Mr Bergo focuses on Norges Bank's responsibility for promoting
an efficient payment system
Address by Mr Jarle Bergo, Deputy Governor of Norges Bank, to the Banks' Payment Systems
Conference, held in Oslo on 11 November 1999.
* * *
1. Background
Risk in the payment system is closely linked to the use of deposits. Payment transactions - via banks
take time, and this time-lag (between payment and settlement) is an important source of settlement
risk. Cash payment allows immediate settlement without any such risk. Therefore, the transition from
cash settlement to the use of deposits involves greater risk, but also greater efficiency. Thus, the
public's choice of means of payment and payment instruments directly affects the degree of risk and
efficiency in the payment system.
The public's choice of different means of payment and payment instruments varies over time. This is,
of course, nothing new. Already in 1924, the Banking Commission - which drafted a new law on
commercial banks at the time - stated the following:
The concept of means of payment is not beyond change; it has taken different forms
throughout time. The law states what should be considered legal tender..., but common
practice also allows certain secure assets to be used as payment... These bank-issued means
of payment have - in the more developed countries - reduced the use of legal tender to minor
daily disbursements (cash payments in its narrowest sense).
Today, the payment system continues to undergo rapid change. New technology, new participants,
new regulations and more globalisation have made this fairly complicated subject matter even more
challenging to keep up with. Norges Bank has a statutory responsibility for promoting an efficient
payment system. This responsibility becomes even more demanding when the systems change rapidly.
The focus of my address here today will be on Norges Bank's responsibility as distinct from the
responsibility of the market participants and, in particular, that of the banks. However, before I embark
upon this I will provide an assessment of risk and efficiency in the Norwegian payment system.
I would like to begin with four observations on risk and efficiency in the payment system:
2. Observations
First, payment system risk is closely linked to the organisation of payment services (legal
agreements, time of payment, etc.)
Central banks have been particularly concerned with risk in large value transfer systems, or systems
for clearing and settlement of payments between banks. These systems are located at the top of the
so-called payment pyramid.
Chart 1: The payment pyramid
The payment pyramid
interbank system
Settlemen t ban k
Clearing h ou se
Ban k B an k payment
services
system
(retail)
P ayer
Payee
This is where the large, time-critical payments occur and obviously where the system risk is greatest.
Disruptions in this segment of the payment system can lead to severe consequences, partly through the
banks' exposure to each other and partly through the banks' processing of payments to and from their
customers - i.e. retail payments.
At Norges Bank, we have come to focus more on risk in the retail payment system, not least because
many small transactions can amount to a fairly large sum, but also because it typically takes some time
before final settlement between banks occurs. Internationally, more attention has been paid to risk in
retail systems. Moreover, if such systems combine pure retail payments and large payments - as is the
case in Norway - it is recommended internationally that the risk-reduction measures be as strict for
these systems as for systems for large-value transfers.
We have also seen that part of the credit risk between banks arises in connection with (the legal basis
related to) the various payment services. In some cases, the banks' legal obligations actually coincide
with the time the customer pays, i.e. long before the actual interbank transaction. For this reason, an
assessment of the risk in interbank systems must be based on a thorough analysis of settlement times
for the most important payment services.
As a central bank, we are naturally concerned that the entire payment system functions smoothly. If
important systems for payment services fail, robust interbank systems will obviously be of limited use.
At the very worst, extensive problems in systems for payment services might reduce the public's
confidence in deposits, leading to a transition to cash payments. Therefore, we need to be aware of the
interplay between the interbank systems and the systems for payment services.
Second, the risk in the payment system can be reduced by increased use of gross settlement in
the central bank - but there are costs attached to such a conversion.
An increasing number of countries, including Norway, have introduced gross settlement systems
RTGS systems - for large-value transfers.1 The conversion from net to gross settlement for large
payments can eliminate credit risk and, thus, a fundamental cause of systemic risk from an interbank
settlement. However, such conversion is not cost-free. Let me briefly mention two disadvantages of
gross settlement:
- First, it is evident that gross settlement does not completely eliminate the danger of systemic
risk. Banks will continue to be linked through interbank loans, and problems in one
institution may still lead to considerable spill-over effects even if the settlement risk of the
net settlement has been eliminated.2 Moreover, the risk may increase for other institutions
which must grant more credit (to those in need of liquidity for the gross settlement) or for
institutions which do not receive settlement as quickly as before (due to queuing problems
with the gross settlement).
