De Nederlandsche Bank Eurosysteem Financial crisis and Global Developments Michael van Doeveren 3rd Conference of the Macedonian Financial sector on Payments and Securities settlement Systems Ohrid 28 June 2010 De Nederlandsche Bank

Eurosysteem Knowledge is power! Sir Francis Bacon, Religious Meditations, Of Heresies, 1597

De Nederlandsche Bank Eurosysteem Agenda Definitions and Roles of Central Banks in Payments Systems Financial crisis Global developments

De Nederlandsche Bank Eurosysteem Agenda FINANCIAL CRISIS PAYMENTS SYSTEMS  CPSS Report on System Interdependencies  Liquidity Issues  TARGET 2

De Nederlandsche Bank Eurosysteem Role of central banks IT´S ALL ABOUT FINANCIAL STABILITY

De Nederlandsche Bank Eurosysteem Mission of the central bank De Nederlandsche Bank Safeguarding the stability of the financial system and the institutions that are part of it, by Contributing to the monetary policy of the Eurosystem Supervising the financial soundness and integrity of financial institutions Promoting the smooth functioning of the payments system

De Nederlandsche Bank Eurosysteem Payment systems policy OBJECTIVES MAIN GOAL to promote safe and efficient payment and settlement systems Other goals: central bank specific e.g. crime prevention, effective competition, consumer protection, accessibility

De Nederlandsche Bank Eurosysteem Importance payment systems Payment systems … … facilitate the exchange of goods and services … are necessary to conduct monetary policy … can be transmission channels of ‘disturbances’ (financial crises)

De Nederlandsche Bank Eurosysteem buyer seller good/service debitpayment instruction bank payment instruction debitcredit payment information payment information Payment chain clearing

De Nederlandsche Bank Eurosysteem Retail versus wholesale payments Low value ↔ Large value High volume↔ Low volume Consumers and ↔ Financial institutions businesses Time less important↔ Time critical Low systemic risk↔ High systemic risk

De Nederlandsche Bank Eurosysteem Payment Pyramid - Eurosystem Average daily number of transactions (millions) Average daily value of transactions (EUR billions) Wholesale PSRetail PS Wholesale PS Retail PS Wholesale: 0,6% in terms of number….. …..but 97,7% in terms of value

De Nederlandsche Bank Eurosysteem How to Achieve Policy Objectives? OPERATIONS OVERSIGHT CATALYST

De Nederlandsche Bank Eurosysteem Operational role central bank Issuance and distribution of cash Operator large value transfer system Settlement services retail transactions Cash settlement securities transactions Clearing services retail payments Operator securities settlement system Other securities related services Public sector payments

De Nederlandsche Bank Eurosysteem Oversight ‘a central bank activity focused on the safety and efficiency of payment and securities settlement systems, in particular to reduce systemic risk’.

De Nederlandsche Bank Eurosysteem Catalyst Case for intervention, but not necessarily regulation or operations  ‘Third way’ - ‘guide’ the market, by promoting initiatives and co-operation between stakeholders between other public authorities, e.g. - Government - Competition authorities

De Nederlandsche Bank Eurosysteem

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS key words: EXCESSIVE OPTIMISM EXCESSIVE RISK APPETITE ASPECTS ● Relative Stability (the great moderation, Bernanke) ● Search for Yield ● Easing Criteria for Credit (subprime, alt-a etc) ● Innovations (originate-to-distribute model, monoliners etc)

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS SOURCES ● US Housing Market  GLOBAL CONTAGION OF markets and financial institutions Unprecedented: scale and scope of contagion

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS Crisis comes in waves

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS 15 september 2008 Lehman Brothers † Trigger of severe loss of confidence, wave of contagion

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS First, liquidity problems but also solvency problems

De Nederlandsche Bank Eurosysteem

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS What´s Next? Credit crunch  Stock Markets  Banking Sector  Insurance sector  House prices  Pension funds  World recession  Protection

