Mr. Matsushita discusses payment and settlement systems with regard to
current issues in Japan Speech by the Governor of the Bank of Japan, Mr. Yasuo Matsushita,
held at the Japan Center for Economic Research on 28/2/97.
I. Introduction
I am greatly honored to have been invited by the Japan Center for Economic
Research to address this distinguished audience. I wish to take this opportunity to first briefly
discuss the recent monetary and economic conditions, and then address the current issues
regarding the payment and settlement systems in Japan.
There have not been many opportunities to discuss payment and settlement on
occasions such as this, despite the fact that they are important to all the economic activities of
households and firms, and that as a central bank, we are very much involved in the
developments in this area. I have not addressed this area partly due to its technical nature, but
recently several developments have attracted much attention to the payment and settlement
issues in Japan, as in other countries: specifically, pilot projects of electronic money products
and the Bank's plans to abolish the designated-time settlement mode to make real-time gross
settlement the only way of settlement on the Bank of Japan Financial Network System
(BOJ-NET).
The role of the central bank in ensuring a smooth and stable operation of payment
and settlement systems has become clearly recognized through the deliberations on the revision
of the Bank of Japan Law that have been taking place since last year. The "Report on the
Revision of the Bank of Japan Law," released recently by the Financial System Research
Council, an advisory committee to the Minister of Finance, states one of the objectives of the
Bank of Japan to be "to ensure smooth fund settlement among financial institutions, thereby
contributing to the maintenance of an orderly financial system."
I wish therefore to discuss today the current issues regarding the payment and
settlement systems in Japan and also refer to the role of the central bank in those systems,
bearing in mind the domestic and overseas trend in these areas.
II. Domestic Monetary and Economic Conditions
I would like to start by reviewing the recent economic condition and the thinking
behind the Bank's current monetary policy management.
With regard to the domestic economic condition, the Bank of Japan judges that a
moderate economic recovery continues and that the recovery is gradually becoming firmer.
A notable change in the economic condition since the latter half of 1996 is that
the decline in external demand, which had been a factor constraining the economic recovery,
halted in autumn 1996 following the depreciation of the yen. Recently there has been an upward
trend in external demand. In addition, inventory adjustment in some raw materials and
semiconductor industries had almost reached completion by the end of 1996. As a result,
production has started to grow at an accelerating pace, reflecting fully the increase in final
demand. Personal consumption continues to grow moderately but steadily, supported by the
buoyant sales of passenger cars, and the recovery in business fixed investment is spreading to a
wider range of industries and to smaller firms than previously observed, reflecting
improvements in corporate sales and profits.
It should be borne in mind that increase in demand ahead of the rise in the
consumption tax rate scheduled for fiscal 1997 is contributing to the recent improvement in
economic indicators, as in housing investment, and these improvements need to be seen in this
light. However, despite a gradual decrease in public-sector investment from the latter half of
1996, the virtuous circle - in which increased production leads to a recovery in business fixed
investment and personal consumption through improved corporate profits and employment
income - is gradually becoming more apparent. This improvement is encouraging.
In contrast to these recent improvements in economic indicators, the beginning of
the year saw a significant fall in stock prices and this, together with the decline in long-term
interest rates in the financial markets, indicates that the confidence of the market participants in
the economic outlook is still slow to improve.
Various causes can be considered for the market's uncertainty as to future
developments in the economy. While the renewed concern over the nonperforming-loan
problem of financial institutions may be one important factor, the strong awareness of the effects
of the anticipated fiscal tightening in the next fiscal year is also significant.
From spring to summer this year, a temporary slowdown in economic recovery
seems inevitable due to a reaction to the boost in demand that is occurring ahead of the rise in
the consumption tax rate. However, given the strengthening of the virtuous circle, it is more
likely than before that the recovery trend of the economy will be sustained. In addition, stock
prices appear to have stabilized. Therefore, in considering whether the economy can overcome
the effects of fiscal tightening to sustain the trend of recovery, it is important to examine
macroand micro-economic data, including the economic indicators that will be released in the future,
signals from financial markets, and firms' business plans for the next fiscal year.