- Second, the transition to gross settlement may increase the liquidity costs for settlement
participants. Whenever transactions are to be settled concurrently, there is always a risk of
"gridlock", i.e. that settlement is halted because liquidity has been unevenly distributed.
However, this is a well-known situation and is resolved in many countries by the central
bank providing loans to system participants.
Third, there is greater need to balance risk against efficiency
In recent years, more attention has been drawn to weighing risk against efficiency. This is particularly
the result of experiences we and other central banks have had with the new payment systems and the
accompanying operating rules. RTGS systems are relatively liquidity intensive, and the cost of
collateral may be fairly high. Compared with the initial situation - "non-secure" net systems - this cost
was widely considered as a reasonable price to pay. However, a number of "in-between solutions"
i.e. hybrids - have appeared over time, blurring the distinction between net and gross systems. For
instance, in some net systems several settlements occur throughout the day, often in conjunction with
various forms of exposure limits and collective guarantee arrangements. Certain gross systems have
solved liquidity problems with new queuing solutions (algorithms), often in combination with new
forms of central bank loans (primarily against security).
We thus see some convergence towards a new type of clearing and settlement system: "secure" net
systems or "optimised" gross systems. This does not mean a reduction in the risk-reduction measures
placed on such systems; if anything, the minimum requirements have become stricter.
And, fourth, there is a greater consensus on the (international) standards that must be met by
the payment systems.
The Lamfalussy minimum standards are well known. They were drafted by a G10 committee at the
beginning of the 1990s, and are minimum requirements intended to reduce the risk in large,
international clearing and settlement systems. Gradually, they have also become standards for
corresponding national systems.
According to the Lamfalussy standards, payment systems should have a well-founded legal
foundation, the risk should be known and understood, the division of responsibility and risk limits
should be clearly defined, settlement should be completed - even if the largest participant experiences
payment problems, and there should be publicly-disclosed admission criteria and satisfactory back-up
routines.
Chart 2: The Lamfalussy minimum standards
Lamfalussy standards
• Well-founded legal basis
• The risk must be known and understood
• Clear division of responsibility
• Exposure limits
• Settlement is to be completed even if the largest
participant experiences problems
• Objective and publicly-disclosed admission criteria
• Operational, reliable technical systems
• Satisfactory back-up routines
The Lamfalussy minimum standards are still viable but, as mentioned above, some adjustments have
been necessary in the light of what has been experienced since they first appeared in 1990. A proposal
for revised standards is currently being evaluated in the BIS3 and a final version is expected to be
available some time next year.
I have pointed out these requirements because they are also relevent for us in Norway. If there should
ever be any link to TARGET,4 our interbank systems would be expected to meet similar requirements.
Moreover, we must assume that foreign bankers will demand that our systems satisfy international
requirements. We could probably discuss whether these requirements are equally relevant for all
portions of the NICS-system,5 but I think that in a given situation involving a link-up with an
international system, we will have only one choice - full implementation of the requirements! In the
proposed system for licensing interbank systems, emphasis will be placed on evaluating whether the
systems fulfil such international requirements.
3. Risk and efficiency in the Norwegian payment system
3.1. Retail payments
Allow me to turn to a closer examination of the state of the Norwegian payment system. First looking
at the retail side of the payment system - where so-called customer payments dominate - there are two
factors I would like to bring to the fore: one is the (continuing) sharp increase in electronic services
and the other is the stable use of cash.
3.1.1. Transition to electronic payment instruments
If we first look at electronic payment services, we see that the increase in the use of cards is what is
most striking.
Chart 3: Retail payment services (number of transactions) in 1990 and 1998
Retail payment services (no. of transactions)
1990 1998
444 million transactions
785 million tran sactions
22 %
25 %
12 %
25 %
63 %
53 %
Cheques and other paper-based
Cards (both credit and debit
Electronic giro services
payment services
card)
Source: Norges Bank, Annual Report on Payment Systems 1998
The use of payment cards in Norway now exceeds use in most other OECD countries6 and the rate of
increase is higher than in many other countries with advanced payment systems - such as Finland and
Denmark.
