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Evolution of Payment Systems based on Technological Progress

Masashi NakajimaProfessor

Reitaku University


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1. Payment Systems

1.1 Importance of Payment SystemsPayment system is a mechanism that facilitates smooth transfer of

funds am ong finan cial inst itu tions. Genera lly, it consists of a set of

instruments, procedures, rules and technical bases, like computers and

networks. It sometimes referred as int erbank funds tra nsfer system.

Payment systems 1 are the important social infrastructures that

support t he whole nat iona l economic activities. Every comm ercial tr ade

an d fina ncial t ra nsa ction will be finalized, only when t he final sett lement is

ma de th rough payment systems. If some malfunctions ever happen in a

payment system, which prevent th e smooth tr ansfer of funds, th e na tiona l

economy and finan cial ma rk ets would be thr own int o extrem e confusion a nd

seriously dam aged. Therefore, safe an d efficient payment system s ar e

critical to the effective functioning of national economies and financial

systems.

1.2 Payment Systems and Information Technology

In the early stages, settlements among the banks used to make by

exchan ging paper payment instr uctions. But, as th e number of payments

increased substantially, it became quite difficult to transfer of funds

smooth ly by paper instr uctions and man ua l ha ndling, So, people tr ied to

ut ilize th e inform at ion technology (IT) to payment system . This endeavor

resulted in developing electronic payment systems which were equipped

with comput ers an d networks.

Host comput ers of settlement institut ions a re linked to the t erminals

or compu ter s of th e par ticipan ts via n etworks in electr onic payment systems,.

These systems used to be called electronic payment systems at first, but

the name shortly became obsolete and these systems came to be called

simply as payment systems, since most major payment systems became

1 Pa yment systems a re genera lly divided into two cat egories: lar ge-value paymen t

systems and retail payment systems. Large-value payment systems facilitat e

paymen ts, genera lly of very lar ge am ount s, which ar e mainly excha nged between bank s

and usua lly require urgent and timely settlement. Retail payment systems han dle

ma inly consu mer paymen ts of relat ively low value an d urgency. As large-value

paymen t syst ems ar e the most significan t pa yment s ystems for t he na tional economy,

hereinafter payment system means large-value payment system in th is chapt er, if nototherwise specified.


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electronic.

In Japan, it was April of 1973 for the Zengin System, October 1988

for BOJ-NET and March 1989 for the FXYCS to become electronic paymentsystems.

2. Evolution of Payment Systems

Dur ing th e past fifteen year s, payment systems h ave evolved in step

with the progress of inform at ion technology. In th e ear ly days, electr onic

paymen t systems could m ake net ting pr ocessing only once a da y an d pr ocess

payments in ra th er simple man ner. Gradu ally, payment systems have

become to be capable of real-time settlement, continuous processing and

ha ndling of payment s with complicat ed algorit hm s.

2.1 From DTNS to RTGS

(1) DTNS System and RTGS System

The first evolution of payment systems wer e observed in th e systems

th at were opera ted by cent ra l bank s. The evolut ion was from the DTNS

systems t o th e RTGS systems.

In many countries, when the electronic payment systems were

int roduced, they were th e Designat ed-Time Net Sett lement (DTNS) systems.

The DTNS is a net sett lement syst em, th us t he sett lement of fun ds occur s on

a net basis. In concrete term s, a net position of each par ticipat ing bank is

calculated, which is defined as the sum of the value of all the transfers a

par ticipant has received up t o a part icular point in time minu s th e value of

all tr ansfers it has sent . The DTNS is a designated-time settlement system,

in which final sett lement ta kes place at a cert ain t ime, usua lly at th e end of

th e day. In short , fina l sett lement of net positions occur s at t he end of th e

day in th e DTNS system.

On t he other h an d, the Real-Time Gross Settlemen t (RTGS) systems

ha ve two feat ur es. The first featu re is th at t he sett lement of funds occur s

on a gross basis, which means payment instructions are processed

one-by-one basis without net tin g. The second feat ur e is final sett lement is

ma de on a rea l-tim e basis dur ing th e day. Thu s th e paymen ts become final

immediately.


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(2) Merits of RTGS System

The RTGS system is superior in reducing settlement risks to the

DTNS system. Settlement risk is the risk that pa rt icipant of paymentsystem su ffer a loss becau se oth er pa rt y does not ma ke paymen ts a s expected.

Sett lement risk includes credit r isk, liquidity risk, legal risk, opera tional risk

and systemic risk.

The DTNS system tends to be vulnerable to settlement risks.

First ly, unsett led payment instr uctions a ccum ulate unt il the end of the day

in the DTNS system . Therefore, un til th e final settlemen t is completed at

th e end of th e day, th e sett lement r isks still exist. On the oth er han d, th e

RTGS system processes each payment instruction one-by-one and makes

th em final durin g th e daytim e. Thus , th e RTGS system can effectively

reduce th e sett lement risk.

Secondly, systemic risk is the keyword. This is the risk t ha t t he

failure of one participant to meet its required obligations will cause other

par ticipan ts to be un able to meet th eir obligations when due. Such a failur e

may cause widespread liquidity or credit risk problems and, as a result,

might th rea ten th e sta bility of finan cial ma rk ets. As overseers of paymen t

systems, cent ra l ban ks ar e par ticularly concerned with systemic risk. The

DTNS system ha s potent iality of system ic risk, becau se if one pa rt icipant is

un able to sett le its n et debit position, th e payment system h as t o recalculat e

a n ew set of net positions for ea ch of th e rem ainin g par ticipan ts by deleting

th e tr an sfers involving defau lt par ticipan t. This procedur e is called

un winding. The un winding could lead to un expected cha nges to th e net

positions of remaining participants, which could result in further knock-on

effects or a cascade of sett lement failures. On th e oth er ha nd, ther e is no

possibility of systemic risk in the RTGS system, because each transfer of

funds becomes fina l inst an tly dur ing th e day and n o need for u nwinding.

