• Payment Systems

The Role of the Central Bank in Payment Systems

The Role of the Central Bank in Payment Systems 

a.    Regulator

The Central Bank objectives and approach to regulation of the payments system are shaped by the requirement to control risk, promote efficiency and competition in the payments system and it discharges its responsibility through:
•    Licensing of all players in the payment systems space in Uganda and
•    Participating and often taking a lead in the creation of rules and regulations, standards and policies that will govern the nation’s payment, clearing and settlement services.

Objectives of Regulation

Regulation of payment systems is intended to contribute to:
•    controlling Payment systems related risk in the financial system;
•    promoting the efficiency of the payments system; and
•    promoting competition in the market for payment services, consistent with the overall stability of the financial system

Controlling Payment systems related Risk
Principle 3 of the PFMI’s talks about a Framework for the comprehensive management of risks. It states that An FMI should have a sound risk management framework for comprehensively managing legal, credit, liquidity, operational, and other risks. It therefore requires:
•    establishment of risk management policies, procedures and systems to identify, measure, monitor and manage risks.
•    Periodic review of risk management frameworks -Scenarios that may potentially prevent FMI from being able to provide its critical functions
•    Planned Recovery and orderly wind-down
Of key importance in risk management/control is the effort to identify and manage systemic risk. Rochet and Tirole define systemic risk as the propagation of an agent’s economic distress to other agents linked to that agent through financial transactions. Systemic risk in financial markets refers to the risk of a disturbance in one section of the financial market that spreads to other parts of the market. The initial disturbance itself can e.g. be severe liquidity problems or insolvency of a bank and its causes varied. The reason of failure may be confided to the single bank (e.g. a rogue trader) or be caused by macroeconomic variables negatively affecting many banks simultaneously (e.g. reduced collateral values). The initial disturbance may become systemic (a systemic event) when it propagates to other participants of the financial system. A systemic event may undermine the confidence in participants of the financial sector and thus propagate through "investor panics" when creditors simultaneously withdraw their claims. A systemic event may materialise as credit losses and/or liquidity problems and may cause other banks to become insolvent or illiquid. A disturbance of systemic nature may weaken the performance of the financial markets and eventually adversely affect the economy as a whole.

Promoting efficiency
In promoting the efficiency of the payments system, the Bank focuses on three things:
•    technical efficiency – can processes be improved to reduce costs or improve the quality of the product?
•    allocative efficiency – are resources being allocated in the most efficient way across the payments system as a whole?
•    dynamic efficiency – do processes, products and the allocation of resources adjust over time?

Promoting competition
In pursuing competition in the payments system, the Central Bank largely focuses on two areas.
•    First, it seeks to free up any unwarranted restrictions on participation in individual payment systems. Doing so inevitably involves managing the balance between the competition that new participants can bring and managing any additional risks that arise, particularly where new entrants are not subject to the same form of prudential regulation as incumbents.
•    The Bank also focuses on whether the actions of one party – whether a participant in a system or the system itself – are adversely affecting the capacity of another party to compete. The bilateral nature of some Australian payment systems can facilitate discriminatory behavior by participants against other participants. Where payment systems rely on shared infrastructure, it is also possible for one payment system to inhibit the access of another payment system. The principal regulatory tool the Bank has for addressing most of these issues is the imposition of an access regime, although a number of issues have been addressed without the need to take this step.

b. Oversight

Oversight of payment and settlement systems is a central bank function whereby the objectives of safety and efficiency are promoted by monitoring existing and planned systems, assessing them against these objectives and, where necessary, inducing change.

In monitoring the central banks focuses on the following areas
•    Publicly available information
•    Official system documentation
•    Regular or ad hoc reporting
•    Self-assessments
•    On-site inspections
•    Information from other regulators
•    Other sources
Assessment is based on:
•    International Standards (i.e. PFMIs) and
•    Central Bank’s Oversight Standards and Policies
Inducing change
With respect to assessment results, the central bank may be compelled to induce change and in inducing change the central bank may use the following option at its disposal:
•    Moral Suasion
•    Public statements
•    Voluntary agreements
•    Statutory power to require change
•    Sanctions
•    Other means of inducing change
Principles of oversight
•    Transparency
•    International standards
•    Effective powers and capacity
•    Consistency
•    Cooperation with other authorities

c. Operator of payment systems

In Uganda the central banks is an operator of the RTGS, ACH and the CSD. Therefore it offers systems which facilitate transfer of value on gross and net basis and settlement; it also offers final settlement on its books for some retail payment systems like interswitch and ABC. The central bank also provides retail payment services to government.

d. Leadership/facilitator

The central Bank plays catalyst role. Activities range from maintaining contacts with private sector firms, to conducting research on important payments topics, to encouraging and initiating various market outcomes. The central bank sometimes works with other public authorities in their catalyst role and also often draws on its strong relationships with the country’s financial institutions and banking and payment associations.