An increased use of electronic services is important for efficiency, including cost-effectiveness, in the
payment system. We know there are considerable cost differences between various payment services
and that there is an equally large potential for savings. In terms of cost, the transition to more
cost-efficient paper-based services - such as the mail giro - is important. It is estimated that the total
cost of the payment system in Western countries may approach 2-3% of GDP. Therefore, a transition
to electronic - or more cost-efficient paper-based - services will be essential to the establishment of an
efficient payment system.
If we look at the breakdown between the various payment services in terms of value, we get a different
picture.
Chart 4: Retail payment services (value) in 1990 and 1998
Retail payment services (value)
1990 1998
(approx. NOK 1735 billion) (NOK 4795 billion)
28%
29%
3%
5%
66%
69%
Cheques and other paper-based
Cards (both credit and debit
Electronic giro services
payment services
card)
Source: Norges Bank, Annual Report on Payment Systems 1998
We see that the share in value of payments made with payment cards - in spite of a sharp increase in
the number of transactions - has not advanced much (still accounting for a mere 3-5% of the total
transaction amount in the payment system). The average amount per transaction remains fairly low -
i.e. approximately NOK 400. In general, we can nevertheless say that with the exception of cash,
payment cards have become Norway's most important payment instrument for small transactions.
On the other hand, the electronic giro is the instrument which has increased the most in terms of value.
The increase in direct transfers by business terminals has been particularly sharp, while the growth rate
has been highest for "new" services - such telebanking and home banking.
These developments are important for the further improvement of payment system efficiency. The
emergence of home banking is a natural progression from telebanking, an area which is already highly
developed in Norway. At the beginning of 1999, the vast majority of banks in Norway were able to
offer giro services over the Internet, and turnover in 1998 already amounted to a good NOK 7bn.
Considering that PC and Internet coverage in Norway is high, conditions should be favourable for
developments in this area. In this connection, it will also be exciting to see how banks meet new
demands for payment services related to increased trading over the Internet.
Based on the above, I would conclude that efficiency in the Norwegian payment system has improved
considerably in the 1990s.
Factors behind these developments
The transition to electronic payment instruments is obviously closely connected with the spread of
information technology in Norway in the 1990s. Nevertheless, it is important to point out that the
correlation between new technology and an increase in efficiency is not automatic. Efficiency is the
result of interaction between technology, institutions and users. The following three prerequisites must
be in place for an efficient use of new technology:
First, system participants must be able to make use of the new technology. Coordination of the
Norwegian payment system has been an important factor behind the swift adoption of new electronic
payment services by the industry. Second, it is imperative that customers gain quick and moderately
priced access to the new payment services, such as has been the case with the spread of EFTPOS
terminals.7 And third - and perhaps most importantly - the payment system must encourage the use of
(cost-) effective payment instruments. The public must face correct incentives if their payment habits
are to be changed in the right direction. Prices which reflect real cost are an important instrument in
this connection. Norway has a substantial head-start on most other countries in this field. Current
prices largely reflect the difference in costs between various payment services, showing that "correct"
prices are a suitable instrument in changing behaviour in the payment system.
3.1.2. The use of cash and the paradox of levelling off
Another characteristic of the Norwegian payment system in the 1990s has been the levelling off of the
use of cash, when measured as the value of banknote and coin circulation as a share of GDP, following
a considerable decrease throughout the 1980s.
Chart 5: Cash in circulation as a share of GDP, 1980-1998
Cash in circulation as a percentage of GDP
8%
7%
6%
GDP
5%
of
4%
3%
Percentage 2%
1%
0%
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Year
Source: Norges Bank: Annual Report on Payment Systems 1990-1998, Annual Report 1980-1990, Statistics Norway: Historical Statistics
1994, Statistical Yearbook of Norway 1999, 1995.
From a level of about 7% of GDP at the beginning of the 1980s, it appears that the use of cash may be
in the process of levelling off at close to 4%. A similar levelling off has also been observed in other
countries, even though the level varies. The question we ask is whether this levelling off is permanent
or whether we may expect a further reduction in the use of cash. Let me briefly outline three factors I
believe may be of some significance:
First, it has become less expensive to use cash in the 1990s. Cash is not an interest-bearing instrument.
