RTGS: Latest Trends and Developments
Inter-bank settlement is to the national financial infrastructure of a country what the digestive system is to man – if it does not function effectively you have a very uncomfortable situation. Inter-bank settlement needs to ensure that all obligations between banks, arising from payments and funds transfers within the economy, are concluded irrevocably. This is not a new phenomenon and has been a traditional role played by central banks for ages.
What is new is that the volumes of transactions and, more importantly, the value of transactions has increased so dramatically in the electronic enabled global economy that the inter-bank exposures of banks have become a threat to the stability of the financial system domestically and, due to the rapid growth in cross-border payment flows, also a threat to the global financial system as a whole. In the eighties, it was realised by the community of central banks that inter-bank settlement risks should be addressed in so-called systemically important payment systems within countries, but also between countries.
The solution was provided by the same technology that had enabled the increase in the speed at which money could be moved -real-time processing. The systems of the past collected payments during the day and at the end of the day, exchanged these payments between the banks, calculated the net flow of funds between the banks and passed entries across the accounts of the banks at the central bank. In the real-time paradigm, payments can be processed immediately between banks across their accounts at the central bank through what has become known as a real-time gross settlement (RTGS) system.
An RTGS system processes payments individually and determines the availability of funds in the paying bank’s account prior to settlement of each transaction. There is, therefore, no build up of exposures within the system and the risk of a bank defaulting on its payment obligations is negated.
The spread of RTGS systems has been rapid and widespread. Major economies and emerging countries are deploying this real-time settlement approach to address the risk of participant failure in the national payment system. Questions often asked are: How big must an economy be to justify an RTGS system? Is an RTGS not too sophisticated for a small economy? The most illustrative way to answer is in the form of a question: How big or sophisticated must an animal be to justify an effective digestive system?
In the simplest terms, an economy that does not have a robust RTGS solution at the core of its financial system depends on the central bank to ensure final end-of-day settlement between banks. Without the mitigation of settlement risk through continuous settlements during the day in real-time, facilitated by the RTGS, the net result of a day’s payment flows between the banks carry through to the end of the day. Only then can the extent of the days payment flows be determined as a result of no intraday flows being visible. The central bank can then be confronted with the situation that a settlement participant is not able to meet its obligations to one or more of the other banks. As the central bank has to ensure the finalisation of the inter-bank settlement it now faces a dilemma – it either has to extend a lifeline to the problem bank to meet its end-of-day obligations or it has to remove the bank’s payments from the day’s transactions, thereby running the risk of causing a run on the problem bank and upsetting the public trust in the national payment system and banking sector.
An effective RTGS solution reduces the value remaining at the end of day to manageable numbers. In countries where RTGS systems have been implemented with the necessary attention to inter-bank business processes and sound central bank system policies between 80% and 95% of the total value of inter-bank payments flows are effected through the RTGS system in real-time with irrevocable finality, during the day.
The business impact of the RTGS system depends not on the software so much as it depends on the process followed in implementing the solution. It is not about implementing a computer system it is about changing the nature of inter-bank payments. It is a major business transformation exercise involving many stakeholders, disciplines and functional areas of central banks, commercial banks and others. It is a complex endeavour because it requires the collaboration of many contributors as well as integration to many systems and components of the financial infrastructure. Once again using the digestive system as a metaphor, it is hard to imagine that a digestive system can be replaced without taking great care of the implications for the potential contamination of the entire body. The same care must be taken to manage the impact of the introduction of a new RTGS system on the central bank in particular and the banking and national payment system in general. Only by doing this properly can the benefits of RTGS be realised fully for the banks, the financial markets and ultimately for government, business and the man in the street.
In recent times there have been two interesting shifts in the RTGS domain. First, there has been a clear move towards off-the-shelf rather than internally developed RTGS applications. Where it was very popular in the nineties for each central bank to develop its own RTGS system according to their unique domestic needs there has clearly been a move towards an off-the-shelf solution. This approach, initially adopted by the emerging markets when introducing RTGS systems for the first time, has now also been adopted by two of the world’s most advanced and electronically enabled economies, Sweden and Norway. Inevitably, this trend will result in a de facto standard for RTGS systems in terms of functionality, integration capability and technical architectures applied.
Second, the idea of outsourcing the RTGS system to some extent has come to the fore. Possibly influenced by the introduction of a pan European RTGS system (Target 2) where central banks across Europe will no longer operate a domestic RTGS system inhouse, some countries are considering outsourcing this most sacred of central bank systems. Although there are instances where central banks have successfully outsourced their RTGS technical environment to domestic service providers it is not impossible that in years to come we will see countries utilising regional and global market infrastructures providing this essential service to central banks.
In order to meet the de facto standard, off-the-shelf RTGS solutions should be able to cover the demanding needs of mature economies but at the same time, the solution should also be applicable to the most basic RTGS needs of a developing country. This implies that the product should be configurable to meet the requirement for real-time settlement, on par and in full compliance of international best practice, but offering a growth path for future enrichment of functionality as the economy develops over time – the ‘think big and start smart’ principle.
This mission critical area of central banking has matured substantially over the past 10 years through the efforts of the CPSS committee of the Bank for International Settlements (BIS) and the payment group of the World Bank. Global best practice has emerged but there is still a long way to go in imbedding these practices in domestic RTGS systems around the world. It is an exciting field offering many opportunities to innovators, financial infrastructure providers and regulators.