Hence, the RTGS system is more robust to sett lement r isk tha n t he

DTND system. However, the elimina t ion of r isk comes at t he cost of an

increased deman d for int ra day liquidity. This is only th e demer it of RTGS.

Due to make up for such liquidity demand, central banks usually provide

intr aday credit to th e part icipants in th e RTGS system. Even th e intr aday

credit is provided with no fee, the in tr ada y liquidity is n ot cost-free, becau se

collater al is r equired for th e int ra day credit, which leads t o collater al cost.


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(3) Introduction of RTGS System

By 1985, th ere were only thr ee coun tr ies tha t implemen ted t he RTGS

system; nam ely, United Sta tes, Denmar k and Nether lands. Fr om the lat e1980s, th e nu mber of RTGS system s increa sed gra dually especially in

industrialized countries, which include RIX in Sweden (1986), SIC in

Switzerlan d (1987), EIL-ZV in Ger ma ny (1988) an d BI-REL in It aly (1989).

In E ur opean Un ion (EU), th e RTGS system spread r apidly in th e late

1990s. It was becau se th e TARGET 2 system was planned to accommodate

th e Economic an d Monet ar y Un ion (EMU). TARGET is the payment

system for th e whole eur o area an d be developed by conn ecting t he pa yment

systems of each member coun tr y. The cent ra l ban ks of EU were obliged to

adopt t he RTGS system as a precondition t o link t o the TARGET system. F or

th is purpose, they reconstr ucted their payment systems a s th e RTGS system

in 1996-97 one a fter a nother.

Influenced by these movements, some Asia-Pacific countries also

int roduced t he RTGS system s in la te 1990s, which included t he BOK-Wire in

South Korea (1994), the BAHTN ET (1995), th e CHART in H ong Kong (1996),

the MEPS in Singapore (1996), RITS in Australia (1998), and the EAES in

New Zealan d (1998).

The use of the RTGS also grew outside industrialized countries.

Some countries in Eastern Europe, Latin America, Middle East, and Africa

were similar ly reported to ha ve th e RTGS systems. Some of th ese coun tr ies

were char acterized to const ru ct t he electr onic payment systems from scra tch

as a RTGS system. According to the sur vey of Feder al Reserve Ban k of New

York , 90 out of the 174 coun tr ies in th e world a dopted a RTGS system a t th e

end of 2005 (Bech & Hobijn 2006). By this mean s, the adoption of RTGS

system becam e th e global tr end of paymen t syst ems.

(4) Adoption of RTGS in Japan

The adoption of th e RTGS system in J apa n is ra th er special. When

th e Bank of J apa n (BOJ ) developed the BOJ -NE T in 1988, th e BOJ-NET ha d

two modes; th e DTNS mode an d th e RTGS mode. Some argues th at t he

RTGS system was int roduced to th e BOJ-NET a t t ha t point (Bech & Hobijn

2 TARGET (Trans-European Automated Real-time Gross settlement Express Transfer)

system. TARGET links th e RTGS systems of EU coun tr ies to facilita te the

cross-border sett lement of Eu ro. Only RTGS systems were permitt ed to be linked toTARGET system becau se TARGET was d esigned as a RTGS system a s a whole.


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2006). But actua lly, th is wan not th e case. The RTGS mode was seldom

used3 by part icipant s due t o th e liquidity cost, an d we should conclude t ha t

the characteristic of old BOJ-NET was basically the DTNS system then.The BOJ changed the BOJ-NET into the RTGS system by abolishing the

DTNS mode in J anu ar y 2001. At this moment, the BOJ-NET was

tr an sform ed from t he de facto DTNS system int o th e real RTGS system.

Table 1 Timing of th e int roduction of RTGS system in selected coun t ries

Figur e 1 Num ber of coun tr ies th at adopt th e RTGS system

2.2 Hybrid System

(1) Feature of Hybrid System

The second evolution of payment system was emergence of Hybrid

System. The Hybrid System mea ns th e combina tion of th e best feat ur es of

th e DTNS system a nd t he RTGS system.

The Hybrid System derived from the DTNS system, in which final

sett lement t ak es place only once at t he end of th e day. In th e Hybrid

System, net settlements ar e made a t frequent intervals or cont inuously and

tr an sfer of fun ds become final at th e tim e of frequen t net sett lement s. The

DTNS ha s a disadvan ta ge th at tr an sfer of funds become fina l only at t he end

of the day, even though it has an advantage that settlement can be made

with sma ll liquidity only for th e net position. With t he frequen t net

settlement, the Hybrid System keeps the merit of the DTNS system, i.e. the

sett lement capa bility with sm all liquidity, and a dditiona lly rea lizes th e merit

of th e RTGS, th at is early finality. Tha t is th e rea son why this system is

called Hybrid System. This system is also somet imes referr ed as the

Cont inuous Net Set tlemen t (CNS) system, compa red t o th e DTNS system.

3

In Sept ember 2000, only 0.1% in t erms of am ount was pr ocessed by th e RTGS mode,th e rest were han dled by the DTNS mode.