I will now turn to the environment surrounding domestic prices. The depreciation
of the yen has continued since the beginning of the year, and a rise in the consumption tax rate is
planned for April. The raising of the tax rate will be passed on to product prices, pushing up the
price index accordingly. However, as long as the price hike does not surpass the increase caused
by the raising of the consumption tax rate, the price rise will only reflect a single price
adjustment, and will not indicate any fundamental change in the situation underlying prices.
Therefore it would not be appropriate to formulate monetary policy to counter such superficial
changes in price indexes.
From the viewpoint of monetary policy management, that is, the viewpoint of
ensuring stable economic development through price stability, the issue of concern is whether
the rise in the tax rate will trigger price hikes that take advantage of the increase or will lead to
inflationary expectations, which in turn might bring about price rises beyond the immediate
effects of the tax rate increase. Whether such a general price increase will occur depends on
various factors, including the prevailing domestic supply and demand conditions and consumer
confidence. It is thus necessary to pay attention to the inflationary expectations and the possible
negative developments, including overreaction by consumers, resulting from the rise in the
consumption tax rate, rather than focusing attention on the superficial hikes in prices.
Although the decline in prices began to slow from the end of 1996, there is only a
limited possibility that domestic prices will take a clear upward path given that improvement in
the supply and demand conditions in the domestic economy is expected to remain moderate for
now. However, in view of the accelerating rise in import prices reflecting the yen's depreciation
and higher crude oil prices since the latter half of 1996, together with the strengthening of the
recovery in private demand, it remains necessary to pay careful attention to the developments in
domestic prices.
In the management of current monetary policy, the Bank of Japan will continue to
monitor economic developments closely, placing emphasis on further strengthening the
foundation of an economic recovery.
III. Current Issues Regarding the Payment and Settlement Systems in Japan
A. Payment and Settlement Systems in Japan
I would now like to move on to the main theme of today's speech: payment and
settlement systems. The expression "payment and settlement systems" may sound somewhat
technical and may indeed be unfamiliar to you. In a market economy, however, every economic
activity conducted by firms and households - be it production or consumption - is concluded
with settlement. Payment and settlement systems, or mechanisms for clearing and settling
payments, are therefore used directly or indirectly by every economic entity. People may not be
conscious of the functions of the systems when they operate smoothly and efficiently. However,
once a problem arises, great difficulties are encountered.
The means of payment used by firms and households vary from cash - that is,
banknotes and coins - to checks and bills, funds transfers between bank accounts, and credit
cards. When payment is made by cash, settlement is final there and then. However, when
payment is made by other means such as checks or bills, the mere handing over of the checks
and bills will not complete the settlement of the transaction. When a check is drawn, for
example, settlement is final only when the check is collected and the stated amount of money is
transferred from the deposit money in the bank account of the payer to the bank account of the
payee. If such transfers are not effected between accounts for some reason, for example, there
are insufficient funds in the payer's account, the transaction will remain unsettled. When the
payer and the payee hold accounts at different banks, interbank settlement is needed, and
settlement will be completed only after the corresponding debit and credit entries are made to
the current accounts held by each bank with the Bank of Japan.
Although various means of payment are available to firms and households,
settlement is ultimately made either by a handing over of cash issued by the Bank of Japan or by
a transfer of funds between bank accounts using deposit money, which are liabilities of private
financial institutions. "Money" in a modern society therefore comprises cash and deposit
money, and is reliant on the confidence of the public that bank deposits can be converted into
cash at any time.
When a large number of relatively small-value payments, such as those using
checks and bills, need to be settled between banks, they are not settled one at a time between the
accounts held by the banks at the Bank of Japan. Rather, payment instruments such as checks
and bills are collected and exchanged at clearing houses, where the credit and debit positions of
each bank are calculated, and then the net positions are settled between the BOJ accounts. This
calculation process is called clearing, and is operated by private institutions. Specifically, there
are three major private clearing systems in Japan: the bill and check-clearing system; the Zengin
Data Telecommunications System (Zengin System) for funds transfers between bank accounts
and for credit card payments; and the Foreign Exchange Yen Clearing System for yen payments
arising from foreign exchange and Euro-yen transactions.