As such, forfeited interest income is part of the "cost" of using cash. A declining interest rate in the
1990s has substantially reduced this cost, both for the public and banks. Second, the public has been
spared the real costs of cash use, while other payment instruments have increasingly been assigned
full-cost prices. And third, developments in new payment instruments for small payments - cash cards
- have progressed slowly. This is probably in part because we already have a well-developed EFTPOS
infrastructure in Norway, and perhaps in part related to what I mentioned above - that cash continues
to be an efficient and inexpensive alternative.
Predicting further developments in the use of banknotes and coin, both internationally and in Norway,
is a difficult task. Low inflation, low interest rates and greater access - for example, via the EFTPOS
system's cash-back arrangement - will promote the further use of cash, whereas new technological
solutions will reduce it. Developments in relative prices will also be of importance.
Many of Norges Bank's activities within this area are linked to our role as issuer of banknotes and
coins; these activities are a public service, and costs are covered by the central bank. However, Norges
Bank is also often in competition with others when it performs a number of other payment system
services for banks and the postal system, which incur either no charges or no cost-covering charges for
these services. This practice is currently under internal evaluation at the Bank. Consequently, we must
anticipate that pricing for processing cash will approach full cost over time. It will be interesting to see
if this has any affect on the public's use of cash.
3.2. Interbank systems (clearing and settlement systems)
I would now like to look more closely at risk and efficiency in interbank systems and, particularly, at
our standing internationally.
3.2.1. We have made a fair amount of progress
The establishment of NICS and NBO8 provided us with a modern clearing and settlement system in
Norway, which we managed to implement at approximately the same time as the G10 countries and
the EU. Our systems have certain positive properties, such as the possibility of releasing a gridlock
situation in gross settlement (in NBO) and centralised information on banks' liquidity (in NICS). Our
central bank lending arrangements are generally similar to those found in other countries, where it is
commonplace for collateral to be furnished for all loans in the central bank.
However, we differ from other countries in two areas in a somewhat disadvantageous way: first of all,
we let a portion of the large-value transfers go through multilateral netting before being settled in
Norges Bank. This is not common, but obviously contributes to less stringent liquidity requirements
(this occurs in Germany and the US, among others). Second, in Norway we still make use of so-called
"T-copying", in which the payee receives information on payments before the settlement has taken
place.9 This creates the risk of the payee bank crediting the customer before the bank has received the
money. The payee bank may thus be exposed to a non-controlled risk relative to the payer bank.
On the whole, however, we may conclude that we have come a long way relative to the systems some
of us recall from 10-15 years ago.
3.2.2 Risk can be further reduced
In spite of the progress which has been made, I still think that risk in the Norwegian clearing and
settlement system can and should be reduced. Allow me to point out three areas where I believe risk is
still too high:
Retail netting in NICS
Turnover in this area has been high and on the rise. Average daily turnover is now NOK 28bn
compared with about NOK 18.5bn in 1998. Turnover has reached up to NOK 76bn on certain days.
Thus, a delayed or rejected netting - resulting from payment problems in one bank - can cause serious
problems for other banks, at any rate if the netting is prolonged until the following day.
In addition, there are no exposure limits or transaction limits for this netting system. The system really
does not live up to its name, because it involves both small and large-value transfers. As I pointed out
previously, this may call for us to place stricter requirements on this clearing system than what we
would demand if only retail payments were involved.
If it should turn out that the bank responsible for the delay in the mass settlement really is insolvent,
then we cannot rule out that the other banks will incur such sizeable losses that systemic problems
may arise. We have very roughly estimated that the bilateral (gross) exposure may exceed NOK 5bn in
certain settlements. However, this situation will soon be improved when the netting is given legal
protection. This may reduce the total maximum loss to the amount of the multilateral net debit of the
insolvent bank. If the banking industry is also able to agree on an adequate loss-sharing agreement, we
assume that the remaining danger of systemic risk in this part of the payment system.
Gross settlements in NBO
Turnover through gross settlements in NBO fluctuates between NOK 100bn and NOK 200bn per day,
which is by far the largest portion of the settlement. Since it is a gross settlement, risk would be
expected to be minimal or non-existent. Such is not the case, however.