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(2) Examples of Hybrid System

The first Hybrid System in th e world was EAF2 in Germ an y. It

becam e Hybrid system from th e DTNS system in Mar ch 1996. In EAF2,bilateral netting settlements were made every twenty minutes in the

morning session a nd t wo mu ltilat eral nett ing sett lement s were made in th e

after noon session. The sett lement s becam e fina l at each net tin g sett lement .

Following EAF2, LVTS in Can ada , PNS in F ra nce, an d CHIP S in US

becam e Hybrid during 1999-2001. In th ese systems, net ting was made

cont inuously based on t he sett lement event , like receipt of new paymen t a nd

addit ion of liquidity, instea d of at r egular t ime int ervals. In th is way, th e

adoption of the Hybrid system for net settlement systems became the trend

in industrialized countries.

The CHIPS is the latest and the most advanced Hybrid System, in

which the system judges the capability of net settlement for each payment

inst ru ction, an d net sett lement is made cont inuously, if possible. The

system, which is called balanced release engine, selects the processing

mode from the three types: individual release, bilateral release and

multilateral release, according to the available balance of payer and payee

an d incoming and out going paymen t situa tion. Bilat era l release is just like

bilat era l net ting between two par ticipan ts. Multilat era l release is a kind of

mu ltilat eral netting among more th an t hr ee part icipants.

Even though these systems belong to the same category of Hybrid

System, the processing method of the payments has been progressed in

accordance with the technological progress.

(3) Situation in Japan

In J apa n, the FXYCS is still opera ted as a simple DTNS system. We

find ourselves with no choice but to feel uneasy to look at the out-of-date net

set t lemen t system . To our r elief, however, th e project is going on to enh an ce

th e FXYCS and redu ce the settlemen t r isk. This project will be described

below.

Table 2 Int roduction of Hybrid System in selected coun tr ies


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2.3 Integrated System

(1) Feature of Integrated SystemNext evolution of payment system was the transition to the

Int egra ted System. The Int egra ted System is defined as the payment

system which has both the RTGS function and the Hybrid function.

Pa rt icipants of the Int egra ted System can u se both functions a s th e situat ion

dema nds. For exam ple, par ticipan ts can use th e RTGS fun ction for th e

urgent payment and time-critical payment, while they can use the Hybrid

function for non-ur gent payment . The Hybrid fun ction perform s cont inuous

or frequent settlement and is often referred as liquidity saving mode,

because pa rt icipants can execut e th eir payment with sm all balance in t heir

deposit a nd can save th e liquidity.

(2) LVTS in Canada

The pioneer of the Integrated System was the Large Value Transfer

System (LVTS) in Cana da. The LVTS sta rt ed its opera tion in Febru ar y

1999. The LVTS ha s two functions of paymen t. One is called Tran che 1,

which is the RTGS mode. The oth er is called Tra nche 2, which is th e

liquidity saving mode. Pa rt icipant s can select either Tra nche 1 or Tra nche

2 and send t heir payment instru ction t o th e appropriate Tra nche.

(3) PIS in France

The second In tegrat ed System was th e Par is Integrat ed System (PIS)

in Fr an ce. Fr an ce ha s two large-value paymen t systems of Eu ro. One is

th e Pa ris Net Settlement (PNS), which became the Hybrid System from th e

DTNS system in April 1999, operated by CRI 4. Another is th e Tra nsferts

th e Banqu e de Fra nce (TBF), which is th e RTGS system operat ed by Banqu e

de Fra nce. In Apr il 1999, CRI developed liquidity bridge between t he TBF

an d the PNS. Liquidity bridge is th e scheme that pa rt icipants can tr ansfer

liquidity between the two paymen t systems at an y time of th e day. In th is

way, although t he PNS and th e TBF a re t wo payment systems, th ey became

4 Centrale des Rglements Interban caires. Created in J anu ary 1995, CRI man ages

th e PNS. The shareholders of CRI are French credit inst itut ions and Banque de

France.


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closely linked. So even th ough th ese ar e two independent pa yment systems,

th ey look to th e par ticipan ts as one combined payment system . Therefore,

th ese two systems ar e called PIS (Par is Integrat ed System) as a whole andregarded as a kind of Int egra ted System.

(4) RTGSplus in Germany

The RTGSplus in Germany was the third Integrated System, which

sta rt ed opera tion in November 2001. RTGSplus ha s t wo modes; EX payment

mode an d Limit payment m ode. The EX paymen t mode is th e RTGS

sett lement for high priority paymen t. And the Limit payment m ode is

liquidity saving element with cont inuous offsett ing sett lement . When a

payment instru ction is sent to the system, a special algorith m searches the

central queue to see if some set of payment instructions might offset each

oth er. Once such a set of paymen t inst ru ctions is foun d, th ese inst ru ctions

ar e sett led in the form of offsett ing. Offsett ing mea ns th e simu ltan eous

booking of outgoing payment and incoming payment, and the effect of the

offsett ing is quite similar t o th e net tin g. In th e Limit payment mode,

par ticipan ts can set sender limit bilat era lly or m ult ilater ally to cont rol th eir

own liquidity. Pa rt icipant s can ma na ge th eir liquidity in a single liquidity

pool an d can use t wo modes accordin g to th e priority of th e paymen t.

(5) TARGET2

In EU, there is a project to reconstruct the decentralized TARGET

and make it into the system with common infrastructure, which is called

TARGET2. The TARGET is plan ned to sta rt operat ion in November 2007.