BOJ accounts are used to settle the net positions resulting from various clearing
systems, as well as to directly settle large-value interbank funds transactions, such as call-money
transactions, which do not go through clearing processes. The value of funds transfers at the
Bank of Japan totals approximately ¥300 trillion per day, which is equivalent to approximately
60 percent of Japan's annual GDP.
B. The Role of the Central Bank in Payment and Settlement Systems
Bank of Japan thus plays an important role in both the settlement made by cash
and the settlement made by deposit money. The duty of central banks is to issue and control
money - that is, to ensure the public's confidence in the holding and the using of money.
To this end, two conditions must be satisfied: (1) the value of money must be
stable - that is, price stability must be maintained; and (2) the circulation of money and the
functioning of payment and settlement systems must be stable and efficient. If it were not
possible to use cash and deposits as desired for settlements, people would not be able to hold
money with confidence. The mission of central banks, therefore, is to make the currencies they
issue more convenient to use and to thereby enable firms and households to confidently engage
in daily transactions and funds settlements. Bank of Japan thus plays a vital role in the
settlement process in Japan as a whole.
Bank of Japan serves two specific functions in securing the stability and
efficiency of the country's payment and settlement systems: (1) providing the means of
settlement to the public; and (2) attending to the smooth execution of payments and settlements
in Japan.
As a provider of the means of settlement, the Bank issues Bank of Japan notes and
ensures their smooth circulation. As I mentioned earlier, cash payments immediately complete
the settlement of a transaction by delivering a means of payment directly to the counterparty.
This on-the-spot completion of settlement, whereby the payee is able to secure the monetary
value received, is described as "settlement with finality."
In order to maintain the finality of cash payments, it is essential to secure the
confidence of the people in the soundness of the central bank's assets, which underpins the value
of the banknotes. The Bank thus pays close attention to the soundness of its assets.
Furthermore, any circulation of counterfeit notes would undermine people's confidence in
holding money. To prevent such an occurrence, the Bank examines the authenticity of the large
volumes of banknotes that are returned to the Bank of Japan every day from financial
institutions. Careful attention is also paid to the cleanness of each of the banknotes in
circulation. The Bank also exerts itself to the utmost to improve anti-counterfeiting measures,
and has recently been engaged in joint research with overseas central banks on the prevention of
banknote counterfeiting using color copiers. Through such efforts, the Bank aims to preclude
the circulation of counterfeits.
The Bank also provides current accounts at the Bank as another means of
settlement. The Bank offers accounts to private financial institutions, and the funds in these
accounts, or deposit money, are equivalent to banknotes in their function as a means of
settlement with finality. In order to improve the safety and efficiency of settlements using these
BOJ accounts, the Bank has made various efforts, including the introduction of the BOJ-NET
the Bank of Japan Financial Network System, which is an on-line system for funds transfers
among the current accounts held by private financial institutions with the Bank of Japan. The
Bank intends to further improve the system in cooperation with those concerned by making
realtime gross settlement the only settlement mode, which I shall discuss in detail later.
The second function of the Bank of Japan with regard to the payment and
settlement systems is to attend to the safety and efficiency of payments and settlements in
Japan, and to provide adequate liquidity when necessary. As I mentioned earlier, the important
tasks of the Bank include ensuring a smooth supply of banknotes throughout the country, and
monitoring the stability of daily settlements across the BOJ accounts.
In addition, the Bank, in coordination with the operators of the private clearing
systems such as the bill and check clearing, plays an important role in preventing any troubles in
the systems or participants from jeopardizing the entire payment and settlement systems in
Japan. In any settlement system, there is the risk that a failure of one bank to meet its
obligations will trigger a chain reaction of defaults, eventually paralyzing the entire system. In
addition, both payment and settlement systems and individual banks constituting the systems are
supported by the market's confidence. As this confidence is in large part a psychological factor,
a failure of a single bank could lead to a run on deposits at other banks. Such risk is referred to
as systemic risk. Materialization of systemic risk will disrupt not only settlements between
banks but also those between firms and households, having a profound impact on the economy
and on the society as a whole. Such systemic risk inherent in the network of settlements is what
differentiates the banking sector from other industrial sectors.
