Payment Systems: Central Bank Roles Vary, but Goals Are the Same
Published: 2002-02-25T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: The central banks of major industrialized countries have agreed on common policy objectives and presented them in the Core Principles for Systematically Important Payment Systems. Intended to help promote safer and more efficient payment systems worldwide, the Core Principles outline specific policy recommendations for systematically important payment systems and describe the responsibilities of the central banks. All of the central banks GAO studied seek to ensure that their wholesale payment systems operate smoothly and minimize systemic risk. All of the central banks provide settlement services for their countries' wholesale payment systems. Some central banks also provide wholesale clearing services. Other central banks own the system but have little operational involvement in clearing, while others participate in partnerships with the private sector. All of the central banks GAO studied provide settlement for some retail payment systems. Some, but not all, central banks exercise regulatory authority over retail payment systems in their countries. Central banks also tend to have less operational involvement in countries where there is a relatively concentrated banking industry. In some cases, laws governing payments and the structure of the financial services industry direct the involvement of central banks in retail payment systems.

section_title: Letter
paragraphs: This report responds to your request that we study the roles of central  banks in payment systems to provide perspective on the roles played by the  Federal Reserve System in the United States’ payment system.  Payment  systems play an important role in the financial and economic health of  nations.  The smooth functioning of payment systems that handle very  high-value, institution-to-institution payments—or wholesale payment  systems—is important in ensuring the stability of financial markets and  systems.  Well-functioning payment systems that handle the low-value  payments that constitute the bulk of payment transactions—or retail  payment systems—are important in helping to maintain public confidence  in financial systems. The degree to which a central bank should be involved  in the payment system has been the subject of controversy.  Views on this  issue have evolved over time and therefore are likely to remain open to  debate.
We discuss the involvement of foreign central banks in their payment  systems to provide perspective on the roles and functions of the Federal  Reserve System in the U.S. payment system.  We describe the roles of the  Federal Reserve System in the Background section of this report.  Although  unique country characteristics make it difficult to conduct direct  comparisons of the roles that central banks play in payment systems  difficult, we reviewed these roles to illustrate the factors that influence the  involvement of central banks in payment systems.  The objectives of this  report are to (1) identify internationally recognized objectives for payment  systems and central bank involvement in those systems, (2) describe the  roles of central banks in the wholesale payment systems of other major  industrialized countries and the key factors that influence those roles, and  (3) describe the roles of central banks in the retail payment systems of  other major industrialized countries and the key factors that influence  those roles.
We reviewed literature provided by central banks and central bank  organizations, foreign law commentaries, central bank Web sites, and  academic studies.  Our information on foreign laws is based on secondary  sources and does not reflect our independent legal analysis.  We also  interviewed Federal Reserve System officials, members of trade  associations, and academics. In analyzing the roles of other central banks  in payment systems, we focused on countries with relatively modern,  industrialized economies. Appendix I presents a detailed discussion of the  scope and methodology of our work.
subsections: section_title: Background
paragraphs: The Federal Reserve System is involved in many facets of wholesale and  retail payment systems in the United States, including providing wire transfers of funds and securities; providing for the net settlement of check clearing arrangements,  automated clearinghouse (ACH) networks, and other types of payment  systems; clearing checks and ACH payments; and regulating certain financial institutions and overseeing certain payment  systems.
Responding in part to a breakdown of the check-collection system in the  early 1900s, Congress established the Federal Reserve System as an active  participant in the payment system in 1913. The Federal Reserve Act directs  the Federal Reserve System to provide currency in the quantities  demanded by the public and authorizes the Federal Reserve System to  establish a nationwide check clearing system, which has resulted in the  Federal Reserve System’s becoming a major provider of check clearing  services.