Liquidity problems can arise as a result of such factors as technical failure at one or several banks -
i.e. operational risk. We have already experienced such situations and seen that they can quickly bring
considerable liquidity strains upon other NBO participants. Norges Bank is actively analysing and
improving routines associated with such situations in connection with preparations for the year 2000.
This work will enable us to be well prepared if such unforeseen situations should arise after the turn of
the century.
Another risk-creating factor in connection with gross settlement is the extended use of early crediting.
Relevant information is lacking, but is our impression that this practice is fairly widespread. The
possibility of early crediting is, as is well known, connected to the information exchange model used
in the Norwegian payment system (see my previous comments on so-called "T-copying"). This
practice - which, by the way, is not in accordance with international recommendations - can result in
the payee bank coming into a position of non-controlled exposure in relation to the payer bank. A
transition to a so-called "Y-copying" - also in the Norwegian SWIFT system - should be a long-term
objective.10
Foreign exchange settlement
We must assume that the Norwegian payment system is also vulnerable to a fairly substantial amount
of foreign exchange settlement risk. This risk arises because the parties to a trade must usually send
the currency sold long before they know whether the currency they have purchased has been received.
We know that the krone portion of foreign exchange turnover makes up a very large part of the
turnover in the gross settlement system, and that such trades can amount to NOK 90bn kroner daily.
The transition to gross settlement has thus reduced settlement risk in the Norwegian system, but at the
same time this transition may not have addressed what may represent the largest risk. Norges Bank
intends to identify foreign exchange settlement risk among Norwegian banks in the same way as has
been done for G10 countries. Norges Bank also supports the inclusion of Norwegian kroner in the
foreign exchange settlement system CLS.11 Ties to the CLS will be in line with international
recommendations and will greatly reduce the foreign exchange settlement risk of trading in NOK.
3.2.3. Efficiency is not satisfactory
This observation is particularly associated with the present lending arrangement with Norges Bank and
its corresponding collateralisation. At present, all loans with Norges Bank must be covered by
security. The last adjustment to this policy was made in September, when collateral requirements were
introduced for F-loans as well. Following this change, we now have a system resembling those of
many other countries, particularly in Europe. However, the government paper market in Norway is
small compared with other countries - which is, for that matter, an advantage - but it also requires us to
make better use of available collateral than other countries.
When measured in October of this year, the ratio of total turnover to security furnished in the
Norwegian settlement system was roughly 5.12 This is on a par with the situation in Stockholm, but far
below London, where daily turnover is around GBP 125bn - with highs of almost twice that amount
while collateral requirements are at a mere GBP 8bn, i.e. a ratio of about 16. When measured in this
way, efficiency is thus at least three times greater in London than in Oslo or Stockholm - and we find
nothing to indicate that the system in London is less secure. This indicates that there is room for
improvement in the Norwegian system.
What areas can we improve? First of all, the retail netting system. The present system is cumbersome
and both banks and Norges Bank would like to see some changes. It should be possible to develop
better routines to reduce the need for collateral. A review of traffic patterns (in particular, for
government payments) combined with other appropriate measures (such as exposure limits and
collective collateral) should make it possible to reduce the collateral requirement substantially.
Changes in the rules for collateralisation are the other promising area for achieving noticeable gains.
Present regulations hamper ongoing changes in the amount that can be pledged in favour of Norges
Bank. Banks are unable to alter the collateral which has already been furnished (the previous day) in
favour of Norges Bank. If it turns out on the day of settlement that too little collateral has been
furnished, banks are not able to increase the amount of collateral - even though they have securities
available in the VPS.13 This sluggish system - resulting from the Act relating to the Norwegian Central
Securities Depository - prevents banks from adjusting their collateral throughout the day. It goes
without saying that this is not an optimal situation, which we have already pointed out. The matter is
under consideration in the VPS legal commission, and we are hoping that a solution is imminent.
Let me now turn to the responsibilities and roles of the central bank and the banks in the payment
system.
