary policy
of the Eurosystem.
After its start of operation in January 1999,
the TARGET became the main payment system
which handled the majority of euro payments. In
2008, the share of the TARGET in total large-value
payment system traffic in euro was 90% in value
terms and 59% in volume terms1.
The operation policy of the TARGET was
decided by the Governing Council of the ECB.
The operating rule was given as the TARGET
Guideline.
131

The TARGET was migrated over to its second
generation, the “TARGET2” during 2007- 2008
(to be discussed below).
System Structure of TARGET
The TARGET was composed of (1) the 15 RTGS
systems in the EU, (2) Interlinking Network, which
was the communication network linking between
the RTGS systems, and (3) the ECB Payment
Mechanism (EPM), which was the application
of the whole system (see Figure 1).
In fact, the most distinctive feature of the
TARGET was to be a decentralized payment
system, instead of the centralized system in which
all the processing were executed in the centralized
computer system (see Figure 2). Therefore, the
cross-border payments were exchanged bilater-
ally between the involved two central banks. Each
RTGS system processed the cross-border pay-
ments individually, instead of concentrating all
the payments to the ECB.
And the settlement accounts of the participants
(i.e., financial institutions) were placed in and
managed by the home central banks.
Figure 1. System Configuration of TARGET
132
Payment Systems in EU
The reason why the TARGET took such a
system configuration was to minimize the system
development cost by building only the common
parts, and to pay due respect to the national cir-
cumstances in each country.
The SWIFTNet, the network of SWIFT, was
adopted as an Interlinking Network.
Components of TARGET
Table 1 shows the components of the TARGET,
which were the RTGS systems in the EU coun-
tries. As of the end of 2006, there were 15 RTGS
systems connected to the TARGET system, of
which 12 systems were from the “in-countries”
that have adopted the euro. And three systems were
from the “out-countries,” which were Denmark,
Sweden and the UK.
Settlement at TARGET
The TARGET was the gross settlement system
and payments are processed individually without
netting. Besides, the TARGET was a real-time
settlement system and the processing of debit and
Payment Systems in EU

Figure 2. Decentralized Structure of TARGET

Table 1. Components of TARGET When a sending amount was debited from

the sending bank’s account at the sending cen-
Country RTGS System Vo l u m e S h a re
(2006, %) tral bank, the same amount was credit to the
Austria ARTIS 1.5 “Interlinking Account.” At this time, the debit
Belgium ELLIPS 3.6 processing became irrevocable. At the receiving
Denmark KRONOS 0.6
central bank, the sending amount was debited
Finland BOF-RTGS 0.7
from the Interlinking Account and credited to the
receiving bank’s account. At this point of credit
France TBF 25.3
processing, the settlement became final. When the
Germany RTGS plus
28.3
credit processing of a payment was completed at
Greece HERMES 1.3
the receiving central bank, an acknowledgement
Ireland IRIS 1.2
was sent to the sending central bank.
Italy BI-REL 7.1
Luxembourg LIPS-Gross 1.5
Payments through TARGET
Netherlands TOP 4.7
Portugal SPGT 0.6
The Eurosystem comprises the ECB and the Na-
Spain SLBE 14.2 tional Central Banks (NCBs) of “in- countries.”
Sweden Euro RIX 0.3 When the Eurosystem executed the operation for
UK CHAPS Euro 8.1 monetary and credit control, the payment for the
Source: ECB (2008c) monetary operation should be made through the
TARGET. Other large-value payments processed
by the TARGET included the payments for the
credit of the accounts were executed in nearly
foreign exchange transactions, money market
real-time2, and the settlements became final when
transactions and securities transactions.
processed.
Although the TARGET was built mainly for
the large-value payment, there was no limit for

133

the minimum value3. Therefore, the retail pay-
ments were also possible to be settled through
the TARGET.
As there were no limits for the type of trans-
actions, the TARGET could handle customer
payments as well as interbank payments. The
TARGET was the payment system for the credit
transfer, but not for the debit transfer.
TARGET Volume
The TARGET handled the huge volumes and
values of the euro payments, and was the largest
payment systems in the world, along with the
Fedwire in the US.
In 2008, the average daily volume was 370
thousand transactions. Of which, 270 thousand
transactions were domestic traffic, in other word,
the “Intra-Member state transactions.” The rest
of 100 thousand transaction, or 27% of daily
transaction was the cross-border traffic, which
is called the “Inter-Member State transactions.”
As for the cross-border traffic, the customer pay-
ment (57%) is larger than the interbank payment
(42%) in volume.
In terms of settlement value, the daily average
value of the TARGET was €2,667 billion in 2008.
This means that the TARGET settled the value
which is equivalent of the annual GDP of the whole
euro area in only 3.5 days. The domestic traffic
Table 2. Volume and Value of TARGET (in 2008)
TARGET overall
Domestic
Cross-border
Interbank
Customer
Note1: Domestic traffic is payment of Intra-Member state.
Cross-border traffic is payment of Inter-Member State.
Note2: Figures in ( ) are percentage in TARGET overall.
Figures in < > are percentage in Cross-border traffic.
Source: ECB (2009)
134
Payment Systems in EU
accounted for 68% of the daily average value,
while the cross-border traffic was 32%. As for the
cross-border traffic, 93% was the interbank pay-
ment and the rest 7% was the customer payment
in value (see Table 2). This suggests the fact that
the average amount per payment is huge in the
cross-border interbank payment.
TARGET Participants
The TARGET is open to the banking community in
the euro area. More specifically, the credit institu-
tions established in the European Economic Area
(EEA4) are allowed to become the participants of
the TARGET.
At the end of 2008, there were 747 direct
participants and 3,806 indirect participants. In
addition to that, 11,031 institutions worldwide
were accessible through the TARGET with the
addressable BICs. These institutions were called
the “Correspondent.”
To add the number of branches of the direct
and indirect participants to these numbers, 55,867
credit institutions around the world are addressable
via the TARGET. Surprisingly, this total number
is equivalent to around 60% of banks connected
to the SWIFTNet worldwide. Of them, two-thirds
are the credit institutions from the Member States
of the EU and one-third are from the other coun-
tries worldwide.
Volume Value
(thousand) (EUR billion)
370 (100.0) 2.667 (100.0)
270 (73.0) 1,823 (68.3)
100 (27.0) 845 (31.7)
43 < 42.5> 786 <93.0>
57 < 57.5> 59 < 7.0>
Payment Systems in EU
The Bank Identifier Code (BIC) and rout-
ing information of participants and addressable
institutions via the TARGET were listed in the
“TARGET Directory.”
Message Format on TARGET
The domestic formats of each RTGS system were
used in the first-generation TARGET. Therefore,
each participant sent the payment message using
the domestic format to the RTGS system of its
own country. When the payment message was
transferred from the sending central bank to the
Interlinking System, the domestic format was
converted to the Interlinking Format, namely the
SWIFT format. In a similar way, when the payment
message was transferred from the Interlinking
System to the receiving RTGS system, the mes-
sage was converted from the SWIFT format to the
domestic format of the receiving country. Thus
the sending and receiving banks could send and
receive the message in a domestic format without
being bothered with formatting.
Operating Hours of TARGET
The operating hours of the TARGET was 11 hours;
from 7:00 a.m. to 6:00 p.m., Central European
Time (CET). The deadline for the customer pay-
ments was 5:00 p.m., and one hour between 5:00
p.m. and 6:00 p.m. was the time frame only for
the interbank payments.
Intraday Liquidity in TARGET
As the TARGET was the RTGS system which
required large liquidity for settlements, the par-
ticipants in the TARGET were allowed to get
intraday liquidity from each central bank through
the collateralized overdraft or the intraday repo
transaction. This intraday liquidity was free of
charge and unlimited within the range of collateral.
Three countries-Denmark, Sweden and the
UK-opted out from the EMU. In other words, these
countries did not introduce the euro. However,
the ECB admitted that the central banks of these
three “out-countries” could provide the intraday
liquidity in euro to the credit institutions in each
country.
The intraday liquidity of the out-country’s cen-
tral bank was guaranteed by the euro deposit that
each central bank held at the ECB. This scheme
was admitted as a “very specific exception” of
the basic rule that the credit of euro should be
made only by the central banks of the euro area.
TARGET2
Background of TARGET2 Project
Shortcomings of TARGET
From the start of operation in January 1999, the
first-generation TARGET operated successfully
over a several years. The TARGET has met all
its main objectives: it supported the implementa-
tion of the single monetary policy and it handled
the vast traffics of euro both at the national and
cross-border level.
In spite of these considerable successes, it
became apparent that the decentralized structure
of the TARGET had some limitations and short-
comings. First, under the decentralized structure,
each central bank should make respective invest-
ments on totally fragmented IT infrastructures,
and operate its own system separately. It was far
from the ideal situation and resulted in the highly-
inefficient situation as a whole.
Second, the service level and fee structure
differed from one RTGS system to another. More
harmonized and enhanced services with a single
fee structure were increasingly required.
And finally, the EU enlargements were con-
sidered to worsen such a situation. In May 2004,
ten courtiers in Central and Eastern Europe were
decided to join the EU, which meant the compo-
nents of the TARGET would increase to 25 in the
135

future. In other words, about 25 RTGS systems
will connect to the TARGET, if the TARGET will
keep the decentralized system configuration. To
address the challenge, the Eurosystem started to
consider redesigning the system configuration of
the TARGET.
Long-Term Strategy of TARGET
In October 2002, the Governing Council of the
ECB published “the Long-term Evolution of
TARGET,” which showed the main principles
and the basic structures of the next-generation
TARGET. At this stage, the Governing Council
advocated that the second-generation TARGET
would continue to be a multiple-platform system.
The “Single Shared Platform” was proposed, but
the use of the Platform was on a voluntary basis,
and the national platforms would be allowed to
use if some NCBs wanted to continue to use their
own systems.
In December 2002, the ECB published the
consultation paper, “TARGET2: Principles and
Structure.” In this document, the “same service,
same price principle” was proposed as follows:
1. All TARGET components should provide
the “core service.”
2. Those services should be offered at a “single
price.”
3. The single price will be based on a most ef-
ficient RTGS system which has the lowest
average cost per transaction.
4. By the end of four-year period after the
start of TARGET2 operations, the platforms
which do not comply with this requirement
will have to be closed.
Proposal of Single Shared Platform
In July 2003, three Eurosystem central banks-the
Banca d’Italia, the Banque de France and the
Deutsche Bundesbank-jointly made a proposal to
develop the “Single Shared Platform” (SSP) for the
136
Payment Systems in EU
Eurosystem. These three central banks proposed
to develop the SSP and operate it on behalf of the
Eurosystem. It was regarded as an “outsourcing”
within a European central banking society.
After a lengthy discussion, all the NCBs finally
agreed to use the SSP provided by the three central
banks. This agreement changed the concept of
TARGET2 from a multiple-platform system to a
single platform system.
Nature of TARGET2
The second-generation TARGET is called the
“TARGET2.” The most distinctive feature of the
TARGET2 is a centralized system with a single
platform, changing from the decentralized con-
figuration of the first-generation TARGET.
It is worth mentioning that it is not only a
system concentration project but also a project
for function enhancement. Under the TARGET
circumstances, each national component was the
“pure RTGS system” with only RTGS function, but
the TARGET2 adopted some advanced features
which were used in German, French and Italian
payment systems.
By the changeover to the TARGET2, the
enhanced functionalities used only in a few coun-
tries were extended to the whole euro area. These
enhanced functions will be described later in this
chapter in more detail.
System Structure of TARGET2
Modular Approach
The TARGET2 adopts a “modular approach” and
the SSP (Single Shared Platform) are made of
several modules. Each module is designed for a
specific service and closely related to each other.
Some modules are mandatory to use and the
others are optional. The mandatory modules in-
cludes the Payments Module (PM), the Informa-
tion and Control Module (ICM), the Contingency
Module (CM) and the Static Data (SD) Module.
Payment Systems in EU

Of them, the most important module is the PM Backup System

which is in charge of processing of payments
(see Table 3).
The optional modules include the Home Ac-
counting Module (HAM), the Standing Facilities
(SF) Module, and the Reserve Management (RM)
Module. The national central banks can use these
modules if they want to use them. And if the
central banks do not want to use them, they may
provide the respective services via the proprietary
applications in their own domestic systems.
Network
The SWIFTNet is used as a network which
connecting between the TARGET2 and its par-
ticipants. Several SWIFT services, including the
FIN, InterAct, FileAct and Browse, are used to
send, monitor and manage the payment messages
in the TARGET2.
To secure the high level of business contingency,
the TARGET2 adopts the “multi-region/multi-
site” architecture. More concretely, there are
computer centers in two regions and two distinct
sites in each region.
The main and backup function rotates periodi-
cally between the two regions. That is to foster
the experienced staff in both regions.
Participation Framework of TARGET2
There are four ways to participate in the TAR-
GET2. These include: (i) Direct participation, (ii)
Indirect participation, (iii) Addressable BICs, and
(iv) Multi-addressee access (see Table 4).
Direct Participation
The “Direct participants” hold a “RTGS account”
on the TARGET2. They can submit and receive
payments directly to/from the system. They can

Table 3. Modular Approach of TARGET2

Mandatory Optional
Payments Module (PM) Home Accounting Module(HAM)
Information and Control Module (ICM) Standing Facilities (SF) Module,
Contingency Module (CM) Reserve Management (RM) Module
Static Data (SD) Module
Source: ECB (2005)

Table 4. TARGET2 Participation Framework

Account on Way to submit/receive Settlement of Subject to the Listed in

TARGET2 payments payments system rules TARGET2
directory
Direct participation Yes Directly Own account Yes Yes
Multi-addressee access No Directly Account of the Yes Yes
direct participant
Indirect participation No Via direct participant Account of the Yes Yes
direct participant
Addressable BICs No Via direct participant Account of the No Yes
direct participant
Source: ECB, modified

137

settle directly with the other direct participants.
Only the credit institutions established in the
European Economic Area (EEA) can become the
direct participants.
Indirect Participation
The “Indirect participant” does not hold a RTGS
account, and payment orders are always sent to/
received from the system via a direct participant
which acts on the indirect participant’s behalf.
Payments are settled in the direct participant’s
account on the TARGET2. Indirect participants
are registered in the TARGET2 Directory and are
under the responsibility of the direct participants.
Only the supervised credit institutions established
within the EEA are able to become the indirect
participants.
Addressable BICs
The “Addressable BICs” are quite similar to the
indirect participants in respect that they do not
hold a RTGS account, and payment orders are
always sent to/received from the system via a
direct participant which acts on the indirect par-
ticipant’s behalf.
There are two differences between the Ad-
dressable BICs and Indirect participants. First, any
financial institution that holds a BIC can become
an Addressable BIC, irrespective of its place of
establishment. That means that any financial insti-
tutions in the world can become the Addressable
BICs, once a direct participant of the TARGET2
admits them to provide such a service.
As any criteria were not established for the Ad-
dressable BICs, the direct participant can decide
which institutions should become the Addressable
BICs based on a marketing strategy of its own.
Second, only the Indirect participants are rec-
ognized by the TARGET2 system, and they are
protected by the “Settlement Finality Directive”
(SFD), which aims to protect the participant of
payment systems from the bankruptcy of another
138
Payment Systems in EU
participant(s) in the system. In sum, the Address-
able BICs are not recognized by the system, and
not protected by the SFD.
Multi-Addressee Access
In the TARGET2 system, the direct participants
are able to authorize their branches and other
credit institutions in the same group, located in the
EEA countries, to channel the payments through
the direct participant’s main account without its
involvement by submitting/receiving the pay-
ments directly to/from the system.
The payments are settled on the main account
of the direct participant. Only the direct participant
has to manage the liquidity as a whole, and the
other affiliated banks or branches are not bothered
with liquidity management. Accordingly, this
scheme offers a direct participant’s affiliated banks
or branches greater efficiency on their liquidity
management and payment business.
Processing of Payments in TARGET2
Priority of Payment
Every payment order can be assigned a spe-
cific payment priority; the “normal,” “urgent,”
or “highly urgent” (see Table 5).
The “Normal payment” is a payment without
urgency and processed in the Liquidity-Saving
mode. The “Urgent payment” is a payment with
some urgency and processed by the RTGS mode.
Table 5. Payment Priority in TARGET2
Priority Intended transactions and features
Highly urgent Settlement with other payment systems
Settlement with a central bank
Pay-in/pay-out to/from the CLS Bank
Urgent Payment with some urgency
Processed with gross settlement mode
Normal Payment without urgency
Processed with liquidity saving mode
Source: ECB, modified
Payment Systems in EU
The “Highly urgent payment” is the pay-
ment with highest priority, which is used for the
settlement with the other payment systems, the
settlement with a central bank, or the pay-in/pay-
out to/from CLS Bank. These payments are also
processed by the RTGS mode. If some payments
with the higher priority remain in the queue, the
payments with the lower priority are not processed.
Timed Payment
The participants are able to submit a payment
order with a “debit time indicator” to assign an
execution time. There are two options; the “pay-
ment till” option and the “payments from” option.
The “payment till” option assigns the deadline of
processing of a payment. The “payments from”
option assigns the starting time of processing
of a payment. These schemes are useful for the
time critical payments, such as the payments for
CLS Bank.
Postdated Payment
The participants are able to submit payments to
the TARGET2 system up to five working days
in advance. This function is referred to as the
“warehouse functionality.” In the first-generation
TARGET, the submissions of payments were pos-
sible only on the day of the settlement.
Debit Function
The TARGET2 provides the direct participants a
debit transfer function as well as a credit transfer
function. With this function, a participant is able
to bring the fund from the account of the other
direct participants. However, the usage of debit
function is limited to the transfer of funds between
the credit institutions.
This function is supposed to be used to make an
adjustment of liquidity among several banks in a
group, or between the head office and the branches
of the same credit institution. The first-generation
TARGET did not have the debit function.
Queue Management
Until the payments are processed, they are placed
in a queue. The TARGET2 provides the several
control functions of the queued payments.
A participant can: (i) change the priority (e.g.,
from the normal payment to the urgent payment),
(ii) re-ordering (change the order in the queue),
(iii) change the settlement time, and (iv) cancel
the queued payment.
Liquidity Reservation and Limits
Liquidity Reservation Facilities
The TARGET2 provides the direct participants
the “Reservation Facilities” in order to control
liquidity. With these facilities, the direct partici-
pants are able to reserve liquidity for the higher
priority payments. Liquidity reservation is possible
separately for the urgent payments and highly
urgent payments.
Assume that the total liquidity in an account
is 1,000, and the participant reserves 100 for the
highly urgent payments and 200 for the urgent
payments. Then, the maximum amount of liquidity
for the normal payments is 700 because 300 are
reserved for the higher priority payments. And
the maximum amount of liquidity for the urgent
payments is 900. The maximum amount of 1,000
could be used for the highly urgent payments
(See Figure 3).
Aside from these facilities, a direct participant
can “set aside” liquidity (the “Dedicated Liquid-
ity”) for the settlement of the “Ancillary Systems”
(ASs). While the Ancillary Systems include the
Securities Settlement Systems (SSSs) and the
retail payment systems, this function is espe-
cially for the night settlement of the SSSs. The
Dedicated Liquidity is transferred from the main
139

Figure 3. Example of Liquidity Reservation
account to the sub-account of a RTGS account,
and reserved for the future settlements of the ASs.
Bilateral Limits and
Multilateral Limits
The TARGET2 allows the direct participants to
set the “Limits” in order to control their liquid-
ity. There are two kinds of Limits, both of them
are optional.
First, “Bilateral Limits” can be set up. These
are the sender limits for the payment amount
that a participant is willing to pay vis-à-vis other
individual participant, without having received
payments first. With these Limits, a participant can
control the outflow of liquidity from its account
to other participant. In addition, the participant
can synchronize the payment flow with the other
direct participants, by offsetting the inflow and
outflow of payments.
The other limits are “Multilateral Limits.”
These Limits are also the sender limits, and can be
set up to the direct participants for whom a Bilateral
Limit has not been set. With these Limits, a direct
participant can restrict the use of liquidity to the
other participants without the Bilateral Limits.
140
Payment Systems in EU
Attention is necessary that these limits are valid
only for the normal payments. As for the highly
urgent payments and urgent payments, the settle-
ments are executed on a gross basis regardless of
the presence of these Limits.
These Limits should be set on the previous day
of the effective date. However, the participants can
change the Limits at any time during the operat-
ing day and the change has the immediate effect.
RTGS Mode and Liquidity-
Saving Mode
RTGS Mode
For the “highly urgent” and “urgent” payments, the
system checks the account of sending participants,
and if there is a sufficient fund for the payments in
the account, the payments are settled immediately.
Payments are picked up from the queue according
to the “First-In, First-Out” (FIFO) principle. That
is, the payments are settled in the chronological
order which the system received them. The nature
of this processing can be characterized as the
settlements in the normal RTGS mode.
Payment Systems in EU
Liquidity-Saving Mode
As for the “normal” payments, the system makes
two kinds of checks. One is the check whether there
is a sufficient fund in an account of the sending
participant. Another is the check of Limits and
Liquidity Reservations.
If-and only if-both conditions are met, the
settlement is executed. More specifically, the
“offsetting” is made bilaterally or multilaterally
within the Bilateral Limits and Multilateral Limits.
In an offsetting processing, the inflow payment
and the outflow payment are processed simulta-
neously, and the result comes to reduce/increase
the liquidity by the difference of the sending and
receiving payments.
This process is referred to as the “optimiza-
tion procedures.” The settlement of the normal
payments in the queue is made as effective as
possible by several optimization procedures on
a continuous basis.
The optimization procedures are used in order
to save liquidity, and the nature of this settlement
can be characterized as the “Liquidity-Saving
mode.”
The normal payments are executed using the
“Bypass FIFO” principle. With this principle, the
normal payments can be executed even if other
normal payments with large value which arrived
earlier are still in the queue, provided that the
sufficient funds are available for the payments
with smaller value which arrived later.
Liquidity Pooling
The TARGET2 provides two types of liquidity
pooling functionality. They are to avoid liquidity
fragmentation in the TARGET2 and to simplify
liquidity management for the banking groups
which have more than one account in the TAR-
GET2. In these functions, a participant can assign
a “group of accounts,” and the “group of accounts
manager” who manages all the accounts in the
group as a whole.
One option is the “Virtual Account Option,”
and the other is the “Consolidated Information
Option.” Both options are mainly for the large
banks, which have several branches and subsidiar-
ies in the EU, to manage the liquidity of the group
at a single location. As of the end of 2008, there
were 66 accounts benefiting from these liquidity
pooling functionalities.
Virtual Account Option
In the Virtual Account Option, all the accounts
belonging to one banking group are consolidated
and the “virtual account” is created (see Figure 4).
In other words, the available liquidity in all the
members’ accounts of the group is consolidated
in a single liquidity pool (the “global liquidity”)
in the virtual account during the day.
Payments are always checked against the
global liquidity of the group, but settled on a
single account of the sender. Therefore, each ac-
count holder can make payments if the global
liquidity in the virtual account is sufficient. Ac-
cordingly, the balance of each account is allowed
to be negative (less than zero).
The queues of each bank are also consolidated
into a “single payment queue.” By using this op-
tion, the multi-country banks can centralize the
processing of payments and concentrate the liquid-
ity management function across many branches
and subsidiaries in the euro area.
At the end of the business day, if some of
accounts are negative, the automatic end-of-day
procedure is executed and liquidity is transferred
from the positive accounts to the negative accounts
to cover the overdraft.
Only the accounts of the participants in the
euro area are allowed to be included in a virtual
account.
Consolidated Information Option
The Consolidated Information Option offers the
information with regard to the liquidity positions
141

Figure 4. Management of Global Liquidity Position by Virtual Account
of all the single accounts in the TARGET2 belong-
ing to the same group.
This function is “information only” and
processing is still carried out exclusively at the
individual account level. If a participant wants to
concentrate liquidity to one location, the pooling
of liquidity should be done by the participant us-
ing the direct debit functionality.
The Consolidated Information Option is also
available to the participants from the non-euro-
area countries.
Home Account
In the TARGET2 system, all the processing to
the account is made by the Payments Module
(PM). An account in the TARGET2 is called the
“RTGS account.” Nevertheless, each central bank
is allowed to maintain so-called additional “Home
Accounts” as an option. This scheme is referred
to as the “dual account structure.”
When the dual account structure is adopted,
the payment processing is made against the RTGS
account, and the Home Account is mainly used for
the reserve deposit. The Home Account concept
was adopted because some banks may not be in-
142
Payment Systems in EU
terested to participate directly in the TARGET2.
In spite of nonparticipation, they are subject to
the minimum reserve requirement in the home
country, and they also require an ability to man-
age the cash withdrawals directly from the home
central bank.
The Home Accounting function is achieved
either through the “Proprietary Home Account-
ing” (PHA) on the local systems, or the “Home
Accounting Module” (HAM) on the SSP. Of the
21 national central banks that connected to the
TARGET2 at the end of 2008, 12 central banks
chose to keep the local PHA.
Ancillary System
The TARGET2 provides the fund settlement ser-
vices in central bank money for other payment and
settlement systems. These systems are referred to
as the “Ancillary Systems” (ASs). The Ancillary
Systems include the retail payment systems, the
large-value payment systems, the FX systems, the
money market systems, the clearing houses (CCP),
and the Securities Settlement Systems (SSSs).
The main advantage of the TARGET2 for the
ancillary systems is to be able to access any ac-
Payment Systems in EU
counts on the TARGET2 system via the standard-
ized interface, the “Ancillary System Interface”
(ASI). The TARGET2 offers six standardized
interface, of which two are real-time procedures
and four are batch procedures. The participants
can use a single RTGS account for the settlement
of several ancillary systems, even some of them
are the cross-border systems.
A total of 69 ancillary systems settled in the
TARGET2 as of the end of 2008. Of them, 36 were
the retail payment systems and clearing houses,
and 33 were the Securities Settlement Systems. 57
of these systems settled directly on the TARGET2
system, while the 12 others settled on the systems
of national central banks.
Operating Hours
As for the “day-time window,” the TARGET2 has
the same operating hours as the first-generation
TARGET. The TARGET2 is open from 7:00 a.m.
to 6:00 p.m. CET on each of its working days.
However, the cut-off time for customer payments
is set at 5:00 p.m. CET.
In addition to the day-time window, the TAR-
GET2 has the “night-time window” as well. The
night-time window is available from 7:30 p.m.
of the previous day to 6:45 a.m., interrupted by
a technical maintenance period of three hours
between 10:00 p.m. and 1:00 a.m. CET. The
night-time window is to facilitate the night-time
settlements of the ancillary systems, especially the
Securities Settlement Systems (SSSs), in central
bank money with finality.
The participants can set aside the “Dedicated
Liquidity” in the dedicated sub-account, which
is exclusively reserved and used for the DVP
settlement with the SSSs. During the night-time
window, the liquidity transfers between the main
account (of RTGS account) and the dedicated
sub-account are possible at any time.
Monitoring Function
The “Information and Control Module” (ICM) of
the TARGET2 allows the participants to access all
the information related to their accounts and the
control measures. In particular, the participants
may benefit from the “single window access”
function of the ICM, which allows the access to
any Module of the TARGET2 system.
The ICM enables the direct participants to
control and manage their liquidity and payment
flows. Using the ICM, the participants can observe
the incoming and outgoing payments in the queue.
Information is not automatically provided,
but obtained by the operation of the participants,
which is called the “pull mode.” Technically, the
participants can access the ICM either through the
“Application-to-Application” (A2A) mode or the
“User-to-Application” (U2A) mode.
Migration to TARGET2
Country Window Approach
As for the migration from the TARGET to TAR-
GET2, the phased migration policy was adopted,
instead of the “big bang” migration approach.
Three “country windows” were set; in November
2007, February 2008, and May 2008. Each country,
including central bank and national banking com-
munity, was assigned to one of the three windows.
The migration was successfully completed in a
six-month period.
Migration of UK Traffic
Surprisingly, the Bank of England (BOE) decided
not to connect to the TARGET2. And the CHAPS
Euro, which was connected to the TARGET, was
closed down in May 2008. Some people worried
that the euro payments in the UK would be ex-
cluded from the TARGET2. Fortunately for the
UK banking community, this was not the case.
143