Congress modified the Federal Reserve System’s role in the payment  system through the Monetary Control Act of 1980 (MCA). One purpose of  the MCA is to promote an efficient nationwide payment system by  encouraging competition between the Federal Reserve System and private- sector providers of payment services.  The MCA requires the Federal  Reserve System to charge fees for its payment services, which are to be set  to recover, over the long run, all direct and indirect costs of providing the  services.  Before the MCA, the Federal Reserve System provided payment  services to its member banks for no explicit charge.  The MCA expanded  access to Federal Reserve System services, allowing the Federal Reserve  System to offer services to all depository institutions, not just member  banks.  Congress again expanded the role of the Federal Reserve in the  payment system in 1987 when it enacted the Expedited Funds Availability  Act.This act expanded the Federal Reserve Board’s authority to regulate  certain aspects of check payments that are not processed by the Federal  Reserve System.
Through specific regulatory authority and its general authority as the  central bank, the Federal Reserve plays an important role in the oversight  of the nation’s payment systems.  The Federal Reserve Board has outlined  its policy regarding the oversight of private-sector clearance and settlement  systems in its Policy Statement on Payment Systems Risk.  The second part  of this policy incorporates risk management principles for such systems.
The Federal Reserve System competes with the private sector in providing  wholesale payment services. Wholesale payment systems are designed to  clear and settle time-critical and predominantly large-value payments.The two major wholesale payment systems in the United States are the  Fedwire funds transfer system, owned and operated by the Federal  Reserve System, and the Clearing House Interbank Payments System  (CHIPS), which is owned and operated by the Clearing House Service  Company LLC, a subsidiary of the New York Clearing House Association  LLC (NYCHA) for use by the participant owners of the Clearing House  Interbank Payments Company LLC (CHIPCo).  Fedwire is a real-time gross  settlement (RTGS) system through which transactions are cleared and  settled individually on a continuous basis throughout the day. CHIPS  began operations in 1970 as a replacement for paper-based payments  clearing arrangements. Since January 22, 2001, CHIPS has operated as a  real-time settlement system. Payment orders sent over CHIPS are either  simultaneously debited/credited to participants’ available balances or have  been netted and set off with other payment orders and the resulting  balance is debited/credited against participants’ available balances  throughout the day. The transfer of balances into CHIPS and payments  out occur via Fedwire. The Federal Reserve System oversees CHIPS’  compliance with its Policy Statement on Payment Systems Risk.
The size and aggregate levels of wholesale transactions necessitate timely  and reliable settlement to avoid the risk that settlement failures would pose  to the financial system. Although wholesale payments constitute less than  0.1 percent of the total number of transactions of noncash payments, they  represent 80 percent of the total value of these payments.  Moreover, in  1999, the value of payment flows through the two major wholesale systems  in the United States, Fedwire and CHIPS, was approximately 69 times the  U.S. gross domestic product in that year.
The Federal Reserve System also competes with the private sector in  providing retail payment services.  For example, the Federal Reserve  System provides ACH and check clearing services.  ACH systems are an  important mechanism for high-volume, moderate to low-value, recurring  payments, such as direct deposit of payrolls; automatic payment of utility,  mortgage, or other bills; and other business- and government-related  payments. The Federal Reserve System also competes with private-sector  providers of check clearing services.  To do this, the Federal Reserve  operates a nationwide check clearing service with 45 check processing  sites located across the United States.
The Federal Reserve System’s market share of payment services as of year- end 1999 is represented in table 1.
During forums held by the Federal Reserve System’s Committee on the  Federal Reserve System in the Payments Mechanism, held in May and June,  1997, committee members and Federal Reserve staff met with  representatives from over 450 payment system participants, including  banks of all sizes, clearing houses and third-party service providers,  consumers, retailers, and academics.  Although a few large banks and  clearing houses thought the Federal Reserve System should exit the check  collection and ACH businesses, the overwhelming majority of forum  participants opposed Federal Reserve System withdrawal.  Participants  were concerned that the Federal Reserve System’s exit could cause  disruptions in the payment system.
section_title: Core Principles Establishes Internationally Accepted Policy Objectives That, Along with National Law, Guide Central Bank Involvement in Payment Systems
paragraphs: The Core Principles illustrates how the central banks see their roles in  pursuing their objective of smoothly functioning payment systems.Further, the Core Principles outlines central banks’ roles in promoting the  safety and efficiency of systemically important payment systems that they  or others operate.  The laws of the countries we studied support this aspect  of the Core Principles.  These countries charge their central banks with  broad responsibility for ensuring the smooth operation and stability of  payments systems.  In their basic role as banks, central banks generally are  charged with acting as a correspondent bank for other institutions,  providing accounts, and carrying out interbank settlements.  Nonetheless,  countries’ laws vary regarding the specific roles a central bank should play  in the payment system.