The role of the central bank is to constantly monitor the institutional framework
and the operation of payment and settlement systems, working in coordination with the parties
concerned to thereby prevent the materialization of systemic risk. The central bank must also
ensure that the system can be provided the funds to break the chain reaction of defaults should
some emergency occur. Another important task of the central bank is to attend to the soundness
of the private financial institutions, which are the participants in the payment and settlement
systems and which settle the payments between firms and households. To summarize these
roles, an important mission of the central bank is to maintain the safety and efficiency of the
entire settlement process, a process which involves (1) private financial institutions which accept
the deposits of firms and households; (2) private clearing organizations processing interbank
payments; and (3) the central bank which discharges interbank settlement obligations resulting
from private-sector clearing systems.
C. Measures to Improve the Safety of Payment and Settlement Systems
Payment and settlement systems have not necessarily been an issue of public
interest reflecting the general perception that these systems are mechanical processing units for
discharging obligations by inputting transaction data. The fact that there had been no financial
institution failures until recently and that payments have been settled safely may have supported
this perception. However, financial institutions have actually failed and the speed at which
systemic risk is transmitted within and beyond international borders has increased significantly
owing to technological innovations in finance and telecommunications, and financial
globalization. Under these circumstances, it is inappropriate to view payment and settlement
systems as merely mechanical processing units. These systems must be resilient against
systemic risk, and the establishing of such systems is an extremely important challenge for both
the private financial institutions and for the central bank. It becomes apparent that various
incidents and studies have raised the awareness of the need to improve the safety of payment and
settlement systems among private financial institutions and central banks both in Japan and
abroad.
In various countries, new safety standards have been applied to private clearing
systems. These standards include limits on each participant's net debit position and collateral
requirements to ensure the provision of adequate backup liquidity in the event of an inability to
settle by the participant having the largest single net-debit position. These standards were
devised by the central banks of the Group of Ten countries as minimum standards to be satisfied
by cross-border and multi-currency netting schemes, and are referred to as the Lamfalussy
standards, after the chairman of the committee on this study. As these standards can apply to
domestic clearing systems, they are being used recently in many countries as guidelines for
improving the integrity of private clearing systems.
In Japan, it has recently been decided to enhance the safety measures of the
Foreign Exchange Yen Clearing System so as to satisfy the Lamfalussy standards. The Bank
will continue to actively support the initiatives to improve the safety of the payment and
settlement systems.
D. Improving the Safety of the Central Bank's Settlement System
Real-Time Gross Settlement
The need to improve safety applies not only to private clearing systems but also to
the settlement systems operated by central banks. In this regard, an increasing number of central
banks have been adopting real-time gross settlement for current account settlements at the
central bank. Real-time gross settlement - called RTGS for short - is a system in which the
central bank processes and effects every payment instruction sent by private financial institutions
in real time and on an order-by-order basis.
Most central banks, including the Bank of Japan, have typically conducted
interbank settlements on a designated-time basis rather than by RTGS. In the conventional
designated-time settlement, payment instructions are accumulated until designated settlement
times instead of each one being settled immediately. At the designated time - at present, 9 a.m.,
1 p.m., 3 p.m., and 5 p.m. in Japan - the net settlement position of each financial institution is
computed and its account is credited or debited simultaneously.
In designated-time settlement, financial institutions need only the funds
equivalent to their net debit positions at the time of settlement, and thus, it is an efficient system
from the viewpoint of fund management. However, if a single financial institution in the system
were to fail to meet its obligations, all payments would inevitably be suspended, in order that all
the payment instructions sent or received by that financial institution could be revoked to
recompute the settlement obligations of each financial institution. In addition, such failure could
create a shortage of funds at the financial institutions which had planned to make payments with
the funds they had expected to receive from the failed financial institution. This may lead to a
series of liquidity shortages or defaults - that is, the materialization of systemic risk. The effects
of this risk could be grave, considering that the amount of funds handled by the central bank's
settlement system is substantial.