There are two ways for the British banks to
access the TARGET2. One way is to make an
access to the TARGET2 from the branches or
subsidiaries in the euro area. Another way is to
make a remote participation directly from the
head office in London to the central bank in the
euro area. The German and Dutch central banks
accepted the remote access positively and became
the two main access points for the British banks
in practice.
According to the research of the ECB, the large
majority of the British bank’s traffics stay in the
TARGET2 by one of two methods, which used
to be handled by the CAHPS Euro.
Share of Each Country in TARGET2
Although the TARGET2 is a unified system with
a single platform, it is still possible to break down
the TARGET2 traffic by country, or national bank-
ing communities.
Figure 5. Share of TARGET2 by Value
144
Payment Systems in EU
Share by Value
The TARGET2 traffic is concentrated on the
relatively small number of countries. In 2008,
only five countries had the share of more than
80% in value. More concretely, Germany, France,
Spain, the Netherlands and Italy had high traffic
turnover and the total share of these five countries
accounted for 82% of the value exchanged (see
Figure 5). These figures basically reflected the
fundamentals of economic power and the activities
of financial market in each country. Additionally,
the fact should be taken into account that the British
bank’s traffic is now included mainly in Germany
and the Netherlands, as mentioned above.
Share by Volume
On a volume basis, the concentration of the
TARGET2 traffic on a few countries is even more
marked. One single country, namely Germany,
represented almost half of the volumes exchanged
on the TARGET2. The total share of five coun-
tries, i.e. Germany, the Netherlands, Italy, Spain
Payment Systems in EU
Figure 6. Share of TARGET2 by Volume
and France, accounted for 86% of the volumes
on the TARGET2 (see Figure 6).
Net Settlement Systems In EU
Net Settlement Systems when
Euro was introduced
When the single currency euro was introduced in
1999, there were five net settlement systems for
euro, namely the EAF, the EURO1, the PNS, the
SEPI and the POPS. Of them, the PNS, the SEPI
and the EAF have already ceased operations and
the remaining systems are only two; the EURO1
and the POPS. However, as the POPS is a local
payment system in Finland with small scale and is
planned to be closed by the end of 2011. Therefore,
the EURO1 is substantially the only net settle-
ment system in the euro area. Before getting into
the detail of the EURO1, the other net settlement
systems are explained briefly.
EAF
The “Euro Access Frankfurt” (EAF) was a Ger-
man net settlement system operated by Deutsche
Bundesbank, which started its operation in March
1990. It was one of the major net settlement sys-
tems of the euro, and the first Hybrid system in
the world. The innovation in the EAF had a great
impact on the progress of other payment systems.
When started its operation, the EAF was a
payment system for Deutsche Mark and changed
into the payment system for euro in January 1999
when the euro was introduced. At that time, the
EAF changed its name from the German name
(“Electronischen Abrechnung Frankfurt”) to the
English name (“Euro Access Frankfurt”).
Originally, the EAF was a typical Designated-
Time Net Settlement (DTNS) system, which
executed settlements only once at the end of the
day. In March 1996, the EAF changed the settle-
ment process drastically to perform the frequent
nettings during the day, which meant the EAF
became the world’s first Hybrid system (See
Chapter 5 for more detail).
145

When the Bundesbank started the operation
of the RTGSplus in November 2001, the function
of the EAF was integrated into the new system
and the EAF was closed down. The RTGSplus was
an Integrated system, which had both the RTGS
mode and the Liquidity-Saving mode. Of them,
the essential part of Liquidity-Saving mode came
from the EAF. Thus, it can be described that the
TARGET2 was indirectly inherits the functional-
ity of the EAF.
PNS
The “Paris Net Settlement” (PNS) was a French
net settlement system operated by the Centrale
des Règlements Interbancaires (CRI). The share-
holders of the CRI were nine private banks and
Banque de France.
The PNS started operation in February 1997 as
a payment system for French Franc, and became
the payment system for euro in 1999.
As in the case of the EAF, the PNS was origi-
nally a DTNS system and changed its settlement
process into a Hybrid system in April 1999. At that
point, the PNS changed its name from the French
name (“Système Net Protégé”) to the English
name (“Paris Net Settlement”). At the same time,
the CRI built the “Liquidity Bridge” between the
PNS and TBF, the French RTGS system. By using
this bridge, the participants can transfer liquidity
freely between the two payment systems. For this
reason, the two systems were collectively called
the “Paris Integrated System” (PIS) as a whole.
The PIS was regarded as one of the Integrated
system (see Chapter 5 for more detail).
When the French RTGS system (TBF) was
integrated into the TARGET2 in February 2008,
the PNS ceased its operation.
SEPI
The “Servicio Espanõl de Pagos Interbancarios”
(SEPI) was a Spanish net settlement system op-
erated by the Madrid Clearing House. The SEPI
146
Payment Systems in EU
started operation in October 1997 as a payment
system for Spanish Peseta, and changed into the
payment system for euro in 1999.
Unlike the EAF and PNS, the SEPI did not
change the settlement method into a Hybrid System
and continued to be a DTNS system.
The SEPI was a small-scale and local settle-
ment system and closed down in December 2004
due to the competitive pressures.
POPS
The “Pankkien On-line Pikasiirrot ja Sekit”
(POPS) is a Finnish settlement system, operated
by Finnish Banking Association. Settlements are
made either on a gross basis or on a net basis.
As for the large-value payments, defined by the
“RTGS Limit,” the settlements are made on a
gross basis. Regarding the retail payments below
the Limit, the settlements are made on a net basis.
The POPS is a small-scale and local settlement
system compared to the two major large-value
payment systems, the TARGET2 and EURO1.
For this reason, the POPS is no longer included in
the payment system statistics of the Eurosystem
from the beginning of 2009. The Finnish bank-
ing society decided to shut down the POPS by
December 2011.
EURO1
Outline of EURO1
The “EURO1” is a private sector owned payment
system for the domestic and cross-border payments
in euro, operated by the EBA CLEARING. The
EBA CLEARING was established in June 1998
by 52 major banks under the French law with
the mission of owning and operating the EURO1
system. The EBA CLEARING was established as
a business administrator under the umbrella of the
“Euro Banking Association” (EBA) and continues
its close cooperation with the EBA.
Payment Systems in EU
The EURO1 is a large-value payment system
for euro and covers the whole area of EU. As of
the end of 2009, the EBA CLEARING has 66
shareholders and also provides the retail clearing
services of the STEP1 and STEP2.
The EURO1 went live in January 1999, and had
become the single pan-European net settlement
system for the high-value payments in euro by the
closedown of the other net settlement systems, as
mentioned above.
In December 2009, the EURO1 processed
on average 238 thousand payments per day for a
value of €247 billion.
Participants of EURO1
The EURO1 is open to banks with a registered
address or branch in the EU with certain level of
capital and credit rating and a head office in an
OECD or an EU country.
As of the end of 2009, the EURO1 had 66 direct
participants and 62 sub-participants. The EURO1
participants can exchange the interbank and cus-
tomer payments in euro with nearly 10,000 banks,
including the branches and subsidiaries. When
the “third party banks” are added, which are the
clients of EURO1 banks, more than 25,000 banks
are reachable through the EURO1. The accessible
banks are listed in the EURO1/STEP1 Directory.
System of EURO1
The EURO1 relies heavily on the messaging and
IT infrastructure provided by SWIFT. First, the
EURO1 uses the SWIFTNet as a network. Sec-
ond, the EURO1 adopts the FIN-Copy service
of SWIFT for message processing. Third, the
EURO1 uses the SWIFT message standards, which
includes MT103, MT202, MT 204 and MT400.
If “EBA” is filled in the field 103 of the SWIFT
message header, the payment message is recog-
nized as for the EURO1. The messages with this
tag are partially copied to the EURO1 system via
the FIN-Copy service of SWIFT.
Processing of Payments in EURO1
The EURO1 system starts processing at 7:30 CET.
And the cut-off time stands at 16:00 CET. During
these operating hours, the EURO1 participants
send payment messages to the EURO1 and the
system checks the sending and receiving partici-
pant’s position. Payment messages are processed
on an individual basis and the system calculates the
multilateral position of each participant resulting
from the processing of payment messages.
When the FIN-Copy send the copy of payment
messages to the EURO1 system, the “limit check”
is made as a first step. The limit check is carried
out both for the sending participant’s “debit cap”
and the receiving participant’s “credit cap.” If and
only if, the checking meets the both conditions,
the system process the payment message and
calculate the new positions of the sending and
receiving participant. If the checking does not
satisfy the conditions, the payment message will
not be processed, and put into an “on-hold queue.”
Once the payments are processed, the EURO1
sends the authorization to the FIN Copy, and the
original payment message is forwarded to the
receiving bank.
Risk Management of EURO1
For the risk management purpose, each participant
is required to set a “debit cap” and a “credit cap”
in the EURO1 system.
Each participant is required to extend to each
other participant a “mandatory limit” of €5 mil-
lion. In addition to the mandatory limit, each
participant may grant a limit up to €25 million at
the discretion of own policy. This means that the
“bilateral limit” ranges from €5 million to €30
million per participant.
The “debit cap” of a participant is the sum of
the bilateral limits received from the other partici-
pants. This is the upper limit for a participant to
processing paying messages, or to have the debt
position on a multilateral basis. On the other hand,
147

the “credit cap” of a participant is the sum of the
limits given to the other participants. This is the
upper limit for a participant to receive payments
on the EURO1 system.
To limit systemic risk, the participants col-
lectively contribute the “liquidity pool” of €1
billion, which is maintained by the ECB. This
fund is to prepare the default of any of EURO1
participants. Therefore, the debit and credit cap
of a participant cannot exceed €1 billion.
The bilateral limits can only be changed until
18:00 CET on the previous day of the settlement.
And a participant cannot change the bilateral
limits during the day until after the final settle-
ment of the day.
The system ensures that the multilateral net
position of each participant never exceeds its debit
and credit cap. When a payment is processed, the
system revisits the related participant’s on-hold
queue to check whether an adjusted position allows
Figure 7. Processing of Payments in EURO1
148
Payment Systems in EU
for further processing of payments in the queue.
The “Bypass FIFO” is adopted for the processing
method of the on-hold queues.
Settlement Process of
EURO1 (see Figure 8)
The final settlement takes place at the ECB after
the cut-off time. The cut-off time is set at 16:00
CET in order to give sufficient time for all the
participants to make pay-in and pay-out pro-
cesses prior to the closing time of the TARGET2,
which is 18:00 CET.
Calculation of Final Balance
At the cut-off time, the system calculates the final
balance (multilateral net position) of each partici-
pant resulting from all the processing of payment
messages. The system informs each participant
Payment Systems in EU
Figure 8. Settlement Process of EURO1
as well as the EBA CLEARING and the ECB, of
the amount of its balance.
Pay-in of Short Participants
Receiving the notice of the final balance, each
participant with a debit balance (the “short partici-
pant”) should send payments via the TARGET2
to pay-in to the “EBA Settlement Account” to
cover the short position. As an alternative method,
a short participant is able to authorize the EBA
CLEARING to directly debit its RTGS account
for the amount of its short position. This method
is called the “direct debit option5.”
Pay-out to Long Participants
Upon receipt of all the funds from the short
participants, the EBA CLEARING sends the in-
struction to the TARGET2 to distribute funds to
each participant with a credit balance (the “long
participant”). The long participants will receive the
funds which are equivalent to their credit balances.
With the instruction from the EBA CLEARING,
the TARGET2 debits the EBA Settlement Account
and makes payments to each long participant.
Once the EBA CLEARING confirms the
completion of all the pay-in and pay-out, it noti-
fies all participants that the EURO1’s settlement
of the day is completed.
Legal Structure of EURO1
The EURO1 adopts the “Single Obligation
Structure” (the “SOS”) as a legal basis, which
is based on the German law. The SOS is a legal
concept that participants always have the claims
or obligations only on a net basis. More specifi-
cally, once a payment message is processed, the
resulting position of multilateral net basis is only
the single claim (in the case of positive balance)
or the single obligation (in the case of negative
balance) toward all the other participants. This
means that participants do not assume any claim
or obligation of gross basis (the gross amount of
individual payments before netting).
The single obligation (or single claim) of each
participant changes from moment to moment, that
is, each time when a payment is processed.
149

Under this legal structure, the single obliga-
tion/claim does not allow for an unwinding. The
combination of the liquidity pool, risk manage-
ment and legal structure, the payment messages
become irrevocable and final when processed.
Traffic of EURO1
As the EURO1 is a pan-European payment system
along with the TARGET2, the main traffics are
the cross-border payments. However, the domestic
payments processed by the EURO1 have been
increasing gradually. For example, the Italian
Bankers Association decided to use the EURO1
for the Italian domestic payment traffic in 2008.
Liquidity Bridge between
EURO1 and TARGET2
The EBA CLEARING and Eurosystem have
established the “Liquidity Bridge” between the
EURO1 and TARGET2. This functionality enables
the participants of the two systems to transfer
liquidity between the two large-value payment
Figure 9. Liquidity Bridge between EURO1 and TARGET2
150
Payment Systems in EU
systems during the daytime and allow the flexible
liquidity management.
The Liquidity Bridge has two functionalities:
(i) prefunding function and (ii) liquidity distribu-
tion function (see Figure 9).
Prefunding Function
The “prefunding function” is used to move liquid-
ity from the TARGET2 to the EURO1. This func-
tion is available from 7:00 CET, the opening time
of the TARGET2, to 15:30 CET. The prefunding
function is useful when a EURO1 participant has
reached its debit cap and is unable to process more
sending payments. In this case, the participant is
able to cut down the debit balance far below its
debit cap by transferring liquidity form the TAR-
GET2 to EURO1. This function can be regarded
as a kind of pay-in at an early hour.
Liquidity Distribution Function
The “liquidity distribution function” is used to
transfer liquidity from the EURO1 to the TAR-
GET2. There are four distribution windows es-
Payment Systems in EU
tablished: at 13:00, 14:00, 15:00, and 15:30 CET.
First, 14:00 and 15:00 windows were established
in June 2006, and 13:00 and 15:30 windows were
added in July 2008.
The liquidity distribution is useful when a
EURO1 participant received a large amount of
funds and the net position is closer to its credit cap.
In this case, the participant is able to cut down the
credit balance far below its credit cap by transfer-
ring liquidity from the EURO1 to TARGET2.
As you can see, the two functionalities of
Liquidity Bridge serve an important role to cor-
rect the imbalances of liquidity between the two
large-value payment systems.
RETAIL PAYMENT SYSTEMS IN EU
Fragmented Situation of Retail
Payment Systems in EU
As mentioned above, the large-value payment
systems in the euro area were integrated into two:
Figure 10. Fragmented Situation of Retail Payment Systems in EU
the TARGET2 and EURO1. Currently, these two
payment systems cover the large-value payments
market of the whole euro area. We can conclude
that the large-value payment markets have been
integrated into a single market. Any credit insti-
tution can send or receive the funds to/from the
other credit institutions throughout the euro area
with the TARGET2 or EURO1.
On the other hand, the retail payment markets
are still very fragmented in the euro area, even
more than ten years after the euro’s launch. Figure
10 shows the image of such fragmented situation
of retail payment systems in the EU. Each country
keeps the Automated Clearing House (ACH),
which is providing the retail payment service
domestically with the domestic format. Thus, the
retail payment markets are divided into pieces,
and the individuals and corporates are unable to
fully enjoy the benefits of introducing the single
currency euro.
Table 6 shows the participant of the “Euro-
pean Automated Clearing House Association”
(EACHA), which is the cooperation forum of
151
 Payment Systems in EU

European ACHs. This table shows that there are make retail payments in euro throughout the euro
22 ACHs from 21 different countries, which also area using a single bank account and a single set
includes some non-EU and non-euro countries. of payment instruments.
The SEPA project was started in 2002 as a
SEPA Project part of the Lisbon Agenda which aims to boost
the competitiveness of the EU economy. The final
Outline of SEPA Project goal is to develop an integrated retail payments
market, the SEPA. Once the SEPA is achieved,
Responding to such a fragmented situation of there will be no differences between the cross-
the retail payment market, a project has been border payments and domestic payments in the
proceeded to integrate the whole euro area into a euro area as for the retail payments.
single retail payment area. This project is called
the “Single Euro Payments Area” (SEPA). The SEPA Countries
SEPA is a project that tries to make the situation
which allows the customers and corporates to The targeted countries of the SEPA project en-
compass 32 countries, which are referred to as the
“SEPA countries.” The SEPA countries include 16
Table 6. Participating ACHs of EACHA euro countries, 11 other EU countries, 3 countries
Country Name of ACH
in the EEA (Iceland, Liechtenstein and Norway),
Monaco and Switzerland.
Austria National Central Bank of
Austria
Belgium CEC Targeted Payments of SEPA Project
Bulgaria BS
Croatia FINA The intended payments of the SEPA project are the
Denmark PBS non-cash euro payments. Even though the SEPA
France STET countries include some “out-countries” which
Germany Deutsche Bundesbank
do not introduce the euro as a national currency,
Germany/Netherlands /Italy Equens
the target of SEPA project is absolutely the pay-
ments in euro.
Greece DIAS
The non-cash euro payments of SEPA project
Hungary GIRO Zrt.
include three payment instruments: (i) credit
Italy Banca d’Italia
transfer, (ii) direct debit and (iii) card payment. In
Italy ICBPI
what follows, the first two instruments are mainly
Italy SIA-SSB
described in more detail.
Macedonia KIBS
Norway BBS
Main Players in SEPA Project
Poland KIR
Portugal SIBS
A wide range of players take part in the SEPA
Romania TransFonD project. They include the public authorities, the
Spain Iberpay banking industry, the operators of retail payment
Sweden BGC systems, the corporates, and so forth.
Switzerland SIX Interbank Clearing
United Kingdom VocaLink
Source: EACHA, website

152
Payment Systems in EU
Public Authorities
The Eurosystem and the European Commission
are the two public authorities which actively pro-
mote the SEPA project. The Eurosystem consists
of the European Central Bank (ECB) and the
national central banks (NCBs) in the euro area.
Substantially, the ECB can be deemed as one of
main promoter of the project. The ECB closely
monitors the progress and development of the
project, and publishes the progress reports on the
SEPA project once in a while.
The European Commission is a policy-imple-
mentation organization of EU and has developed
the strategies and published some Directives.
The two authorities keep close contact in
monitoring and promoting the project.
Banking Industry
The banking industry in the EU established the
“European Payments Council” (EPC) in 2002 for
the SEPA project. The EPC is a self-regulation
body of pan-European banking industry. The EPC
is a coordination body of banking industry as
well as a decision-making body which made the
Rulebook and the Guideline for the SEPA project.
As of the end of 2009, the EPC consisted of
76 members, composed of banks and the repre-
sentatives from the three banking associations6.
The EPC plays a leading role7 to promote the
SEPA project.
The EPC already developed and published
the two Rulebooks regarding the “SEPA Credit
Transfer” (SCT) and the “SEPA Direct Debit”
(SDD), and also the “Framework for SEPA Card
Payment.”
With regard to the SCT and the SDD, the
EPC adopts the “replacement strategy,” which
intends to replace the existing schemes with a
new scheme. That is because each country has its
own national scheme for the credit transfers and
direct debits and it is quite difficult to eliminate
the differences among countries and establish the
common scheme.
As for the Card payment, the EPC adopts
the “adaption strategy,” which intends to adjust
the existing schemes of each country to the new
standard of business and technologies.
Operators of Retail
Payment Systems
As for the operators of retail payment systems,
the “Euro Banking Association” (EBA) and the
“European Automated Clearing House Associa-
tion” (EACHA) play a key role to implement the
SEPA project.
The EBA is the parent organization of the EBA
CLEARING which operates the pan-European
payment systems, such as the EURO1, STEP1
and STEP2.
The EACHA is the cooperation forum of Au-
tomated Clearing Houses (ACHs) in Europe. As
of the end of 2009, 22 ACHs are members of the
EACHA (see Table 6). The EACHA published the
“Technical Interoperability Framework,” which
facilitate building of bilateral linkages between
ACHs.
Corporate
From the corporate community, the “European
Associations of Corporate Treasures” (EACT)
actively participates in the activities of the SEPA
project. The EACT is an association of corporate
treasurers, comprising more than 4,500 members.
National Community
In each SEPA country, a national body for the
SEPA migration is established, which is called
the “national SEPA migration committee” or the
“SEPA Forum.” The body is composed of the
banks, corporates and public organizations, and
usually co-chaired by the central bank and a major
bank in the country. The national body develops
153

a policy how to respond to the SEPA project and
makes a migration plan of the country.
SEPA Credit Transfer (SCT)
Features of SCT
The “SEPA Credit Transfer” (SCT) is a SEPA
scheme for credit transfer payments. First, an
Originator asks the Originating Bank to send a
certain amount of fund to the Beneficiary. Then,
the Originating Bank sends the payment mes-
sage to the Beneficiary Bank which is the bank
the Beneficiary has an account, through an ACH
or an intermediary bank. Upon receiving the
payment message, the Beneficiary Bank credits
the sending amount to the Beneficiary’s account
(see Figure 11).
The characteristics of the SCT are as follows.
1. Originator is able to make payments8 to any
account of any bank in the euro area.
2. Payments are made for the full original
amount and there are no deductions.
3. There is no limit for the sending amount.
Figure 11. Scheme of Credit Transfer
154
Payment Systems in EU
4. The credit to the beneficiary’s account should
be made within three days (maximum settle-
ment time).
5. “International Bank Account Number”
(IBAN) and “Bank Identifier Code” (BIC)
should be used in order to identify the
accounts.
6.140 characters of remittance information
are delivered to the beneficiary without
alternation or omission.
7. The ISO 20022 message in XML
format should be used between
banks.
8. The SCT scheme is separated from
the processing infrastructure.
Utilization Status of SCT
The EPC has developed the Rulebook for the SCT.
And the SCT was launched in January 2008. At
this stage, more than 4,300 banks in 31 countries,
representing roughly 95% of payment volumes
in Europe, confirmed that they were able to send
and receive the SCT messages.
However, the traffic using the SCT is much
less than previously expected. Transaction in the
Payment Systems in EU
SCT format as of total transactions in the euro
area was only 14.7% as of January 2011. Most
of them are the cross-border transactions and the
usage of the SCT for the domestic transactions
are extremely limited.
Obstacle for Penetration of SCT
The first reason why the SCT penetration is low
is that there is no obligation to use and no pen-
alty for not using the SCT. The SEPA project has
adopted the “self-regulation approach” thus far.
Therefore, the usage of the SCT is completely
on a voluntary basis. The lack of binding power
puts the limitation on the broad use of the SCT.
The second reason for the low adoption rate
of the SCT is the presence of the domestic ACHs.
In each country, an ACH is providing an efficient
retail payment service at a low price with a do-
mestic format. Even though many ACHs became
the SCT compliant, there are no incentives for the
banks and customers to use the new SCT scheme
instead of the domestic scheme which they get
accustomed to.
Third, the obligation usage of the BIC and the
IBAN is another obstacle to implement the SCT.
Figure 12. Scheme of Direct Debit
Until a company collects all the BICs and IBANs
of the business partners, it will not start sending
payments in the SCT. For large companies, it
usually takes so much time and cost to build the
database of the BICs and the IBANs for the vast
numbers of business partners. Therefore, a large
majority of companies keep a wait-and-see attitude
to the SEPA project.
SEPA Direct Debit (SDD)
Features of SDD
The SEPA Direct Debit (SDD) is a SEPA scheme
for direct debit payments. In the direct debit, a
Creditor will ask his/her bank (Creditor Bank) to
debit the Debtor’s account and credit the amount
to his/her account (Creditor’s account). For this
purpose, the Creditor Bank sends the direct debit
instruction to the Debtor Bank. Upon receiving
this instruction, the Debtor Bank will debit the
Debtor’s account and send the amount to the
Creditor Bank. Receiving the amount from the
Debtor Bank, the Creditor Bank will credit the
amount to the Creditor’s account (see Figure 12).
155

The direct debit is often used for the recurring
payment, such as payment for the utility charges,
electric bills and phone charges. This is a useful
and convenient way of payment for both the pay-
ers and payees. The Debtor should submit the
“mandate” (written paper or electronically-based
instruction) to the Creditor and the Debtor Bank
in advance.
In the euro area, as the case now stands, the
direct debit was possible only at the national
level, or within the borders. When a company
provides a service to the customer who lives in
the neighboring country, it was unable to collect
the service charges by way of direct debit from
the customer’s bank in another country. It was a
very inconvenient situation for the company and
also for the customers. The SDD is a scheme that
allows such a company to collect charges from
any bank in the euro area.
The characteristics of the SDD are as follows.
1. Creditor is able to make direct debit from
any account of any bank in the euro area.
2. Both recurring debit and one-time debit are
possible.
3. Creditor is able to appoint the exact due date.
4. Creditor should send a pre-notification to
the debtor more than 14 days prior to the
due date.
5. Direct debit instruction to ACH should be
sent more than 5 days prior to the due date
for the first time, and more than 2 days for
the second time or after in recurring debit.
6. “International Bank Account Number”
(IBAN) and “Bank Identifier Code” (BIC)
should be used in order to identify the
accounts.
7. The ISO 20022 message in XML format
should be used between banks.
8. Direct debit scheme is separated from the
processing infrastructure.
156
Payment Systems in EU
Two Schemes of SDD
The EPC has developed the two schemes for
the SDD. One is the “SEPA Core Direct Debit
Scheme,” which is for the direct debit where the
debtor is an individual. The other is the “SEPA
Business to Business (B2B) Direct Debit Scheme,”
which is for the direct debit where payments are
made between corporates as part of their business
transactions.
Main differences between the two schemes are
as follows. First, the Core Direct Debit Scheme
admits the broad rights for the consumer (Debtor),
such as a refund. Second, the B2B scheme requires
the Debtor Bank to ensure that the collection is
authorized, and also requires the Debtor Bank
and the Debtor to agree on the verification to be
performed for each direct debit.
Launch of SDD
The SDD was introduced in November 2009.
This means that the SDD scheme is available,
if all the relevant parties (the Creditor, Debtor,
Creditor Bank and Debtor Bank) are agree to use
and ready to offer the service.
However, both the companies and customers
are not prepared for the SDD; the actual usage
of the SDD is still quite limited. The SDD as a
percentage of total transaction was only 0.07%
as of January 2011.
Response of Retail Payment
Systems to SEPA Project
SEPA Compliance of ACHs
Under the SEPA project, the Automated Clearing
House (ACH) has become to be called the “Clear-
ing and Settlement Mechanism” (CSM). That is
because the ACH has a subtle nuance of domestic
service, and the CSM has a connotation of cross-
border activities. This implies that the ACHs are
required to extend their business to the whole euro
Payment Systems in EU