subsections: section_title: Core Principles Outlines Central Banks’ Objectives and Responsibilities for Systemically Important Payment Systems
paragraphs: Central banks in the G-10 countries and Australia have endorsed the Core  Principles, which sets forth 10 basic principles that should guide the  design and operation of systemically important payment systems in all  countries as well as four responsibilities of the central bank in applying the  Core Principles. (The principles and responsibilities are presented in app.  II.)  The overarching public policy objectives for the Core Principles are  safety and efficiency in systemically important payment systems.  Although  the Core Principles generally is considered to apply to wholesale payment  systems, some payments industry officials said that some payment systems  that process retail payments could reasonably be considered systemically  important because of the cumulative size and volume of the payments they  handle.
Providing for the safety of payment systems is mostly a matter of mitigating  the risks inherent to the systems. These risks are listed and defined in table  2.
Core Principle IV seeks to mitigate settlement risk by endorsing prompt  final settlement, preferably during the day but, minimally, at the end of the  day.  The two major types of wholesale payment settlement systems are  RTGS and multilateral netting systems.  Recently, several hybrid systems  have also been developed.  (These two major types of systems are  described further in app. III.)  In general, multilateral netting systems offer  greater liquidity because gross receipts and deliveries are netted to a single  position at the end of the day.  An institution can make payments during the  day as long as its receipts cover the payments by the end of the day.  However, multilateral netting systems without proper risk controls can  lead to significant systemic risk.  Because transactions are processed  throughout the day, but not settled until the end of the day, the inability of a  member to settle a net debit position could have large unexpected liquidity  effects on other system participants or the economy more broadly.  RTGS  systems rely on immediate and final settlement of transactions, and these  systems have much less exposure to systemic risk that could result from a  settlement failure.  Without a system for the provision of adequate intraday  credit, these systems cause potential liquidity constraints because they  require that funds or credit be available at the time that a payer initiates a  transaction.
Efficiency in payment systems can be characterized as both operational  and economic.  Operational efficiency involves providing a required level  and quality of payment services for minimum cost.  Cost reductions beyond  a certain point may result in slower, lower quality service.  This creates  trade-offs among speed, risk, and cost.  Going beyond operational  efficiency, economic efficiency refers to (1) pricing that, in the long run,  covers all of the costs incurred and (2) charging those prices in a way that  does not inappropriately influence the choice of a method of payment.
The Core Principles sets forth four responsibilities of the central bank in  applying the core principles, two of which address oversight functions.  The first is that the central bank should ensure that the systemically  important systems it operates comply with the Core Principles, and the  second is that the central bank should oversee compliance with the Core  Principles by systems it does not operate, and it should have the ability to  carry out this oversight. Therefore, the Core Principles affirms the  importance of central banks’ oversight responsibility for their countries’  systemically important payment systems, including those that they do not  own or operate.
section_title: Laws Give Many Central Banks Broad Responsibility for Ensuring Efficient Operations and Reducing Systemic Risk in Payment Systems
paragraphs: The laws of most of the countries we studied give the central bank broad  responsibility for ensuring that payment systems operate smoothly.  In  addition, in their basic role as banks, central banks are generally charged  with providing accounts to certain financial institutions and effecting  interbank settlement.  While some countries are specifically charged with  providing additional payment services or regulating private payment  systems, others are not.  Similarly, regulatory and oversight authority is not  always specified in laws but is obtained through historical development  and the broader mission of the central bank.
The European Central Bank (ECB) is the central bank for the countries that  have adopted the euro. In conjunction with the euro area countries’  national central banks, the ECB oversees payment systems for the euro  area and operates the Trans-European Automated Real-time Gross  settlement Express Transfer (TARGET) system, the primary payment  system for euro payments.The ECB’s powers and responsibilities are  similar to those of national central banks.  We therefore analyzed the ECB  along with countries’ national central banks.  In developing TARGET, the  ECB set out strict rules regarding the national central banks’ provision of  payment services, requiring each central bank to provide a RTGS system,  which serves as a local component of TARGET.