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS CRISIS MANAGEMENT Provision Liquidity Nationalizations Savings Guarantee Capital Injections & Debt Guarantees Interest rates ↓ In order to UNDERPIN CONFIDENCE

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS Other Crises Great Depression ( ) Savings and Loan Crisis (US,1984) Japan (1984) Sweden (1991)

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS Differences with Great Depression Many (regional) banks had no access to Fed money No Savings Guarantee System National Protectionism Tight monetary policy

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS : NEXT WAVE of Crisis: RECESSION Issues: Credit Crunch: dilemma for banks Avoid beggar-thy-neighbour policy How to restore confidence?  Crisis is worldwide  Establishment of ´bad banks´?

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS – FUTURE Recommendations of Financial Stability Forum Improve Risk Management Enlarge Transparency Further Cooperation between Public Authorities Reform supervision Improve Crisis Management

De Nederlandsche Bank Eurosysteem RISK MANAGEMENT USED TO BE SMART

De Nederlandsche Bank Eurosysteem Crisis: Payments Systems Angle STYLIZED FACT: Scale and Scope of Contagion We live in global village

De Nederlandsche Bank Eurosysteem

De Nederlandsche Bank Eurosysteem Payments and Securities Infrastructure WEB OF GLOBAL INTERDEPENDENCIES (LVPSs, CCPs, CSDs, Banks) WITH TIGHT DEADLINES (RTGS, DVP, PVP) Key words ● technological developments ● globalization ● consolidation in financial sector

De Nederlandsche Bank Eurosysteem CPSS REPORT ON INTERDEPENDENCIES

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS No Crisis of P&SS Infrastructure BUT it may have an infrastructural impact, e.g. Need for further standardization (operating rules,legal devices etc)? US: intraday credit policy UK: highly tiered structure of CHAPS

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS FURTHER ISSUES Assess BCP arrangements: scope and scale of contagion, cross-border Cross-border Collateral: ELA facilities Growth and Quality of Collateral

De Nederlandsche Bank Eurosysteem FINANCIAL CRISIS COOPERATION WITH SUPERVISORS (domestic and cross-border) FX Settlement Risk: use of CLS Correspondent banking: risk management Update Sound Practices on Liquidity Management: intraday liquidity

De Nederlandsche Bank Eurosysteem FX Settlement Risk – Continuous Linked S ettelement CLS: Continuous Linked Settlement ● FX Risks ● basically a ´guaranteed refund´ scheme, i.e. you will either receive the correct currency or a refund

De Nederlandsche Bank Eurosysteem Bank 2Bank 1 Yen Japanese payment system US$ US payment system A: Japanse correspondent B: Japanse correspondent B: US correspondent A: US correspondent Correspondent banking: FX transaction

De Nederlandsche Bank Eurosysteem CLS Bank Continuous Linked Settlement CLS

De Nederlandsche Bank Eurosysteem Yen Bank B Bank A A: Settlement member B: Settlement member CLS BANK US $ A: Settlement member B: Settlement member FX transaction, via CLS

De Nederlandsche Bank Eurosysteem FX Settlement Risk CPSS Report 2008 Progress in reducing foreign exchange settlement risk ● major reduction of FX settlement exposures ● 45% of total obligations are settled via corresponding banking channel ● risk exposures are underestimated

De Nederlandsche Bank Eurosysteem Correspondent Banking NCB A D BANK A2 BANK A1 NCB A D BANK B2 C NCB B BANK B1

De Nederlandsche Bank Eurosysteem Correspondent Banking Risks for Bank B1 Bank A1 fails on its obligations with reference to intraday credit Bank A1 uses scarce liquidity Bank A1 has operational problems

De Nederlandsche Bank Eurosysteem Correspondent Banking Risks for Bank A1 Bankruptcy Bank B1 Impossibility to use credit lines with Bank B1 Operational outage at Bank B1