Table 7. SCT Scheme-compliant CSMs (as of the

area, instead of confining their functions only to
end of 2009)
the domestic services. However, the term of ACH
will continue to be used in what follows, which Country, Area Name of CSM
is more familiar to the reader. Austria National Central Bank of
The ACHs in the euro area has made response Austria
to the SEPA project. As of the end of 2009, 17 Belgium CEC
ACHs (or CSMs) made a declaration that they Bulgaria Bankservice JSC
were SCT Scheme-compliant (see Table 7). Denmark Eurogiro
The Eurosystem has defined four criteria to France STET
assess the SEPA-compliance of infrastructures. Germany Deutsche Bundesbank
The four criteria are as follows: Germany / Netherlands Equens
Greece DIAS
1. To comply with the requirements of Italy Banca d’Italia
Rulebook and Guidelines of the EPC. Italy ICBPI
2. To adopt interoperability rules between
Italy SIA-SSB
infrastructures.
Poland KIR S.A
3. To have full reachability: be able to send or
Portugal SIBS
receive euro payments to/from all banks in
Slovenia Bankart
the euro area.
Spain Iberpay
4. To enable banks to make choice of ACH
United Kingdom VocaLink
based on service and price.
Euro Area STEP2

Approach to the SEPA Project Source: EPC

There have been several approaches of ACHs

PEACH Concept
to the SEPA project. The first approach was to
create a “Pan-European Automated Clearing
Definition of PEACH
House” (the “PEACH”). The PEACH is a country
neutral ACH, which covers the whole euro area
The “Pan-European Automated Clearing House”
and handles both the cross-border and domestic
(PEACH) is defined as a country neutral ACH,
retail payments. But later, another idea was put
which process the cross-border and domestic
forward. That was the concept of linking between
payments of the whole euro area. The PEACH
the local ACHs bilaterally and creating the wide-
should have the SEPA-wide reachability, that is,
range ACH network in the euro area.
any bank in the euro area should be reachable
As the situation stands, the PEACH Concept
through the PEACH. The PEACH is supposed
and Cross-border Linkage Concept have been
to handle both the credit transfer (SCT) and the
making progress in parallel. There will be a long
direct debit (SDD). The PEACH is a concept of
way to go before the retail payment systems in
country neutral ACH and is not necessarily limited
the euro area become SEPA-compliant as a whole.
to one ACH.
It is very natural that a single ACH will cover
the whole euro area, as with other currency zones.
Figure 13 shows the concept of the PEACH. In
an early stage, only the cross-border payments are

157

Figure 13. Concept of PEACH
supposed to go to the PEACH and the domestic
payments continue to be processed by the local
ACH in the country (see the Country B’s case in
Figure 13).
At a later stage, however, the domestic pay-
ments are supposed to make a shift from the local
ACH to the PEACH, and the PEACH will process
both the cross-border and domestic transactions
(see the Country A’s case in Figure 13).
First PEACH
The first and only PEACH so far in the EU is the
“STEP2.” The STEP2 is a retail payment system
for bulk payments in euro, which is operated by
the EBA CLEARING. The STEP2 provides the
SCT and SDD service; both are fully compliant
with the SEPA Scheme Rule book.
The STEP2 started its operation in April 2003
and was accredited as the first PEACH by the
EPC in the same year. This is the only PEACH
identified until now.
158
Payment Systems in EU
As for the SCT Service on the STEP2, there
are 117 Direct Participants and more than 4,300
Indirect Participants, as of the end of 2009. Re-
garding the SDD Service, there are 56 Direct
Participants for the SDD Core Service, and 40
Direct Participants for the SDD B2B Service.
Through these Direct Participants, more than
2,200 banks across Europe are reachable. With
the SCT and SDD services, the STEP2 provides
the reachability to all 32 SEPA countries.
In addition to these cross-border transactions,
the banking community of Luxembourg mitigated
its domestic traffics to the STEP2 in 2006. It was
the first community to move from a local ACH
to the PEACH.
In November 2006, another service was
launched to process a part of the Italian domes-
tic traffics, which is called the “Italian Credit
Transfer” (ICT) Service. Thus, parts of Italian
traffics are processed by the STEP2, with 7 Direct
Participants and 69 Indirect Participants.
The STEP2 provides the wide reachability
across Europe, and processes over 190 thousand
Payment Systems in EU
payments per day. However, the traffic is rather
small compared to the whole retail payments
in the euro area. Therefore, it can be concluded
that the situation is far from the “real PEACH,”
which processes the large portion of euro traffics
in Europe. In sum, the PEACH concept is still in
its infancy.
Cross-Border Linkage Concept
Linkage Concept and EACHA
From around 2005, some ACHs in the euro area
began to consider the alternative idea to the
PEACH concept. That was the “Cross-border
Linkage Concept” which each ACH becomes the
SEPA scheme-compliant first, and then establishes
the bilateral linkages in order to process the cross-
border transactions through the linkages.
For this purpose, the European Automated
Clearing House Association (EACHA) was estab-
lished in September 2006. The EACHA aimed to
be a forum of European ACHs as well as to work
on the specific issues such as developing common
standards for interoperability between the ACHs.
Figure 14. Cross-border Linkage Concept of ACHs
The EACHA membership consists of 22 ACHs
from 21 different countries as of the end of 2009.
The EACHA published the “Technical In-
teroperability Framework9” in 2007, which was
a technical paper to set the minimal specifica-
tions of the technical elements needed to secure
interoperability between the ACHs.
In this linkage model, the domestic transactions
are processed by the local ACH in the country and
only the cross-border transactions are exchanged
between the two ACHs concerned using the bi-
lateral linkage (see Figure 14).
Spaghetti Model
Figure 14 shows the relationship between the two
ACHs. However, in a real situation, the single link-
age is not enough to cover many markets in Europe.
Each ACH should have quite a lot of linkages, if
it wants to have a wide range of accessibility to
many markets in the euro area. Therefore, this
concept is sometimes criticized as the “Spaghetti
Model” because a shape of many linkages looks
like Spaghetti (see Figure 15). If twenty ACHs
want to have bilateral linkages each other, the
number of linkages reaches the startling figure
159

Figure 15. Spaghetti Model in real situations
of 190. To build such a huge number of linkages
is unrealistic and next to impossible.
It is worth mentioning that the same kind of
linkage model was discussed in the past years as
for the securities settlement. Concretely, the in-
tegration of Central Securities Depositories
(CSDs) in the EU was discussed during 1998-
2002. Some linkages between the CSDs were
actually built following the linkage concept, but
the ambitious concept was abandoned on the way
due to the complexity and troublesome task of
building a large number of linkages. This case
shows the difficulty of the cross-border linkage
model.
Settlement Scheme of
EACHA Framework
The EACHA Framework adopts the “Fiduciary
account model.” When payment messages are
exchanged between the two ACHs, the settlements
for the payments are made through the TARGET2.
The ACHs are eligible to have an account at
the TARGET2. In the Fiduciary account model,
such accounts of ACH (hereinafter referred to as
160
Payment Systems in EU
the “T2 ACH account”) will be used to hold the
intra-day funds for the settlements between the
two ACHs.
Assume that one bank send payments to another
bank through the linkage between the ACH1 and
ACH2. In the first cycle (the “sending cycle”),
the ACH1 (ACH of sending side) debit the funds
from the account of Originating Bank and credit
to the T2 ACH account. In the second cycle (the
“receiving cycle”), on successful completion of
settlement, the ACH2 (ACH of receiving side)
debit the funds from the T2 ACH account and
credit to the Receiving Bank (see Figure 16).
Both fund transfers are initiated by the ACH1
and ACH2. In this model, the T2 ACH account
will hold the funds in a time between the first and
second cycle. That is why this model is called the
“Fiduciary account model.” The funds are held
in the name of the ACH2, although the fund is
owned by the Receiving Bank. The funds are held
in the T2 ACH account only intraday and the
overnight balance in the account is not envisaged.
In order to eliminate settlement risk, a “settle-
ment before output model” is used, such that the
payment messages are forwarded from the ACH
Payment Systems in EU
Figure 16. Settlement Model of EACHA Interoperability Framework
1 to the ACH 2, only when the first settlement
cycle has been successfully completed.
There is no unwinding of the inter-ACH mul-
tilateral balances, since only gross credit positions
are dealt with and there is no netting executed.
Linkages Built
Some bilateral linkages were already built between
the ACHs in Europe. These linkages are based
on the “Technical Interoperability Framework”
of the EACHA.
Figure 17. Bilateral Links between ACHs
The main player is the Equens, which came
into existence in 2006 by the merger between the
Dutch and German ACH. As of the end of 2009,
the Equens has bilateral linkages with DIAS
(Greece), Iberpay (Spain), ICBPI/Banca d’Italia
(Italy), OeNB (Austria), SECB (Switzerland) and
VocaLink (UK). These linkages have the “hub &
spoke” structure, and the Equens became the hub
of these bilateral linkages (See Figure 17).
Only the linkage that the Equens is not involved
is the link between the Vocalink and the STET
(France). If a linkage will be built between the
161

Equens and the STET, the “golden triangle” will
emerge among the three big markets: Germany,
France and the UK.
The cross-border payments can be processed
with these linkages, but only among the eight
countries and only bilaterally. In sum, there is
a serious limitation in this linkage model at this
stage. Therefore, the situation is still far from the
fundamental solution, which a single ACH or a
network of linkages between the ACHs will cover
the whole euro area.
Single ACH Concept
One ACH in One Currency Zone
Generally speaking, one ACH is sufficient for
one currency zone. Most countries have only one
ACH, and almost all financial institutions in the
country usually have the connection to the ACH.
Such situation creates the nation-wide network
and a bank can send/receive payments to/from
any banks in the country.
To apply this “one-country model” to the euro
area, the ultimate conclusion is that only a single
Figure 18. Single ACH Concept
162
Payment Systems in EU
ACH is necessary and sufficient in the euro area.
If one ACH handles both the domestic and cross-
border transactions in euro, it will be the most
efficient way to handle the whole retail payments
in the euro area. This way of thinking is referred
to as the “Single ACH Concept.” Figure 18 shows
this concept, where one and only ACH processes
both the domestic and cross-border transactions.
Single ACH and SEPA
If this situation will be materialized, the aim of the
SEPA project, to treat the cross-border payments
in the same way as the domestic payments, will
be achieved in a complete manner. Besides, the
cost of single ACH will be much lower than the
distributed local ACHs due to the economy-of-
scale advantages. Additionally, each bank has no
need to accommodate several schemes or to keep
the connections to the multiple ACHs. In sum, the
Single ACH concept has the greater merits and
is the ideal situation for the integration of retail
payment systems in the euro area.
In order to realize the Single ACH situation,
however, it is necessary to abolish the local ACHs
Payment Systems in EU
in each country. This is quite a major surgery and
difficult to implement, considering the political
resistance and national sentiments.
Therefore, for the time being, it is realistic to
integrate the retail payment infrastructure gradu-
ally in a slow manner by consolidating payment
flows into the STEP2 and promoting the bilateral
linkages between the ACHs.
Comparison with Other
Cases of Integration
In the case of the integration of large-value pay-
ment systems for reference, the TARGET was
introduced at first as a distributed system, which
connected the national RTGS systems with the
interlinking network. Later on, the TARGET was
transformed into the TARGET2 as a centralized
system. This might be a final situation for this
matter.
As this case shows, a steady way has been taken
in the integration process of financial infrastruc-
ture in the euro area. More concretely, the general
principles were established in the first place, and
then a consensus among the parties concerned was
tried to be created following the general rules. In
this approach, it takes considerable time to reach
a consensus with containing oppositions from the
local point of view.
Thus far, the same kind of approach has been
adopted for the integration of retail payment sys-
tems. It seems very possible that the Single ACH
Concept will be pursued in the long run, which
will be an ultimate situation.
By comparison, the Eurosystem has launched a
project, called the “TARGET2-Securities” (T2S),
which is the integration project of Central Secu-
rities Depositories (CSDs) in the euro area. The
Eurosystem embarked the T2S project because it
had fully frustrated the slow progress of the integra-
tion of the CSDs by the private sector initiative.
If the same situation will occur due to the
blundering response in the private sector, the pos-
sibility cannot be ruled out that the Eurosystem
will launch on a new challenge for the integration
of retail payment systems in the euro area as its
own initiative.
STEP1
The following part gives an explanation of the
clearing and settlement mechanism of two EU-
wide retail payment systems; the STEP1 and
STEP2.
Features of STEP1
The “STEP1” is a retail payment system for euro
in the EU-wide economy. The EBA CLEARING
owns and operates the STEP1. The STEP1 was
launched in November 2000 to enable banks in
the EU to make the cross-border retail payments
in euro within a short period of time at low cost.
The STEP1 is a service for the individual
commercial payments in euro, which contrast
sharply with the fact that the STEP2 is a service
for the bulk payments or payment files (to be
discussed below).
The STEP1 service is provided using the
platform of the EURO1. Even though a bank
does not comply with the strict EURO1 partici-
pation criteria, it can be the “STEP1 Banks,” the
participants of the STEP1. The admission criteria
for the STEP1 participation neither involves a
minimum credit rating nor a minimum own funds
requirement.
Each STEP1 Bank designates one of EURO1
Banks as a “clearing bank” and delegate the clear-
ing of own position in the STEP1 to the clearing
bank. The STEP1 comprises 99 direct participants
and 50 sub-participants from the EU-wide coun-
tries as of the end of 2009.
On a daily basis, the STEP1 processes on
average 232,000 transactions for a total value of
€250 billion.
163

Risk Management of STEP1
The STEP1 set the debit cap of each participant
at zero (the “zero debit cap”) in order to avoid
the occurrence of systemic risk. In other words,
when a participant has a negative potential balance
(i.e., position is less than zero), the payments of
the participant are not processed and released to
the receiving bank until the clearing bank of the
participant makes a pay-in and make the partici-
pant’s balance more than zero.
On the other hand, each STEP1 Bank is re-
quired to set a “credit limit” between €2 million
and €10 million. This is the upper limit that the
participant allows to receive the payments from
other participants. The credit position of a par-
ticipant is not allowed to exceed the credit limit.
If the position of a participant after the netting
satisfies both conditions of the debit cap and credit
limit, the payments are processed and released to
the receiving bank. On another front, if the par-
ticipant’s position does not meet the conditions,
the payments are kept in the waiting queue as
“on-hold payments”.
Figure 19. Processing Cycle of STEP1
164
Payment Systems in EU
Processing Cycle of STEP1
The processing of the STEP1 starts at 7:30 at
the same time of the EURO1, and ends at 16:00
(all times are in CET). The cut-off time for the
same-day value payments is 14:30. The EBA
CLEARING executes the netting and informs the
“Potential Net Balance” (PNB) to each STEP1
Bank at around 14:40. The participant with the
negative balance ask its clearing bank to pay-in to
make up the debit position, while the participant
with the positive balance ask its clearing bank
to pay-out the credit balance. These pay-ins and
pay-outs are called the “capacity transfer.” After
the capacity transfer, the balances of all the par-
ticipants are assumed to be zero (see Figure 19).
STEP2
As the name suggests, the STEP2 is an exten-
sion of the STEP1. The several different types
of services and the settlement mechanisms of the
STEP2 are as follows.
Payment Systems in EU
Several Services of STEP2
The STEP2 is the “Pan-European Automated
Clearing House” (PEACH) for bulk payments in
euro, which is operated by the EBA CLEARING.
The first service of the STEP2 was launched in
April 2003, which was to process credit transfers.
This service is called the “XCT Service,” and is
in line with the “CREDEURO Convention” of
the European banking industry.
The second service was the Italian Credit
Transfer (ICT) Service, launched in November
2006. That was a specific service for the Italian
domestic transactions.
The third service was the SEPA Credit Transfer
(SCT) Service, which went live in January 2008.
The SCT Service allows the European banks to
send their SEPA-compliant credit payments.
The fourth service was the SEPA Direct Debit
(SDD) Service, which went live in November
2009. The SDD Service includes both the “SEPA
Core Direct Debit Service” for consumer direct
debits and the “SEPA B2B Direct Service” for
business-to-business direct debits.
The EBA CLEARING is offering these services
in parallel on the platform of the STEP2. In other
words, the STEP2 provides the SEPA-compliant
services as well as the non-SEPA-compliant
services. With these services, the STEP2 allows
banks across Europe with a single channel to
send and receive the credit and debit payments.
In line with the PEACH concept defined by the
EPC, the STEP 2 provides the full reachability to
the banks in the euro countries, and the European
countries as well.
Processing and Settlement
in XCT Service
Participants
Any Bank operating in the European Economic
Area (EEA) is able to become a participant of
the STEP2 XCT Service. There were 105 Direct
Participants and over 1,700 Indirect Participants
for the service as of the end of 2009.
The STEP2 service is based on the network
and service of SWIFT. For sending the payment
files, the SWIFTNet File Act is used. The payment
message is based on the MT103+ with formatting
in the XML (eXtensible Markup Language) using
the SWIFT Bulk Payment standard.
Processing and Clearing Stage
The XCT Service has only one clearing cycle
on a daily basis. The participants are able to
send “Input Payment File” (IPF) which contains
many payments, to the STEP2 until 22:00 CET
on D-1 (the previous day of the settlement date).
The STEP2 processes the files during the night.
More concretely, the files are opened and vali-
dated whether key fields are in accordance with
the formatting rules. If an individual payment
message fails to pass the validation check, it is
rejected and returned to the sending participant
with the reason.
The payment messages which passed the vali-
dation are sorted into the “bilateral sub-files.” The
sub-file is created per receiving participant, which
contains payments to each receiving participant
from the various sending participants.
For each sub-file resulting from the sorting
of the payment messages, the STEP2 calculates
the amount of the bilateral payment obligations
between the sending participant and receiving
participant.
Once the bilateral payment obligations are
calculated, the STEP2 generate and send the
payment messages to the EURO1. They are the
payment instructions for the amount of each sub-
file. Settlements of the sub-files are made through
the EURO1.
Settlement Stage
When the EURO1 starts up processing at 7:30 CET
on D (the settlement date), the Euro1 executes
165

Figure 20. Processing and Settlement in STEP2
the payments regarding each sub-file, and send a
confirmation message of settlement to the STEP2
by 8:00 CET (see Figure 20).
Upon receiving the confirmation message, the
STEP2 release the sub-file as the “Settled Payment
File” (SPF) to the receiving participant by 8:30.
Then, the sending participant will receive a report
that notifies the payment messages are settled and
forwarded.
Roles of STEP1 and STEP2
Until an integrated retail payment market becomes
a reality by the successful implementation of the
SEPA project, the STEP1 and STEP2 will play a
critical role in the retail payment area in the EU.
REFERENCES
Deutsche Bundesbank/TARGET2:
EACHA (2009, March). Technical Interoperability
Framework for SEPA (version 4.1).
EBA CLEARING (2008, March). Report on
Activities 2007.
166
Payment Systems in EU
EBA CLEARING (2009, March). Report on
Activities 2008.
European Automated Clearing House Associa-
tion. (2009, March). Technical Interoperability
Framework for SEPA – Compliant Payments
Processing Version 4.1.
European Central Bank. (1999, September). Im-
proving cross-border retail payment services - The
Eurosystem’s view.
European Central Bank. (2000, September).
Improving cross-border retail payment services
- Progress report.
European Central Bank. (2001, November).
Towards an integrated infrastructure for credit
transfers in euro.
European Central Bank. (2003, June). Towards
a Single Euro Payments Area – (2nd) Progress
Report.
European Central Bank. (2004, December).
Towards a Single Euro Payments Area – Third
Progress Report.
Payment Systems in EU
European Central Bank. (2005, November). Single
Shared Platform.
European Central Bank. (2006a, February). To-
wards a Single Euro Payments Area: Objectives
and Deadlines – Fourth Progress Report.
European Central Bank. (2006b, August). The
Evolution of Large-Value Payment Systems in
the Euro Area. ECB Monthly Bulletin.
European Central Bank. (2006c, November).
Information Brochure: SEPA.
European Central Bank. (2007, July). Single Euro
Payments Area (SEPA) from Concept to Reality
– Fifth Progress Report.
European Central Bank. (2008a, November). Sin-
gle Euro Payments Area – Sixth Progress Report.
European Central Bank. (2008b, April). Terms
of reference for the SEPA-compliance of infra-
structures.
European Central Bank. (2008c, May). TARGET
Annual Report 2007.
European Central Bank. (2009a, March). Euro-
system’s SEPA Expectations.
European Central Bank. (2009b, May). TARGET
Annual Report 2008.
European Central Bank. (2009c, July). The Single
Euro Payments Area (SEPA): An Integrated Retail
Payments Market.
European Commission/ SEPA. http://ec.europa.
eu/internal_market/payments/sepa/
European Payments Council. (2002, May). Eu-
roland – Our Single Payment Area.
European Payments Council. (2009a, January).
Making SEPA a Reality.
European Payments Council. (2009b, January).
Shortcut to the SEPA Credit Transfer Scheme.
European Payments Council. (2009c). Shortcut
to the SEPA Direct Debit Schemes.
WEBSITES
EBA CLEARING: http://www.abe.org/ ECB/
Payments & Markets: http://www.ecb.int/paym/
html/index.en.html
European Payments Council. http://www.europe-
anpaymentscouncil.eu/
http://www.bundesbank.de/zahlungsverkehr/
zahlungsverkehr_2target.en.php
VocaLink. http://www.voca.co.uk/
ENDNOTES
1
The other large-value payment systems are
the EURO1 and POPS.
2
It took two to three minutes from the debit
processing of the sending bank’s account to
the credit processing of the receiving bank’s
account.
3
The TARGET had also no limit for the
maximum value.
4
The EEA includes Iceland, Norway and
Liechtenstein as well as the EU member
countries.
5
The direct debit option had not been available
under the TARGET, and became available by
the migration to the TARGET2. More than
half of the participants have adopted this
option, which has shortened the settlement
phase of the EURO1.
6
They are: the European Banking Federation
(EBF), European Savings Banks Group
(ESBG), and European Association of Co-
operative Banks (EACB).
7
It is sometimes said that it is the EPC which
is at the pilot’s seat of the plane called SEPA.
8
Both single payments and bulk payments
are supported. Bulk payment comprises one
debit to the originator’s account and multiple
credits to different beneficiaries.
9
The latest version is version 4.1, published
in March 2009.
167
168

Chapter 11
Payment Systems in Japan

ABSTRACT
This chapter takes a close look at the payment systems in Japan. There are three payment systems in
Japan: the Bank of Japan Financial Network System (the “BOJ-NET”), the Foreign Exchange Yen
Clearing System (the “FXYCS”) and the Zengin Data Telecommunication System (the “Zengin System”).
The BOJ-NET is operated by the Bank of Japan (BOJ), and the FXYCS and Zengin System are operated
by the private sector.

The BOJ-NET is a large-value payment system, which is mainly used for payments for the money market
transactions and government bond transactions. It also handles the settlement of net positions of the
private-sector netting systems and the payments for the BOJ’s open market operations. The BOJ-NET is
the equivalent of the Fedwire in the US, and the TARGET2 in the euro area. The BOJ-NET was originally
a Designate-Time Net Settlement (DTNS) system, and became the Real-Time Gross Settlement (RTGS)
system in 2001. Then, the BOJ-NET enhanced its functionality and became the Integrated system in
2008, which has both the RTGS mode and Liquidity-Saving mode. The enhancement of the BOJ-NET to
the Next-Generation RTGS system is explained in detail.

The FXYCS is a payment system that handles the Japanese Yen (JPY) leg payments for the foreign ex-
change transactions and international treasury settlements. In this sense, the FXYCS is the equivalent
of the CHIPS in the US. With the reform of the BOJ-NET in 2008, the importance of the FXYCS has
decreased substantially.

DOI: 10.4018/978-1-61520-645-2.ch011

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
Payment Systems in Japan

The Zengin System is a nationwide electronic fund transfer network mainly for the customer payments.
Almost all the financial institutions in Japan, approximately 1,400 institutions, participate in the Zengin
System. As most of the payments made through the System are the consumer and commercial payments,
the transaction volumes are huge, while the amount of each payment is rather small. In addition to the
single payments, the Zengin System also supports the batch payments, such as the payroll and pension
payments. The Zengin System is a DTNS system, where the final settlement of the net positions takes place
at the end of the day. The Zengin System is planned to be upgraded to the sixth generation system in
November 2011. The details of new mechanisms of the six generation system are described in the chapter.

INTRODUCTION But at length, the BOJ enhanced its RTGS

The BOJ-NET and FXYCS are mainly for the inter-
bank payments and characterized as a large-value
payment system. On the other hand, the Zengin
System is mainly for the customer payments and
regarded as a retail payment system.
However, we have to pay some attention that
some large-value payments are also processed
in the Zengin System. The Foreign Exchange
Act had stipulated that the international related
payments should be processed by the FXYCS
for the purpose of foreign exchange control1. As
a result, the Zengin System is dedicated to the
domestic payments, which include some large-
value payments.
In other countries, the division of roles between
payment systems is generally made by the value
of the payments between the large-value pay-
ments and retail payments. In the case of Japan,
however, the assignment of roles is made between
the international payments and domestic payments
due to the above legal reason. This was one of the
features of Japanese payment systems.
The second feature was the delay in the re-
form of payment systems. The major advanced
countries in Europe, North America and the Asia-
Pacific region introduced the RTGS systems in
late 1990s, but the BOJ-NET finally became the
RTGS as late as in 2001.
Besides, the Hybrid systems and Integrated
systems were introduced one after another in the
US and European countries during 1996-2004,
the Japanese payment systems showed little sign
of the sweeping reform.
system to a sophisticated system in 2008. This
project was called the “Next-Generation RTGS
(RTGS-XG) project” of the BOJ-NET. As a result
of this project, the Japanese payment systems
caught up with the global trend and became one
of the cutting-edge payment systems in the world.
BOJ-NET
Outline of BOJ-NET
Two Roles of BOJ-NET
The BOJ-NET is a payment system owned and
operated by the Bank of Japan (BOJ), the central
bank of Japan.
The functionality of the BOJ-NET can be
divided broadly into two. One is a function as
a fund settlement system, and the other is as a
function as a settlement system of the Japanese
Government Bonds (JGBs).
First, the BOJ-NET as a fund settlement
system (the BOJ-NET Funds Transfer System)
process the large-value payments concerning the
money market transactions, the government bond
transactions, and the settlement for net settlement
systems, such as the Bill and Cheque Clearing
Systems and the Zengin System.
Second, the BOJ-NET as a securities settlement
system (the BOJ-NET JGB Services) handles the
settlements of the JGBs including the buying and
selling, the issuing, and the BOJ’s operation.