The laws of Canada, France, Japan, and the United Kingdom cast the  central bank as a monitoring entity having general powers to ensure that  payment systems do not pose systemic risk.  The central banks in those  countries are not specifically charged with providing particular payment  clearing services.  However, as a matter of practice, the central bank in  France, which plans to discontinue its check clearing service in 2002, will  continue to operate services related to check fraud.  Although Australia’s  law recognizes a limited role for the Reserve Bank of Australia to act as a  service provider, the Reserve Bank of Australia’s primary purpose  regarding payments systems is to serve as an oversight and regulatory  mechanism designed to control risk to promote the overall efficiency of  Australia’s financial system.  German law authorizes the Bundesbank to  furnish payments services, and the Bundesbank performs retail payment  functions, including check processing, credit transfers, checks, and direct  debits as well as owning and operating RTGSplus, which is an RTGS hybrid  system for wholesale payments.
The central banks we studied have general authority to take actions to  protect against systemic risk.  In some cases, the banks are to serve a  particular regulatory function.  For example, under Canadian law, the  central bank decides upon the qualifications of payment systems  determined by the central bank to pose systemic risk.  However, except for  Germany, Australia, and the United States, the laws of the countries we  reviewed generally do not contemplate that the central bank is to regulate  the provision of payment services for purposes unrelated to systemic risk.
section_title: Central Banks Are Involved in the Operations and Oversight of Wholesale Payment Systems
paragraphs: All of the central banks we studied provide settlement for wholesale  payment systems.  Moreover, these central banks participated in the design  and development of, and have oversight over, wholesale payment systems.  Most central banks play a role in providing these wholesale payment  services.  However, as demonstrated by the central banks we studied,  central bank involvement in wholesale payment systems varies.  Some  central banks have full ownership and operational involvement in the  payment system; others have little operational involvement beyond  settlement services.  Other central banks participate in partnerships.  In  some cases, the central bank is a major provider or perhaps the only  provider of wholesale payment services. The Federal Reserve System, as  previously noted, is a major provider of wholesale payment services.
subsections: section_title: Central Banks Participated in the Design and Development of Wholesale Payment Systems
paragraphs: Each of the central banks we reviewed has participated in the design and  development of its country’s wholesale payment system.  For example, the  Bundesbank collaborated in developing the RTGSplus system. The Bank of  France played a major role in the development of France’s systems.  The  Bank of England cooperated with the Clearing House Automated Payment  System (CHAPS) in the development of a new system, NewCHAPS; the  Bank of Canada assisted in the design and development of the Large Value  Transfer System.
In the G-10 countries, the first automated RTGS system was Fedwire in the  United States, which is owned and operated by the Federal Reserve  System.  Although there are some net settlement systems for wholesale  payments today, many countries are transitioning to RTGS systems.  In  Europe, various decisions over the past 5 to 10 years have encouraged  current and potential euro area countries to develop national RTGS  systems.  The trend toward RTGS systems extends beyond Europe’s  boundaries, as countries worldwide are adopting RTGS systems.
section_title: Central Banks’ Roles in Providing and Overseeing Wholesale Payment Systems Vary
paragraphs: Central banks we studied played various roles in providing and overseeing  wholesale payment services.  All central banks provide key settlement  services for wholesale payment systems.  Some central banks own and  operate wholesale payment systems that include clearance and settlement  while others only provide oversight and settlement, leaving clearance and  other processing activities to other parties.  There is no clear pattern in the  roles played by central banks in clearing wholesale payments.
In addition to the United States, two of the central banks we studied, the  Bundesbank and the Bank of France, have full ownership of their  respective wholesale payment systems. The Bundesbank owns and  operates the RTGSplus system, which was developed with the input of the  German banking industry.  The Bundesbank has full control over the  practices of the system for large-value payments.