Advanced features of RTGSplus, new BI-REL and PIS are planned to be

tr ansplant ed to the TARGET2. Thus, it is designed as an Integrated

System with RTGS mode an d liquidity saving mode. In addit ion, new

features would be introduced in the TARGET2, including liquidity control

with sender limits, prioritization of payments, and liquidity reservation for

ur gent payment . Thu s, th e TARGET2 would be th e one of th e most

advan ced payment syst ems, tra nsform ed from th e simple RTGS system.

Table 3 Int roduction of Int egrat ed System


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3. Next-Generation RTGS Project in Japan

The Bank of Japan (BOJ) plans to enhance its RTGS system to asophist icat ed system. This project is called Next-Gener at ion RTGS

(RTGS-XG) project of the BOJ-NET.

3.1 Background of the RTGS-XG Project

In Japan, there are three payment systems: the Bank of Japan

Financial Network System (BOJ-NET5), th e Foreign Exchange Yen Clear ing

System (FXYCS), and the Zengin Data Telecommunication System (Zengin

System). The BOJ-NET is opera ted by th e BOJ , an d two privat e-sector

paymen t syst ems, th e FXYCS an d th e Zengin System, ar e opera ted by Tokyo

Ban ker s Associat ion (TBA).

The BOJ-NET is the RTGS system and mainly used for the funds

tr ansfers for m oney mar ket t ran sactions a nd govern ment bond t ra nsactions,

settlement of net positions of private-sector netting systems, and funds

tr an sfers ar ising from BOJ s open ma rk et opera tions. Pa yment

instr uctions pr ocessed in th e BOJ-NET a re m ainly inter-bank tr ansa ctions

an d ar e very high value payment s. As mentioned above, th e BOJ -NE T

became t he RTGS system form th e DTNS system in J anu ar y 2001.

The FXYCS is basically a DTNS system that handles yen payments

to sett le foreign excha nge tr ades. Most of th e tr an sactions tha t are

processed by this system are yen leg settlements of foreign exchange

tr ansa ctions and intern at ional treasur y settlements. The FXYCS has the

RTGS mode as well as t he DTNS m ode, although t he u se of the RTGS mode,

which includes the sett lement for CLS ban k, is quit e limit ed.

The Zengin System is a nationwide electronic fund transfer network

ma inly for cust omer payment s. Almost all fina ncial instit ut ions in Ja pan ,

more than 2 thousand institutions, are participants of the Zengin System

an d use this system ma inly for cust omer paymen ts. As ma ny of th e

payments made through this system are consumer and commercial

payments, th e tr ansa ction volume ar e huge, but amount of each payment is

ra th er small. In addition to single payments, the system also support s

5 The BOJ-NET compr ises two systems : a system for funds t ra nsfer (BOJ -NE T Fun ds

Tran sfer System) and a system for the settlement of Ja panese Government Bonds

(BOJ -NET J GB Services). In th is cha pter, BOJ -NET Fu nds Tra nsfer System (FTS) isreferred simply as BOJ -NE T.


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bat ch payment s, such as payroll an d pension payment s. The Zengin

System is a DTNS system, whose final set tlemen t of net positions t ak es place

at th e end of th e day at th e curr ent a ccount of th e BOJ .The BOJ-NET and the FXYCS are mainly for the interbank

payments and char acterized as lar ge-value payment systems. On the oth er

ha nd, the Zengin System is ma inly for th e customer payment s an d regarded

as a retail payment system. But, we have to pay some atten tion tha t some

lar ge-value payment s are also processed in the Zengin System . Tha t is

because of a historical reason; international related payments are assigned

to the FXYCS by law, and domestic payments are handled by the Zengin

System.

3.2 Outline of the RTGS-XG project

The RTGS-XG pr oject cons ists of two sub-project s. The first

sub-project is to add liquidity-saving featu res (LSF) to th e pur e RTGS mode

of th e BOJ -NET. The second sub-pr oject is to incorp orat e lar ge-value

payments currently handled by two private-sector DTNS systems, the

FXYCS an d th e Zengin System, int o th e new RTGS system with t he LSF.

(1) Sub-project A

The sub-project A is to add t he LSF int o th e BOJ -NE T. The LSF

consist s of Centr alized Queu ing Fu nction a nd Offsett ing Fu nction.

i ) Centralized Queuing Function

As th e cur ren t BOJ -NE T doesnt h ave cent ra lized queue, if a sen ding

bank doesnt have enough liquidity at th e cur rent accoun t a t th e BOJ, th e

payment instruction is rejected by the system and send back to the bank.

Once centralized queue is constructed in the BOJ-NET, the payment order

that is not covered by adequate liquidity would be suspended in the queue.

Each participant can actively control the payment instructions in the queue

for the efficient settlement, which includes monitoring, setting the priority,

reordering an d can cellat ion of th e payment inst ru ctions.

ii ) Offsetting Function

Offsetting means the simultaneous processing of outgoing and

incomin g paymen t order s. The offsett ing algorit hm sear ches for the


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participants who have submitted payment orders for each other, and

calcula tes the net inflow an d out flow. If th e net out flow ha s sufficient cover,

which m eans t he credit balance of the debited par ticipant is lar ger th an th enet outflow, the system process the incoming and outgoing payment order

simu ltan eously. The out come of th e offsett ing is exactly th e same as t he

netting of the two payment orders. Only the difference is whether two

individua l payment order s ar e processed or a net am oun t is processed.

