_17_ _Settlement failure and policies to contain systemic risk and daylight overdrafts._ The risks associated with a settlement failure on a wire transfer network differ depending on how payments are settled. On a net settlement network, payments are sent and received during the business day and only the net position of each participant is settled at the end of that day (or the next day). On a real time gross settlement (RTGS) network, each payment sent is settled when it is made. Of the 9 major wire transfer networks outlined in Table 2, 5 have employed net settlement (SAGITTAIRE, EAF, ME, CHAPS, CHIPS) while 3 are RTGS (TBF, SIC, Fedwire). One network handles both net settlement and RTGS payments (BOJ-NET).

Until recently, the failure of a participant on a net settlement network would typically have led to the unwinding or reversal of all of that day's payments and receipts by the failed participant. The remaining participants would then be faced with trying to settle a recalculated net debit or credit position-recalculated after excluding the payments and receipts of the failed participant. This would not be a problem if receivers of funds did not use them-by releasing them to customers-until after the day's transactions were settled. However, because of the float cost of waiting until the next morning to use the funds received, receivers typically use funds before the transactions are finally settled.

If there is an unexpected settlement failure, then it may not be possible for other participants on the network to obtain sufficient funds to settle their recalculated net debit or credit positions. Indeed, in simulations performed for the CHIPS net settlement network using actual payment data (Humphrey, 1986), the increases (decreases) in other participants' net debit (net credit) positions in many cases exceeded their capital levels. Faced with either (a) settling their recalculated payment position by effectively selling or pledging the entire value of their capital or (b) not settling and having their own payments and receipts that day unwound from the settlement, it is clear that the logical choice would be (b).

The possibility of a domino-like series of settlement failures is termed systemic risk. In simulations using CHIPS data, the failure of one randomly chosen participant led to the failure to settle of almost one-half of the over 100 CHIPS (domestic and international bank) participants. It also led to the elimination of around one-third of that day's payments of $885 billion. However, similar simulations for an Italian wire transfer network led to a much smaller number of additional failures and a correspondingly smaller reduction in payment value (Angelini, Maresca, and Russo, 1996). As the value of payments over the Italian network were much smaller, so were the participant net debit/capital ratios. Thus systemic risk is smaller when a country does not have a large and welldeveloped domestic money market (so interbank net debits are not absolutely large) and when a country's banking system is highly concentrated (so that bank capital levels are more likely to cover net debits).

One way to effectively eliminate systemic risk on a net settlement network is to have each participant post collateral sufficient to cover their net debit position. Payment flows would be monitored in real time and payments that would push a participant's net debit above its collateral value would be rejected. If there were a failure to settle, the collateral would be liquidated to obtain a central bank loan to make settlement. CHAPS, established in 1984, plans to have all net debits fully collateralized by 1997. Participants on CHIPS (established in 1971) have since 1990 posted collateral sufficient to cover the single largest net debit permitted to occur on that network. The CHIPS approach eliminates systemic risk if there is a failure to settle by one participant whereas the CHAPS