The Bank of France owns and manages Transferts Banque de France,  which is a RTGS system that is one of the two wholesale payment systems  in France.  The Bank of France is also a joint owner of the company that  owns and operates France’s other wholesale payment system, which is a  hybrid, real-time net settlement system. Although the Bank of France is  only a partial owner of this system, it can exert considerable influence over  it by virtue of its ownership role in the controlling company.
The Bank of England is a member and shareholder of CHAPS Inc., which  operates England’s sterling and euro RTGS systems.  Although the Bank of  England does not own or manage any payment clearing system, CHAPS  payments settle by transferring funds among participating institutions’  Bank of England accounts. The Bank of England is the settlement bank for  both the CHAPS Sterling and CHAPS Euro.
The Bank of Canada has a more limited operational role in its system.  The  Bank of Canada entrusts the ownership and operation of the Large Value  Transfer System (LVTS) to the Canadian Payments Association, which the  Bank of Canada chairs.  The Bank of Canada expressly guarantees  settlement of LVTS in the event of the simultaneous default of more than  one participant, and losses exceed available participant collateral.  This  guarantee is likened to “catastrophic insurance with a very large  deductible,” with the latter being the collateral provided by the  participants.
section_title: Central Bank Involvement in Retail Payment Systems Varies Considerably and Is Influenced by a Variety of Factors
paragraphs: Although the extent of central bank oversight over retail payment  operations varies, central banks generally consider retail payments as an  important component of the payment system.  As such, central banks have  some responsibility for promoting well-functioning retail payment systems.  The operational role of the central bank in retail payment clearing varies  considerably among the countries we studied.  The basic structure of retail  payment systems depends largely on the structure of the underlying  financial system and on the historical evolution of payment processes.  Factors that influence central bank involvement in retail payment systems  include the history and structure of the country’s payment system and  banking industry.  While we identified several factors that influenced the  involvement of a central bank in its country’s retail payment system, these  factors interact uniquely and occur to varying degrees in the systems we  studied.
subsections: section_title: Retail Payments Are Paper- Based or Electronic and May Be Cleared through a Variety of Arrangements
paragraphs: Retail payments are generally lower in value and urgency from the  perspective of the financial system than wholesale payments, but retail  payments occur more frequently. They typically include consumer and  commercial payments for goods and services.  Noncash retail payment  instruments are generally categorized as paper-based (most commonly  checks) or electronic (most commonly credit cards, credit transfer, debit  cards, and direct debits).  These payment instruments are further described  in table 3.
Central banks provide settlement for retail payments, but commercial  banks also settle retail payments. Where the central bank provides  settlement, it does so for “direct participants”—that is, institutions having  settlement accounts at the central bank.  Settlement of payments at the  central bank sometimes requires tiering arrangements.  Under these  arrangements, “direct participants” settle payments through their accounts  at the central bank, with indirect participants’ settling accounts with a  direct participant with whom they have a settlement arrangement.  Such is  the case with the Bank of England, which acts as a banker to the settlement  banks that are direct members of the United Kingdom’s primary payment  clearing association.  Settlement of retail payments may also occur through  settlement agents, third-party arrangements, or correspondent accounts  that institutions hold with each other for bilateral settlement.
section_title: Despite Variations in Central Bank Involvement, Most Have an Interest in Promoting Well-Functioning Payment Systems
paragraphs: Although many central banks work to ensure that their retail payment  systems are well-functioning, their approaches diverge.  Some central  banks play a prominent regulatory and operational role in retail payments  and see these roles as keys to fostering well-functioning retail systems,  while others assume more limited roles. Whatever the level of involvement  in oversight or operations, most central banks consider retail payments as  important components of the payment system and therefore assume some  responsibility in promoting well-functioning retail payment systems.
section_title: Structural Factors Influence Central Bank Involvement in the Clearance of Retail Payments
paragraphs: A number of structural factors influence the central bank’s role in retail  payments.  For example, the involvement of the central bank in check  clearing can vary.  In countries with a concentrated banking industry, on-us  check clearing will occur with higher frequency.  On-us checks are checks  that are deposited at the same bank on which they are drawn, so that no  third party, including the central bank, is required for clearing or  settlement.  For example, Canada has few banks, heavy check use, and  little central bank involvement in clearing retail payments. On the other  hand, the United States has a large number of banks and its central bank is  heavily involved in providing check clearing services.  If a country has  many smaller banks, such as savings, rural, and cooperative banks, there  will be more need for some kind of retail clearance system, thereby  creating greater potential need for central bank involvement.