In the RTGS-XG project, two kinds of offsetting are planned to be

int roduced. One is bilat era l offsett ing, in which paymen t order s are

processed between the two par ticipan ts. Bilat era l offsett ing is regar ded as

the main function for settlement, and the algorithm will run when certain

movemen ts t ake place in th e system, including subm ission of a n ew payment

instruction, increase in credit balance, and settlement, reordering or

can cellat ion of a top-queu ed paymen t. The oth er is mu ltilater al

offsetting, in which payment orders are processed among more than three

par ticipan ts. Multilat era l offsett ing is regar ded as th e complemen ta ry

function to the bilateral offsetting, and the algorithm will run at designated

t imes of the day. The execution times of mu ltila ter al offsett ing will be set

when there are fewer events initiating bilateral offsetting, since while the

multilateral algorithm runs, the receipt of the new payment orders will be

suspen ded. With th ese two offsett ing functions, rea l-tim e gross sett lement

will be possible in a faster pace with less liqu idity.

iii ) LSF account

Participant who wants to use the LSF should open the special

accoun t , th e LSF account , in th e RTGS-XG. The LSF account is

independent from th e cur ren t a ccoun t of th e BOJ -NE T, thu s each pa rt icipant

should ma na ge the liquidity of two accoun ts 6.

Par ticipant can tr an sfer th e liquidity at a nytime during the daytime

between th e cur ren t accoun t and the LSF accoun t. Alth ough the overdra ft

is not a dmit ted at th e LSF accoun t, par ticipan t can obta in liquidity from th e

BOJ th rough th e overdra ft facility at th e cur ren t accoun t. While th e

opera tin g hour of the cur ren t accoun t is from 9:00 to 17:007, participant can

6 Reasons to set up indepen dent LSF account include t he considera tions for t ra nsa ction

processing perform an ce an d for sm ooth system development.7 Par ticipant can extend the operating hour unt il 19:00 with a perm ission of th e BOJ.


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use th e LSF accoun t from 9:00 to 16:30. At 16:30, all the balan ces at t he

LSF accounts will be automatically transferred to the current accounts,

which mea n t he balan ce of th e LSF will be zero at th e end of th e day. Ifth ere ar e some rema ining payment orders in t he queue at th e end of the day,

these orders will be cancelled automatically.

The incomin g and out going paymen t to/from a LSF a ccoun t should be

processed only against th e LSF a ccoun t of oth er pa rt icipant s, an d cant be

processed against t he cur ren t accoun ts of oth er par ticipan ts.

Most t ra nsa ctions between par ticipan ts can be processed th rough th e

LSF. Although some tr an sactions should be execut ed only at t he cur ren t

account, which includes the transaction involving the BOJ and the

government, net settlement of clearing systems (Bill and Check Clearance

and Zengin System), the Delivery versus Payment (DVP) settlement of

J apa nese Governm ent Bonds (J GB) an d corpora te bonds.

(2) Sub-project B

i ) Current situation of large-value payment in Japan

The large-value payments in Japan are divided into three payment

systems. First of all, th e BOJ-NET is the main settlement channel of

lar ge-value paymen ts a nd set tled 88.3 tr illion yen on a da ily avera ge basis in

2005. The second one is th e FXYCS, which han dles ma inly foreign

excha nge related payment s. The FXYCS sett led 16.4 trillion yen per day in

2005. The last one is th e Zengin System , which is usu ally regar ded as a

ret ail paymen t system. However, a par t of paymen ts in Zengin System,

0.2% of tota l volume, ar e large-value paymen ts t ha t a re 100 million yen a nd

up . These 0.2% lar ge-value paymen ts account s for 65% of tota l value, which

is equivalent t o 6.2 tr illion yen per day in 2005.

These divided lar ge-value payment s lead to some issues. Fir st of all,

despite t he Zengin System is char acterized as a reta il payment system and

deploys the risk management scheme for small value payment, the System

also handles large-value payments and there is a mismatch between the

payments an d the risk ma nagement. Secondly, th e Zengin System and th e

FXYCS ar e both th e same kind of paymen t system , i.e. the DTNS at th e end

of th e day. It used to be th e request of th e law8 to divide foreign exchange

8 Foreign Excha nge an d Foreign Tra de Cont rol Law us ed to strictly restr ict t he foreign


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relat ed payment s from domest ic paymen ts, but th e law was r adically revised

in 1996 an d there is no need for th e distinction an y more. This

environmental change created the duplication as a result, more specifically,to opera te t he t wo sam e kind of end of day net sett lement systems.

ii ) Consolidation of large-value payment flows

The sub-project B of the RTGS-XG project is to incorporate

large-value payments on the FXYCS and the Zengin System into the

BOJ -NET. The two benefits are pointed out for incorpora ting the payment s

in th e privat e-sector DTNS systems int o th e BOJ -NE T. Fir stly, par ticipan ts

can obta in int ra day finality with th e cont inuously sett lement of th e LSF. It

is a significan t r isk mit igat ion compa red t o the curr ent scheme of end of day

fina lity in the pr ivate-sector system s. Second ly, the RTGS-XG achieves

great er efficiency in liquidity usa ge. The LSF can sa ve the liquidity by

offsetting the outgoing payment and incoming payment compared to the

pur e RTGS system, in which a ll th e settlemen t is ma de on gross basis.

The FXYCS payment will be forwarded to BOJ-NET via FYXCS.