169

The BOJ-NET is quite similar to the Fedwire
in respect that it is not only the fund settlement
system but also a government bond settlement
system.
Participants of BOJ-NET
The Participants of the BOJ-NET as a fund settle-
ment system is 348 as of the end of 2009. The
participants cover wide range of financial institu-
tions, which include the major commercial banks,
regional banks, trust banks, foreign banks, credit
unions, securities companies, securities finance
companies, clearinghouses and money brokers.
The BOJ does not allow foreign institutions
to access to the BOJ-NET from outside of Japan
in principle. Only the exception to this restriction
on the “remote access” is CLS Bank.
Traffic of BOJ-NET
The average daily volume of the BOJ-NET funds
transfer settlement service was 50,675 in 2009.
The average daily value of transfer was \112 tril-
lion in the same year.
To break down the transaction value, the pay-
ments for JGBs transactions accounted for 38%,
and the money market transactions was 34%. In
addition, the money market operations of the BOJ
and the receipts and disbursements of banknotes
was 14%, and the traffic from the FXYCS ac-
counted for 12%.
As most of the transfers are interbank trans-
actions, the average value per payment was $2.2
billion, which was a very large amount.
The BOJ-NET is open to the customer pay-
ments as well as the interbank payment, but the
usage of customer payments are quite limited,
i.e., less than 1% in volume and 4% in value in
2009. As the figure shows, the BOJ-NET is almost
dedicated to the interbank payments. This is a
distinctive feature of the BOJ-NET compared to
the Fedwire and the TARGET2, both of which
170
Payment Systems in Japan
processes the significant amount of customer
payments.
Access to BOJ-NET
The computer center of the BOJ and the partici-
pants are connected by the dedicated communi-
cation line.
The participants with low volumes can send
the payment messages and monitor the situation
of own account by using the terminal for the BOJ-
NET. On the other hand, the major participants
with large volumes of traffic can make a “CPU
connection” to the BOJ-NET, which is the direct
connection between the computer of the BOJ and
that of the participant.
As an exceptional measure, the BOJ accepts
the payment orders in writing from the small-scale
participants.
Operating Hours of BOJ-NET
The operating hours of the BOJ-NET are 10 hours
from 9:00 a.m. to 7:00 p.m. in Japan Standard
Time (JST). The closing time was extended by two
hours2 from 5:00 p.m. in 2001. The BOJ is now
studying the possibility to extend the operating
hours of the BOJ-NET to more than 20 hours as
is the case in the Fedwire and TARGET2. If the
plan is realized, the settlement of the JPY pay-
ments will be possible late at night or early in the
morning in JST.
TRANSITION OF BOJ-NET
TO RTGS SYSTEM
Framework of Real-Time
Gross Settlement
Changeover to RTGS System
When started operation in 1988, the BOJ-NET
was a Designated-Time Net Settlement (DTNS)
Payment Systems in Japan
system, settling on a net basis at designated times
during the day. In January 2001, the BOJ changed
the settlement method of the BOJ-NET from the
DTNS to the Real-Time Gross Settlement (RTGS).
Before the transition to the RTGS system, the
BOJ-NET had two settlement modes: the “Real-
Time Processing” and the “Designated-Time Pro-
cessing.” In 2001, the Designated-Time Processing
was abolished and only the Real-Time Processing,
the RTGS mode, continued to be available.
Simultaneous Settlement
As an exception of the RTGS processing, some
transactions are processed at a fixed time, which
is called the “Simultaneous Settlement.” The Si-
multaneous Settlement is limited to the payments
that one party of the transaction is the BOJ, and
therefore there is no systemic risk involved. Such
transactions include the payments with the deposits
of the foreign central banks, and the transfers aris-
ing from the open market operations of the BOJ.
The Simultaneous Settlement is not a net
settlement but a simultaneous processing of the
gross payments as of a specific time.
Settlement Service to Net
Settlement Systems
The BOJ-NET provides a settlement service to
the Net Settlement Systems, which includes the
Bill and Cheque Clearing System and the Zengin
System. In other words, the net positions calculated
in these systems are settled through the BOJ-NET.
For this purpose, each Net Settlement Sys-
tem opens the “System Account” at the BOJ
and informs the BOJ the net positions of each
participant of the system by a certain time. Upon
receiving the notice of the net positions, the BOJ
debits the accounts of the “short participants” (the
participants with a net debit balance) and credit
the amount to the System Account. After all the
debits processing from the short participant’s ac-
counts are completed, the BOJ debits the System
Account and distributes the funds to the accounts
of the “long participants” (the participants with a
net credit balance).
The settlement time for the Bill and Cheque
Clearing System is 12:30 p.m. and 4:15 p.m. for
the Zengin System3.
Situation Before Changeover
to RTGS System
Two Processing Modes
Before the changeover to the RTGS system in
2001, the BOJ-NET had two processing modes:
the “Real-Time Processing” and the “Designated-
Time Processing.” The Real-Time Processing is
equivalent to the RTGS mode, where payments
are settled individually on a gross basis. As for
the Designated-Time Processing, the distinctive
feature was that there were four settlement times:
9:00 a.m., 1:00 p.m., 3:00 p.m., and 5:00 p.m.
Participant could send a payment assigning one
of these settlement times. And the payments are
processed through the net settlement mode at the
designated time, which calculates the net position
of each participant with the outgoing payments
and incoming payments assigned for the same
settlement time. In short, this was the Designated-
Time Net Settlement mode.
Even though two settlement options were pro-
vided, the Real-Time Processing was seldom used
and almost every payment was settled with the
Designated-Time Processing. That was because
the Real-Time Processing is a gross settlement
mode and required a lot of liquidity for settle-
ments. From the participant’s point of view, the
Designated-Time Processing was more efficient,
which requires a small liquidity only for the dif-
ferences between the outgoing payments and
incoming payments.
In fact, the settlement value in September 2000
shows that the Real-Time Processing accounted
only for 0.1% and the rest, 99.9% of the payments
were processed with the Designated-Time Process-
171

ing. Practically, the BOJ-NET can be defined as
a DTNS system at that time as this figure shows.
The settlement at 1:00 p.m. had the largest share
of 59%, and the settlement at 3:00 p.m. came
second with the share of 35%.
Purpose of Changeover
to RTGS System
The changeover of the BOJ-NET to the RTGS
system was intended to reduce settlement risk
involved in the DTNS method. Depending heavily
on the Net Settlements at the Designated times,
there was systemic risk, which is the risk the
failure of one participant might have the wide-
ranging impact over the other participants. Since
this risk is inherent to the DTNS system, it could
be removed by adopting the RTGS method. In
the RTGS system, each payment is processed
individually and given the finality and there is no
accumulation of the unsettled payments.
Another motivation of the changeover to the
RTGS system was to catch up with the global
trend of payment systems. Ahead of the BOJ,
many central banks adopted the RTGS system in
late 1990s (see Chapter 6 for more detail).
Supply of Intra-day Liquidity
As the RTGS system requires larger amounts of
liquidity compared with the DTNS system, many
central banks provide the intraday liquidity to the
participants of the system as a “lubricant” for
smooth settlements. The BOJ also supply intraday
liquidity to the participants of the BOJ-NET in
the form of “Intraday Overdraft” (Intraday O/D).
The Intraday O/D is free of charge but it requires
to be fully collateralized. Any participant who
wants to use the Intraday O/D is able to utilize the
scheme. There is no fixed limit for the Intraday
O/D; however, the usage amount should be within
the range of collateral that the participant pledged
to the BOJ in advance.
172
Payment Systems in Japan
The eligible collateral includes the Government
Bond, Treasury Bill, Municipal Bond, Corporate
Bond, Asset-Backed Securities, Bill, and Com-
mercial Paper (CP). In practice, the Government
Bond is mainly used. The loan-to-value ratio is
determined according to the type of securities and
the remaining period to the maturity.
The Intraday O/D is provided automatically by
the system, when a sending payment is larger than
the balance in the sending participant’s account,
provided there is enough collateral pledged. A
participant is able to monitor own usage situation
of Intraday O/D in real time. The Intraday O/D
is essentially meant only for the daytime use. So
if the Intraday O/D is not repaid until the end of
business day, the penalty rate (6% over the official
discount rate) is imposed on the participant for
the overnight lending.
Next-Generation RTGS
Project of BOJ-NET
The Bank of Japan (BOJ) enhanced the function-
ality of the BOJ-NET in October 2008 and plans
another reform in 2011. This project is called the
“Next-Generation RTGS (RTGS-XG) project” of
the BOJ-NET. It is interesting to know that the
project to implement the TARGET2 in the euro
area was also called the Next-Generation RTGS
project. The two enhancement projects of the
payment systems were progressed in the different
parts of the globe at the same time, respectively.
Background of RTGS-XG Project
Dispersed State of Large-Value Payments As men-
tioned above, there are three payment systems in
Japan: the BOJ-NET, the FXYCS and the Zengin
System. Actually, the large-value payments are
divided into those three systems. Interbank pay-
ments such as the money market transactions are
processed by the BOJ-NET, and the JPY settle-
ments of the foreign exchange (FX) transactions
are made through the FXYCS. On the other hand,
Payment Systems in Japan
the commercial large-value payments are handled
by the Zengin System. The daily average value
of large-value payments processed in 2008 was
\121 trillion in the BOJ-NET, \21 trillion in the
FXYCS, and \11 trillion in the Zengin System
(see Table 1).
Effort to Comply with the Global
Standard
The Japanese Bankers Association (JBA), which
is responsible for deciding the operation policy
of the FXYCS and the Zengin System, had con-
ducted a comprehensive study for improvement
of these payment systems. The main point of the
review was to ensure the “intraday finality” in
these systems.
Concretely speaking, these two systems were
operated as the Designated-Time Net Settlement
(DTNS) systems, where the net positions are
settled at the end of the day. In these DTNS sys-
tems, the finality of settlement is ensured only at
the end of the day.
The Committee on Payment and Settlement
Systems (CPSS) of the Bank for International
Settlements (BIS) published the “Core Principles
for Systemically Important Payment Systems”
(hereinafter called the “Core Principles”) in Janu-
ary 2001. The Core Principles are regarded as a
global standard with which payment systems in
the world should comply.
In the Core Principles, the two levels of stan-
dards are set regarding the finality of settlement.
As a “minimum standard,” the final settlement
should occur by the end of the day of value. This is
to ensure the “end-of-day finality.” On top of that,
Table 1. Division of Large-Value Payments by Three Payment Systems
The BOJ-NET
Value ¥120.6 trillion
Share 79%
Source: BOJ
the Core Principles stipulates that it is desirable
to provide the real-time final settlement during
the day as a “best practice.” This kind of finality
is referred to as the “intraday finality.” The Core
Principles describes that to ensure the intraday
finality is particularly desirable in the countries
with large volumes of high-value payments and
sophisticated financial markets. It is obvious that
Japan belongs to the group of countries which the
intraday finality is required. To comply with the
global standard, it was an urgent task for the Japa-
nese payment community to make fundamental
reform to the DTNS systems.
After a long discussion, the JBA published
a report on the reform of the DTNS systems in
March 2004. In this report, the JBA made the two
proposals. One is to add the Liquidity-Saving mode
to the BOJ-NET. And the other is to aggregate the
large-value payments on the FXYCS and Zengin
System to the BOJ-NET. Upon receiving these
proposals, the BOJ started the project in February
2006. Tracking back to the start of the project, it
can be pointed out that the global standard (the
Core Principles) was a strong driving force for
the RTGS-XG project.
Two Sub-Projects of
RTGS-XG Project
The RTGS-XG project is composed of the two
Sub-Projects: the Sub-Project A and Sub-Project
B. The Sub-Project A is to add the Liquidity-
Saving Features (LSF) to the BOJ-NET, which
had been the pure RTGS system. The Sub-Project
B is to aggregate the large-value payments from
The FXYCS The Zengin System
¥21.1 trillion ¥11.0 trillion
14% 7%
173

Table 2. Sub-Project A and Sub-Project B of RTGS-XG Project
Sub-Project A
Contents of project Introduce Liquidity-Saving Fea-
tures (LSF) into the BOJ-NET
Timing of implementation October 2008
Objective To further enhance the safety and efficiency of large-value payment systems in Japan.
Source: BOJ
the FXYCS and Zengin System to the enhanced
BOJ-NET.
The Sub-Project A was implemented in Octo-
ber 2008. With regard to the Sub-Project B, the
aggregation of payment flows from the FXYCS
was realized in October 2008, and incorporating
the large-value Zengin payments will be executed
in November 2011 (see Table 2). The two Sub-
Projects will be described below in more detail.
Sub-Project A of RTGS-XG Project
The Sub-Project A is made up of three components:
(i) to establish the centralized queuing function,
(ii) to introduce the Liquidity-Saving Features
Figure 1. Three Components of Sub-Project A
174
Payment Systems in Japan
Sub-Project B
Incorporate large-value payments Incorporate large-value payments
handled by the FXYCS handled by the Zengin System
October 2008 November 2011
(LSF), and (iii) to develop the special account for
the LSF (see Figure 1).
Centralized Queuing Function
The BOJ-NET before the reform did not have a
“centralized queuing function.” For this reason,
a payment order was rejected and returned to the
sending participant by the system, if the sending
participant did not have enough liquidity in its
account.
With the new queuing function, a payment
order is placed in the waiting queue when the
system receives it. Then, the system will check
the processing capability of the payment later on.
Payment Systems in Japan
A participant is able to monitor its settlement
situation in real time, including the balance in the
account, the settlement situation of each payment
order (already settled or non-settled), the waiting
payments in the queue. Each participant is also
able to actively control the payments in the queue
with the “queue management function,” which
include the payment priority, reordering, and
cancellation of payments.
The “payment priority” is a function that each
participant is able to assign a priority to each
payment: “high priority” or “normal.” The queue
is managed separately between the high priority
payments and the normal payments. And if any
high priority payment remains in the queue, the
normal queued payments are not processed.
The “reordering” is a function that each par-
ticipant is able to move a payment to the top of the
queue or to the bottom of the queue (see Figure
2). Participant can manage the processing order
of payments with this function.
Figure 2. Queue Management Function of RTGS-XG
Liquidity-Saving Features (LSF)
(i) Functionality of LSF
The “Liquidity-Saving Features” (LSF) were
introduced to the new BOJ-NET. This function
is identical to the “offsetting mechanism” in the
European payment systems. The “Offsetting”
means the simultaneous processing of the outgoing
and incoming payment instructions. The offset-
ting algorithm searches for the pair (or a group)
of participants which have submitted payments
for each other (or one another), and calculates
the net inflow/outflow. When the net outflow has
sufficient cover, which means the balance of the
outflow participant is larger than the net outflow,
the system processes the incoming and outgoing
payments simultaneously on a gross basis.
The new BOJ-NET introduced two kinds of
offsetting mechanisms: the “bilateral offsetting”
and “multilateral offsetting.”
175

(ii) Example of LSF
The concrete example of the “bilateral offsetting”
is as follows. Assume that there is a payment of
40 from Bank A to Bank B, and another payment
of 100 from Bank B to Bank A. If Bank B has a
sufficient balance in its account, these two pay-
ments are processed simultaneously on a gross
basis with bilateral offsetting (see Figure 3a).
This process will result in increasing of 60 in
the Bank A’s account and decreasing of 60 in the
Bank B’s account. In short, the outcome of the
bilateral offsetting is exactly the same as the net-
ting of the two payments. Only the difference is
whether two individual payments are processed
on a gross basis, or once the net positions are
calculated and processed on a net basis.
With this mechanism, the participants are able
to make settlements with smaller liquidity. That
is, only the net amount of the two payments is
necessary to proceed the settlement. That is why
this mechanism is referred to as the “Liquidity-
Saving Features” (LSF). The processing of two
payments on a gross basis become final when
processed. This means that the finality is ensured
during the day.
Figure 3. Liquidity-Saving Features (LSF)
176
Payment Systems in Japan
In the case of the “multilateral offsetting,” the
same mechanism works for the payments among
three or more participants (see Figure 3b).
(iii) Bilateral Offsetting and
Multilateral Offsetting
An offsetting algorithm searches for a set of pay-
ments that can be settled when taking into account
the incoming payments as a source of liquidity,
and settles the selected payments simultaneously.
In this process, each payment is settled on a gross
basis, and a group of payments is never replaced
by a net obligation.
The bilateral offsetting algorithm runs continu-
ously throughout the day. This is the main engine
for settlements. The bilateral offsetting algorithm
is “event driven” and it will run when one of the
following events occur: (i) the submission of a
new payment order; (ii) the increase in the LSF
Account balance; or (iii) the settlement, reordering
or cancellation of a top-queued payment.
On the other hand, the multilateral offsetting
algorithm is regarded as a complementary function
to the bilateral offsetting. This algorithm is “time
driven” and it runs at designated times of the day4.
Payment Systems in Japan

LSF Account
Participant who wants to use the Liquidity-Saving
Features (LSF) has to open5 the special account for
the LSF (the “LSF Account”). The LSF Account
is different from the “Current Account” which
is used for the settlement of the RTGS mode.
The Current Account is also used for the reserve
requirements (see Table 3).
The LSF is available only for payments be-
tween the LSF Accounts. On the other hand, the
settlement of RTGS mode is executed only be-
tween the Current Accounts in the past. No settle-
ment takes place between the LSF Account of a
participant and the Current Account of other
participant.
The Intraday O/D is not available at the LSF
Account. Thus, the only way of funding the LSF
Account is the liquidity transfer from the Current
Account. This means that the participant should
manage the liquidity of two accounts: the Current
Account and LSF Account. In this regard, the
participants are able to transfer funds between the
two accounts at any time during the day. Usually,
the first thing in the morning, the participants
transfer the funds necessary for the settlements
of the day to the LSF Account, and transfer the
additional funds to the LSF Account during the
day if necessary.
At the end of the day, the balance in the LSF
Account is transferred back to the Current Account
automatically. Therefore, the outstanding of the
LSF Account become zero at the end of the day.
Most of the interbank transactions and cus-
tomer transactions are eligible for the settlement
at the LSF Account; however, some transactions
should be settled only in the Current Account.
Such transactions include the transactions with the
BOJ and the government, the settlement obligation
arising from the clearing systems, and the cash
legs of securities transactions.
Sub-Project B of RTGS-XG Project
Dispersed Situation of Large-
Value Payments in Japan
As mentioned above, the large-value payments in
Japan were divided into three payment systems.
First, the BOJ-NET was the main settlement
channel of the large-value payments mainly for
the money market transactions and securities
transactions. The second one was the FXYCS,
which handled mainly foreign exchange related
payments. The last one was the Zengin System,
which handled mainly the customer payments.
However, a part of payments in the Zengin System,
just 0.2% of total volume, were the large-value
payments that are \100 million and up per transac-

Table 3. Current Account and LSF Account

Current Account LSF Account

Types of transactions settled
Liquidity supply
Liquidity saving
Balance management
Time available
Source: BOJ (2005), modified
-Interbank transactions
-Third-party transactions
-Transactions with BOJ/government
-Settlement obligations arising from clearing
systems
-The cash legs of securities transactions
Intraday overdrafts
Not applicable (pure RTGS)
Overnight
9:00-19:00
-Interbank transactions
-Third-party transactions
Liquidity transfer from the current account
LSF
Intraday (zero balance at the end of the day)
9:00-16:30

177

tion. These 0.2% large-value payments accounted
for 65% of total value.
These fragmented large-value payments led
to some issues. First, despite the Zengin System
was characterized as a retail payment system and
deployed the risk management scheme for the
small value payments, the System also handled the
large-value payments and there was a mismatch
between the character of payments and its risk
management.
Second, the Zengin System and the FXYCS
were both the same type of payment system, i.e.,
the DTNS system at the end of the day. It used
to be the request of the Foreign Exchange Act
to divide the foreign exchange related payments
from the domestic payments, but the regulation
of Act was relaxed substantially in 1996 and
there was no need for the distinction between the
international related payments and domestic pay-
ments any more. As a result of the changing legal
environment, the duplication was created between
the two payment systems: the Zengin System and
the FXYCS. More specifically, there were the two
same types of payment systems, both of which
perform the end-of-the-day net settlement.
Figure 4. Incorporation of Payment Flows from FXYCS
178
Payment Systems in Japan
Consolidation of FXYCS Flows
In October 2008, the FXYCS payments were con-
solidated into the BOJ-NET. At the same time, the
DTNS mode of the FXYCS was abolished. In other
words, the payments sent from the participants of
the FXYCS are forwarded to the BOJ-NET and
settled in the BOJ-NET either by the LSF or RTGS
mode (see Figure 4). Only the RTGS mode of the
FXYCS continues to be used, which was mainly
used for the pay-ins/pay-outs to/from CLS Bank.
The main flows of the FXYCS go through the
FXYCS and forwarded to the BOJ-NET, where
the payments are processed with the LSF mode.
The framework of the FXYCS is maintained,
which includes the system rules, participation
rules and cost sharing. Especially, the framework
of the direct and indirect participant is most im-
portant because the BOJ-NET does not have the
scheme of indirect participation.
With the new scheme, most of the payments
just go through the FXYCS and the settlements
take place at the BOJ-NET. In sum, the role of
the FXYCS was significantly reduced by the ag-
gregation of the payment flows to the enhanced
BOJ-NET.
Payment Systems in Japan
Consolidation of Large-
Value Zengin Payments
As for the Zengin System, a newly developed
“Interface” will pick up the large-value pay-
ments (\100 million and up) from the Zengin
payment flows and send them to the BOJ-NET.
The forwarded large-value Zengin payments are
processed with the LSF mode at the enhanced
BOJ-NET.
Meanwhile, the remaining small-value pay-
ments are processed in the Zengin System with
the DTNS method as in the past (see Figure 5).
By this consolidation, the Zengin System will
become a hundred-proof retail payment system.
When the Interface sends large-value payments
to the BOJ-NET, only the interbank payment
information will be sent, while the customer in-
formation will be kept in the Zengin System. This
aggregation of the large-value Zengin payments
is going to be implemented in November 2011.
Reconstruction of Payment Systems
With the incorporation of large-value payment
flow from the FXYCS and Zengin System, the
Figure 5. Incorporation of Large-Value Zengin Payments
BOJ-NET will be substantially the one and only
large-value payment system in Japan. On the other
hand, the Zengin System will become the pure
retail payment system. Now, the division of roles
between payment systems becomes crystal clear.
The estimated values derived from the statis-
tics of 2008, the new BOJ-NET will process \142
trillion, or more than 97% of payment flows in
value. Meanwhile, the Zengin System will handle
\4 trillion, less than 3% of the whole payment
values in Japan (see Figure 6).
Features of RTGS-XG
Regarding the features of the RTGS-XG, three
characteristics could be identified: (i) Integrated
system, (ii) two-account system, and (iii) offset-
ting system.
Integrated System
The enhanced BOJ-NET (the RTGS-XG) has two
modes for settlements. In the Current Account, the
settlements are made in a simple RTGS method,
just the same as the BOJ-NET in the past. This
mode can be called as the “pure RTGS mode.”
179

