Brazil - Building a World Class Payments Infrastructure
In the 1980s and 1990s from a financial viewpoint Brazil conjured up an image of hyperinflation and economic instability. Today Brazil’s economy is growing healthily and although current inflation is higher than in Europe it is at a manageable level, with 5.3 per cent being predicted for 2005. One of the cornerstones underpinning this much brighter economic outlook was monetary reform and a new payments system, SPB – Sistema de Pagamentos Brasileiro (Brazilian Payment System), now one of the most advanced in the world. So how did this come about?
Prior to the mid 1990s developments in the Brazilian payments system were motivated by the need to cope with hyperinflationary pressures and in particular speeding up the payments process. Since 1997 the Brazilian Government, with the BCB – Banco Central do Brasil (the Brazilian Central Bank) and the CMN – Conselho Monetário Nacional (The National Monetary Council), has focused on reducing risk and improving efficiency in the payments process. A detailed review of the existing financial framework was undertaken, taking into account the recommendations of international organizations including, BIS/CPSS (Bank for International Settlements/Committee on Payments and Settlement Systems) and IOSCO (International Organization of Securities Commissions). Clear objectives were set for a framework to reduce settlement, credit and systemic risk, and to create a fully integrated settlement and payments infrastructure for all systemically important clearing and settlement systems. Such systems are now required to act as central counterparties, to assure settlement and provide adequate risk protection mechanisms. Specific issues were identified which required changes to the regulatory framework. For example, Brazilian Law 10,214, enacted in March 2001, recognizes multilateral netting for clearing and settlement and ensures that events such as insolvency, bankruptcy, and liquidation do not affect participants’ obligations to settle. The power to decide which settlement systems are systemically important was given to the BCB.
At the heart of the SPB is a new real-time gross settlement system (RTGS) for interbank funds transfer, STR – Sistema de Transferência de Reservas (Reserves Transfer System) operated by the BCB. The banks, and other participants, do not maintain accounts with each other, rather they settle via accounts with the BCB using STR. STR uses credit orders and requires that all transfers are irrevocably and unconditionally settled in real time, which is an important step in reducing settlement risk. STR also requires the banks to maintain positive reserve balances at the BCB at all times, significantly reducing credit risk. The BCB provides liquidity via intraday credit lines, using repos, and can intervene during the day to optimize the settlement process. In parallel with the introduction of STR the system for settling federal government securities, SELIC – Sistema Especial de Liquidação e de Custódia (The Special System for Settlement and Custody), which is also operated by the BCB, was modified from a deferred, multi-lateral settlement system to real-time DVP Model 1 (Delivery Versus Payment with simultaneous settlement of securities and funds on a gross basis), with payments settled through the STR. As mentioned above systemically important clearing and settlement systems are required to use STR to settle payments in reserve accounts at the BCB. These include:
So how did Brazil go about realizing the new payments infrastructure and how long did it take? The project commenced in 1999 and went live in April 2002, taking just one year and nine months. Key to the approach and success was Brazil’s indigenous information technology skills, government leadership and a track record with government sponsored IT projects.
They recognized the need for security and resilience. A private, secure communications network incorporating encryption and digital certification, RSFN – Rede do Sistema Financero Nacional (the National Financial System Network) was built and is operated by the BCB for all financial communications between the SPB participants and the BCB.
When it came to deciding whether to buy or build the STR Brazil opted for the build route. They felt that integration with existing market systems was a significant issue, a package solution would be too restrictive and they would be too dependent on the package vendor. Previous experience gained from dealing with hyperinflation had given them the business and the technical skills required. While there were over 180 participating organizations in the STR’s creation the core project team at the BCB involved only 30 analysts. BCB, the banks associations and clearing and settlements providers worked jointly to define the comprehensive XML based message catalogue (there are over 300 messages at present) for the complete payments and clearance process. The total development cost for STR was R$40m ($10m). Individual participants were responsible for developing their own interfaces to the STR.