With RTGS, the smooth execution of settlements solely depends on the ability of
the parties concerned to meet their obligations, as every payment instruction is processed in real
time on an order-by-order basis. Therefore, even if a bank were to suddenly become unable to
settle, disruption to the system would be limited: suspension of the operation of the entire
settlement system, which can occur under designated-time settlement, can be avoided. The
introduction of RTGS in many countries around the world, including some Asian countries, is a
result of the efforts of central banks to improve their settlement systems to contain systemic risk.
Against this background, the Bank of Japan also decided at the end of 1996 to
make RTGS the only mode of settlement via BOJ accounts. Specifically, by the end of the year
2000, the Bank plans to abolish designated-time settlement and make all funds transfers on the
basis of RTGS. This may require market participants to establish new transaction and settlement
practices. To ensure the smooth operation of RTGS, the Bank intends to directly supply
intraday liquidity, which is indispensable for smooth settlements, to cover liquidity shortages
that might arise in the system despite the efforts of participant financial institutions.
Last December, the Bank announced its policy to realize RTGS as the only
settlement mode on the BOJ-NET with some specific proposals for design features and
requested comments from the public. The Bank was fortunate to receive many valuable
comments and recognized the increasing awareness of settlement risk among market
participants. The Bank believes that it has been able to gain strong support from the private
financial institutions for RTGS, and plans to publish in the near future its policies along with the
comments received. The Bank strongly hopes to receive constructive opinions and suggestions
in deciding the details of the design of the system. The Bank will also solicit views from a
broad range of market participants whenever making a major change in the operation of the
Bank's settlement system, as a change in the system could have a significant impact on the
market practices and the daily business of the financial institutions participating in the system.
It should be noted that realization of RTGS does not necessarily mean the
elimination of all the risks in payment and settlement systems. Moreover, RTGS on the
BOJNET will produce the desired effects only when the safety of the private clearing systems
connected to the Bank's system is ensured. To illustrate this point, suppose that the private
financial institutions, for some reason, switched from direct settlements via BOJ accounts to
indirect settlements using private clearing systems given the introduction of RTGS. The total
amount of risks in the payment and settlement systems as a whole would not decrease if there
were inadequate management of risks in the private systems. In this respect, it is indispensable
for the private financial institutions, the private clearing organizations, and the central bank to
work together to enhance the efficiency and safety of the payment and settlement systems in
Japan.
Such efforts of the private sector and the central bank to improve the
infrastructure for settlements will also contribute to the strengthening of the global
competitiveness of Japan's financial markets, which is indeed the aim of the Japanese "Big
Bang" deregulation package proposed by Prime Minister Hashimoto.
E. Improvement in Securities Settlement Systems
In addition to the safety of funds settlements, much attention has been paid
globally to the safety of settlements of securities such as government securities and stocks.
Although I do not have enough time today to discuss this issue in detail, the
established guidelines for risk management in securities settlements are the recommendations set
out in 1989 by the Group of Thirty, an international group of experts in finance.
In accordance with the recommendations, significant progress has been made
recently in Japan toward improving the settlement systems for securities. For the settlement of
Japanese government securities (JGS), for example, an on-line network and
delivery-versuspayment system have been established. Delivery versus payment, known as DVP, is a
mechanism which links the delivery of JGS with the corresponding funds transfer so that both
are executed simultaneously. In such a way, a failure to collect payments or receive securities
can be avoided. In addition, rolling settlement was introduced in October 1996. Here,
settlements are made on every business day for the contracts that were agreed on a specific
number of business days previous to that settlement date (currently seven days). This replaces
the prior arrangement where contracts made over a certain period were accumulated before they
were settled on one of the six designated settlement days of each month (the 5th, 10th, 15th,
20th, 25th, and the last day of the month). The system will be improved further in April 1997 to
complete settlement on the third business day after the date of contract.
Regarding settlement of corporate bonds, which may be familiar to many of you
here, delivery of bonds has conventionally been made by a document called registration
certificate and the corresponding payment has been settled separately through clearing of bills.
