The views expressed in this presentation are those of the authors and do not necessarily reflect those of the Bank of England

1
The views expressed in this presentation are
those of the authors and do not necessarily
reflect those of the Bank of England
2
The history of interbank settlement arrangements
exploring central banks role in the payment
system

• Ben Norman, Rachel Shaw, George Speight,
• Financial Stability Area
• Bank of England

3
Motivation

• Bank of Englands role in the payment system
  what should it be?
• To inform this
• - evolution of payment systems, focusing on
  interbank clearing and settlement
• - how roles now carried out by CBs featured

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Structure

• Role of CBs today in the payment system
• How clearing and settlement arrangements
  developed over time
• How does central banking fit in to the
  historical development?
• Focusing on role as issuer of outside money

5
Structure

• Role of CBs today in the payment system
• How clearing and settlement arrangements
  developed over time
• How does central banking fit in to the
  historical development?
• Focusing on role as issuer of outside money

6
Role of CBs in payment system (1)

• Most money is commercial bank money
• But the most reliably liquid asset is central
  bank money
• Naturally, banks want to use this to settle
  obligations between them
• CBs like them to use it to settle up
• Implementing monetary policy
• Reducing contagion risk
• Emergency liquidity

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Role of CBs in payment system (2)

• Reflecting this core interest, CBs also
• Own individual payment schemes
• Own and operate infrastructure
• Conduct oversight
• Settlement in CB money seen as natural order of
  things how happened before?

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Structure

• Role of CBs today in the payment system
• How clearing and settlement arrangements
  developed over time
• How does central banking fit in to the
  historical development?
• Focusing on role as issuer of outside money

9
Development of clearing and settlement
arrangements (1)

• What banks clear and settle claims on other
  banks
• Can have banks without having interbank
  settlement!
• Over time, banks increasingly redeemed claims on
  other banks
• - Differs according to payment instrument

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Development of clearing and settlement
arrangements (2)

• Economic pressures for banks to accept claims on
  other banks
• Demand from customers to make bank money more
  liquid
• Accepting bank can issue its own money
• Disciplines other banks

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Development of clearing and settlement
arrangements (3)

• But costs in accepting claims on other banks
• Credit risk
• Clearing the payments
• Holding the settlement asset
• Transferring the settlement asset

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Development of clearing and settlement
arrangements (4)

• But costs in accepting claims on other banks
• Credit risk (frequent settlement rounds)
• Clearing the payments (route payments via
  nodes)
• Holding the settlement asset (netting)
• Transferring the settlement asset (exchange paper
  or book entry claims)

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Cost Credit risk Cost of clearing payments Holding settlement asset Transferring settlement asset
England By 1660s regular (but ad hoc) settlement in London daily from 1775 Country banks London correspondents clearing house in London By 1660s bilateral netting in London multilateral from 1841 By 1775, London banks use BoE notes 1854 BoE deposits
Scotland From 1770s (twice?) weekly settlement, more frequent over time Provincial banks Edinburgh correspondents note exchanges in Edinburgh provinces 1770s bilateral net settlement in note exchanges multilateral by 1870s. Variously specie, commercial bills on London, Treasury bills, and by 1886 drafts on London banks
Canada To 1887 ad hoc bilateral settlement then daily sment in clearing houses 1887 redemption agents in each province Up to 1887 net bilateral settlement then multilateral in each region 1868 settlement in Dominion Notes
US (before Civil War) Suffolk system daily settlement, one-day lag Suffolk a clearing house 1816-1836 Second Banks inter-regional payment services Suffolks multilateral netting service Settlement in deposits at Suffolk
US (National Banking System) Daily settlement in clearing houses Tiered structure of correspondent banking clearing houses in reserve cities Netting across books of correspondents, and in clearing houses Deposits held with correspondents and clearing houses
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Structure

• Role of CBs today in the payment system
• How clearing and settlement arrangements
  developed over time
• How does central banking fit in to the
  historical development?
• Focusing on role as issuer of outside money

15
Clearing and settlement and central banking (1)

• How did CS work before central banks on the
  late C20th model?
• Central bank bankers bank supervisor
  monetary policy note monopoly ?
• Our focus issuer of the most reliably money-like
  asset
• And willing to act as lender of last resort

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Clearing and settlement and central banking (2)

• England
• BoE notes used from early on
• Sufficiently safe to be used instead of gold
• Economies of scope to holding settlement balance
  in same asset as needed in a crisis
• That BoE money used for interbank sment
  contributed to role as quasi-outside money?

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Clearing and settlement and central banking (3)

• US late C19th
• No obvious candidate bank (why not US Treasury?)
• In panics, clearing houses issued quasi-outside
  money central banks
• LoLR function grew out of a pure CS arrangement
  something about providing CS service facilitates
  it?

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Clearing and settlement and central banking (4)

• Suffolk banking system
• Suffolk money did not assume special status
  (though some debate)
• No underlying relative advantage
• And no scope for a joint liability
• Commercial rivalries

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Clearing and settlement and central banking (5)

• Scotland and Canada
• CS not centred on one local bank
• Less need for a LoLR
• Commercial rivalry
• Role of institutions outside of the banking
  system (LoLR and settlement asset)
• Bank of England (esp. after 1845)
• Canadian government Dominion notes

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Conclusion

• If there is an asset close enough to outside
  money, banks likely to use that for settlement
• Economies of scope in a crisis
• If not, banks develop alternative solutions for
  settlement
• May be a link to LoLR function
• But not necessary examples of systems in
  equilibrium without the settlement asset
  developing special status