Managing Bank Liquidity in real time

Then banks enjoyed a high degree of anonymity and choice in how it managed its liquidity. This became as a result of the techniques then used for settling interbank obligations. These techniques had been developed and refined over two or more centuries. They had come from a pre-computer world that counted on manual transaction processing of instruments such as cheques. Early moves at computerization of bank processes simply mechanized the manual approach with the portion processing system. So the critical factor that related to the measuring of a bank’s liquidity could only be determined after the end of the trading day had been completed and all the “ins” and the “outs” were matched up. Even then, a bank had a safety net, offered by the central bank, which in most countries was ready to cover any weakness, and then to backdate this cover to the previous trading day.

An expanding understanding of settlement risk and the possible contagion to systemic failure led central banks, almost without exemption, to implement payment monetization of leased bank instruments. systems, usually under their own direct control that ascertained finality of settlement. Real-time Gross Settlement (RTGS) especially where high value payments were involved is just about the accepted mechanism of ensuring safety in national payment systems.

This became accompanied by the need to ensure that the settlement of stock exchange transactions also happened in a secure manner and that delivery of the shares was only contrary to the exchange of a payment that was final and irrevocable. The RTGS approach fitted this need admirably.

Foreign exchange settlements were the next problem. The failure of the Herrstadt Bank had caused major problems. The solution propsed by a small grouping of major international banks was for the CLS (continuous linked settlement) system which won the approval of the major central banks. Again the RTGS system was pushed into use to provide the secure payments leg.

Each new payment dimension (i. e. RTGS, DvP, CLS) increases the intricacy of the problem. Funds flows now involve domestic, foreign and sec payments as a minimum — each flow is really dependent on the other flows. There may be other dimensions too, depending on local arrangement and conditions, where other settlements may be require to be settled in real-time and on RTGS principles, such as VERY operations or cheque clearing operations.

The intricacy of these requirements was the main topic of a rigorous study in 2000 by the Payments Risk Committee of the Federal Reserve Bank of New york (“Interday Liquidity in the Growing Payment System: A survey of the impact of the Euro, CLS Bank and CHIPS finality”). The study examined the potential ramifications for us dollar intraday liquidity risks that would come to pass from planned changes to payment systems in the usa and elsewhere. In the words of the committee the report was “intended to stimulate debate on the issue and to suggest some possible best practices”. Even though the main focus was on the liquidity effect to banks in the usa, the difficulties and the solutions are applicable to banks everywhere. A key finding is estimated below in full, and demonstrates the direction in which bank liquidity management has been heading.

“These changes will create a need for better rating of payments flows, use of queuing techniques to regulate payment flows, better communications, and a generally higher awareness by treasury administrators of developments in the payments processing functions. Payment operations will assume some of the characteristics of continuous industrial processes where real-time rating is required to assess the build-up of fluctuations within systems, identify gridlocks within and between systems, and establish more elaborate contingency plans. The interconnections between systems will also require new control processes in order to cope with unexpected volume and systems changes. inch

Depending on the size of the bank, the basic problem that is faces changes. As an example, in a smaller bank, the problem could well be one of trying to match the magnitudes of the inflows and the outflows in “approximate” real-time. This kind of problem does not arise in the case of the bigger banks for the reason that send and receive high amounts of payments almost continuously throughout the day. So essentially they have a natural flow of funds that supports the matching process. In countries where CLS is now fully in business banks have found they may have another dimension to this real-time aspect. What has happened is a whole choice of fresh scenarios as a result of connections between the liquidity side of the RTGS system (which one must remember are real-time domestic payments) and the CLS system (which is real-time Forex settlement). A further example of this process is the RTGS interaction with the sec system.

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