At the end of 1997, however, on-line delivery of corporate bonds will be brought into effect. A
delivery-versus-payment service is also envisioned for the future by connecting the settlement
system for corporate bonds with the BOJ-NET.
Various efforts are thus under way in Japan to enhance the safety of securities
settlements. However, much remains to be improved. A large volume of stocks and other
securities continues to be delivered physically, and DVP systems are yet to be established for
such securities. Furthermore, the lag between the contract and the settlement, that is, the final
transfers of securities and funds, needs to be shortened for various securities. In this respect, the
Bank intends to contribute actively and expects further efforts on the part of the private sector.
F. Developments in Electronic Money
I would now like to briefly discuss the developments in electronic money, which
might become a popular means of settlement in the future.
The term electronic money is used to refer to payment mechanisms in which
electronic records of funds are stored in devices such as IC cards - with microprocessor chip
(integrated circuits) embedded - or in computer networks and then transferred safely from one
customer to another. Many pilot projects are under way in various countries, making use of the
recent technological innovations in IC cards and computer networks as well as in such security
features as encryption. In Japan as well, financial institutions and firms have begun various
projects individually or jointly. For example, some banks are individually using IC-card based
electronic money on trial within certain buildings in Tokyo. A joint project by a credit card
company and several banks on card-based electronic money is also being planned for summer
1998 in a certain area of Tokyo. It is said to be of the largest one of its kind in the world,
involving approximately 1,000 stores and 100,000 cards.
When electronic money products become prevalent, they may be used as new
means of settlement replacing cash and deposits. People may settle various retail transactions by
transferring the electronic values between IC cards or on networks instead of banknotes and
coins. To prepare for this possibility, central banks are keenly interested in the soundness and
the implications of electronic money developments. From this viewpoint, the central banks of
the Group of Ten countries have been studying various aspects of electronic money: security
features to prevent fraud and counterfeiting, implications for the effectiveness of the central
bank's monetary policy, and the stability of payment and settlement systems.
At present, however, it is very difficult to project how electronic money
technology will develop, to what extent electronic money products will be used by the public as
a substitute for cash or deposit money, and at what pace these developments will proceed. The
pace of the developments will depend on how the reliability of electronic money products is
secured and how conveniently these products are utilized. Under these circumstances, it is not
easy to reach a verdict on the various relevant issues, nor would it be appropriate to jump to
conclusions. Developers and operators of electronic money schemes can be expected to exercise
ingenuity on such aspects as security and legal matters, and the innovative capabilities of the
private sector should not be discouraged. The basic stance that the Bank should maintain at
present is to be flexible to the various possibilities concerning the future course of development
in electronic money.
Regarding the implications of the development of electronic money on monetary
policy, monetary policy will, in theory, continue to be effective, provided that the situation does
not become one where electronic money extensively substitutes not only for cash as a means of
retail payment but also for deposit money for large-value transfers. Although the spread of
electronic money products might affect the stability of monetary indicators, this will be
adequately managed by identifying the amount outstanding of electronic money issued and by
devising monetary policy management. Therefore, I wish to state that the Bank of Japan does
not intend to put a brake on the development and introduction of electronic money in
consideration of its effects on monetary policy.
Maintaining this stance, the Bank intends to continue research on electronic
money while observing the developments in the private sector in Japan and abroad. It will
release the results of the research, as it has done in the past, wishing to support the efforts of the
private sector.
G. The Necessity of Risk Management by Individual Financial Institutions
I have so far discussed the developments regarding payment and settlement
systems to contain systemic risk. It is obvious, however, that establishing an appropriate system
structure alone is not enough to secure the safety of the systems. It is also important for the
system participants, or individual financial institutions, to improve risk control measures by
establishing a system for identifying and managing settlement risk.
In a modern society, monetary systems, as mentioned earlier, are based on the
public's confidence in: (1) cash issued by the central bank; and (2) deposit money offered by
private financial institutions. In order for monetary systems to function smoothly, it is necessary
for the financial system as a whole to function with stability and, to that end, financial
institutions themselves need to be respon