The Brazilian Payment System and the Value of Infrastructure

Rodrigo Azevedo

10 November 2006

The Brazilian Payment System and the Value of Infrastructure

Rodrigo Azevedo

10 November 2006

1. Payment System Infrastructure: importance and background to an adequate infrastructure

2. Brazilian Payment System (SPB): an overview

3. The Role of the Banco Central do Brasil (BCB):Settlement Service Provider

Central Securities Depositary

Payments System Overseer

4. Conclusion and Next Steps

Outline

1. Payment System Infrastructure: importance and background to an adequate infrastructure

The SPB and the Value of Infrastructure

Infrastructure - Importance

•Allows for better risk control

• Strengthening of financial system and reduction of systemic risk

•Reduction of operational risks

•Reduction of credit risk for the Central Bank

•Allows for the reduction of settlement lags decreasing credit and liquidity risks

•Avoidance of restrictions due to path dependence

Infrastructure – Requisites

• Automation and reduction of manual intervention

• Standardization

• Systems integration security and efficient straight through processing (STP)

• Performance

• Internal controls and reduction of back-office costs

• Reduction of unitary costs of processing

Infrastructure – Requisites (cont.)

• Flexibility

• Speed of process

• Safety

• Continuity:

•availability

•contingency

• Possible network externalities

2. Brazilian Payment System (SPB): an overview

The SPB and the Value of Infrastructure

• Contain systemic risk and promote financial stability

• Improve legal and regulatory basis• Launch a large-value funds transfer system on a RTGS mode

• Compliance of DNS systems with Core Principles and CPSS/IOSCO recommendations / standards

• Settlement Certainty• Prompt final settlement

• Implement adequate contingency arrangements

Payment System Reform – General Objectives

Payment System Reform – Infrastructural Changes

• National Financial System Network (RSFN)• Internal Message System (“mensageria”)• System Redundancy• Contingency• Cryptography• Digital certification• Technical groups• Documentation

The Brazilian Payment System - Overview

Banco Central do Brasil

SELICGovernment

bondsRTGS

STRFunds transfer

RTGS

Settlementaccounts

Banco Central do Brasil

SELICGovernment

bondsRTGS

SELICGovernment

bondsRTGS

Funds transferRTGS

STR

Settlementaccounts

BM&F FXDNS (D+1;D+2)

BM&F DerivativesDNS (D+1)

CETIPPrivate debt securities

DNS(D+1) - RTGS

CIP -SILOCFunds transferDNS (D+1)

TECBANFunds transfer

DNS (D+0;D+1)

CIP -SITRAFFunds transfer

HIBRID

CBLCSecurities

DNS (D+1;D+3)RTGS

COMPEFunds transfer

(check)DNS (D+1)

BM&F SecuritiesGovernment bonds

DNS (D+1)

BM&F FXDNS (D+1;D+2)

BM&F FXDNS (D+1;D+2)

BM&F DerivativesDNS (D+1)

BM&F DerivativesDNS (D+1)

CETIPPrivate debt securities

DNS(D+1) - RTGS

CETIPPrivate debt securities

DNS(D+1) - RTGS

CIP -SILOCFunds transferDNS (D+1)

CIP-SILOCFunds transferDNS (D+1)

TECBANFunds transfer

DNS (D+0;D+1)

TECBANFunds transfer

DNS (D+0;D+1)

CIP -SITRAFFunds transfer

HIBRID

CIP-SITRAFFunds transfer

HIBRID

CBLCSecurities

DNS (D+1;D+3)RTGS

CBLCSecurities

DNS (D+1;D+3)RTGS

COMPEFunds transfer

(check )DNS (D+1)

COMPEFunds transfer

(check )DNS (D+1)

BM&F SecuritiesGovernment bonds

DNS (D+1)

BM&F SecuritiesGovernment bonds

DNS (D+1)

RSFNRSFN

• A RTGS system for transfer of funds

• Settlement in central bank money (inter-bank settlement)

• Full automation with straight through processing (STP)

• All settlement systems are supported by a high-performance and open architecture network, using XML language

• Three central securities depositaries (CSD)

• Securities and derivatives settlement systems must be central counterparties

The Brazilian Payment System - Some Features

3. The Role of the Banco Central do Brasil (BCB)

The SPB and the Value of Infrastructure

The Role of the Banco Central do Brasil

• Payment system oversight• regulates issues related to safety and efficiency

• Assessment of risk management• Establishment of criteria in order to determine

which systems are systemically important• Provision of settlement services

• STR RTGS• SELIC DVP

The Role of the Banco Central do Brasil (cont.)

• Act as CSD for federal government securities

• Act as the settlement bank for all multilateral net settlement systems considered systemically important

• Monitor in real-time the payment system liquidity

• Provide intraday credit to banks

The BCB as Settlement Service Provider

•Operating a RTGS payment system – STR• Final settlement of cash leg of securities transactions• Allow DVP and PVP mechanisms• V-shaped

•Operating a custody and settlement system – Selic• Fully dematerialized since it started in 1979 • Linked to STR• Real-time finality • DVP – model 1

• Interbank funds transfer system with a unified and centralized account structure

•Participants (136 banks, 8 clearinghouses, National Treasury and the BCB)

•Transfers all value related to:• Domestic interbank and customer operations• The settlement of clearinghouse’s multilateral net positions• The cash leg of securities settlement systems• Monetary policy transactions

•Supports securities DVP

The BCB - Settlement Service ProviderSTR - Main Features

•Queuing facilities• FIFO with prioritization• Optimization routine

• Intraday standing credit facility• Zero-Interest intraday Repo fully collateralized in

government securities (adjusted haircut)• If the intraday Repo is not repaid it turns into overnight

Repo automatically (Selic + 6% p.y.)• Balances maintained as required reserve can be used

for making funds transfers during the day

The BCB - Settlement Service ProviderSTR - Main Features (cont.)