A key factor was the determination of all parties to make the system a success, something that is inherent in Brazilian culture. Febraban, the Brazilian Banking Federation, played a key role in liaising between all the participants needing to interface to the system and the BCB. From an early stage of the project it was apparent that a big bang approach to going live was the only option. It was Febraban that negotiated the go live date of 22nd April 2002. Initially the system was to handle transactions above R$5m. According to a senior executive of Febraban the reason was simple, “if it doesn’t work we can do it manually and no one will notice”. It did work and according to Febraban by the 29th April STR was processing every transaction over R$5,000 (approx USD2,1001).
For resilience and continuity, everything in the payment system is duplicated with automatic switchover. There are duplicate communications networks with duplicate connectivity at different sites for every participant on the network. All application processing systems on the participant side are also duplicated. The security of the system is monitored and tested by the BCB.
The technology used is based on IBM, the DB2 database with Java and Natural as the programming languages and MQ Series and XML for connectivity and messaging. From the participant’s perspective a range of technologies are utilized, as it was necessary to interface the many legacy systems that existed within these institutions.
STR is currently processing around 160,000 transactions per day but is sized to be able to process more than 10 times that and is capable of processing 2 million transactions per day.
Both consumers and businesses are benefiting. The World Bank report “Payments and Securities and Clearance Systems in Brazil – September 2004” indicates that there have been positive impacts following the introduction of the new payments framework. Between 1998 and 2003 the number of bank accounts in Brazil has risen over 50 per cent from 52.5 million to 87 million. The historic reliance on checks as the main payment mechanism by consumers and corporations has decreased and has moved in favor of electronic transfers, for both large and small transactions. Over the period payments made by check has decreased from 68.3 per cent to 40.7 per cent with the bulk of these being for the purchases of goods and services with most financial market transfers now being paid electronically. Today individuals and companies alike can make payments between banks in real time using TEDs (Transferência eletrônica disponível), which are settled using STR through CIP and use of TEDs has soared. Consumers can pay bills electronically from ATM machines, which scan the bar coded bills, using a variety of payment mechanisms including cash, checks and debit cards. It is easy to move funds from different types of accounts including current, savings, time deposit and mutual funds and there has also been a significant growth in Internet banking.
In Brazil inflation is now down towards European levels. Manufacturing was up 6.2 per cent in 2004 along with GDP growth of 4.9 per cent. Unemployment is heading down and is currently 9.6 per cent and will for sometime ensure that wage inflation will be kept in check and not damage its international competitiveness. A significant contributing factor to this is Brazil’s new payments infrastructure. With the risk controls that are in place through this system, the chance of a domino effect – caused by a bank default – are effectively reduced to zero, with risk being taken by central counter-parties backed by layers of reserves and collateral. The new payment system is also enhancing Brazil’s reputation internationally, having a positive impact on its credit rating, which in turnwill cascade down to all parts of the economy benefiting both Brazilian companies and consumers. Brazil is becoming a good place to do business.
Moving to full real time settlement across all markets is one of the best ways of reducing risk. Yet the US and UK have shied away from T+0 often citing the lack of benefit versus the cost of doing so, but if international convention moved to T+0 settlement, Brazil would be there with virtually no additional investment. However, as the economies of countries such as Brazil develop and become stronger the benefits of their modern infrastructures will help them develop into true international finance centers.
SPB is also a showcase for the capabilities of Brazilian IT sector as it seeks to develop overseas markets. It illustrates the depth and breadth of its capability to understand complex business requirements and develop world-class solutions to tight timescales, using both new and legacy technologies. These are skills that can readily be exported. It is not beyond the bounds of possibility that Brazil could provide other economies with off the shelf financial infrastructures. Watch out the Brazilians are about to arrive and it won’t be just World Cup goals they’ll be scoring!
1 According to the BRL/USD exchange rate dated July 22, 2005.