And DTNS mode of FXYCS will be abolished. As for t he Zengin System , a

newly developed interface will pick up the large-value payments and send

them to the BOJ-NET, while the remaining small-value payments are

processed in the Zengin System as th e DTNS. When th e int erface sends

large-value payments to the BOJ-NET, only interbank payment information

will be sent, while cust omer inform at ion will be kept in t he Zengin S ystem.

Figu re 2 Consolidat ion of lar ge-value paym ent flows

3.3 Implementation timetable

Ph ased implemen ta tion is plann ed for the RTGS-XG project. In the

phase 1, development of the LSF an d modificat ion for F XYCS will be rea lized

an d th e new system a re plan ned to be laun ched in fiscal year9 2008.

In the phase 2, modification for large-value Zengin payments,

excha nge tran sactions. In 1996, th e law was dras tically revised an d foreign excha nge

tr ansa ction was fully deregulated.9

J apan ese fiscal year st art s in April and finish at the end of March of the next calendaryear.


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including the development of interface to the BOJ-NET, will be completed in

2011, when th e next u pgradin g of the Zengin System is plann ed.

3.4 The RTGS-XG project and the global trend

Lets discuss the cha ra cterist ics of th e RTGS-XG from th e perspect ive

of the global t ren d of paymen t systems.

(1) Integrated System

Since 2001, th e BOJ -NET ha s been the pure RTGS system . The

RTGS-XG will ha ve two modes for sett lement . At t he cur ren t accoun t,

participant will be able to make a simple RTGS, just as the same as the

cur ren t BOJ -NE T. This mode can be called as pure RTGS mode. On th e

oth er h and, a t th e LSF a ccoun t, real-time settlement with liquidity saving

featu re will be possible. The lat ter m ode, liquidity saving mode, can be

regarded as a Hybrid mode, where offsetting will be executed on a

cont inuous ba sis.

Having both RTGS mode and Hybrid mode, the RTGS-XG will be

defined as an Integrat ed System as a whole. Pa rt icipant can select th e

mode of sett lement according to th e cha ra cter of th e paymen t. It is

expected that most of the payment will be made in liquidity saving mode,

because participant will be able to make settlement with fewer liquidity,

which mean s th e cost-saving for th e par ticipan t. As for the urgent pa yment

or time-critical payment, such as a payment to the Continuous Linked

Settlement (CLS) Bank, it is expected to be processed in the pure RTGS

mode. Also some tra nsa ctions, including BOJ an d governm ent relat ed

transaction and DVP settlement of JGB, will be assigned to the pure RTGS

mode.

The RTGS-XG will be one of the cutting edges of the world payment

system, along with TARGET2 in EU an d LVTS in Can ada .

(2 ) Two-account system

The RTGS-XG will have two separate accounts in one system: the

cur rent a ccount a nd the LSF account . Par ticipant will have to monitor and

ma na ge th e two liquidities in each accoun t dur ing th e day. In some

Integrated Systems, like RTGSplus

in Germany, single liquidity pool is


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adopted, and participant can control the liquidity in the single account.

Single liquidity pool would be more user-friendly than two-account system.

But, the RTGS-XG will allow participants to transfer the liquidity flexiblybetween th e two accoun ts dur ing th e day. Thu s, it is presu med tha t

ma na gement bur den of two liquidity would not be significan t. It is

appa ren t wh en compa red t o th e case of th e EAF2 in Germ an y, which a llowed

tr an sferr ing th e liquidity only once every h our.

In terms of two accounts, the RTGS-XG has similar structure to the

PIS in France, where liquidity bridge combines the PNS account and the

TBF a ccoun t.

(3) Offsetting system

The RTGS-XG will adopt the offsetting scheme as well as RTGS plus

an d TARGET2. As ment ioned ear lier, th ere is not much difference between

net tin g an d offsett ing, with regar d to th e out come of th e processing. In both

cases, th e net position of out going paymen t an d incoming pa yment would be

added or debited from th e pa rt icipan t s accoun t . Only th e differen ce is

whet her both incoming a nd out going paymen ts ar e processed individually or

th e net am ount is processed.

4. Mechanisms that support the advanced payment systems

With the development of IT, payment systems have been evolved

grad ua lly to th e sophist icat ed processing schem e. Some mecha nisms which

support th e advan ced paymen t syst ems a re described below.

4.1 Frequent netting and continuous processing

When the DTNS system was developed, most systems executed

net ting only once a da y, mostly at t he end of the da y, due t o the const ra int of

compu ter capacity. Fu rt her more, in some system s, it took such a long time

to calculate t he net ting positions of all par ticipan ts t ha t t hey could not m ake

th e final settlement on th e day and th e final settlement of the net position

was ma de on t he next day10.

In recent years, thanks to the enhanced processing capability of

computer and other technical progress, frequent netting became possible,

10

For example, the Zengin Syst em was chan ged over from th e next-day settlemen tsystem to th e curr ent-day settlement system in March 1993.


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which lead to th e emer gence of th e Hybrid System . Fr equency of net ting

progressed from net ting with regular int ervals to cont inuous net ting. The

latt er pr ocess nett ing consta nt ly when some sett lement events happen, suchas addit ion of liquidity, new pa yment order or cha nge of sender limit .

4.2 Partial netting

In the DTNS system, the full netting was executed, in which all the

payment instructions in the system was included to calculate the net

positions.

Due t o the pr ogress of IT, th e par tia l net tin g becam e possible, which

execute the netting only for the some payments extracted from the queue.

Partial netting includes the bilateral partial netting between two

participants and multilateral partial netting among more than three

par ticipan ts. Liquidity saving mode was realized with th e capa bility of

partial n etting.