Figure 6. Consolidation of Large-Value Payment Flows
On the other hand, the settlements are made
continuously with bilateral and multilateral offset-
ting in the LSF Account. This is called the “Li-
quidity Saving mode” or “Hybrid mode,” where
the offsetting is executed on a continuous basis.
Having both the RTGS mode and Hybrid mode,
the RTGS-XG can be defined as an Integrated
system (see Chapter 5 for more detail). The par-
ticipants are able to select the mode of settlement
according to the urgency and character of the pay-
ment. Most of the payments are supposed to go to
the Liquidity-Saving mode, because a participant
can make settlements with fewer amount of liquid-
ity using this mode, which means the participant
can save the liquidity cost. By the nature of things,
the urgent payments or time-critical payments are
supposed to be processed in the pure RTGS mode.
Also some transactions, including the BOJ-related
and government-related transactions and the DVP
settlements of the JGBs are also assigned to the
pure RTGS mode.
With the evolutionary reform, the RTGS-XG
became one of the cutting edges of the world
payment systems, standing comparison with
the TARGET2 in the euro area and the LVTS in
Canada.
180
Payment Systems in Japan
Two-Account System
The RTGS-XG has two separate accounts in
one system: the Current Account and the LSF
Account. Participant has to monitor and manage
the two liquidities in each account during the day.
In some Integrated systems, the single liquidity
pool scheme is adopted, and the participants can
control the liquidity in a single account. It can’t
be denied that the single liquidity pool might be
more user-friendly than the two-account system.
However, the RTGS-XG allows participants to
transfer the liquidity flexibly between the two
accounts anytime during the day, which could be
called the “full-time Liquidity Bridge.” Thus, it
can be presumed that the management burden of
two liquidities is not so heavy. A lighter burden
is apparent when compared to the EAF2 in Ger-
many, which allowed transferring the liquidity
only once every hour.
In terms of two accounts, the RTGS-XG has
a similar structure to the Paris Integrated System
(PIS) in France, where the Liquidity Bridge com-
bines the PNS account and the TBF account (see
Chapter 5 for more detail).
Payment Systems in Japan
In the case of the RTGS-XG, the consideration
for the system development was the major factor
to choose the separate account system. The BOJ-
NET provides not only the fund transfer service
but also the government bond settlement service.
Therefore, the Current Account already has a
very complicated link with the JGBs account in
the BOJ-NET through the DVP mechanism and
the self-collateral scheme. It seemed concerned
that it might make the account structure too much
complicated to add the LSF function to the Cur-
rent Account.
Offsetting System
The RTGS-XG adopts the offsetting scheme. As
mentioned earlier, there is not much difference
between the netting scheme and offsetting scheme,
with regard to the outcome of the processing. In
both cases, the amount of difference between
the outgoing payment and incoming payment is
added or debited from the participants’ accounts.
Originally, the concept of offsetting was
introduced in the RTGSplus in Germany in 2001
for the first time in the world. It was because the
RTGSplus should be a part of the TARGET which
allowed the linkage only to the RTGS systems.
So to avoid becoming the netting system that
could not be linked to the TARGET, the Deutsche
Bundesbank invented the concept of “offsetting,”
which means the simultaneous booking of the
offsetting payment flows on a gross basis.
In the case of the BOJ-NET, there is no such
a constraint and the BOJ could possibly have
adopted the netting concept. But only a situation
was that the BOJ abolished the netting mode in
2001 when the BOJ-NET became a pure RTGS
system. So it will presumably be rather difficult
for the BOJ to explain the LSF as adding a netting
function again only several years after. It’s just
conceivable that this might be a sort of reason to
adopt the offsetting concept instead of the netting
concept.
Benefits of RTGS-XG
Based upon the characteristics of the RTGS-XG
mentioned above, the benefits of the enhanced
project can be interpreted as follows.
To Achieve Earlier Settlement
The first benefit of the RTGS-XG is to realize
the earlier settlement and ensure the finality in
the daytime, which lead to the risk reduction.
In the past, the large-value payments that were
processed in the FXYCS and Zengin System ob-
tained the finality of settlements only at the end
of the day. After incorporating all the large-value
payments into the RTGS-XG, all the settlements
will be made on a continuous or real-time basis.
Thus, all the settlement has the finality during
the day, which is called the “intraday finality.”
It is a major benefit of the RTGS-XG to give the
intra-day finality to all the large-value payments
and reduce settlement risk.
To Reduce Liquidity Cost
The second benefit is to reduce the liquidity cost for
the participants. With the LSF, the participants can
make the continuous gross settlement with small
amount of liquidity by offsetting their outgoing
payments with the incoming payments from the
other participants. Although the BOJ provide the
intraday overdraft with no fee, the participants
have to pledge the collateral to get the overdraft,
which is accompanied by the collateral cost.
Thereafter, the RTGS-XG reduces the intraday
liquidity cost for the participants by reducing the
liquidity amount necessary for settlements.
To Prevent Gridlock
The third benefit is to prevent a “gridlock” in the
payment system. In the pure RTGS system, the
participants tend to wait for the incoming pay-
ments before sending their outgoing payments,
181

or sometimes try to send the payment instructions
as late as possible in order to save their liquidity.
If many participants try to do the same thing,
the circulation of liquidity in the system will be
blocked and prevents a substantial number of
instructions from being executed. This kind of
situation is called the “gridlock.”
With the LSF, the RTGS-XG matches the off-
setting payment flow and save the liquidities of
both sides. This substantially reduces the necessity
for the participants to hold the sending payments.
This means that there is no incentive any more for
the late payments which might bring the gridlock.
Accordingly, the participants are expected to send
their instructions earlier than before and the overall
settlements should become earlier in the system.
To Comply with Global Standard
As described above, the effort to comply with the
Core Principles was the outset of the RTGS-XG
project. After the project is completed, all the
large-value payments are forwarded to the BOJ-
NET and will be settled with the intraday finality
during the day.
This situation meets the “best practice” of
the Core Principles, which requires large-value
payment systems to provide the intraday finality.
The enhanced BOJ-NET as well as the FXYCS
and Zengin System meet the requirement of the
Core Principles. This is another important benefit
of this project.
FXYCS
Outline of FXYCS
Role of FXYCS
The Foreign Exchange Yen Clearing System
(the FXYCS) is a private payment system oper-
ated by the Tokyo Bankers Association (TBA).
182
Payment Systems in Japan
The FXYCS handles the JPY leg of the foreign
exchange transactions.
When it started its operation in 1980, the
paper-based instructions were exchanged manu-
ally between the participants. And the net position
of each participant was settled at the accounts in
the BOJ.
In 1989, the FXYCS became the electronic
payment system, utilizing the computers and net-
works. At that time, the operation of the system was
outsourced to the BOJ. It was rather exceptional,
the central bank became the IT system operator
of the private payment system.
Participants of FXYCS
The participants of the FXYCS were 212 banks
as of the end of 2009. Direct Participants are less
than 30 banks, and almost 90% of participants
were Indirect Participants, which outsourced the
sending and receiving of the payments and the
fund settlement to one of the Direct Participants.
Settlement Method of FXYCS
The FXYCS was originally a DTNS system,
settling the net positions at the end of the day.
In 1998, the RTGS mode was added. The RTGS
mode was introduced to achieve the pays-in to
CLS Bank, which is the time-critical payment.
Risk Management of FXYCS
In order to strengthen the risk management, the
FXYCS introduced the “bilateral net credit limit”
(the net receiver limit) and the “multilateral net
debit cap” (the net sender cap) in 1998. The loss-
share rule, liquidity provider scheme, and collat-
eral scheme were also introduced. With these risk
management schemes, the FXYCS accomplished
the “Lamfalussy Plus One” in 2004.
When the net settlement mode was closed in
2008, all of these risk management schemes were
Payment Systems in Japan
abolished because these schemes are to brace for
the risk arising from the net settlement.
Decreased Role After
RTGS-XG Project
As explained above, the FXYCS payments were
incorporated to the BOJ-NET in October 2008. In
other words, the payments sent to the FXYCS are
just forwarded to the BOJ-NET and the settlements
take place at the BOJ-NET. This means that the
FXYCS became a payment system through which
the payment messages just pass. Stated differently,
the role of the FXYCS decreased substantially
after the incorporation of the payment flows to
the BOJ-NET.
ZENGIN SYSTEM
Outline of Zengin System
Role of Zengin System
The Zengin Data Telecommunication System
(the Zengin System) is a nationwide electronic
fund transfer network mainly for the customer
payments. It is operated by the Japanese Banks’
Payment Clearing Network (the Zengin-Net).
The Zengin System is regarded as a retail
payment system mainly for the small-value pay-
ments by individuals and corporates. The Zengin
System is the equivalent of the Automated Clearing
House (ACH) in the US, the Vocalink in the UK,
or other retail payment systems in euro area, such
as the Equens (Germany/Netherlands), the STET
(France), the ICBPI (Italy), the Iberpay (Spain),
the DIAS (Greece), and the rest.
One of the features of the Zengin System is that
it is dedicated to the domestic payments. This is
because the international payments (e.g., the pay-
ments for the FX transactions) were allocated to
the FXYCS by the law. Consequently, the Zengin
System is sometimes called the “Domestic Fund
Transfer System.”
Another feature of the Zengin System is that
it is basically a retail payment system but also
handles the large-value payment. The large-value
payments (\100 million or more) are just 0.2% of
the payments handled by the Zengin System in
volume, but it is equivalent to 65% of the payments
in value. It is planned the large-value Zengin pay-
ment will be incorporated to the new BOJ-NET
in November 2011, as mentioned above.
When the Zengin System started operation in
1973, it was originally a payment network mainly
for the city banks and regional banks. Later, it
extended its participation to other categories of
financial institutions, including the credit unions,
credit cooperatives and agricultural credit coopera-
tives. With the phased expansion of the participat-
ing categories, it became the nationwide network
which almost all financial institutions participated
in. All thanks to the nationwide coverage of the
Zengin System, individual and corporate can make
the yen payment from any banks to any financial
institutions in Japan.
The Zengin System upgrades its system every
eight years. The current system is the fifth-genera-
tion system, which started operation in November
2003. The six-generation system, or the next
generation system with enhanced functionality, is
planned to go into operation in November 2011.
Participants of Zengin System
The participants of the Zengin System were 1,396
financial institutions and 32,865 branches, as of
the end of 2009. It covers from the leading com-
mercial banks to the small credit cooperatives and
agricultural cooperatives. It can be described that
almost all financial institutions in Japan are the
participants of the Zengin System. However, the
number of participants and participating branches
are on a downward trend from 1990s. That is
because of the mergers between financial institu-
183

Figure 7. Number of Participating Banks and Branches of Zengin System
tions, and the eliminations and consolidations of
branches as a streamlining measure (see Figure 7).
Traffic of Zengin System
The average daily volume of Zengin System was
5.7 million in 2009. On a peak day, the transaction
volumes exceeded 21 million, which was more
than three times of the daily average.
In terms of transaction value, the average daily
value was \9.8 trillion, and the value of the peak
day was \53.8 trillion in 2009. The figure of \9.8
trillion was the amount before netting and the
amount after netting and settled at the BOJ-NET
was \1.8 trillion, or 19% of the transaction value.
The credit transfer accounted for 81% in vol-
ume and the direct deposit of payrolls made up
18% of the traffic.
On the contrary to the decrease of the partici-
pating banks and branches, the traffic of Zengin
System is growing year by year gradually. The
transaction value of the Zengin System fluctuates
according to the economic situations of Japan.
For example, the transaction value of 2009 de-
creased by 9.8% from the previous year due to
184
Payment Systems in Japan
the economic downturn as a result of the global
financial crisis (see Figure 8).
The average value per transaction was \1.7
million, which was much smaller than \2.2 billion
of the BOJ-NET, and \512 million of the FXYCS.
This figure shows that the characteristic of the
Zengin System is retail payment system.
Settlement Method of Zengin System
The Zengin System is a Designated-Time Net
Settlement (DTNS) system, settling the net posi-
tions at the end of the day. The participants are
able to send payment messages to the Zengin
center from 8:30 a.m. to 3:30 p.m. Payment mes-
sages can be sent one by one, or by the batch file
transfer. Once received by the system, the payment
messages are exchanged between the participants
nearly in real time.
With these payment messages, the system
calculates the net position of each participant
by netting, and transmits the final net position
information to the BOJ-NET at around 3:50 p.m.
Following the instructions, the BOJ-NET debits
the accounts of the “short participants” and credits
the amount to the Zengin-Net account at 4:15 p.m.
Payment Systems in Japan

Figure 8. Traffic of Zengin System (daily average of each year)

And after the completion of these processing, the
BOJ-NET debits the Zengin-Net account and
distributes the funds to the accounts of the “long
participants.” Then, the settlements of the net
positions are completed (see Figure 9).
A participant can monitor its own net position
in real time in order to manage its own liquidity.
Risk Management of Zengin System
Same-Day Settlement
The Zengin System was originally a “Next-Day
Settlement System,” where the final settlement
is made at 1:00 p.m. on the next business day

Figure 9. Message Traffic and Settlement of Zengin System

185

after the payments are exchanged. The Next-Day
Settlement System is accompanied by the over-
night settlement risk, as the unsettled obligations
are carried forward until the next day. Therefore,
the Zengin System changed the settlement cycle
in 1993, and currently the settlement is executed
on the same day when the participants send the
payment messages.
Net Sender Cap
The “Net Sender Cap” was introduced in 1990.
The “excess amount” is calculated for each par-
ticipant by subtracting the amount of incoming
payments from the amount of outgoing payments.
The system automatically controls the excess
amount under a certain level.
More concretely, if the excess amount of a
participant exceeds a certain level, the system
sends the warning message to the participant.
And if the excess amount goes over the Net
Sender Cap, the outgoing payment message is
returned to the participant as an error message.
This scheme plays a role to control the risk of
overall unsettled obligation under a certain level
for the whole system.
When introduced in 1990, the warning level
was set at the five times of a participant’s average
daily value of the previous year, and the Cap was
set at the ten times of that.
In 1994, the “self-assessment method” was
introduced, and each participant was able to decide
its own Cap. In return, each participant should
pledge the collateral in accordance with the Cap.
Later, the Cap management and the required col-
lateral were strengthened.
By tightening the risk management, the Zengin
System accomplished the “Lamfalussy Plus One”
in 2002, which the system can complete the timely
settlement even if the top two participants with
the largest debit position would become default
on the same day.
186
Payment Systems in Japan
Bank Guarantee Scheme
Choice between Collateral
and Bank Guarantee
In 2001, the Zengin System introduced the “Bank
Guarantee Scheme.” Under this scheme, the par-
ticipants make a choice between the collateral and
the Bank Guarantee. In principle, the participants
should pledge the collateral equivalent to 100%
of the Net Sender Cap which each participant de-
clared. However, a participant is able to substitute
the Bank Guarantee for collateral as for a portion
or entire Cap. The merit of this scheme is that the
participant which received the Guarantee can save
the collateral and reduce the collateral burden.
Meanwhile, the bank which gives the Guaran-
tee to the other participants is able to gain a fee
income. However, the bank should increase its own
collateral by the amount which is equivalent to the
top two Guarantees given to the other participants.
Example of Bank Guarantee
The concrete example of the choice between the
collateral and the Bank Guarantee is as follows.
Assume that Bank X and Bank Y declared each
the Net Sender Cap of 100 to the Zengin-Net.
When Bank X received the Guarantee of 50 from
Bank A and the Guarantee of 30 from Bank B,
the collateral of 20 is enough to cover the Cap.
On the other hand, if Bank Y does not receive
any Guarantees from other participants, it should
pledge the collateral of 100 to the Zengin-Net
(see Figure 10).
Collateral Required for the
Guarantees
Assume that Bank Z gave the Guarantee of 50 to
Bank C, 30 to Bank D and 20 to Bank E. In this
case, Bank Z has to pledge the collateral for the
top two Guarantees (i.e. 80 = 50 + 30), in addition
to the collateral for its own Cap (see Figure 11).
Payment Systems in Japan
Figure 10. Bank Guarantee Scheme of Zengin System
Loss-Share Rule
The loss-share rule of the Zengin System is
basically based on the “Defaulter’s Pay.” Each
participant should pledge the collateral or receive
a Guarantee from other participants, the total of
which should be equivalent or more to the Net
Sender Cap of each participant. If a participant
becomes unable to pay the obligation of the day,
Figure 11. Collateral entailed by Giving Guarantee
the Zengin-Net borrows the funds from the “Li-
quidity Providers” with the collateral pledged
by the defaulter. With the borrowed funds, the
Zengin-Net completes the settlements of the day
in a timely manner. Later, the Zengin-Net repays
the borrowed funds with the money received from
sale of the collateral. The Zengin-Net assigns more
than twenty Liquidity Providers with borrowing
facility of more than \2 trillion.
187

If a defaulter received a Guarantee from the
other banks, the banks should bear the cost of
default within the range of the Guarantee. To put
it the other way around, unless a participant gives
the Guarantee to the defaulter, no loss-share will
arise from the default of the other participants.
Sixth Generation of Zengin System
The Zengin-Net is planning to upgrade the Zengin
System to the sixth generation system in November
2011. With this upgrade, the new communication
protocol and message format will be introduced
and some new functionality will also be added.
New Communication Protocol
and Message Format
Communication Protocol
The Zengin System uses the communication pro-
tocol and message format which are specific to
the Japanese market, and are sometimes criticized
as not fitting with the international standard. In
the sixth generation system, the new protocol
and format will be adopted to comply with the
international standard.
As for a communication protocol, the “Trans-
mission Control Protocol/Internet Protocol”
(TCP/IP) will be adopted, which is regarded
as the standard of communications throughout
the world. And as a communication network,
the “Internet Protocol-Virtual Private Network”
(IP-VPN) will be adopted instead of the current
Frame Relay network.
Message Format
The new message format will be introduced, which
is using the XML (eXtensible Markup Language)
and based on ISO 20022.
The “XML” is a markup language for describ-
ing the messages and data. The XML has a wide
interoperability and flexibility, and also has the
188
Payment Systems in Japan
features of computer-processable and human-
readable. With these characteristics, the XML is
becoming widely used in the financial industry.
The “ISO 20022” is the international standard
that defines the scheme for the development of
financial message standards. This is regarded as
the next-generation international standard for
message format used in the financial industry.
This is the reason why the Zengin-Net decided
to adopt the future de facto standard.
The adoption of the XML and ISO 20022 will
contribute to enhance the flexibility in connection
mechanism between the Zengin System and other
systems. Especially, it will be a great benefit for the
foreign banks, which should convert the message
format between at home and abroad.
It should be noted that the usage of the new
message format with the XML and ISO 20022 is
an option. Therefore, the participants who want
to continue to use the old format can stick to it.
The central system makes the mutual conversions
between the new and old message format.
EDI Capability
The sixth generation system of the Zengin Sys-
tem will have the “Electronic Data Interchange”
(EDI) capability. The participants are able to
send several EDI files with a payment message,
which contains the remittance information, or
the information to identify the transaction which
caused the payment. A single “EDI file” is able
to contain up to 140 characters. And a number of
EDI files can be added to one payment message
within the limit of maximum length of the whole
message. This means that more than 30 EDI files
can be sent with a single payment message. The
EDI capability is available, only when both the
sending bank and the receiving bank adopted the
new message format with the XML and ISO 20022.
The fact is that the current Zengin System
had the very limited EDI capability, which could
handle only a single file with the maximum length
of 20 characters. However, the 20 characters were
Payment Systems in Japan
too limited to be used in the real business. As a
result, this function was seldom used.
With the drastic enhancement of the EDI
capability, it is predicted that the Zengin System
will handle a lot of EDI files, which will be a
great benefit to the corporate sector (see Chapter
9 for more detail).
REFERENCES
Bank of Japan. (2005, December). Proposal for
the Next-Generation RTGS Project of the BOJ-
NET Funds Transfer System.
Bank of Japan. (2006a, February). Framework
for the Next-Generation RTGS Project of the
BOJ-NET Funds Transfer System (in Japanese).
Bank of Japan. (2006b, September). The New
Development of the BOJ-NET Funds Transfer
System (in Japanese).
Bank of Japan. (2006c, October). Japan’s Next-
Generation RTGS.
Bank of Japan. (2009, May). BOJ-NET Funds
Transfers after the Implementation of Phase 1 of
the Next-Generation RTGS Project.
Bank of Japan. (2006-2008). Payment and Settle-
ment Systems Report (in Japanese).
Bank of Japan/ Payment and Settlement Systems.
http://www.boj.or.jp/en/theme/psys_seibi/index.
htm
Imakubo, K., & McAndrews, J. (2005, August).
Initial Funding Levels for the Special Accounts
in the New BOJ-NET. Bank of Japan Working
Paper Series.
Japanese Bankers Association. (2004, March).
Proposal for Reorganizing Fund Transfer Systems
in Japan – Introducing a “Large Value Settlement
System” (in Japanese).
Nakajima, M. (2007). Coincidental Developments
of the Two “Next Generation RTGS Projects” in
EU and Japan (in Japanese). Reitaku International
Journal of Economic Studies, 15(1).
Nakajima, M. (2008). Global Trends of Payment
Systems and the Next-Generation RTGS Project
in Japan. In Kubota, T. (Ed.), Cyberlaw for Global
E-Business: Finance, Payment, and Dispute
Resolution. Hershey, PA: IGI Global.
Zengin Net. http://www.zengin-net.jp
ENDNOTES
1
Although the foreign exchange control had
been already relaxed, the division of roles
between the payment systems continued.
2
The closing time is 5:00 p.m. for the partici-
pants that have not applied for the access to
the extended hours.
3
On the last business day of the month, the
settlement time is extended by 30 or 60
minutes because the transaction volumes
are very high at the end of the month.
4
The multilateral offsetting algorithm runs
four times a day: at 10:30 a.m., 1:30 p.m.,
2:30 p.m., and 3:30 p.m. in Japan Standard
Time.
5
Approximately 300 institutions, or 80% of
the participants, opened the LSF Account
as of March 2009.
189
190

Chapter 12
CLS Bank

ABSTRACT
This chapter focuses on the CLS Bank. CLS Bank International (hereinafter referred to as “CLS Bank”)
was established in 1999 to eliminate settlement risk associated with settling foreign exchange (FX) trans-
actions in different time zones. It provides the unique multi-currency Payment versus Payment (“PVP”)
settlement service for the major players in the FX market. Although CLS Bank was established as a
private bank in the US, the main purpose of the Bank is neither to accept deposits nor to make loans.
Its function is dedicated to providing a multi-currency settlement service. Thus it is more appropriate to
regard CLS Bank as a kind of payment system, or market infrastructure than just a private bank. This
chapter elaborates on the mechanism of CLS Bank, which includes the organization, the shareholders,
the eligible currencies, and the accounts used for CLS settlement. The funding and settlement procedures
and risk management schemes of CLS Bank are discussed in greater detail. In addition, the impact of
CLS Bank to FX settlements and the FX market is also analyzed.

INTRODUCTION is settled in the European time zone, and the US

In FX settlements, there is settlement risk arising
from settling two currencies in different jurisdic-
tions and often different time zones. That is the
risk that one party of a FX transaction pays the
currency it sold but does not receive the currency
it bought.
For example, the Japanese Yen-leg is settled at
Tokyo market in the Japan time zone, the euro-leg
dollar-leg is settled in the US time zone. In the case
of transaction between Japanese Yen (JPY) and
the US dollar (USD), there is a time-lag between
the settlement time of the JPY-leg and that of the
USD-leg. Therefore, one party has the risk that
it cannot receive the counter value in the USD,
even if it delivers the JPY amount.
This kind of settlement risk caused by the time
difference is referred to as the “Herstatt risk.”

DOI: 10.4018/978-1-61520-645-2.ch012

Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited.
CLS Bank
The presence of this risk was widely recognized
for the first time by the financial community
and regulators in 1974, when Herstatt Bank in
Germany was closed on 26th June. Herstatt Bank
was ordered the closure at 3:30 p.m. in Frankfurt,
after the close of the interbank payment system
in Germany. The closure time of the Bank was
10:30 a.m. in New York.
Under such circumstances, the FX counter-
parts of Herstatt Bank had all paid their Deutsche
marks to Herstatt Bank but never received their
purchased USD. With the bankruptcy of Herstatt
Bank, all the counterparties lost the total value of
their FX trades with the Bank (see chapter 3 for
more detail).
Similarly, at a later date, some major banks
suffered the huge losses when the Bank of Credit
and Commerce International (BCCI) went into
bankruptcy in 1991. This incident caused the
banking community to consider again the gravity
of the FX settlement risk.
Since the FX market has grown strongly over
fifty years, even if this settlement risk persists for
only a short and limited time, the total exposure
of the FX trades could be very large compared
to the capital of the banks involved in the trade.
Usually, the average value per FX transaction is
large and can be enormous. The FX settlement
risk is not the “Replacement Cost Risk” but the
“Principal Risk,” which is a risk that a party will
lose the full value of the trade. Therefore, the ac-
tive banks in the FX market hold significant risk
on a day-to-day basis. In some cases, the large
banks may have almost three times more exposure
to the FX settlement risk than to the credit risk
which the banks hold as a whole. The daily settle-
ment exposure reaches tens of billions of dollars
constantly. In an extreme case, the exposure of
a bank to a single counterparty goes beyond the
entire capital of the bank.
There were long discussions about how to cope
with the Herstatt risk at the level of central banks,
at industry group level, and in the individual banks,
respectively. The PVP concept of CLS Bank was
derived from these discussions.
BACKGROUND OF CLS BANK
Effort to Reduce FX Settlement Risk
Concern of Central Banks
From the mid-1990s, the central banks became
increasingly concerned that the high level of the
FX settlement risk could trigger a serious disrup-
tion of the global FX markets and cause a major
damage to the financial stability.
In 1996, the Committee on Payment and
Settlement Systems (CPSS) of the Bank for In-
ternational Settlements (BIS) published a report
titled “Settlement Risk in Foreign Exchange
Transactions.” This report is sometimes referred
to as the “Allsopp report,” after Mr. Peter Allsopp
of Bank of England, the chairman of the working
group which prepared the report.
Three-Track Strategy of Allsopp Report
This report advocated the “Three-Track Strategy”
to reduce the systemic risk associated with FX
settlements. The strategy called for actions at three
different levels. First, individual banks should take
actions to control their FX settlement exposure.
Second, the industry groups should develop the
FX settlement risk-reducing multi-currency ser-
vices. Third, the central banks should take actions
to promote the prompt improvement in the FX
settlement risk reduction in the private sector.
Among these actions, the highest priority was
given to the industry initiatives. In brief, the report
gave a significant homework to the industry group.
Result of G20 Study
In parallel with the preparation of the Allsopp
report, the “Group of Twenty” (G20), which was
191
 CLS Bank

comprised of the world’s 20 major banks, con-
ducted a comprehensive study on the necessary
multi-currency settlement service to eliminate
the FX settlement risk. The result of this study
was the “Continuous Linked Settlement” (CLS)
concept, which was a simultaneous exchange of
each of the two legs of an FX transaction, using
a “Payment versus Payment” (PVP) mechanism.
The source of the FX settlement risk lies in the
fact that each currency leg of an FX transaction is
being settled separately. Thus, the CLS concept is
intended to settle two payment instructions relating
to a FX transaction simultaneously to eliminate
the time lag between the two legs.
Establishment of Organizations
Along with the progress of the discussion on the
settlement mechanism, the project to establish
the organization to provide the multi-currency
settlement service was also proceeded. First, “CLS
Services Ltd” was established in London in July
1997. Later, “CLS Bank” was established as an
Edge Act Corporation in New York in November
1999. After the development phase of the CLS
system and an extensive test phase, CLS Bank
started operations in September 2002. CLS Bank
went live with 39 Settlement Members and seven
eligible currencies (Table 1).
True Nature of CLS Bank
CLS Bank is a “special purpose bank” which is
dedicated to eliminating the FX settlement risk
by providing a special mechanism of settlement
called the “Continuous Linked Settlement.”
PVP Mechanism
CLS Bank adopts the method of the “Payment
versus Payment” (PVP), which is a mechanism
that ensures a final transfer of one currency oc-
curs if, and only if, a final transfer of the other
currency takes place simultaneously. With the
PVP scheme, the payment of one currency always
goes hand-in-hand with the payment of another
currency. In sum, the PVP is an effective solution
for eliminating settlement risk caused by the time
lag of the two legs. In other words, the settlement
through CLS Bank (the “CLS settlement”) effec-
tively eliminates the FX settlement risk.