Identifying the extent to which payment preferences influence central bank  involvement in clearing payments is difficult.  Some have suggested that  central banks in countries that rely heavily on paper-based instruments are  more involved in clearing retail payments, and that central banks of  countries that are more reliant on electronic payments provide fewer  clearing services.  Central banks involved in check clearing include those in  Germany, France, and the United States. France and the United States  rely heavily on checks for retail payments.  In contrast, the Bundesbank is  heavily involved in clearing a variety of retail payment instruments, but  Germany is not particularly reliant on checks as a means of payment.
The physical size of a country determines the distances that payment  instructions might have to travel between the paying and the drawing  banks.  This has particular relevance in countries that rely heavily on paper- based instruments such as checks, which might have to be physically  moved great distances to be processed. For example, this is the case in the  United States, which is much larger than any European country.  The  United States currently has approximately 19,000 depository institutions.  Canada, on the other hand, has far fewer financial institutions but is also  physically large and uses checks extensively.  Private- sector  correspondent banks clear many checks and compete with the central  bank.  The central bank, however, is perceived as a reliable and neutral  intermediary to clear payments and provide settlement on a large scale for  a diverse set of institutions.
Table 4 shows the relative importance of noncash payment instruments in  selected countries.
section_title: Other Factors Influence the Involvement of Central Banks in Retail Payment Systems
paragraphs: A central bank’s role in the retail payment system reflects historical events  and developments that have shaped retail payment systems in a particular  country over many years. For example, the GIRO system serves as a  primary retail payment in many European countries.  The GIRO system was  originally developed by the European Postal agencies, rather than by  banks.  Historically, European banking systems were largely decentralized  and in most cases highly regulated.  Therefore, in the absence of an  efficient payment system for retail payments developed by the banking  industry, payers in most European countries turned to national institutions,  such as the postal service, which offered credit transfers (so-called GIRO  payments) through a nationwide network of branches.  Commercial banks  subsequently began to offer GIRO services.  As a result of these events,  many European countries have well-developed systems that do not rely on  central bank clearing for credit transfers.  These systems were originally  established by the public sector to respond to needs that were not being  met by the private sector.  Similarly, as previously noted, the Federal  Reserve System was established to respond to events that pointed to the  lack of a private remedy to market problems.
section_title: Agency Comments
paragraphs: We received comments on a draft of this report from the Board of  Governors of the Federal Reserve System.  These comments are reprinted  in appendix IV.  Board staff also provided technical comments and  corrections that we incorporated as appropriate.
We are sending copies of this report to the chairman of the House  Subcommittee on Domestic Monetary Policy, Technology, and Economic  Growth; the chairman of the Board of Governors of the Federal Reserve  System; the president of the Federal Reserve Bank of Atlanta, and the  president of the Federal Reserve Bank of New York.  We will make copies  available to others on request.
Please contact me or James McDermott, Assistant Director, at  (202) 512-8678 if you or your staff have any questions concerning this  report.  Other key contributors to this report are James Angell, Thomas  Conahan, Tonita W. Gillich, Lindsay Huot, and Desiree Whipple.
section_title: Objectives, Scope, and Methodology
paragraphs: The objectives of this report are to (1) identify internationally recognized  objectives for payment systems and central bank involvement in those  systems, (2) describe the roles of central banks in the wholesale payment  systems of other major industrialized countries and the key factors that  influence those roles, and (3) describe the roles of central banks in the  retail payment systems of other major industrialized countries and the key  factors that influence those roles.