In some systems, bilateral and multilateral partial netting are

tr eated separ at ely. For example, bilatera l netting is regar ded as a ma in

function and is run during the day, and multilateral netting is regarded as

supplemen t way an d is execut ed at certa in time or when gridlock ha ppens.

4.3 Searching and matching facility

Techn ology progres s ma de it possible to sear ch some app ropr iat e pair

of paymen t inst ru ctions in th e queue based on t he conditions of paymen t a nd

liquidity. Such conditions include liquidity situ at ion of th e sender, ava ilable

valance of the receiver, sender limit, credit limit of the receiver and so on.

The searching engine can find out and match the appropriate pair of

paymen ts to be net ted or offset. In addition, th e sear ching and mat ching

can be made for the vast number of payments in the queue as quick as a

flash . This capa bility of swift searching an d ma tching resu lted in invent ing

th e liquidity sa ving function.

4.4 Queue Management

Queue is a scheme whereby payment instructions are held pending

according to certain rule until sufficient cover is available in the account of

th e sender. In a few RTGS systems, there ar e no queuin g mechan isms, like

th e cur rent BOJ -NET. But most RTGS systems have centr al queue to


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bett er cont rol paymen t flows. By accum ulat ing th e un sett led paymen ts in

the queue, the system is capable of extracting some of them and netting

them or the participants can control his payment flow and liquidityeffectively.

(1) Processing rule of the Queue

The most basic rule of queue processing is first-in first-out (FIFO).

In t he FIF O rule, payments a re waiting in order of ar rival to th e system, and

th e processing would be tr ied in order from t he t op paymen t in t he queu e.

Recently, diversified rules other than the FIFO are observed, which

include th e Bypass FIFO an d the first -available, first -out (FAFO). In th e

Bypass FIFO11, when the first payment in the queue does not satisfy the

condit ion of settlement , th e second paymen t would be t ried t o be processed.

In the RTGSplus of Germany, the strict FIFO rule is adopted for the EX

Payment mode and the Bypass FIFO rule is applied to the Limit Payment

mode. The FAFO ru le tr ies to execut e as ma ny payment s as possible to

sett le, regar dless of th e order in th e queue. In some system s including new

BI-REL in Ita ly, the FAFO r ule is applied instea d of th e FIFO r ule at th e end

of th e day in order to process the u nset tled paymen ts a s ma ny as possible.

(Table 4) Processing r ule of the Qu eue

(2) Advanced queue management functions

It is the tendency of newly designed payment systems to add the

queue management functions which enable participants to actively control

payment in the queue. These advanced queue mana gement functions

include 1) prioritization of payments, 2) reordering of payments, 3) timed

paymen ts, an d 4) optim izat ion.

Prioritization is to add priority code to each payment to assign the

priority in th e queue. Once th e paymen ts with high priorit y ha s processed

and deleted from the queue, the payments with low priority starts to be

processed.

11

This is the scheme which a voids the situ ation th at th e first large payment blocks allthe other payments.


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Reorder ing mea ns the cha nge of th e order in the queue. For

example, when t he str ict FIFO r ule is applied an d th e large payments on the

top block all the payments, it is possible to promote the processing of thepaymen ts by put t he top payment to the lower order tem pora lly.

Timed payment is a function to appoint the execution time for each

paymen t. This fun ction includes till paymen t fun ction which appoint s the

finish t ime, and from paymen t fun ction which a ppoints t he st ar tin g time.

Optimization is a mechanism which promotes the processing of

unsettled payments in the queue, typically when a gridlock situation

ha ppens. When t his mechan ism is executed, th e FIFO is usually substituted

by the FAFO and promote the processing as many payments as possible

regardless of th e orders in the queue. The system operat or put t he

optim ization in motion a t regular tim e of th e day or when gridlock comes u p.

These queue management functions heavily depend on the real-time

capability of monitoring and controlling of payments in the queue by

par ticipan ts, which a re r ealized by ut ilizing int era ctive network.

4.5 Pre-funding Account

It is often the case that advanced payment systems have special

accoun ts for sett lement . Pa rt icipant s ha ve to ma ke pre-fun ding; to put th e

fund t o th e accoun t for t he sett lement for t he da y at th e beginning of th e day.

The DTNS system is based on the concept of pay later, in which

par ticipant should pay th e net debit position t hat was calculated a t th e end

of th e day. The DTNS system requires some risk mit igat ion arr an gements

including t o set sender limit an d t o pledge collater al, becau se th ere ar e some

possibilities of defau lt in th e pay lat er scheme. In th e pre-fun ding system,

as set tlemen ts a re pr ocessed using the fund pa id in ad vance, th ere is no need

for the risk mitigation arrangement, which would reduce the risk

ma nagement bur den for th e participants.

However, it should be noted that pre-funding scheme is workable

only in the payment system which have the considerable high speed of

circulation of liquidity in th e system . If pre-fun ding schem e is int roduced to

the payment system with inefficient liquidity circulation, huge amount of

funds should be paid in advance, which is the big burden to participants.

For example, in CHIP S, the sett lement a mount of th e day is 500 to 600 times

of th e initial fun ding am oun t. Thus, pre-fun ding an d efficient circulation of


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liquidity ar e closely conn ected each oth er.

4.6 Multiple Functions in Single Payment SystemHistorically, it was quite common that one payment system support

only one scheme of processing, like RTGS or DTNS. It wa s becau se it was

quite difficult to realize multiple functions in one system from the

perspective of system development as well as risk management scheme and

loss-share rule is different according to the processing type.