Table 1. Brief Sketch of Establishment and Development of CLS Bank

Timing Affair
March 1996 The BIS published the Allsopp report (“Settlement Risk in Foreign Exchange Transactions”).
July 1997 The CLS Services Ltd was established in London.
November 1999 The CLS Bank was established in New York.
April 2002 The CLS Group Holdings AG was established in Zurich.
September 2002 The CLS Bank started operations for 7 currencies.
September 2003 The eligible currencies were extended to 11.
December 2004 The eligible currencies were extended to 15.
November 2007 The CLS Bank started credit derivative settlement with DTCC.
December 2007 The CLS Bank started NDF service.
May 2008 The eligible currencies were extended to 17.
Source: CLS Group

192
CLS Bank
Support of Central Banks
Even though CLS Bank was established as a
private bank, establishing CLS Bank was not a
pure private-sector-driven project. As mentioned
above, the project was an assignment from the
central banks to the industry group. With this
background, the central banks have encouraged
and supported the progress of the project towards
achieving its goal. Some central banks even
encouraged the major banks at home to join the
project or become a Member of CLS Bank.
In addition, the central banks contribute to the
daily CLS settlements by allowing CLS Bank to
have an account at each central bank and to be-
come a direct member of the RTGS system in each
country. This is a unique arrangement between
the central banks and private sector. Therefore,
it can be described that this was a project of
public nature with the purpose of reducing the
FX settlement risk.
CLS Bank is an institution dedicated to the
settlement service, and undertakes no other busi-
ness such as the commercial lending or securities
investment. And as CLS Bank never becomes
counterparty to the FX transaction at any time, it
does not bear any FX settlement risk.
CLS Bank as a Payment System
CLS Bank is a global multi-currency payment
bank that has the organizational form of a private
bank. However, as the background for its creation
shows, CLS Bank was intended to be a market
infrastructure to deal with multi-currency settle-
ments specifically for the FX transactions. For
this reason, it is appropriate to recognize CLS
Bank as a kind of payment system rather than an
ordinary bank. Actually, the Federal Reserve Bank
of New York regulates and supervises CLS Bank
as a “Systemically Important Payment System”
(SIPS).
OUTLINE OF CLS BANK
Organization of CLS Bank
CLS Group Holdings AG
The CLS Group is composed of four institutions
(see Figure 1). The “CLS Group Holdings AG”
is the ultimate holding company, which has the
wholly-owned subsidiary, the CLS UK Hold-
ing. The CLS Group Holdings AG fulfils the
management function of the entire group and
makes strategic decisions. It was established in
Switzerland and regulated by the Federal Reserve
as a US bank holding company. It is owned by
72 shareholders consisting of the world’s leading
banks as of the end of 2010.
CLS UK Holding
The CLS UK Holding is a private limited company
in the UK, which has two wholly-owned subsidiar-
ies, CLS Bank and CLS Services. Based in London
and with a representative office in Tokyo, it acts
as an intermediate holding company of the CLS
Group. It provides the financial, personnel and
audit services to the group companies.
CLS Bank International
CLS Bank (CLS Bank International) is a 100%
subsidiary of the CLS UK Holding. It was estab-
lished as an Edge Act Corporation in New York,
which is a banking institution with a special charter
from the Federal Reserve to specifically conduct
international banking operations and does not
accept retail deposits. It is directly supervised by
the Federal Reserve. CLS Bank is also subject to
a “cooperative oversight” arrangement, in which
the central banks whose currencies are settled in
CLS Bank participate. The Federal Reserve is
the lead overseer of the cooperative oversight,
and organizes and administers the “CLS Joint
193

Figure 1. Organization of the CLS Group
Oversight Committee,” the primary forum for the
participating central banks.
CLS Services Ltd
CLS Services Ltd is a company organized under
the UK law and located in London. It provides
the technical and operational support to CLS
Bank, including the operation of the system and
back-office support.
Shareholders of CLS Group
As noted above, 69 major banks in the world
are shareholders of the CLS Group as of the end
of 2009. These shareholders bore the system
development cost and assume the corporate
governance of the Group. The Board of the CLS
Group Holdings AG is composed of 15 directors
from the shareholders as well as the CEO and the
deputy CEO. Each shareholder has an equal vote
in the governance of the CLS Group Holdings.
Only a shareholder bank can become a Settlement
Member of CLS Bank.
194
CLS Bank
Eligible Currencies of CLS Bank
When CLS Bank started operations in September
2002, there were only seven eligible currencies of
the Bank: the US Dollar, the euro, the UK Pound,
the Japanese Yen, the Swiss Franc, the Canadian
Dollar, and the Australian Dollar. One year after
the launch, CLS Bank added four currencies for
settlement: the Swedish Krona, the Danish Krone,
the Norwegian Krone, and the Singapore Dollar.
As the third wave currencies, a further four
currencies were added in 2004: the Hong Kong
Dollar, the New Zealand Dollar, the Korean Won,
and the South African Rand.
Most recently, two currencies, the Israeli
Shekel and the Mexican Peso, were added in
2008, which made the total eligible currencies
17 (Table 2). These 17 currencies account for
94% of the transaction value in the worldwide
FX market. However, it does not mean that 94%
of the transactions are settled through CLS Bank,
as described below.
CLS Bank
Table 2. Expansion of Eligible Currencies in CLS Bank
Wave When introduced
First wave curren- September 2002
cies
Second wave cur- September 2003
rencies
Third wave curren- December 2004
cies
Fourth wave cur- May 2008
rencies
Total --
Targeted Transaction of CLS Bank
The targeted transaction of CLS Bank covers a
wide range of FX transactions as well as some
derivatives transactions. CLS Bank settles pay-
ment instructions received for the following kinds
of transactions: (i) FX spot, (ii) FX forwards,
(iii) FX option exercises, (iv) FX swaps, (v) Non
Deliverable Forwards (NDFs), and (vi) Credit
derivatives (see Table 3).
CLS settlement is possible only if two condi-
tions are satisfied. First, both payment instructions
should be the CLS eligible currencies. Second,
both parties of the transaction should be able to
settle at CLS Bank directly or indirectly.
Traffic of CLS Bank
CLS Bank settles on average 589 thousand FX
instructions with a total daily average value of
$3.66 trillion per day in 2009. On a peak day (16
February 2010), CLS Bank settled more than 1.7
Table 3. Six categories of Targeted Transaction
of CLS Bank
€€€€€€€€€€€€(i) FX spot
€€€€€€€€€€€€(ii) FX forwards
€€€€€€€€€€€€(iii) FX option exercises
€€€€€€€€€€€€(iv) FX swaps
€€€€€€€€€€€€(v) Non Deliverable Forwards (NDFs)
€€€€€€€€€€€€(vi) Credit derivatives
Source: CLS Group
Number of Currencies Target currencies
7 currencies US Dollar, Euro, UK Pound, Japanese Yen, Swiss Franc,
Canadian Dollar, Australian Dollar
4 currencies Swedish Krona, Danish Krone, Norwegian Krone, the
Singapore Dollar
4 currencies the Hong Kong Dollar, the New Zealand Dollar, the Korean
Won, the South African Rand
2 currencies the Israeli Shekel, the Mexican Peso
17 currencies --
million instructions with a value of more than
$6.1 trillion in a single day. We can recognize
CLS Bank as the world’s largest FX settlement
infrastructure.
The shareholder banks actually use CLS Bank
very extensively. That is, 95% of their trades with
each other are settled at CLS Bank. In a global
sense, it is estimated that approximately 58% of
daily FX transactions are settled through CLS
Bank in value. In sum, CLS Bank is a huge pay-
ment system which handles more than half of the
FX transactions across the globe. It is obvious
that CLS Bank makes an extremely significant
contribution to reduce the FX settlement risk.
Membership of CLS Bank
There are several types of participants in the CLS
settlement service. First, the “Settlement Mem-
bers” are the direct participants of CLS settlement
and have an account at CLS Bank. Second, the
“User Members” are the indirect participants of
CLS settlement, and do not have an account with
CLS Bank and outsource the CLS settlement to
a Settlement Member. Third, the “Third parties”
are the customers of the Settlement Members or
User Members. The details of these memberships
are as follows.
195

Settlement Members
A “Settlement Member” is a direct participant of
CLS Bank and has a single multi-currency account
with CLS Bank. The Settlement Members may
submit the payment instructions directly to CLS
Bank, which include their own FX transactions
as well as their customers’ transactions.
The requirements to become a Settlement
Member1 are; (i) To be a shareholder of CLS
Group Holdings AG, or a 100% subsidiary of
the shareholder, and (ii) To have certain level of
financial and operational capabilities (the capital,
rating, financing capacity of liquidity, business
processing capability, etc.). There are 61 Settle-
ment Members as of the end of 2010.
User Members
A “User Member” may submit payment instruc-
tions directly, but it does not have an account
with CLS Bank. Thus, the settlements of the User
Member’s instructions are executed through the
sponsoring Settlement Member. Stated differently,
the “Designated Settlement Member” (DSM) is
responsible for all the funding for the obligations
relating the User Member’s instructions and for
having these instructions processed through its ac-
count. For this reason, each instruction submitted
by a User Member must be authorized by its DSM.
A User Member’s instructions may include
its own transactions as well as its customers’
transactions.
The requirements to become a User Member
are; (i) To be a shareholder of CLS Group Holdings
AG, or an affiliated company of the shareholder,
and (ii) To have certain level of financial resources
and operational capabilities. The Settlement Mem-
bers and User Members are collectively-referred
to as the “CLS Members.” There were only 2 User
Members as of the end of 2010.
196
CLS Bank
Third Parties
A “Third party” is a customer of the Settlement
Members or User Members. It does not have any
relationship with CLS Bank, and is able to make
CLS settlements through the Settlement Members
or User Members. The relationship between the
Third parties and Settlement Members (or User
Members) is defined by a contract between them
and CLS Bank is not involved in this relationship.
There were 10,886 Third parties as of the end
of 2010, which included 379 banks, 39 corporates
and 143 non-bank financial institutions. More
than 10 thousands of them were investment funds.
Third Party Service Providers
The “Third Party Service Providers” are the
Settlement Members or User Members who offer
the CLS settlement service to their customers.
The customer may achieve the benefits of the
CLS settlements as a Third party. There are 24
Members across the globe acting as a Third Party
Service Provider.
Accounts Used for CLS Settlement
The account relationships of CLS Bank are two-
tiered. First, CLS Bank holds an account at each
central bank of eligible currency. The funds are
received and paid between CLS Bank and the
Settlement Members through the Bank’s accounts
at the central banks.
Second, each Settlement Member holds a
multi-currency account at CLS Bank. The CLS
settlements are made across these accounts at
CLS Bank.
CLS Bank Accounts at
Each Central Bank
As CLS Bank holds an account at the central bank
for each eligible currency, CLS Bank therefore
can participate directly in the Real-Time Gross
CLS Bank

Figure 2. CLS Bank’s Link to RTGS System and Central Bank Account

Table 4. Eligible currencies and related RTGS

Settlement (RTGS) systems of the eligible cur- systems
rencies (Figure 2).
When a Settlement Member makes a payment Eligible currency RTGS systems used for Pay-ins and
Pay-outs
(Pay-In) to CLS Bank, the Member uses the RTGS
US Dollar (USD) Fedwire
system of the currency and transfers funds to the
Euro (EUR) TARGET2
CLS Bank account at the central bank. In the same
Japanese Yen (JPY) FXYCS/BOJ-NET
way, CLS Bank distributes funds (Pay-Out) to the
UK Pound Sterling CHAPS
Member’s accounts at the central bank using the (GBP)
RTGS system of the currency (Table 4). Swiss Franc (CHF) SIC
Canadian Dollar (CAD) LVTS
Nostro Agent Australian Dollar RITS
(AUD)
A Settlement Member can make a Pay-In to CLS Swedish Krona (SEK) RIX
Bank by itself. Alternatively, if the Member is not Danish Krone (DKK) KRONOS
a direct participant of the RTGS system of the Norwegian Krone NICS/NBO
currency, they use an appointed “Nostro Agent” (NOK)
for the currency to either pay or receive on their Singapore Dollar MEPS+
(SGD)
behalf. The Nostro Agent takes care of funding
Hong Kong Dollar CHATS
and the Pay-In procedure on behalf of the Member. (HKD)
For example, when a Japanese bank asks a US New Zealand Dollar ESAS
bank to make Pay-Ins on its behalf in the USD via (NZD)
the Fedwire, the US bank is the Nostro Agent for Korean Won (KRW) BOK-Wire
the Japanese bank. In the opposite direction, a US South African Rand SAMOS
bank may assign a Japanese bank as its Nostro (ZAR)

Agent for the JPY. Israeli Shekel (ILS) ZAHAV System

Mexican Peso (MXN) SPEI
Source: CLS Bank (2009a)

197

Figure 3. Multi-currency Account at CLS Bank
Member Accounts at CLS Bank
Settlement Members have a single account at
CLS Bank. This single account is composed of
the “sub-accounts” of the eligible currencies. That
is a “multi-currency account” made of the sub-
accounts of 17 currencies (see Figure 3).
Finality of CLS Settlement
The Settlement Members make Pay-Ins to the
CLS Bank account, and CLS Bank makes Pay-
Outs to the Settlement Members’ accounts at each
central bank. These fund transfers are made with
the “Central Bank Money” and have the real-time
finality when processed.
The settlement across the Members’accounts at
CLS Bank is also final and irrevocable. The finality
on the fund transfer at CLS Bank is secured by
the common contract between CLS Bank and the
Settlement Members under the New York state law.
Access to CLS System
Each Member connects to the CLS system in one
of two ways. One way is to use a “CLS gateway”
198
CLS Bank
using a CLS Graphical User Interface (GUI).
Another is to use an “Application Programming
Interface” (API), which connects a Member’s
in-house system with the CLS system.
In each case, the messages and information are
exchanged between CLS Bank and the Member
over the SWIFT network. The SWIFTNet InterAct
service is used as the messaging service.
With these connections, the Settlement Mem-
bers receive the real-time information on the status
of all their payment instructions, and the related
Pay-Ins and Pay-Outs in each currency.
FUNDING AND SETTLEMENT
PROCEDURES OF CLS BANK
Brief Overview of Funding and
Settlement Procedures
The relationship between the Settlement Members’
funding to CLS Bank and the settlements across
the Member’s accounts at CLS Bank is rather
complicated. Because the funding (Pay-In) process
and the settlement process in the CLS system are
executed separately. The settlement process takes
CLS Bank
place over a two-hour period (07:00- 09:00 CET),
while the funding process takes place over a five-
hour period (07:00-12:00 CET). The settlements
are made individually on a gross basis, while the
funding is made on a multilateral net basis.
The settlement process utilizes the concept
of “equivalent value” across each Member’s ac-
count. This means that the CLS system measures
the positive values in some currencies against
the negative values in the other currencies, all
converted to the USD in real time. Each Member
cannot go overdrawn as for an aggregate balance
at any time as a result of settlements. There must
always be enough “positive values” in the Mem-
ber’s account to make each settlement. This is a
highly dynamic process during each daily settle-
ment cycle and is also a fundamental part of the
risk management at CLS Bank.
The following is a brief overview of the settle-
ment procedures at CLS Bank.
Figure 4. Submit Payment Instructions to CLS Bank
Before Settlement Process
Submitting Payment
Instructions to CLS Bank
First, the CLS Members (the Settlement Members
or User Members) should submit the payment
instructions to CLS Bank for CLS settlements
within two hours after the trades are made.
There are two ways to submit payment in-
structions to CLS Bank. One way is that the
CLS members submit the instructions directly to
CLS Bank via the “Gross Direct Input” (GDI) or
MT3042 on the SWIFT network
Another way is to send the copy of confirmation
to CLS Bank. After the FX trade is made, both
of the counterparties exchange the confirmation
of the trade via MT3003 on the SWIFT network.
The SWIFT provides a service that the copies of
confirmations are sent to CLS Bank as a payment
instruction (Figure 4).
199

Validation of Payment Instructions
Upon receipt of payment instruction, the CLS
system authenticates and validates the certain field
of payment instruction. If the payment instruction
is not successfully authenticated or validated, it
will be rejected by the CLS system.
Matching of Payment Instructions
Once the payment instruction is successfully
authenticated and validated, the CLS system
matches the payment instructions from both
parties of the transaction. If the contents (the
counterparty, amount, currency, value date, etc.)
of the instruction are confirmed to be matched,
these instructions are recognized as the payment
orders to CLS Bank. Then, the CLS members
receive the matched trade status from CLS Bank.
In addition, if the amount of a single instruc-
tion is too big, the PVP process does not work
efficiently. Thus, any ultra-large payment instruc-
tions, the equivalent of $100 million or more, is
automatically divided into several instructions of
smaller amounts.
Pay-In Schedule
At midnight in Central European Time (CET),
CLS Bank calculates the “net positions” of each
CLS member on a multilaterally netted basis for
each currency and each value date. These net
positions for each currency are noticed to each
member as a “Pay-In Schedule” well before the
starting time of settlement process, which was in
order to provide enough time for each member to
prepare its necessary funding.
The amount of Pay-In is much smaller than
the gross amount of transactions as a result of the
netting. The netting effect is remarkable especially
when many transactions (in both buying and sell-
ing) are made among the Members in the same
currency pairs for the same value date.
200
CLS Bank
Settlement Process
Feature of CLS Settlement
The features of the settlement process at CLS
Bank are as follows.
i. The settlement process starts at 07:00
CET every business day (15:00 in Tokyo).
Settlement is completed by 09:00 CET.
Payments to fund negative positions in
some currencies are split into three hourly
amounts for the Asian currencies and five
hourly amounts for the European, African
and American currencies.
ii. CLS Bank holds the payment orders in the
settlement processing queue and processes
them when there is enough value, across all
currencies in each Member’s account to settle
each individual transaction, as explained
above.
iii. At sub-account level, the intraday overdraft
(O/D) is allowed within a certain limit. Stated
differently, the balance of some sub-accounts
could be negative (less than zero) until the
end of settlement cycle.
iv. CLS Bank executes the “Payment versus
Payment” (PVP) settlement. More con-
cretely, the payment of selling currency and
the payment of buying currency is made
simultaneously. In the event of a failure
by one side of a transaction, the principle
amount paid by the other is immediately
returned to their account and by this action
the FX settlement risk is eliminated.
Figure 5 shows the simple example, in which
Bank A sold the USD to Bank B against JPY, and
vice versa. In this case, the payment of the USD
from Bank A to Bank B and the payment of JPY
from Bank B to Bank A are made simultaneously
in the CLS system.
CLS Bank
Figure 5. PVP Settlement at CLS Bank
Net Funding and Gross Settlement
As Figure 5 shows, the PVP settlement at CLS
Bank is executed on a gross basis, while the fund-
ing or Pay-In to CLS Bank is made on a net basis.
After Settlement Process
CLS Bank makes the Pay-Out to the Members’
account at each central bank through each RTGS
system for the long position (the balance is more
than zero) currencies. Pay-Out is made in accor-
dance with a Pay-Out algorithm, which ensures
that CLS Bank holds the necessary liquidity.
When the settlement process is completed, the
balance of each Member’s account at CLS Bank
becomes zero.
Pay-In Schedule
Notice of Pay-In Schedule
As mentioned above, the Settlement Members
submit payment instructions to the CLS system
for matching on a trade date. Instructions of the
standard trades4 (T+2) can be submitted up to 00:00
CET5 on the settlement date. Then, the “Initial Pay-
In schedule” is sent to each Settlement Member.
From 00:00 to 06:30 CET, the instructions relating
to the same-day swaps between Members who
participate in the In/Out swap trades are submitted.
At 06:30 CET, each Settlement Member receives
its “Revised Pay-In schedule” for the day.
The Pay-In schedule indicates the net positions
for each currency and the required Pay-In amount
for the fixed hours (see Table 5).
Funding Period
The Pay-In time is defined in CET. As for the
European and North American currencies, the
funding period is 07:00-12:00 CET, which is
equivalent to 01:00-06:00 in the Eastern Standard
Time (EST) in the US. This time zone for funding is
called a “five-hour window.” For the Asia-Pacific
currencies, the Pay-In time is over three hours of
07:00- 10:00 CET, equivalent to 15:00-18:00 in
Japan Standard Time (JST).
Approximately 80% of total Pay-In obligations
are required to be paid to CLS Bank by 10:00
CET, while the remaining 20% should be paid
by 12:00 CET.
201
 CLS Bank

Table 5. Pay-In Schedule (Example)

Currency Net position Required Pay-in (cumulative amount until each deadline)
until 8:00 until 9:00 until 10:00 until 11:00 until 12:00
USD +1000
Euro -500 125 250 333 416 500
JPY -900 400 800 900
GBP +900
CHF +460
AUD -600 200 400 600
SGD -300 100 200 300
HKD -60 20 20 20
Note: Time is CET.

These Pay-In time windows were defined to out Pay-Ins according to the Pay-In schedule,
coincide with the operating hours of the relevant approximately 99% of payment instructions will
RTGS systems, such as the Fedwire, TARGET2 be settled by 08:00 CET, with the remaining 1%
and FXYCS/BOJ-NET. of payment instructions settling by 09:00 CET.

Operational Timeline of CLS Bank6 Pay-In and Pay-Out Process

Funding and Settlement
Settlement Members makes Pay-Ins based on the
Pay-In schedule to the CLS Bank account at the
relevant central bank. The Pay-Ins are executed
using the relevant RTGS systems: the Fedwire for
the USD, the TARGET2 for euro, the FXYCS/
BOJ-NET for JPY, the CHAPS for Pounds Sterling
(GBP), the SIC for CHF and so on. Upon receiving
the funds at the CLS Bank account at the relevant
central bank, CLS Bank credits the same amount
to the Member’s account at CLS Bank.
CLS Bank settles each pair of matched pay-
ment instructions within the range of the aggregate
available balance in the Member’s account. The
settlements are made trade-by-trade on a gross
basis, and the settlements become final when
processed. Payment instructions that cannot
immediately settle remain in the queue and are
continually revisited.
The funding and settlement procedures begin at
07:00 CET. And if all Settlement Members carry
Between 07:00 and 09:00 CET of every business
day, each Settlement Member makes its funding
to the multi-currency account at CLS Bank by
making payments (“Pay-Ins”) to CLS Bank. CLS
Bank then settles payment instructions with the
received funds between the Members’ accounts
at CLS Bank. Then CLS Bank makes payments
(“Pay-Outs”) to the Settlement Members’ account7
from CLS Bank’s central bank accounts through
the applicable RTGS systems. CLS Bank repeats
this process (the Pay-In, settlement and Pay-Out),
continuously every few minutes (Figure 6).
All fund transfers occur during a five-hour
period. For the Asia Pacific currencies, the Pay-
In and Pay-Out process occurs over a three-hour
period until 10:00 CET and for the European and
North American currencies the process occurs over
a five-hour period until 12:00 CET.
Between 9:00 and 12:00 CET, the Pay-Ins and
Pay-Outs are completed. All funds will be paid-
out, i.e. disbursed back to the relevant Settlement

202
CLS Bank
Figure 6. Operational Timeline of CLS Bank
Members by 12:00 CET, which allows the Mem-
ber to manage liquidity requirements efficiently.
Multi-Currency Account at CLS Bank
Each Settlement Member has a single account
at CLS Bank. The single account is composed
of sub-accounts of all CLS eligible currencies.
During the settlement cycle (7:00-12:00 CET),
the balances of each sub-account are constantly
changing from moment to moment (see Figure
7). At this stage, some sub-accounts have a credit
balance, while the other sub-accounts have a nega-
Figure 7. Balances of Sub-accounts during Settlement Cycle (Example)
tive balance, since the intraday O/D is allowed at
the sub-account level.
In normal circumstances where the settlements
of all payment instructions are completed, CLS
Bank completes Pay-Outs of the long balances in
its central bank accounts to Settlement Members
before the close of each RTGS system. As a result
of these procedures, Settlement Members will
have a zero balance in its account at CLS Bank.
On the other hand, CLS Bank will have no funds
in its central bank accounts at the end of each
business day.
203
 CLS Bank

Table 6. Three Risk Management Measures of CLS Bank

Risk management measures Contents

Positive Adjusted Account Balance
Short Position Limit (SPL)
Aggregate Short Position Limit
(ASPL)
Net Account Balance is calculated by adding up the dollar-based amount of all the sub-accounts of a
Member. The Balance should be positive (more than zero) all the time.
SPL is set for each currency, which is common to all Members. The negative balance of each sub-
account cannot exceed the SPL of the currency.
Aggregate Short Position is calculated by adding up the dollar-based amount of negative sub-accounts
of a Member. This Position should not exceed the ASPL that is fixed for each Member.

RISK MANAGEMENT OF CLS BANK
Three Risk Management Tests
According to the provision of the CLS settlement
service, CLS Bank applies three risk management
tests to each payment instruction which mitigate
the credit, market and liquidity risk. These are:
(i) Positive Adjusted Account Balance, (ii) Short
Position Limit (SPL) and (iii) Aggregate Short
Position Limit (ASPL), (see Table 6).
These risk management tests are designed to
ensure that CLS Bank has sufficient funds for
settlements and Pay-Outs, even if the Settlement
Member with the largest Pay-In obligation fails
to satisfy its funding requirements. The following
three tests are applied to each payment instruction,
regardless of the type of underlying transaction
involved.
Positive Adjusted Account Balance8
CLS Bank never settles a payment instruction
when such settlement will cause the sum of all
the currency balances in the Settlement Member’s
Account, (the “Account Balance,” expressed in
USD equivalent), to be less than zero.
This means that the short positions of a Mem-
ber should be fully covered by the long positions
of the other currencies. Stated differently, CLS
Bank is ensured to have more than equivalent
value in the USD than the short positions in some
currencies. Thus, CLS Bank does not bear the net
credit risk as a whole to any Member, even if it
allows Members to have the short positions in
some currencies.
For the exchange rates used for the currency
conversion to the USD, the “haircuts” are applied.
CLS Bank applies a currency specific haircut to
each currency balance in the Settlement Member’s
Account. The haircut percentages are decided
according to the historical volatility of each cur-
rency. The “haircuts” provide a cushion against
the adverse FX rate movements; they have the
effect of increasing the value of each short posi-
tion and reducing the value of each long position
to ensure the adjusted Account Balance does not
fall below zero even during periods of the extreme
FX market volatility.
It does not mean that the Settlement Members
are required to fund their respective Accounts for
additional amounts to cover haircuts. The haircuts
only affect a Settlement Member by withhold-
ing value in its Account through the reduced
Pay-Outs until a Settlement Member covers the
entire amount of the relevant short positions by
its Pay-Ins to CLS Bank.
Short Position Limits (SPL)
At no time may the Settlement Members Account
have a short position (the negative balance) that
exceeds the “Short Position Limit” (SPL) estab-
lished by CLS Bank for the relevant currency. The
SPL for each currency is unique and is determined
from time to time by CLS Bank for all Settlement
Members based on the committed amount of
Liquidity Facilities (to be described below). The

204
CLS Bank
SPL is set in order to complete the CLS settle-
ment in a timely manner. CLS Bank permits each
Settlement Member to incur the short positions in
a currency to facilitate settlements. It is beneficial
for participants to have the allowed short posi-
tions, which allows settlements to occur even if
the Member does not have enough liquidity in its
sub-account of the currency. If a Member with a
short position in a currency is unable to make a
Pay-In, the “Liquidity Providers” of the currency
are obliged to provide the funds to complete the
CLS settlement (to be described below).
Aggregate Short Position
Limit (ASPL)
At no time may the Settlement Member’s Account
Balance exceed the “Aggregate Short Position
Limit” (ASPL). The ASPL represents the maxi-
mum amount of all short positions (expressed in
USD equivalent) in the Account and is determined
from time to time by CLS Bank based on the spe-
cific criteria relating to the Settlement Member.
The ASPL is set for each Member taking into
consideration of the capital, rating and other finan-
cial conditions. In contrast to the SPL, which is the
same amount for all the Settlement Members, the
ASPL is unique to each Member depending on its
financial condition. For example, a Member with
the high level of capital and safety rating will have
a larger ASPL. On the other hand, a Settlement
Member with the rating of non-investment grade
maybe given a zero ASPL. Additionally, the ASPL
of each Member cannot exceed US $1.5 billion.
Risk Management Tests
for Queued Payments
Upon receipt of the payment instructions, CLS
Bank put them in the queue of the system. Once
the queued payments pass all the risk manage-
ment tests, these payments are picked up from
the queue and processed for settlement. The risk
management tests (the Positive Adjusted Account
Balance, SPL and ASPL) are applied to both sides
of the transaction, namely the selling Member and
the buying Member.
When Risk Checks are Not Passed
When a payment instruction cannot pass one or
more risk management tests, it is not processed
and remains in the queue. However, this does not
mean that the payment is rejected, or a default takes
place. This situation only means that the payment
instruction is unable to settle immediately. The
system will try the instrument again and again in
later stages of the settlement cycle.
If CLS Bank is unable to settle a payment in-
struction by the relevant currency just before the
deadline, since the applicable risk management
tests for the two relevant Settlement Members
are not satisfied, the payment instruction will be
rejected by the CLS Bank system.
When Risk Checks are Passed
When a payment instruction passes all the risk
management tests, it is picked up from the queue
and processed for settlement. At this stage, two
matched payment instructions involving two
currency payments (buy and sell) are settled si-
multaneously and individually, which means that
the PVP settlement is executed on a gross basis.
With the sound legal basis, these settlements are
final and irrevocable when processed.
Pay-Out
CLS Bank makes the Pay-Outs from its central
bank accounts to the Settlement Member’s ac-
count at the central bank, in accordance with a
Pay-Out algorithm. As a result of the Pay-Outs,
the balances of both the Member’s account at
CLS Bank and the CLS Bank accounts at the
relevant central banks become zero when all the
CLS settlements are completed. Normally, the
Pay-Outs are completed by 12:00 CET.
205