In analyzing the roles of other central banks in payment systems, we  focused on countries with relatively modern, industrialized economies.  These countries included Australia, Canada, France, Germany, Japan, the  United Kingdom, and the United States.  To identify widely held public  policy objectives for payment systems, we reviewed Core Principles for  Systemically Important Payment Systems, which was developed by the  Committee on Payment and Settlement Systems (CPSS), of the Bank for  International Settlements.  The CPSS established the Task Force on  Payment System Principles and Practices in May 1998 to consider what  principles should govern the design and operation of payment systems in  all countries.  The task force sought to develop an international consensus  on such principles.  The task force included representatives not only from  G-10 central banks and the European Central Bank but also from 11 other  national central banks of countries in different stages of economic  development from all over the world and representatives from the  International Monetary Fund and the World Bank.  The task force also  consulted groups of central banks in Africa, the Americas, Asia, the Pacific  Rim, and Europe.  We also reviewed materials available on the Web sites of  the central banks we studied; these sites often included mission  statements, basic data, and authorizing statutes.  We reviewed a variety of  legal analyses and commentaries to analyze those statutes.  Where we  make statements regarding to central banks’ authorizing statutes, they are  based on these sources rather than on our original legal analysis.
To describe the roles of central banks in the wholesale and retail payment  systems of other major industrialized countries and the key factors that  influence those roles, we reviewed materials available on central bank Web  sites as well as other articles and publications from various central banks.  We reviewed publications available from the Bank for International  Settlements, and also the European Central Bank’s Blue Book: Payment  and Securities Settlement Systems in the European Union.  We also  reviewed numerous articles and commentaries on the roles of central  banks as well as discussions of recent reform efforts.  To enhance our  understanding of these materials, we interviewed Federal Reserve officials,  members of trade associations, and officials from private-sector payment  providers.
We conducted our work in Washington, D.C., and New York, N.Y., between  June 2001 and January 2002 in accordance with generally accepted  government auditing standards.
section_title: The Core Principles for Systemically Important Payments Systems and Central Bank Responsibilities
paragraphs: The core principles for systemically important payments systems (core  principles) are shown in table 5.
The responsibilities of the central bank in applying the core principles are  as follows:
The central bank should define clearly its payments objectives and  should disclose publicly its role and major policies with respect to  systemically important payments systems.
The central bank should ensure that the systems it operates comply with  the core principles.
The central bank should oversee compliance with the core principles by  systems it does not operate and should have the ability to carry out this  oversight.
The central bank, in promoting payment system safety and efficiency  through the core principles, should cooperate with other central banks  and with any other relevant domestic or foreign authorities.
section_title: Different Wholesale Settlement Systems Mitigate Different Risks
paragraphs: Different forms of settlement for wholesale payments result in different  risks.  Various wholesale payment systems in major industrialized  countries use similar means to transmit and process wholesale payments.  However, they sometimes use different rules for settling those transactions.  In general, wholesale payments are sent over separate, secure, interbank  electronic wire transfer networks and are settled on the books of a central  bank.  That is, settlement is carried out by exchange of funds held in banks’  reserve accounts at a central bank.  However, various wholesale payment  systems use different rules for settling these large-value payments.  Some  systems operate as real-time gross settlement (RTGS) systems, which  continuously clear payment messages that are settled by transfer of central  bank funds from paying banks to receiving banks.  Other systems use net  settlement rules, wherein the value of all payments due to and due from  each bank in the network is calculated on a net basis before settlement.  Each form of settling wholesale payments presents different risks to  participants.  Recently, some hybrid systems have been developed, building  on the strengths and minimizing the risks associated with pure RTGS or  netting systems.
subsections: section_title: RTGS Systems Mitigate Systemic Risk
paragraphs: RTGS systems are gross settlement systems in which both processing and  settlement of funds transfer instructions take place continuously, or in real  time, on a transaction by transaction basis. RTGS systems settle funds  transfers without netting debits against credits and provide final settlement  in real time, rather than periodically at prespecified times.  In most RTGS  systems, the central bank, in addition to being the settlement agent, can  grant intraday credit to help the liquidity needed for the smooth operation  of these systems. Participants typically can make payments throughout the  day and only have to repay any outstanding intraday credit by the end of  the day.
Because RTGS systems provide immediate finality of gross settlements,  there is no systemic risk—that is, the risk that the failure to settle by one  possibly insolvent participant would lead to settlement failures of other  solvent participants due to unexpected liquidity shortfalls.  However, as the  entity guaranteeing the finality of each payment, the central bank faces  credit risk created by the possible failure of a participant who uses intraday  credit.  In the absence of collateral for such overdrafts, the central bank  assumes some amount of credit risk until the overdrafts are eliminated at  the end of the day.