4. Responsibilities and roles in the payment system
The primary responsibility for the development of the payment system lies with, and must lie with, the
banks. Self-regulation is still the rule. However, more complex systems and the potential of new
participants increase the need for the public sector to take on partial responsibility. This is the
background to the proposal for a new act on payment systems, which is under deliberation in the
Storting. According to the bill, Norges Bank is to be granted responsibility for licensing and
supervision of interbank systems in Norway. We wish to exercise this responsibility together with the
industry and its participants. In the following, I will take a closer look at this interaction, how it may
be developed and what our respective roles and responsibilities should be. I will also briefly touch on
our preparations for the new role as licensing authority, and provide a few opinions on which
requirements must be placed on the interbank systems.
4.1. The importance of self-regulation
Norges Bank's new licensing and supervisory responsibility will be a supplement to present-day
self-regulation. Up to the present, participants have cooperated on standards, rules and routines for
security and transaction exchange within the payment system. Agreements on obligations and
responsibilities between the participants have assured coordination between banks. Self-regulation has
primarily taken place through and between the two banking associations. There is consensus that this
model has given rise to substantial results, not least an infrastructure which safeguards important
social considerations, while also providing for active competition between participants.
The challenge for Norges Bank will be to fulfil its licensing and supervisory responsibility in such a
way that self-regulation may be maintained, but which also allows us to move in the right direction in
terms of both risk (reduction) and efficiency in the interbank systems.
4.2. Norges Bank's responsibility
That Norges Bank has responsibility in connection with the payment system is not new to this bill.
Under the Norges Bank Act, Norges Bank shall promote an efficient payment system domestically as
well as vis-à-vis other
countries. This formulation requires us to balance risk against efficiency.
Norges Bank also serves as settlement bank for the banks. Norges Bank has, as a result of this
function, set requirements on the banks and their clearing systems, with particular emphasis on
risk-reducing measures.
As a future licensing authority for the interbank systems, we will have to strike a balance between risk
and efficiency in our assessment of the systems.
In the following, I will provide a few observations on our new responsibility before commenting on
the licensing process itself and the requirements which must be placed on the systems. Given that the
law has not yet been adopted, this is of course somewhat speculative.
We are highly aware that the law is to be supplementary to the approach of self-regulation. We must
(according to proposition 96, 1998-99 to the Odelsting) endeavour to promote incentives which enable
this approach to be maintained. At the same time, I showed above that risk in the settlement system
can and should be further reduced. This raises the question of whether we have had the proper
incentives up to now. It will be a challenge to find incentives which accommodate the industry's need
for self-regulation, while leading to a better system - with slightly lower risk.
As licensing authority, we must take a stand as to which systems are to fall under the licensing
requirement and which will be exempt (because they have no significance for financial stability).
There are several issues which will have to be addressed in this area. Turnover and risk exposure in the
systems will be key indicators in our evaluations. NICS is obviously a system which will be subject to
the licensing requirement, and we will probably have to focus our evaluations on this system initially.
We will also have to define which requirements will apply to the interbank systems and, particularly,
what actions must be taken for us to fulfil the law's objective that:
Interbank systems shall be organised with a view to promoting financial stability. Special
emphasis shall be placed on countering risks resulting from a deficiency in liquidity or
financial strength among participants in the system.
This must be interpreted to mean that the interbank systems should be organised in such a way that
they are robust and can withstand stress. They will probably have to satisfy international requirements
placed on similar systems. This is not to say that Norges Bank will dictate specific solutions for these
systems, but that we will demand that risk be identified and brought under control, and that there be
satisfactory solutions for dealing with crisis situations. Several alternative solutions may be possible.
The banks will have to decide for themselves within the limits set by sound risk management.
An example may serve to illustrate this. Risk in net settlement arises primarily because of the time-lag
between payment and settlement. It has been common up to now for the payee bank to make funds
available to its customer - pending the final transfer of funds from the payer bank in the settlement.
This practice can lead to large and unforeseen exposure before settlement is finalised. If the payee
bank postpones crediting instead, credit risk will be eliminated from the net settlement, but at the
expense of efficiency - because the customers receive funds one (or perhaps two) days later. The
advantages of delayed crediting must therefore be weighed against the disadvantages. My point here is
that the banks themselves must be responsible for this assessment, while we at Norges Bank must
evaluate w