LIQUIDITY FOR CLS SETTLEMENT
Reduced Liquidity
Since the required funding amount is calculated
on a multilateral netted basis, the funding burden
for Pay-In is significantly reduced compared to
the gross amount of the FX trades. This becomes
possible because CLS settles payment instruc-
tions by circulating the liquidity of each currency
within CLS Bank. Thus the required liquidity for
the CLS settlement is much less than that neces-
sary for the gross settlement on a bilateral basis.
For those payment instructions which have been
qualified as the “settlement eligible instructions,”
the settlements are made on a sequential basis.
For instance, after the liquidity is transferred from
Bank A’s account to Bank B’s account, the same
liquidity can then be used for the settlement from
Bank B to Bank C.
The Pay-In amount is less than 2% of the gross
amount of FX transactions because of the effects
of netting and liquidity circulation. In other words,
the required liquidity is reduced by more than 98%
compared to the ordinary gross settlement value.
On peak days, the netting efficiency exceeds
99%. For example on 16 February 2010, the total
value settled was $6,181 billion with a net fund-
ing (Pay-In amount) of $44.8 billion. It was the
most recent record volume day when more than
1.7 million trades were settled, and the ratio of
the net funding to total settlement value was only
0.7% on the day.
In/Out Swap
Between 00:00 CET and 06:30 CET, CLS Bank
identifies and calculates any intraday swap op-
portunities between different members – “In/
Out Swaps.” By implementing In/Out Swaps,
CLS Bank reduces Members’ overall liquidity
requirements, while leaving their FX positions
unchanged.
206
CLS Bank
An In/Out Swap consists of two equal and
opposite FX transactions that are agreed as an
intraday swap. One leg of the transaction is settled
at CLS Bank and the other leg is settled outside
CLS Bank. This transaction is referred to as an
“In/Out Swap” or an “I/O Swap.”
The I/O Swaps are used by Members to reduce
their positions in CLS Bank – leading to a reduc-
tion in the Pay-In amount. For example, Member
A has a significant short position in euro and a
significant long position in the USD and Member
B has the opposite position (the significant long
position in euro and significant short position in
the USD). In this case, the two Members would
agree the Swap transaction between euro and the
USD. More concretely, Member A would like to
buy euro and sell the USD which are settled at
CLS Bank (in-leg), and would like to sell euro
and buy the USD which are settled outside CLS
Bank (out-leg). The overall FX positions of the
two Members are unchanged by these transactions.
However, Member A is able to reduce the short
position of euro at CLS Bank, and Member B can
reduce the short position of the USD. Therefore,
two Members can reduce the intraday funding
requirements for Pay-In to CLS Bank.
The advantage of I/O Swap is to reduce the
“In-CLS” cash positions, which enables Members
to manage liquidity more easily. However, the
disadvantage is that the I/O Swap generates the
out-leg transactions which are settled outside of
CLS Bank, thus re-introducing settlement risk.
However, the re-introduced settlement risk via I/O
Swap is much smaller than the original settlement
risk. According to the CLS data for the first three
quarters of 2009, the settlement risk re-introduced
by the I/O Swap was approximately 3.9% of the
total gross settlement value.
CLS Bank
COUNTER-MEASURES
FOR PAY-IN FAILURE
Pay-In Failure
In CLS settlements, there is a possibility that a
Member might miss the deadline of the Pay-In
schedule because of the operational or credit
issues. This situation is called the “Pay-In fail-
ure.” CLS Bank prepares the counter-measures
to ensure the smooth settlement, even if a Pay-In
failure occurs.
Pay-In Call
CLS Bank will stop the Pay-Out to the relevant
Member, when it realizes the incident of a Pay-
In failure. Then CLS Bank sends a request for
an additional Pay-In to the failed Member9 (the
“primary member”) and the counterparty of the
failed transaction (the “secondary member”). This
is referred to as the “Pay-In Call” – a process
implemented to complete the settlement process
in a timely manner.
It is the first means of raising additional liquid-
ity in response to a Settlement Member’s failure
to satisfy its funding requirements. It is important
to note that the Pay-In Calls are only issued to
the failed Member and its counterparty; the other
Settlement Members (the “distant members”) are
not notified. If the relevant Member completes
the additional Pay-Ins in response to the Pay-In
Call, all the involved settlements and Pay-Outs
will be completed within the assigned timetable.
Liquidity Facilities
CLS Bank maintains the committed “Liquidity
Facilities10” in each eligible currency. If the reac-
tion by the failing members to the Pay-In call is
inadequate, CLS Bank withholds the Pay-Outs
to the involved Members until such time as its
funding obligations to CLS Bank are satisfied.
If this failure situation continues, CLS Bank will
access its committed liquidity facilities in order
to satisfy its Pay-Out obligations to other Settle-
ment Members.
Under these liquidity facilities, CLS Bank may
call upon its “Liquidity Providers” to enter into
the FX currency swaps or outright transactions
intra-day, which in turn allows CLS Bank to raise
the liquidity in the currency it needs in exchange
for currency in which it has balances on its central
bank accounts. These balances effectively repre-
sent the long positions in the failing Settlement
Member’s Account, the funds which CLS Bank
would otherwise have paid to the Settlement
Member in the absence of its failure to cover its
short position(s). The currency haircuts applied to
the currency balances in the Settlement Members’
Accounts and the withholding of Pay-Outs to the
failing Settlement Members together ensure that
the value of these central bank balances are more
than sufficient to equal the value of the currency
that is to be acquired through the liquidity facility.
Without a Pay-In failure, the liquidity facilities
are never used to facilitate the daily settlement of
payment instructions.
Extremely Exceptional Cases
CLS Bank is well prepared for the extremely
exceptional cases.
Pay-In Failure of Liquidity Provider
It is usually the case that the main player of a
currency is also the Liquidity Provider of that
currency. CLS Bank is prepared for the worst-
case scenario - that the largest Liquidity Provider
of a particular currency is also the largest short
position Member at the same time leading to a
Pay-In failure on that currency.
CLS Bank determines the maximum Short
Position Limit (SPL) of each currency based on
the available liquidity commitment amounts (less
the largest commitment amount from any single
liquidity provider). With this cautious design, CLS
207

Bank maintains the sufficient liquidity facilities
in each currency to satisfy its Pay-Out obliga-
tions in the correct currency if there is a Pay-In
failure by the Settlement Member with the largest
short position in that currency (even if the failed
Member is also the largest Liquidity Provider in
that currency).
Multiple Pay-In Failures
If, by any remote chance, major multiple Pay-in
failures of more than one member would occur
in the same day, it would not be improbable that
the sum of short positions of the failed Members
is larger than the sum of the committed liquidity
facilities of Liquidity Providers of the currency.
In several currencies, CLS Bank has the com-
mitted liquidity facilities that allow it to satisfy
its Pay-Out obligations in the correct currency
if there are Pay-In failures by the Settlement
Members with the two largest short positions
in the currency. However, if the major multiple
Pay-In failures of more than one member occur
and the sum of short positions of failed Members
is larger than the sum of the committed liquidity
facilities of Liquidity Providers of the currency,
then CLS Bank can make Pay-Outs to the Mem-
bers in a “third currency,” an alternative currency
to the currencies involved in the transaction. In
this extreme case, the Members would receive
an unexpected currency. Although the Pay-Outs
of an “alternate currency” could cause a liquidity
impact on the relevant Members, they would not
bear Principal Risk that a party will lose the full
value of a transaction.
Loss-Sharing Rule
CLS Bank does not guarantee the settlement of
any payment instruction or become counterparty
to any FX transaction of payment instruction,
which means that the credit risk of the non-paying
Settlement Member is ultimately borne by the
Settlement Members. The CLS Bank Rules require
208
CLS Bank
a mandatory assessment of these FX market losses
to the Settlement Members through a loss-sharing
process.
The conditions for the loss-sharing process
are as follows: if there is a continued failure by
a Settlement Member to satisfy funding require-
ments (for example, a permanent failure as a result
of bankruptcy), coupled with the significant fluc-
tuations in the FX rate around settlement date, in
excess of the currency haircut percentages applied
to the Accounts, a “mark to market loss” (or the
“FX market loss”) will be incurred. In this case,
even though most unlikely, each Member would
bear the loss-share depending on the transaction
value with the failed Member. This method is
called the “combined loss allocation.”
IMPACT OF CLS BANK
CLS Bank has had several significant impacts
on the FX market and CLS Members as follows.
Reduction of FX Settlement Risk
The primary aim of establishing CLS Bank was to
reduce the FX settlement risk. It began operations
in 2002 with 39 Settlement Members and seven
currencies. Since then, another ten currencies
have been added and today over 10 thousands
funds, banks, and corporates use CLS Bank to
eliminate the FX settlement risk and enjoy the
benefits of greater operational efficiency and
liquidity management.
The estimated coverage of CLS Bank is about
58% of the total market value in 2010. This figure
indicates that CLS Bank has eliminated 58% of
the global FX settlement risk.
It can be said that CLS Bank has achieved its
objectives to a substantial extent. Especially, the
Asia-Pacific currencies enjoy the considerable
benefits, since they always have to be settled in
advance of the USD and euro.
CLS Bank
Nevertheless, there are still some 42% of
FX transactions settled outside of CLS Bank.
Efforts are underway to extend the CLS Bank’s
coverage more broad and further reduce the FX
settlement risk.
Importance of Intraday
Liquidity Management
Each Settlement Member is responsible for manag-
ing the funding for their respective accounts, either
directly or indirectly (through the Nostro Agents).
Although the funding is calculated on a multilat-
erally netted basis, the Pay-In to CLS Bank is a
time-sensitive payment (the “timed payments”).
This may increase the importance of liquidity
management for the Settlement Members. Tradi-
tionally, the liquidity management is undertaken
on a day-to-day basis, but the CLS Members need
to manage the liquidity more strictly to cope with
the timed payments. Therefore, the management
of intraday liquidity on an hourly basis becomes
more and more important.
In addition, the time zone of Pay-In differs
according to area: in the morning in the EU, in
the evening in the Asia-Pacific region, and before
dawn in the US. To cope with this global-scale
situation, each Member sets up a “control branch”
which controls the liquidity in all CLS curren-
cies. The European banks and the US banks tend
to select London for the location of their control
branches and most Japanese banks locate their
control branches in Tokyo.
Concentration of Payment Business
CLS Members can also offer the settlement service
to their customers – the “Third party service,”
i.e. small banks, corporate and funds. By provid-
ing the multi-currency service to its customers,
the Members can earn fee revenues and further
strengthen their customer relationships. In addi-
tion, the more the third parties use the service, the
greater the benefits of the “netting effect” among
the Third parties’ positions become.
However, the Members do need to invest in
the system development and secure the adequate
number of personnel to provide the Third party
service. For this reason, the Third party service
providers tend to be the larger banks, which
would promote the concentration of the world’s
payment business.
Role of CLS Bank During Crisis
Lehman Bankruptcy
Lehman Brothers Holdings Inc. filed for the US
bankruptcy protection under Chapter 11 on 15
September 2008. Some reports11 highlighted the
role of CLS Bank during the financial crisis after
the Lehman shock. According to these reports, the
situations were as follows.
The filing for Chapter 11 of Lehman Brothers
was a dramatic event that pushed the banking
world into the crisis situation. And the inter-bank
lending market dried up immediately after the
event, as all banks took the protective measures.
Prior to the bankruptcy, Lehman Brothers was
a User Member of CLS Bank, using Citigroup as
a Designated Settlement Member to settle its FX
transactions. Lehman Brothers was a top quartile
participant both by value and volume.
CLS Settlement under
Lehman Shock Crisis
During the week of 15 September (so-called
“Lehman’s week”), the CLS system handled and
settled more than $150 billion of transactions, in
which Lehman Brothers was a counterparty.
The volume in the FX market grew consider-
ably due to the increased volatility in exchange
rates. As a consequence, CLS Bank settled a total
of $26.5 trillion and 4.4 million instructions dur-
ing that week. Despite the failure of one of its
larger participants and a historically high level
209

of transactions, CLS Bank did not suffer severe
disruption and all the settlements and Pay-Outs
were carried out without any incident.
On the other hand, there were some compli-
cations and disruptions for market participants
not using the CLS settlement. The bottom line
is that CLS Bank played a vital role during the
Lehman shock crisis. It was proved that the CLS
settlement system worked effectively, even when
a major market participant failed. It is a general
recognition after the Lehman shock that CLS Bank
is an effective and robust measure to mitigate the
FX settlement risk.
As mentioned previously, there are still some
42% of FX transactions that are settled outside
of CLS Bank and further efforts are underway
to expand the portion of FX settlements settled
through CLS Bank.
EXTENTION OF BUSINESS
AREAS BY CLS BANK
CLS Bank has been extending its business areas
step by step. There are four new business areas
so far.
CLS Aettlement for Non-
Deliverable Forwards (NDFs)
In December 2007, CLS Bank extended the
settlement service to include the Non-Deliverable
Forward (NDF) FX transactions.
An NDF is a cash-settled, short-term forward
contract on a thinly traded or non-convertible
foreign currency. In NDFs, the traded currencies
are not physically delivered for settlements, and
instead the contract is settled by calculating the
difference between the agreed exchange rate
and the spot rate at the time of settlement for the
notional amount of funds. One party in the agree-
ment will make a payment to the other party on
the basis of the profit or loss on the contract. The
210
CLS Bank
NDF contracts are mostly, but not exclusively,
quoted and settled in the US dollars.
The “CLS NDF service” includes captur-
ing the various instructions (e.g., the opening
and valuations) for the entire life of the NDF
contract, providing the matching and reporting,
and settling the net amount in one of the 17 CLS
eligible currencies.
The post-trade processing of NDFs has tradi-
tionally been manually intensive, due to lack of
standardization and the use of long-form confir-
mations. The CLS NDF service provides Straight
Through Processing (STP) on the post-execution
process, which leads to a significant reduction of
both cost and operational risk.
It is worth pointing out that the settlement of
NDF is a one-way settlement (a single currency
payment) and not a PVP settlement. This is the
first service CLS Bank provides which is outside
the framework of PVP settlement. Until now, the
settlement volume of NDFs has been small and
cash flow on NDFs has not disrupted the normal
balance of PVP settlement.
CLS Aettlement for OTC
Credit Derivatives
In January 2008, CLS Bank launched the settle-
ment service for the over-the-counter (OTC) credit
derivative transactions. This service is provided in
partnership with the Depository Trust & Clearing
Corporation (DTCC). More concretely, the CLS
settlement service is made available by linking
the “Trade Information Warehouse” (TIW) of the
DTCC Deriv/SERV and CLS Bank.
The DTCC Deriv/SERV provides the post-
trade processing for OTC derivatives, and most
OTC credit derivatives transactions are now
matched and confirmed electronically through
this service. However, the settlements were still
made bilaterally over the life of each contract in
a fragmented and non-standardized manner. With
the CLS Bank’s service, the TIW automates and
centralizes the most up-to-date information about
CLS Bank
a derivatives contract, and sends this data to CLS
Bank for settlement, so that payments take place
automatically, resulting in more efficient and ac-
curate payment processing.
To be more precise, the TIW generates bi-
laterally netted payment instructions and sends
them to CLS Bank early in the morning on the
settlement day. Then, CLS Bank automatically
notifies its Settlement Members, and settlement
will be made as a part of CLS settlement on a
multilateral netted basis.
Payments through this service are possible
in five currencies: the US dollar (USD), euro
(EUR), Japanese Yen (JPY), British pound (GBP)
and Swiss franc (CHF). By using this service,
the number of payment instructions is reduced
by more than 99.99%. This is another service
that is a single currency payment and outside the
framework of PVP settlement.
CLS Settlement for FX
Option Premiums
CLS Bank has also extended the settlement service
to FX Option Premium transactions. An FX Op-
tion is a derivative instrument where the Option
owner has the right, but not the obligation, to
exchange one currency with another currency at a
pre-agreed exchange rate. The Option owner can
execute the right only on a specified date (“Euro-
pean Option”) or at any time before the maturity
date (“American Option”). The FX Options are
used to hedge the future cash flows in a foreign
currency, or to take a speculative position for the
fluctuation of an exchange rate.
The FX Option Premium is the price that the
buyer of the Options pays to the seller in com-
pensation for the right.
The CLS Option Premium service consists
of a matching service of the economic terms of
the trade and an automated settlement service of
premium. By using this service, the main players
in the FX Option market have streamlined the
confirmation and premium payment processes,
and reduced the underling settlement risk if also
settled in CLS Bank when the option is exercised.
The CLS Option Premium service supports
both deliverable and non-deliverable Options for
Vanilla options.
CLS Aggregation
More recently, CLS has also extended its service
to provide “trade aggregation” to participants
through the “CLS Aggregation” service. The
development of this service addresses the rapid in-
crease in foreign exchange trading as an asset class
by a widening group of hedge funds, algorithmic
traders, retail and institutional market participants
which has brought substantially higher volumes
to the foreign exchange industry.
Many of these participants are the prime broker-
age clients of CLS settlement Member banks and
this increase in volume has led to capacity, cost and
operational challenges for them. The aggregation
service provides these Settlement Members with
a solution to these challenges.
REFERENCES
CLS Bank. (2009a, December). Assessment of
Compliance with the Core Principles for Systemi-
cally Important Payment Systems.
CLS Bank. (2009b, September). Briefing on the
Global FX Market and the Role of CLS Bank.
Bank for International Settlements. (1993, Sep-
tember). Central Bank Payment and Settlement
Services with Respect to Cross-Border and Multi-
Currency Transaction (the Noël Report).
Bank for International Settlements. (1996, March).
Settlement Risk in Foreign Exchange Transactions
(the Allsopp Report).
Bank for International Settlements. (1998, July).
Reducing Foreign Exchange Settlement Risk: A
Progress Report.
211

Bank for International Settlements. (2007, July).
Progress in Reducing Foreign Exchange Settle-
ment Risk.
GroupC. L. S.http://www.cls-group.com/Pages/
default.aspx
ENDNOTES
1
A central bank who issues or, if applicable,
otherwise circulates a currency that is settled
in CLS Bank is also eligible to become a
contractual Member.
2
MT304 is a Message Type of SWIFT to send
advice/instruction of a third party deal.
3
MT300 is a Message Type of SWIFT to send
foreign exchange confirmation.
4
In FX market, the settlement date of standard
trade is two days after the trade date (T).
5
Central European Time.
6
This operational timeline is only applicable
to Settlement Members. User Members and
Third parties can set up different timeline
by mutual agreement with their Settlement
Member.
212
CLS Bank
7
When a Settlement Member uses a Nostro
Agent, the Pay-Outs are transferred to the
account of Settlement Member’s Nostro
Agent at the central bank.
8
This is also called the “Net Positive Value
Test.”
9
The Pay-In call to the failed Member might
be made in other currencies than the failed
currency.
10
CLS Bank maintains a “Foreign Exchange
Liquidity Agreement” with each Liquidity
Provider that provides the committed liquid-
ity facilities in a particular currency to CLS
Bank.
11
These reports include the followings: “Re-
port on Operational Lessons from the Demise
of Lehman Brothers in Autumn 2008,” ECB,
March 2009, “FXJSC Paper on the Foreign
Exchange Market,” the Foreign Exchange
Joint Standing Committee (FXJSC), Sep-
tember 2009, and “The Functioning and Re-
silience of Cross-border Funding Markets,”
Committee on the Global Financial System
and Markets Committee, BIS, March 2010.
 213

About the Author

Masashi Nakajima is a professor of Faculty of Economics and Business Administration at Reitaku

University, Japan. He had a long career at the Bank of Japan (BOJ) after graduating from Hitotsubashi
University. During his career at the BOJ, 1981-2006, he gained a wide range of experience as a central
banker holding senior positions in various departments including Research and Statistics Department,
Institute for Monetary and Economic Studies, International Department, and Financial Systems and
Bank Examination Department. He also had experience working for the Bank for International Settle-
ments (BIS) 2003-2005 and the Center for Financial Industry Information System (FISC) 1999-2001.
He distinguishes himself as a coauthor of All about Payment Systems (2000, 2nd edition 2005)(in Japa-
nese) and All about Securities Settlement Systems (2002, 2nd edition 2008)(in Japanese). These two books
cover a wide-range of payment and settlement system issues and are regarded in Japan as must-read
books on the subject of payment and settlement systems. He is also the author of All about SWIFT (2009)
(in Japanese), which is the first book in the world in any language to give a comprehensive presentation
of SWIFT that is the essential global provider of secure financial messaging services. As a key figure
in the payment and settlement arena, he has been on several committees of public institutions, which
include the Financial Services Agency (FSA) of Japan, Ministry of Economy, Trade and Industry (METI)
of Japan, Tokyo Financial Exchange (TFX) and Japanese Banks’ Payment Clearing Network (Zengin-
net).
214

List of Abbreviations

A2A: Account-to-Account
A2A: Application-to-Application
A2R: Account-to-Receiver
ACH: Automated Clearing House
ACHA: American Clearing House Association
API: Application Programming Interface
AS: Ancillary System
ASI: Ancillary System Interface
ASO: Additional Settlement Obligation
ASPL: Aggregate Short Position Limit
B2B: Business-to-Business
B2C: Business-to-Consumer
BCBS: Basel Committee on Banking Supervision
BCEAO: Banque Centrale des Etats de l’Afrique de l’Ouest (Central Bank of West African States)
BCP: Business Contingency Plan
BIC: Bank Identifier Code
BIREL: Banca d’Italia Regolamento Lordo
BIS: Bank for International Settlements
BOE: Bank of England
BOJ: Bank of Japan
BOJ-NET: Bank of Japan Financial Network System
C2C: Consumer-to-Consumer
CACHA: Calwestern Automated Clearing House Association
CBF: Clearstream Banking Frankfurt
CBL: Clearstream Banking Luxembourg
CCASS: Central Clearing and Settlement System
CCD+: Cash Concentration or Distribution+
CCP: Central Counterparty
CET: Central European Time
CGFS: Committee on the Global Financial System
CHAPS: Clearing House Automated Payments System
CHATS: Clearing House Automated Transfer System
CHIPCo: Clearing House Interbank Payments Company LLC
List of Abbreviations

CHIPS: Clearing House Interbank Payments System

CLS: Continuous Linked Settlement
CM: Contingency Module
CMU: Central Moneymarkets Unit
CNS: Continuous Net Settlement
CP: Commercial Paper
CPSS: Committee on Payment and Settlement Systems
CRI: Centrale des Règlements Interbancaires
CSD: Central Securities Depository
CSM: Clearing and Settlement Mechanism
CTP: Customer Transfer Plus
CTX: Corporate Trade Exchange
DORPS: Daylight Overdraft Reporting and Pricing System
DSL: Daily Settlement Limit
DTCC: Depository Trust & Clearing Corporation
DTNS: Designated-Time Net Settlement
DVP: Delivery versus Payment
EACB: European Association of Co-operative Banks
EACHA: European Automated Clearing House Association
EACT: European Associations of Corporate Treasures
EAF: Euro Access Frankfurt
EAF: Electronischen Abrechnung Frankfurt
EBA: Euro Banking Association
EBF: European Banking Federation
ECB: European Central Bank
ECCB: Eastern Caribbean Central Bank
ECS: Electronic Clearing Services
ECU: European Currency Unit
EDI: Electronic Data Interchange
EEA: European Economic Area
ELLIPS: Electronic Large Value Interbank Payment System
ELS: Euro Link System
EMU: Economic and Monetary Union
EMZ: Elektronischer Massenzahlungsverkehr
EPC: European Payments Council
EPM: ECB Payment Mechanism
EPN: Electronic Payments Network
ESBG: European Savings Banks Group
EST: Eastern Standard Time
FAFO: First-Available, First-Out
FF: Fixed-to-Fixed
Fedwire: Federal Reserve’s wire transfer system
FGO: Foreign Gateway Operator
FIFO: First-In, First-Out

215
 List of Abbreviations

FRBNY: Federal Reserve Bank of New York

FSAP: Financial Sector Assessment Programme
FSB: Financial Stability Board
FV: Fixed-to-Variable
FX: Foreign Exchange
FXJSC: Foreign Exchange Joint Standing Committee
FXYCS: Foreign Exchange Yen Clearing System
G10: Group of Ten
G20: Group of Twenty
G30: Group of Thirty
GDI: Gross Direct Input
GO: Gateway Operator
GSE: Government-Sponsored Enterprises
GUI: Graphical User Interface
HAM: Home Accounting Module
HKAB: Hong Kong Association of Banks
HKICL: Hong Kong Interbank Clearing Limited
IAT: International ACH Transaction
IBAN: International Bank Account Number
ICM: Information and Control Module
ICSD: International Central Securities Depository
ICT: Italian Credit Transfer
IOSCO: International Organization of Securities Commissions
IPF: Input Payment File
IP-VPN: Internet Protocol-Virtual Private Network
ISO: International Organization for Standardization
ISSA: International Securities Services Association
IT: Information Technology
JBA: Japanese Bankers Association
JGB: Japanese Government Bond
JST: Japan Standard Time
LLR: Lender of Last Resort
LSF: Liquidity-Saving Features
LVPS: Large-Value Payment System
LVTS: Large Value Transfer System
MAS: Monetary Authority of Singapore
MEPS: MAS Electronic Payment System
MT: Message Type
NACHA: National Automated Clearing House Association
NCB: National Central Bank
NCE: National Check Exchange
NCSD: National Central Securities Depository
NDF: Non Deliverable Forward
NPVT: Net Positive Value Test