In recent years, central banks have taken steps to more directly manage  intraday credit, including collaterization requirements, caps on intraday  credit, and charging interest on intraday overdrafts. Fedwire was  established in 1918 as a telegraphic system and was the first RTGS system  among the G-10 countries.  Presently, account tallies are maintained  minute-by-minute.  The Federal Reserve Banks generally allow financially  healthy institutions the use of daylight overdrafts up to a set multiple of  their capital and may impose certain additional requirements, including  collateral.  In 1994, the Federal Reserve System began assessing a fee for  the provision of this daylight liquidity.  Other central banks have only  recently adopted RTGS systems and have established a variety of intraday  credit policies, such as intraday repurchase agreements, collateralized  daylight overdrafts, and other policies.
section_title: Net Settlement Systems Reduce Liquidity Needs
paragraphs: Other networks operate under net settlement rules. Under these rules, the  value of all payments due to and due from each bank in the network is  calculated on a net basis bilaterally or multilaterally. This occurs at some  set interval—usually the end of each business day—or, in some newly  developed systems, continuously throughout the day. Banks ending the day  in a net debit position transfer reserves to the net creditors, typically using  a settlement account at the central bank.
Net settlement systems, with delayed or end of business day settlement,  enhance liquidity in the payment system because such systems potentially  allow payers to initiate a transaction without having the funds immediately  on hand, but available pending final settlement.  However, this can increase  the most serious risk in netting systems, which is systemic risk.  Recognizing that systemic risk is inherent in netting systems, central banks  of the G-10 countries formulated minimum standards for netting schemes  in the Lamfalussy Standards. The standards stress the legal basis for  netting and the need for multilateral netting schemes to have adequate  procedures for the management of credit and liquidity risks.
Although netting arrangements generally reduce the need for central bank  funds, they also expose the participants to credit risks as they implicitly  extend large volumes of payment-related intraday credit to one another.  This credit represents the willingness of participants to accept or send  payment messages on the assumption that the sender will cover any net  debit obligations at settlement. The settlement of payments, by the delivery  of reserves at periodic, usually daily, intervals is therefore an important test  of the solvency and liquidity of the participants. In recent years, central  banks in countries using net settlement rules have taken steps to reduce  credit risks in these systems as part of overall programs to reduce systemic  risks.
section_title: Comments from the Federal Reserve System
subsections: section_title: GAO’s Mission
paragraphs: The General Accounting Office, the investigative arm of Congress, exists to  support Congress in meeting its constitutional responsibilities and to help improve  the performance and accountability of the federal government for the American  people. GAO examines the use of public funds; evaluates federal programs and  policies; and provides analyses, recommendations, and other assistance to help  Congress make informed oversight, policy, and funding decisions. GAO’s  commitment to good government is reflected in its core values of accountability,  integrity, and reliability.
section_title: Obtaining Copies of GAO Reports and Testimony
paragraphs: The fastest and easiest way to obtain copies of GAO documents is through the  Internet. GAO’s Web site (www.gao.gov) contains abstracts and full-text files of  current reports and testimony and an expanding archive of older products. The  Web site features a search engine to help you locate documents using key words  and phrases. You can print these documents in their entirety, including charts and  other graphics.
Each day, GAO issues a list of newly released reports, testimony, and  correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site  daily. The list contains links to the full-text document files. To have GAO E-mail  this list to you every afternoon, go to www.gao.gov and select “Subscribe to daily  e-mail alert for newly released products” under the GAO Reports heading.
subsections: section_title: Order by Mail or Phone
section_title: Visit GAO’s Document Distribution Center
section_title: To Report Fraud, Waste, and Abuse in Federal Programs
paragraphs: Web site: www.gao.gov/fraudnet/fraudnet.htm, E-mail: fraudnet@gao.gov, or 1-800-424-5454 or (202) 512-7470 (automated answering system).
section_title: Public Affairs