The Canadian Payments System - Safe, Efficient and Changing
Global competition and advances in technology have contributed significantly to ongoing evolution of Canada’s well-managed payment system. Advances in transaction processing and network services, for example, have opened the door to a broader range of participants. While mutual trust has long been the hallmark of a system that relies on a relatively small number of highly regulated, financially sound clearing banks, a growing collection of smaller financial institutions and third-party service providers continue to investigate the viability of participating within the framework of the system.
In addition, improvements in networking and electronic imaging are driving Canada’s adoption of a new check (cheque) image-based clearing system that is scheduled to be put into practice beginning in 2008.
Canadians will continue to expect the same high level of service they have received for decades whatever the changes to the payments system. And it is entirely possible that in spite of, and perhaps even because of, these changes, one of the world’s most efficient payments clearing and settlement systems will become even more proficient in the future.
The Canadian clearing and settlement system, administered by the Canadian Payments Association (CPA), is based on a risk-sharing model that requires all members to absorb losses resulting from failure of a member to meet its settlement obligations.
This model works for two reasons. First, membership of the clearing system is limited to a dozen banks. Only federally and provincially regulated deposit-taking institutions are eligible for membership. Because each of these institutions shares the same regulatory requirements for capital, asset quality, accounting/auditing requirements and inspection practices, a climate of mutual trust prevails.
A strict oversight of liquidity requirements for member institutions also engenders trust between the 12 institutions. In certain situations where a CPA member finds itself short of funds, it can borrow the needed funds overnight from the Bank of Canada, the country’s central bank. In most circumstances, an Indirect Clearer has access to this type of liquidity through its direct clearing agent.
The CPA operates two systems for clearing and settlement of payments:
The Automated Clearing Settlement System (ACSS), introduced in 1984, handles clearing and settlement for most payment items – more than 17 million transactions are processed on an average business day. Within the ACSS, the 11 CPA members, referred Direct Clearers1 and the Bank of Canada process payment items for their own customers as well as for customer institutions that maintain accounts at other financial institutions, known as Indirect Clearers.
Direct Clearers must maintain settlement accounts at the Bank of Canada. Each business morning, the Bank of Canada adjusts the financial positions of Direct Clearers to reflect the net balances of the previous day’s ACSS clearing. In turn, Indirect Clearers settle with their respective Direct Clearers through special accounts they maintain with them.
The ACSS clears both paper-based and electronic transactions. As payment items are exchanged between Direct Clearers, the ACSS tracks value and volume and determines the net positions for each institution.
Most ACSS payment items are low-value credit and debit transfers or low-value electronic payment items. As such, while the ACSS is responsible for clearing 90% of the daily transaction volume, this amounts to just 12% of the total value cleared each business day. The remaining 88% of total value – about C$146bn – is cleared through the Large Value Transfer System (LVTS).
LVTS is a real-time gross settlement (RTGS) system that was introduced in 1999 to facilitate the transfer of irrevocable payments in Canadian dollars. The system enables almost instantaneous electronic transfer of funds between member institutions with payments that are final and irrevocable. The payment recipient may withdraw the money, invest it or use it to make another payment. The first model of its kind in the world, LVTS achieves the real-time payment finality of an RTGS system with collateral costs that are considerably less than those normally associated with a netting system.
Currently, 15 members of the CPA and the Bank of Canada participate directly in LVTS2. All other CPA members can arrange LVTS payments through these participants. A third payment system in Canada, the US Dollar Bulk Exchange (USBE), settles payment items in US dollars, drawn on and payable to accounts at financial institutions in Canada, on a next-day basis. Like the ACSS, the USBE tracks the exchange of US dollar payments between participants as well as the resulting balances due.
Today, the Canadian payments system is no longer awash in paper transactions. Five years ago, paper checks made up about 80% of the total transaction volume. While they remain a popular payment method, today nearly half of all the transactions flowing through the payments system are electronic. In addition, the CPA is spearheading an initiative to adopt a new clearing process based on electronic check images called Truncation and Electronic Cheque Presentment (TECP).
Like Check-21 in the United States, this shift to image-based processing promises to improve efficiency and safety, and deliver more convenience and a range of new services to consumers.
Full national implementation of the check imaging initiative is expected to be complete in 2008. However, some Canadian financial institutions, most notably credit unions in the western provinces, have already begun using the image-based check clearing process, and it is expected that the delivery of image-based services to customers will continue to expand.
The TECP initiative is just one of the many technological changes happening to the Canadian payments system. The development of electronic payments instruments such as debit cards and prepayment cards, as well as advances in processing and management of payment information, are all changing the way the payments systems function and are managed.
So too is the increase in the number and variety of financial service providers in Canada. By providing financial instruments and associated services that were once available only through member banks, these new entrants to the payments system marketplace are increasing competition and choice for customers.
In order for a fully competitive and level playing field to be realized, these new participants argue that they require greater direct involvement in the payments system. However, the possibility of non-deposit- taking institutions gaining access to some of the networks used for the clearing and settlement of payments is raising some difficult questions. Many of these questions are aimed toward the regulatory requirements and oversight that have helped to create one of the safest, most efficient payments systems in the world.
Technological, physical and liquidity-based changes to the Canadian payments system landscape will be part of an ongoing dialogue among financial institutions, the payments system providers and consumers in the years ahead. And while it is impossible to stem the tide of change, it is certain that in Canada, the need to adapt to change will at all times be challenged by the desire for stability.
1 ACSS Direct Clearers are: Alberta Treasury Branches, Bank of Montreal, Bank of Nova Scotia, Caisse centrale Desjardins du Quebec, Canadian Imperial Bank of Commerce, Credit Union Central of Canada, HSBC Bank of Canada, Laurentian Bank of Canada, National Bank of Canada, Royal Bank of Canada, Toronto-Dominion Bank.
2 Direct participants in the LVTS are: Alberta Treasury Branches, Bank of America National Association, Bank of Canada, Bank of Montreal, Bank of Nova Scotia, BNP Paribas (Canada), Caisse centrale Desjardins du Quebec, Canadian Imperial Bank of Commerce, Credit Union Central of Canada, HSBC Bank Canada, Laurentian Bank of Canada, National Bank of Canada, Royal Bank of Canada, State Street Bank and Trust Company, Toronto-Dominion Bank.