US$

trill

ion

0.0

0.5

1.0

1.5

2.0

2.5

May-2 Dec Dec-3Dec-4 Jan-5 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Other interbank transfers Intraday Repos

STR – Total Value of Transactions per Month

May 2002

34.0%

2.8%63.2%

October 2006

64.9%2.7%

32.4%

Domestic Customers Payments Intraday Repos Other interbank transfers

STR – Volume of Transactions

•Main settlement and custody system for government securities in Brazil.

• Double command: participants input only debit authorizations.

• seller: authorizes a debit to its custody account.• buyer: authorizes a debit to its reserve account.

• Other safety features: contingency site, encryptioned messages, digital signature

•No overdraft allowed in securities accounts•Securities queuing facility until 30 minutes

BCB´s Central Securities DepositaryThe Selic system

• Bank B buys a bond from A by using funds provided by the intraday credit facility.

• Both operations are settled simultaneously.

Banco Central

do Brasil

Bond Bond

$ $ - haircut

SELIC System: associated operations

BA

1

2Nominal securities only

Transactions

are settled

simultaneoulsly,

as only one deal

Banco Central

do Brasil

PARTICIPANT

1 2

Government Securities

Participant

SELIC System: linked operations

Selic

National Treasury

Clearing Houses

Settling Banks

Other Financial

Institutions

Omnibus accounts

ClientsII

IIII

IIII II

Institutional Investors*

Individual accounts

(*) Financial investment funds, pension funds, insurance and capitalization co. etc.

BCB

Institutional Investors*

Individual accounts

Omnibus accounts

SELIC System: participants

September/2006– Participants (market) …………………………. 4,607

• Settling banks …………………………………... 135• Other financial institutions ………..……………… 421• Institutional investors ……………………………… 4,051

– Assets under custody ……………….. USD 470.8 billion

4.61,804Outright sales

71.03,133Repurchase agreements (repos)

USD billionUSD billionQuantityQuantityTypes of operationsTypes of operations

Daily averages as of September/2006

SELIC System: statistics

• Available in the BCB website:

(http://www.bcb.gov.br/?SELIC)

Example: information on trades in the secondary market

.....................NTN-B4/17/061408.2821404.1001399.530384.9274,129838/15/10NTN-B4/17/06

.....................LTN4/1706

741.029739.655738.848955.41291,600

387/01/08LTN4/17/06907.330907.195907.0422730.63009,89

8591/01/07LTN4/17/06

.....................LFT4/17/06

2694.3422694.1352693.699313.4116,2931953/21/07LFT4/17/06

Maximumprice (R$)

Averageprice(R$)

Minimumprice(R$)

Financial volume

(R$million)Quantitytraded

Number of trades

Maturitydate

SecurityDate

SELIC System: Information

The BCB as Payments System Overseer

•Regulates issues related to payment and settlement systems’ safety and efficiency

• Defines which settlement systems are systemically important

• Sets forth criteria and technological requirements to be observed by clearing and settlement systems

• Sets permanent working groups, all of them coordinated by the BCB, to address technological issues related to the RSFN

•Assesses payment and settlement systems’ risk management and their compliance with regulations

• Tests of the contingency plans• Clearinghouses’ credit risk management mechanisms (back testing)• Clearinghouses’ access to liquidity facilities• Clearinghouses’ systems and operational procedures

The BCB as Payments System Overseer

• Monitoring of payment system’s liquidity to maintain a smooth flow of payments• Real-time basis• Prevent gridlock situations• Monitoring centers with backup sites

Quantitative data and back-testing

Questionnaires External meetings

Internal analysis (laws/regulations

/manuals)External analysis

(auditing/legal opinion)

Oversight Instruments

The BCB as Payments System Overseer

GovernanceAccessTransparencyEfficiency

Credit and Liquidit RisksInvestment riskCustody RiskLegal RiskOperational Risk

Infrastructure consolidation(CCP, CSD, SSS)Systemic impact of banksfailures

Oversight

Individual Systemic

4. Conclusion and Next Steps

The SPB and the Value of Infrastructure

Conclusion

• The Brazilian Payment System: safe, efficient, reliable.• High Standardization

• High Flexibility• Straight Through Processing - STP• Strong Risk Mitigation

• The BCB aims at and complies with the best practices to:• Funds Transfer (BIS’s core principles)• Securities Settlement Systems (BIS/IOSCO’s

recommendations)• Central Counterparties (BIS/IOSCO’s recommendations)

•To improve the oversight instruments of the BCB

•To improve the efficiency of retail payment instruments• Increasing use of electronic payment instrument

•To foster cooperation among participants to improve the infrastructure usage• Scale and Scope economies

• Network externalities

Next Steps

The Banco Central do Brasil website

http://www.bcb.gov.br/?english

The Brazilian Payment System and the Value of Infrastructure

Rodrigo Azevedo

10 November 2006

The Brazilian Payment System and the Value of Infrastructure

Rodrigo Azevedo

10 November 2006

• Access to the STR• Through National Financial System Network (RSFN) - a

close, exclusive access, high performance and nationwide network. The owners of RFSN are the banks and the regulator is the Central Bank

• STR has a common message standard developed by a partnership among representatives of central bank, bank associations, clearinghouse and securities settlement system. The message standard uses the XML syntax.

• The STR security standard has two main features: digital signature and encryption

The BCB – Settlement Service ProviderSTR – Main Features (cont.)