Rapid p rogress of t echn ology enabled to rea lize two modes in a single

paymen t system, which paved th e way for th e Int egrat ed System. To adopt

the offsetting concept also helped to combine two functions in one system by

avoiding the netting concept, which requires the different risk management

scheme.

6. Conclusion

Payment systems have evolved from the DTNS system to the RTGS

system, Hybrid system a nd Int egrat ed system. The driving force for th e

recent evolution was development of technology as well as other

environment al changes, which include 1) ra pid growth of sett lement values,

2) increased awareness for the settlement risks, 3) competition between

payment systems.

Looking ahead, payment systems are likely to continue to evolve as

technological pr ogress per mit s t he pr ocessing in m uch m ore in novat ive ways

or with more complicat ed algorit hm s. It was regret ta ble th at th e reform s of

payment systems in J apan have lagged behind t he movement in E ur ope and

th e U.S. It is desirable to wat ch closely to the global movement of paymen t

system innovations as well as technological progress, and to enhance the

Japanese payment systems in a timely manner for the improvement of the

convenience of th e par ticipan ts. These enha ncements of th e paymen t

systems would lead directly to the improvement of the efficiency of financial

ma rket functions an d financial tra des in J apan .

References

Bank for International Settlements, Core Principles for Systemically


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Importan t Pa yment Systems, J anu ar y 2001

Bank of Japan, Proposal for the Next-Generation RTGS Project of theBOJ -NET Fu nds Tra nsfer System, December 2005

Bank of Japan, Framework for the Next-Generation RTGS Project of the

BOJ -NET Fun ds Tra nsfer System, Febru ar y 2006

Bank of Japan, Outline of the 2005 Issue of the Payment and Settlement

Systems Report, March 2006

Bech, Morten L., Bart Hobijn, Technology Diffusion within Central

Ban king: The Case of Real-Time Gr oss Set tlemen t, Federa l Reserve Bank of

New York St aff Report s, Septem ber 2006

Imakubo, Kei, and James J. McAndrews, Initial Funding Levels for the

Special Accounts in the New BOJ-NET, Bank of Japan Working Paper

Series, August 2005

Japanese Bankers Association, Proposal for Reorganizing Fund Transfer

Systems in Japan Introducing a Large Value Settlement System

(overview), March 2004

Martin, Antoine, Recent Evolution of Large-Value Payment Systems:

Balancing Liquidity and Risk, Economic Review, First Quarter 2005,

Feder al Reserve Ban k of Kan sas City

McAndrews, James, and John Trundle, New Payment System Designs:

Causes and Consequences, Financial Stability Review, Bank of England,

December 2001

Nakajima, Masashi, and Junichi Shukuwa, All about Payment Systems,

(in J apan ese) , Toyo Keizai In c. Mar ch 2005

Nakajima, Masashi, Global Trends in Payment Systems and Their

Implications for Japan(in Japanese), Forum of International Development


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Studies, Nagoya University, March 2003


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Table 1 Timing of the introduction of RTGS system in selected countries

Country Payment System note Timing of th e int roduction

of RTGS syst em

US Fedwire 1982

Switzerland SIC 1987

Germa ny EIL-ZV 1988

UK CHAPS 1996

Belgium ELLIPS 1996Fr an ce TBF 1997

Italy BI-REL 1997

Netherlan ds TOP 1997

Korea BOK-Wire 1994

Hong Kong CHATS 1996

Singapore MEPS 1998

Austr alia RITS 1998

J apan BOJ-NET 2001

(note) : the na me when th e RTGS system was int roduced.


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Figure 1 Number of countries that adopt the RTGS system

0

10

20

30

40

50

60

70

80

90

100

1981

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

num ber of adoption

accum ulated num ber of

countries

source Bech&Hobijn 2006, modified

Table 2 Introduction of Hybrid System in selected countries

Coun tr y Pa yment System Timing of int roduction of

Hybrid System

Germa ny EAF2 March 1996

Cana da LVTS Febru ar y 1999

Fr an ce PNS April 1999

US CHIPS Februar y 2001


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Table 3 Introduction of Integrated System in selected countries

Coun tr y Pa yment System Timing of intr oduction of

Integrat ed System

Cana da LVTS Febru ar y 1999

France PIS PNS TBF April 1999

Germany RTGSplus November 2001

Ita ly new BIREL April 2004

EU TARGET2 November 2007(plan ned

Japan BOJ-NET RTGS-XG fiscal 2008 planned

Figur e 2 Consolidat ion of lar ge-value paymen t flows

BOJ-NET(RTG S)

FXYCS(DTN S)

Zengin System(DTN S)

(RTG S-XG )BOJ-NET

RTG S m ode

Hybrid m ode(LSF)

Zengin System(DTN S)

88.3 trillion

16.4 trillion

9.5 trillion

110.9trillion

3.3 trillion

sm all value

large value

Note: Settlem ent values are daily averages in 2005.


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Table 4 Pr ocessing rule of Queu e

FIF O Payment s ar e placed in th e queue in order of ar rival to th e

system. Pr ocessing is tr ied first -in first -out basis, which

mean s from the t op payment in t he queue.

by-pass FIF O When th e first payment in th e queue can not be processed, th e

second pa yment would be t ried.

FAFO Regar dless of th e order s in th e queue, processing is ma de as

mu ch as possible with th e available liquidity.

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