216
List of Abbreviations

NSS: National Settlement Service

NYACH: New York Automated Clearing House
NYCH: New York Clearing House
O/D: Overdraft
ODFI: Originating Depository Financial Institution
OTC: Over-the-counter
PEACH: Pan-European Automated Clearing House
PHA: Proprietary Home Accounting
PIS: Paris Integrated System
PM: Payments Module
PNB: Potential Net Balance
PNS: Paris Net Settlement
POPS: Pankkien On-line Pikasiirrot ja Sekit
PSR: Payment System Risk
PVP: Payment versus Payment
RDFI: Receiving Depository Financial Institution
RITS: Reserve Bank Information and Transfer System
RM: Reserve Management
ROSC: Reports on the Observance of Standards and Codes
RSSS: Recommendations for Securities Settlement Systems
RTGS: Real-Time Gross Settlement
RTGS-XG: Next Generation RTGS
SCT: SEPA Credit Transfer
SD: Static Data
SDD: SEPA Direct Debit
SEC: Standard Entry Class
SECB: Swiss Euro Clearing Bank
SEPA: Single Euro Payments Area
SEPI: Servicio Espanõl de Pagos Interbancarios
SF: Standing Facilities
SFD: Settlement Finality Directive
SIC: Swiss Interbank Clearing
SIPS: Systemically Important Payment System
SNP: Système Net Protégé
SOS: Single Obligation Structure
SPF: Settled Payment File
SPL: Short Position Limit
SSP: Single Shared Platform
SSS: Securities Settlement System
STP: Straight Through Processing
SVPCo: Small Value Payments Company LLC
SWIFT: Society for Worldwide Interbank Financial Telecommunication
T2S: TARGET2-Securities
TARGET: Trans-European Automated Real-time Gross settlement Express Transfer system

217
 List of Abbreviations

TBA: Tokyo Bankers Association

TBF: Transferts Banque de France
TC: Technical Committee
TCH: The Clearing House
TCP/IP: Transmission Control Protocol / Internet Protocol
TDC: Tokyo Dollar Clearing
TIW: Trade Information Warehouse
U2A: User-to-Application
XML: eXtensible Markup Language

218
 219

Index

A Bank of Japan (BOJ) 48, 60, 71, 168-174, 177, 181-

182, 189
Account-to-Account (A2A) 126, 143 Bank of Japan Financial Network System (BOJ-
Account-to-Receiver (A2R) 126 NET) 6, 12, 14, 48, 53, 56, 60, 64, 71, 168-
Additional Settlement Obligation (ASO) 108 175, 177-179, 181-185, 189, 202
A European Automated Clearing House Associa- bank-related settlement 3
tion (EACH) 5, 7-9, 12-13, 20, 24-25, 30-35, Banque Centrale des Etats de l’Afrique de l’Ouest
39, 44, 47-48, 50, 52-53, 57-58, 62-64, 66-68, (BCEAO) 73
74-77, 79-80, 83-85, 88, 90-93, 96-97, 99-102, Basel Committee on Banking Supervision (BCBS)
104, 107-115, 120, 125, 127-128, 130-132, 77, 88
135-137, 141-144, 147-149, 151, 153, 155-156, BCCI incident 17, 22, 76
159, 162-166, 169, 171-172, 175-176, 180, Bearing incident 17
182, 184-187, 192-196, 198-210, 212 bell-shaped curve 60-61
Aggregate Short Position Limit (ASPL) 204-205 bilateral net balance 112-113
American Clearing House Association (ACHA) 129 bilateral net credit limit 33, 40, 108, 116, 182
Ancillary System (AS) 1-12, 14-15, 17-28, 30-40, bilateral netting 13, 23-24, 49, 84, 113
42, 44-53, 57-64, 66-68, 71-72, 74-87, 90-93, bilateral offsetting 50, 53, 175-176
96-97, 99-107, 109-110, 112, 114-120, 122- bilateral partial netting 49
125, 129-132, 134-147, 149-167, 169-173, bilateral release 44, 63, 112-113
176-184, 186, 188-211 BOK-Wire 59
Ancillary System Interface (ASI) 143 book transfer 5, 68-69
Application Programming Interface (API) 198 Business Contingency Plan (BCP) 20, 92
Application-to-Application (A2A) 126, 143 Business-to-Business (B2B) 2, 14, 156, 158, 165
Automated Clearing House (ACH) 12, 14-15, 73, Business-to-Consumer (B2C) 14
96-97, 101, 117-129, 151, 154-163, 183 bypass FIFO 51-52, 141, 148
Available Balance 44, 63, 109-113, 115, 202
C
B
calcuating net positions 15
BAHTNET 59 Calwestern Automated Clearing House Association
balanced release engine 44, 63, 111 (CACHA) 118
Banca d’Italia Regolamento Lordo (BIREL) 64, cascade effect 58
85-86, 130 Cash Concentration or Distribution+ (CCD+) 128
Bank for International Settlements (BIS) 2, 9-10, cash position manager 20, 32
14-16, 19-20, 23, 27, 51-52, 75-78, 81, 83, 88, cash settlement 3
90, 92, 173, 191, 212 CCD+ (Corporate Credit or Debit +) 128
Bank Identifier Code (BIC) 135, 138, 154-156 central bank money 5, 7, 11, 15-16, 31, 37, 82, 88,
banknotes 1, 3, 7, 170 102, 142-143, 198
Bank of England (BOE) 143 Central Bank of West African States 73

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central bank payment system 5, 12, 31, 96, 100
central banks 1-2, 4-5, 7-9, 11-12, 15-16, 19, 28,
30-32, 35-41, 48, 54, 56-62, 64, 66, 71-73, 75-
77, 79, 82, 87-90, 93, 96, 98-100, 102, 118-119,
130-133, 135-137, 139, 142-144, 153, 166-167,
169, 171-172, 182, 191, 193-194, 196-198,
201-203, 205, 207, 211-212
Central Clearing and Settlement System (CCASS)
67
Central Counterparty (CCP) 24, 142
Centrale des Règlements Interbancaires (CRI) 46,
146
Central European Time (CET) 135, 143, 147-148,
150-151, 164-166, 199-203, 205-206
Central Moneymarkets Unit (CMU) 67
central queue 40, 47
Central Securities Depository (CSD) 9, 70-71
CHIPS Finality 86, 96, 103, 106, 109, 111-112, 114,
116
CHIPS Online Cash Management Tool 111
Clearing and Settlement Mechanism (CSM) 156
clearing bank 6, 22, 68, 163-164
clearing house 12, 22, 44, 66, 73, 96-97, 101, 103,
117-119, 129, 146, 151, 153, 156-157, 159,
165-166, 183
Clearing House Automated Payments System
(CHAPS) 6, 14, 22, 74, 78, 143, 202
Clearing House Automated Transfer System
(CHATS) 59, 66-67, 74
Clearing House Interbank Payments Company LLC
(CHIPCo) 103, 129
Clearing House Interbank Payments System
(CHIPS) 12, 14, 22, 44, 53-54, 62, 73, 81, 86,
96-97, 102-112, 114-118, 120, 123, 129, 168
clearing process 7, 12, 15
Clearstream Banking Luxembourg (CBL) 71
close-out netting 24-25
CLS Bank International 190, 193
CLS UK Holding 193
Collateral Scheme 81, 108, 116, 182
commercial bank money 11, 15, 67
Commercial Paper (CP) 172
commercial trade 3
commerical banks 2, 4, 6, 11, 15, 67, 105, 170, 183
commitment line 35
Committee on Payment and Settlement Systems
(CPSS) 77, 79-81, 90, 173, 191
Committee on the Global Financial System (CGFS)
88
Consumer-to-Consumer (C2C) 14
contagious default 58
220
Index
Contingency Module (CM) 136
Continuous Linked Settlement (CLS) 9, 65-66, 79,
139, 170, 178, 182, 190-212
Continuous Net Settlement (CNS) 44, 62
continuous settlement system 13, 15, 25
Corporate Trade Exchange (CTX) 128-129
credit limit 25, 33-35, 40, 50, 87, 108, 116, 164,
182
credit obligations 24
credit risk 16-17, 19-20, 28, 32, 34, 38, 57, 99, 108,
110, 191, 204, 208
credit transfer order 7
Customer Transfer Plus (CTP) 116-117
D
Daily Settlement Limit (DSL) 25
Daylight Overdraft Reporting and Pricing System
(DORPS) 99
debit cap 25, 33-34, 40, 80, 87, 99, 108-109, 116,
147, 150, 164, 182
debit transfer order 7
debt obligations 24
defaulters pay 34-35
Delivery versus Payment (DVP) 9, 17-18, 26-27,
36, 67, 71-72, 102, 143, 180-181
deposit balance 7, 15, 37
Depository Trust & Clearing Corporation (DTCC)
210
Designated-Time Net Settlement (DTNS) 30-36,
40, 42-46, 49, 53, 56-58, 60, 62, 64-65, 74, 76,
79, 82, 84-86, 96, 103, 106-107, 116, 131, 145-
146, 168-173, 178-179, 182, 184
designated-time settlement system 13, 25, 31, 57
diffusion of innovations 60, 73
Direct Deposit 123, 184
direct participants 6, 134, 137-140, 143, 147, 158,
163, 165, 182, 195-197
Direct Payment 123
distributed queue 40
DN inquiry and transfer system 58
DVP settlement 72, 102, 143
E
Eastern Caribbean Central Bank (ECCB) 73
Eastern Standard Time (EST) 100-102, 106, 110,
201
ECB Payment Mechanism (EPM) 132
Economic and Monetary Union (EMU) 59, 131,
135
Electronic Clearing Services (ECS) 129
Index
Electronic Data Interchange (EDI) 56-57, 72-73,
96, 117, 127-129, 188-189
Electronic Payments Network (EPN) 117, 119, 129
electronic payment system 3-4, 182
Electronischen Abrechnung Frankfurt (EAF) 44, 62,
81, 84-85, 145-146, 180
Elektronischer Massenzahlungsverkehr (EMZ) 68,
74
end-of-day settlement system 13, 25
Enhanced Computer Capacity 75, 86
environmental interdependencies 10
Euro Access Frankfurt (EAF) 44, 62, 81, 84-85,
145-146, 180
Euro Banking Association (EBA) 130, 146-147,
149-150, 153, 158, 163-167
Euro Link System (ELS) 84-85
European Association of Co-operative Banks
(EACB) 167
European Associations of Corporate Treasures
(EACT) 153
European Banking Federation (EBF) 167
European Central Bank (ECB) 48, 54, 71, 77, 130-
138, 144, 148-149, 153, 167, 212
European Currency Unit (ECU) 22-23, 28
European Economic Area (EEA) 134, 138, 152,
165, 167
European Savings Banks Group (ESBG) 167
exchange-for-value settlement 17-18, 20, 23, 26,
100
EX payment mode 47, 51, 64
eXtensible Markup Language (XML) 73, 117, 154,
156, 165, 188
F
Federal Reserve 3, 5, 12, 21-22, 38, 54, 59, 61, 73,
96-102, 108-110, 117-119, 121, 123-127, 129,
193
Federal Reserve Bank of New York (FRBNY) 54,
109, 115
Federal Reserve Banks 21-22, 54, 59, 73, 97-99,
101-102, 108-110, 117-119, 123-127, 129, 193
Federal Reserve’s wire transfer system (Fedwire)
3, 12, 14, 21-22, 38, 58, 71, 73, 86, 96-98,
100-104, 106, 110, 114-118, 123-124, 129, 134,
168, 170, 197, 202
FedGlobal ACH 96, 125-127
FEDNET 98
Fedwire Funds Service 97, 100, 102
final settlement 8, 18, 22, 31-32, 43, 49, 57, 62, 71,
81-82, 86, 148, 169, 173, 185
Financial EDI 56-57, 72-73, 96, 117, 127-129
financial markets 2-3, 8, 14, 19, 21-22, 36-37, 57,
82, 92, 97, 100, 131, 144, 173
Financial Sector Assessment Programme (FSAP) 83
Financial Stability Board (FSB) 77, 83, 88
financial system 2-3, 88, 94, 212
First-Available, First-Out (FAFO) 52-53
First-In, First-Out (FIFO) 51-53, 140-141, 148
first-tier participant 6
Fixed-to-Fixed (FF) 125-126
Fixed-to-Variable (FV) 125
foreign currency 3, 19-20, 67-68, 126, 210-211
Foreign Exchange (FX) 3, 5, 9, 18-19, 21-23, 26,
36-37, 65-66, 92, 96, 100, 104, 117, 125, 131,
142, 172, 183, 190-196, 199-200, 204, 206-212
foreign exchange (FX) settlement 3, 18, 23, 65-66,
100
foreign exchange (FX) settlement risk 65-66, 100
Foreign Exchange Joint Standing Committee
(FXJSC) 212
Foreign Exchange Yen Clearing System (FXYCS)
22, 81, 168-170, 172-174, 177-179, 181-184,
202
Foreign Gateway Operator (FGO) 125-126
frequent netting 42, 49, 86-87
full duplication 92
full netting 49, 87
fund settlement 3-4, 71, 102, 142, 169-170, 182
funds transfer system 4, 7, 12, 14, 169, 189
FX market 5, 19, 21, 96, 190-191, 194, 204, 208-
209, 211-212
G
Gateway Operator (GO) 13-14, 20, 33, 125, 157-
158, 178, 180, 183, 199
gentlemen’s agreement 39
Global Standard 79, 90, 173, 182
government bond market 19, 96
Government-Sponsored Enterprises (GSE) 102
Graphical User Interface (GUI) 198
gridlock 39-40, 50, 53, 181-182
gross basis 11, 13, 24-25, 27, 31, 50, 57, 97, 140,
146, 149, 171, 175-176, 181, 199, 201-202, 205
Gross Direct Input (GDI) 199
gross-gross type DVP 27
gross-net type DVP 27
gross settlement system 12-13, 23, 31, 36, 132
Group of Ten (G10) 48, 77
Group of Thirty (G30) 27
Group of Twenty (G20) 191
221

H intraday overdraft (intraday O/D) 37-38, 172, 177,
Herstatt Bank incident 17, 21, 76
Herstatt risk 21-22, 66, 100, 190-191
Home Accounting Module (HAM) 137, 142
Hong Kong Association of Banks (HKAB) 74
Hong Kong Interbank Clearing Limited (HKICL)
74
hybrid mode 42-43, 45-46, 65, 180
hybrid system 42-46, 49, 56, 62-65, 76, 82, 84-85,
87, 96, 103, 130, 145-146
I K
illiquidity 38
immediate finality 43
incentive pricing policy 40
indifference curve 45
indirect participants 6, 134, 138, 158, 165, 182, 195
Individual release 44, 63, 111-113
Information and Control Module (ICM) 136, 143
Information Technology (IT) 1-2, 4-5, 7-8, 10-17,
19-26, 28, 30-38, 40-46, 48-50, 52-54, 56-59,
61-62, 64-66, 69-71, 73-76, 81-82, 84-87, 89-
93, 97-103, 108, 111, 114-115, 117-121, 123,
130-131, 135-136, 144-147, 149, 153, 155-160,
162-163, 165, 167-168, 170, 172-174, 176,
178, 180-183, 186, 188-190, 193-196, 200,
204-208, 210
Input Payment File (IPF) 165
Institution-based Interdependencies 9
Integrated systems 42-43, 45-49, 53-54, 56-57, 63-
65, 76, 82, 85, 87, 130, 146, 168-169, 179-180
interbank payments 5, 18, 21-22, 44, 53, 68, 96, 98,
100, 103, 129, 134-135, 169-170, 172, 179, 191
internal settlement 3-5
International ACH Transaction (IAT) 125
International Bank Account Number (IBAN) 154-
156
International Central Securities Depository (ICSD)
71
International Organization for Standardization (ISO)
117, 154, 156, 188
International Organization of Securities Commis-
sions (IOSCO) 77, 93
International Securities Services Association (ISSA)
27
Internet Protocol-Virtual Private Network (IP-VPN)
188
intraday liquidity 5, 8, 28, 32, 37-41, 58, 66, 93, 98-
100, 135, 172, 181, 209
222
Index
203
intraday repo transaction 8, 37-38, 99, 135
in-transit collateral 72
Italian Credit Transfer (ICT) 158, 165
J
Japanese Bankers Association (JBA) 173
Japanese Government Bond (JGB) 169
Japan Standard Time (JST) 170, 201
knock-on effect 58
L
large-value payments 3, 5, 7-9, 11, 14-16, 28, 31,
46, 54, 68, 73, 79, 82, 93, 96-97, 103-104, 120,
130-131, 133, 142, 146-147, 150-151, 163,
167-169, 172-173, 177-183
Large-Value Payment System (LVPS) 3, 14
Large Value Transfer System (LVTS) 35, 46, 54,
56, 63, 180
legal framework 91
legal risk 17, 19, 57, 91
Lender of Last Resort (LLR) 35
level of liquidity 30-32, 36, 93
limit payment mode 47, 64
liquidity 5, 7-9, 15, 17-19, 28, 30-33, 35-41, 43-51,
53-54, 57-58, 60, 62-63, 65-66, 73, 83-85, 89,
93, 98-100, 109-110, 114, 123, 135, 138-143,
146, 148, 150-151, 171-172, 174, 176-177,
180-182, 185, 187, 196, 201, 203-209, 212
liquidity costs 32, 39, 60, 62, 89, 93, 180-181
liquidity management 28, 36, 54, 85, 99, 138, 141,
150, 208-209
liquidity providers 9, 35-36, 182, 187, 205, 207-
208, 212
liquidity risk 17, 19, 28, 32, 36, 57, 204
Liquidity-Saving Features (LSF) 48, 64, 173-182,
189
liquidity-saving mode 46-49, 63-64, 85, 138, 140-
141, 146, 168, 173, 180
liquidity shortage 18, 36, 114
Loss-Share Rule 182, 187
loss-sharing agreement 34
loss-sharing rule 33-34, 81, 108, 116, 208
M
market liquidity 36-37
Index
MAS Electronic Payment System (MEPS) 48, 53-
54, 56, 59, 64
Message Type (MT) 147, 165, 199, 212
Monetary Authority of Singapore (MAS) 53
monetary value 1
money market 5, 19, 37, 70, 96, 133, 142, 168-170,
172, 177
monobank system 3
multi-currency payment systems 56-57, 65
multilateral net balances 112, 114
multilateral net debit cap 34, 40, 182
multilateral netting 13, 23-24, 44, 49, 62, 82-84
multilateral offsetting 48, 50, 53, 175-176, 180, 189
multilateral partial netting 49
Multilateral Release 44, 63, 112-114
N Paper payment 4
National Automated Clearing House Association
(NACHA) 118-119, 121-122, 125, 128-129
National Central Securities Depository (NCSD) 70
National Check Exchange (NCE) 129
National Settlement Service (NSS) 101-102, 124
natural monopoly 1, 8, 75, 84
net basis 11-12, 27, 57, 83, 109, 146, 149, 171, 176,
199, 201
net credit position 7, 13, 33, 107
net debit cap 33-34, 40, 80, 99, 108-109, 116, 182
net debit position 7, 12-13, 22, 32, 53, 58, 80-81,
107-109
net-net type DVP 27
net payment system 7
net position 7, 12-13, 22, 24-25, 31-33, 43, 49, 57-
58, 62, 107, 148, 151, 171, 182, 184-185
net positive position 32
net receiver limit 33, 182
net settlement position 13, 15
Net Settlement Systems 79-81, 110, 145, 147, 169,
171
netting by novation 24
network externalities 1, 8
New York Automated Clearing House (NYACH)
119
New York Clearing House (NYCH) 103, 119
next-day payment system 14-15
Next Generation RTGS (RTGS-XG) 48, 169, 172-
175, 177, 179-183
Non Deliverable Forward (NDF) 210
O principal risk 17, 20-21, 26, 191, 208
obligation netting 24-25
offsetting 23, 40, 42, 47-51, 53, 64, 85-87, 140-141,
175-176, 179-182, 189
offshore payment systems 56-57, 65-67
operational reliability 82, 89-92
operational risk 17, 20, 57, 91, 210
operational security 89
opportunity cost 38, 93
Overdraft (O/D) 37-38, 172, 177, 200, 203
Over-the-counter (OTC) 210
P
Pan-European Automated Clearing House (PEACH)
157-159, 165
Pankkien On-line Pikasiirrot ja Sekit (POPS) 145-
146, 167
Paris Integrated System (PIS) 46-48, 56, 63-64, 85-
86, 130, 146, 180
Paris Net Settlement (PNS) 44, 46, 54, 62-63, 81,
85, 130, 145-146, 180
partial netting 42, 49, 87
participation rules 89-90, 178
payment instruction 6, 13, 22-23, 44, 46, 57, 63,
199-200, 204-205, 208
payment message 6, 105, 110-111, 117, 125-126,
135, 147, 149, 154, 165, 186, 188
payment netting 24
payment obligation 31
payment order 3, 6, 12-14, 18, 25, 31-32, 36, 38-40,
44, 49, 52, 62, 84, 97, 101, 110-112, 114, 116-
117, 127, 138-139, 174-176
payment process 7, 15, 72
Payments Module (PM) 136-137, 142
payments received 12, 33, 106, 117
payments sent 13, 33-34, 178, 183
Payment System Risk (PSR) 99-100
payment systems 1-22, 25, 28, 30-37, 39-46, 48-54,
56-59, 62-68, 71, 73-93, 96-97, 99-100, 103-
104, 106, 109, 114, 118, 120, 127, 129-132,
134, 136, 138-139, 142-143, 145-147, 150-153,
156-158, 162-163, 167-169, 172-173, 175, 177-
184, 189-191, 193, 195, 211
Payment versus Payment (PVP) 9, 17-18, 26, 36,
66-67, 190-192, 200-201, 205, 210-211
Potential Net Balance (PNB) 164
preferred flag 111
pre-funding scheme 53
pre-settlement risk 18
private payment system 4-5, 8, 12, 31, 65, 96, 104,
223

130, 182
private sectors 11, 89
Proprietary Home Accounting (PHA) 142
pro-rata basis 35, 108
protected DTNS system 33-34
provisional settlement 71
Q 145-146
quasi payment system 6
queue 14, 32, 40, 42, 47, 49-53, 87, 105, 111, 114-
115, 139-141, 143, 147-148, 164, 174-175,
200, 202, 205
queue management 40, 42, 49, 51-52, 87, 139, 175
R 36, 44-45, 54, 57-58, 64-66, 71, 75-76, 79, 86-
Real-Time Gross Settlement (RTGS) 7-8, 15-16,
25, 28, 30-33, 36-38, 40-43, 45-48, 50-51, 53-
54, 56-68, 73-74, 76, 79, 82-87, 90, 96-98, 102,
111, 114, 130-132, 135-140, 142-143, 146, 149,
163, 168-173, 177-182, 189, 193, 197, 201-203
real-time settlement system 13, 31, 36, 132
Receiving Depository Financial Institution (RDFI)
120, 123-124
Recommendations for Securities Settlement Systems
(RSSS) 92
replacement cost risk 17, 19-21, 191
Reports on the Observance of Standards and Codes
(ROSC) 83
repo transaction 8, 37-38, 99, 135
repurchase agreement 38, 99
Reserve Bank Information and Transfer System
(RITS) 59
Reserve Management (RM) 137
Retail payment systems 3, 5, 7-8, 14-15, 31, 41,
73-74, 96-97, 118, 130-131, 139, 142-143, 151-
153, 156-158, 162-163, 169, 178-179, 183-184
risk management 6, 9, 25, 28, 33-35, 53-54, 58, 77,
79, 89-91, 107-108, 116, 147, 150, 164, 178,
182, 185-186, 190, 199, 204-205
risk mitigation arrangement 53
rist management schemes 53, 89-90, 178, 182, 190
RTGS mode 42-43, 45-46, 48, 53, 60, 63-65, 74,
85, 138-140, 146, 168, 171, 177-180, 182
S T
same-day payment system 14-15, 31
second-tier participant 6
securities settlement 3-4, 10, 18, 20, 26-27, 36, 41,
56-57, 70-71, 79, 87, 92-93, 102, 139, 142-143,
224
Index
160, 169
Securities Settlement System (SSS) 56-57, 70-71,
74
self-collateralization 72
Sender Net Debit Cap 108-109, 116
SEPA Direct Debit (SDD) 153, 155-158, 165
Servicio Espanõl de Pagos Interbancarios (SEPI)
Settled Payment File (SPF) 166
settlement asset 7, 11-12, 15, 82
Settlement Finality 7, 28, 89, 101, 108, 138
Settlement Finality Directive (SFD) 138
settlement process 7, 12-13, 15, 18, 20-21, 26, 101,
145-146, 148-149, 198-201, 207
settlement risk 2, 5, 15, 17-21, 23, 25-26, 28, 30-34,
88, 100-101, 116, 160, 172, 181, 186, 190-193,
195, 200, 206, 208-212
settlement system 7, 9, 12-15, 23-25, 31, 36, 41, 43,
56-57, 67, 70-71, 80-81, 88, 93, 102, 107, 118,
132, 145-147, 169-171, 185-186, 189, 210
Short Position Limit (SPL) 204-205, 207
simple settlement 17-18, 23
Single Euro Payments Area (SEPA) 73, 130, 152-
159, 162, 165-167
Single Obligation Structure (SOS) 149
Single Shared Platform (SSP) 48, 64, 136, 142
small-value payments 11, 14, 179, 183
Small Value Payments Company LLC (SVPCo)
119, 129
S-shaped diffusion curve 61
Standard Entry Class (SEC) 92, 94, 125
Static Data (SD) 136
Straight Through Processing (STP) 117, 210
survivors pay 34-35
Swiss banks 68
Swiss Euro Clearing Bank (SECB) 68, 161
Swiss Interbank Clearing (SIC) 58, 68, 202
synchronous settlement 26
systemically important payment systems (SIPSs)
15, 81-82, 89
systemic risk 17, 19, 28, 32, 36, 43, 45, 57-58, 92,
148, 164, 171-172, 191
system-wide liquidity 39
TARGET2-Securities (T2S) 163
Targeted Transaction 195
TCH Payments Co. 96, 103, 114, 118-119, 124-125,
129
Index

Technical Committee (TC) 117 Transmission Control Protocol / Internet Protocol

telecommunication networks 89 (TCP/IP) 188
telecommunications 10, 89, 92, 168, 183 two-week average cap 99
the bank for banks 5
The Clearing House (TCH) 96, 103-106, 114, 117- U
119, 124-125, 129
third parties pay 34-35 urgent flag 111
throughput guideline 39 US dollar (USD) 3, 22, 66-71, 97, 100, 104-106,
tiered membership 6 125-126, 190-191, 197, 199-200, 202, 204-206,
tiered structure 6 208, 211
timing-based fee structure 40 User-to-Application (U2A) 143
Tokyo Bankers Association (TBA) 182
Tokyo Dollar Clearing (TDC) 68-70 V
Trade Information Warehouse (TIW) 210-211 voluntary collateral regime 99
trade-off curve 45
Trans-European Automated Real-time Gross settle- Z
ment Express Transfer system (TARGET) 12,
14, 48, 50-52, 56, 58-59, 64, 68, 71, 85-86, Zengin System 12, 14-15, 73, 81, 168-169, 171-
130-146, 148-152, 160, 163, 166-168, 170, 174, 177-179, 181-189
172, 180-181, 202 zero-hour rules 20, 28, 91
Transferts Banque de France (TBF) 46, 63, 85, 146,
180

225