On November 16 2002, Zimbabwe partially implemented the Real-Time Gross Settlement (RTGS) system. The partial implementation mainly focussed on commercial banks. This was after a series of training sessions of relevant banking staff who were, at that time, in treasury operations or who carried out some back office roles. I was part of this initial team which went through this training.
By Daniel Ngwira
In Zimbabwe, RTGS is adopted as a national payments system in the name of Zimbabwe Electronic Trading and Settlement System (ZETSS).
Under the RTGS system, transfer of money between banks happens “real-time”, entailing that transactions are settled as soon as they are processed. The term “gross” means that transactions are settled individually without netting them off. Essentially, RTGS speeds up transactions.
Without RTGS, transactions would have to be accumulated and netted off at the end of the day with the central bank adjusting balances thereafter. This is slower, cumbersome and inefficient. With RTGS, as soon as processing is complete, payments become final and irrevocable. This entails that neither the remitting bank nor the customer can reverse this transaction at that point. Thus RTGS ensures that a customer gets “same day” value. This is unlike with the cheque system whereby one has to wait for the full clearing period to get value or request for a special clearance from the bank or apply for a bank cheque or bank certified cheque. All these came at a cost far higher than what the customer pays by requesting an RTGS transfer.
The introduction of RTGS was not smooth. The market was not ready but the central bank ensured that the system was used because it had many advantages that would help a modern financial system including fostering stability. Before the introduction of the RTGS system, the market relied extensively on the cheque system, with many commercial banks running large clearing departments at the time. Building societies maintained accounts with commercial banks. High-value transactions and large volumes of transactions were, at that time, carried out by cheque, hence the significance of the cheque clearing system. Zimbabwe became one of the few African countries to run such a robust transfer payments system.
In the 20 years from 1985 to 2005, the number of countries using RTGS grew from three to 90 and this included Zimbabwe. The report, Systemic Risk in Alternative Payment System Designs, by Peter Galos and Kimmo Soramaki and published in July 2005, the European Central Bank working paper series states that: “In 1985, three central banks had implemented RTGS systems and a decade later the number had increased to 15. However, since the mid-1990s, the adoption of RTGS has rapidly increased. By year-end 2002, 69 central banks had implemented RTGS systems and at least 20 central banks were planning to do so in the near future. Until the late 1990s, the system type was largely an industrialised country phenomenon, but since then, both transitional and developing countries have switched to such systems.”
To put things into perspective here is how the system was before RTGS. After clearing whatever a bank was owing a counterparty bank, it was said to be “due by” whereas a bank that was owed money by a counterparty bank was said to be “due to”. This meant that settlement had to happen.
Invariably, it took a considerable period of time. The European Market Infrastructure Regulation (EMIR) defines clearing as “the process of transmitting, reconciling and, in some cases, confirming payment orders or security transfer instructions prior to settlement, possibly including netting of instructions and the establishment of final positions for settlement”.
On one hand, settlement is a process involving delivery in simultaneous exchange for payment of money in order to fulfil an obligation created by a contract. In common parlance people refer to clearance as settlement but the two are not the same. Clearance is followed by an exchange of money against delivery of an asset or an instrument.
To settle, banks would write letters to the central bank giving instructions to debit their accounts which were held at the central bank. Banks which turned out to be “due by” in clearing would have to borrow from those which were “due to”. The bank with a surplus (long) would need to place the surplus funds with a counterparty bank which was in deficit (short) overnight. These transactions used to happen in retrospect to cover the clearing day and in order to start a new trading day, the matured amounts would be paid on the new trading day with interest. The borrowing bank would need to give security to the lending bank. At this point in time, Treasury Bills (TBs) were in physical form and they were not necessarily lodged with the lending counterparty, but rather they were “shown” to them. The risk was that the same TBs could be shown to many counterparties by a bank which would have borrowed from more than one bank. This entails that a bank which had no adequate security would be carried through even when they had no security and they were a reckless trader, thereby inadvertently protecting weak banks from going under. In addition, it took around three weeks for a bank to have a truly reconciled position with the central bank, by which time things would have changed on the ground.
This was not the only problem. During the trading hours, those banks which had surplus positions used to write cheques in favour of those which were in deficit (they would have borrowed from the surplus counterparties). This means that there was a high possibility of kite flying. This is a term used in cases whereby a party would be writing cheques from unfunded accounts basing on cheques which would not have been cleared and settled.
Essentially, what happens is that a cheating party opens accounts with different banks preferably as far apart as possible. The party writes cheques from one bank account to deposit them into another held with a different bank.
When the cheques are cleared, one bank account would have a huge positive balance. In banks which offered swift customer cheque clearing arrangements, the depositor would withdraw the money and the cheques would bounce after value had been taken. This is a form of cheque fraud. Kiting has no role to play in an RTGS regime.
Those who care to analyse will notice that following the introduction of the RTGS, there were many local banks which collapsed. It could have been different if the banking system was using the cheque system. In addition, the weaker bankers, most of which collapsed, were in the forefront to push for the suspension of the RTGS platform at the time.
RTGS is a credit push system which requires a bank’s account to be funded at the central bank for payments to be enabled, short of which it is not possible to make payments. If a bank does not have a funded account they should have adequate acceptable securities in order to access liquidity from the market or from the central bank as lender-of-last-resort. Many of the small banks were found with neither the liquidity nor the necessary securities to lodge to access funding. They would be having a huge gap called “other assets” or “non-trading gap”. This is a technical term of saying the bank has funded non-core assets with customer deposits or has funded operations with deposits instead of capital. Alternatively, a bank would not be profitable so they would have used depositors’ funds to cover operating expenses.
To put it in common parlance, credit push means that if a bank does not have money in its account at the central bank, they cannot successfully execute a client’s transfer instruction to another bank even when the client’s account is funded. The system will not allow the funds to be remitted to another bank. In order for this transaction to be executed, the bank must fund its account held at the central bank. Funding can happen through receipt of customers’ deposits from other banks, deposits by the bank of cash held in its vaults, transfers of nostro balances to the local account on the RTGS platform or borrowing from other parties, including the central bank. Transferring balances from nostro is not an instant matter. It takes an average of two days depending on where the account is held and the settlement arrangement of the currency requested and the jurisdiction.
On the other hand, the frequency of deposits from other banks depends on the size of the bank in terms of its customer base. Large banks like CBZ and Stanbic are likely to have frequent deposits from other banks due to the size and quality of their customer base. This is more so in volatile markets where customers prefer to deal with the banks with stronger balance sheets to enhance the security of their deposits. While borrowing is one of the key solutions of obtaining liquidity, it depends on the depth of the market, the strength of the borrowing party and the securities held to secure the borrowing.
In addition, banks have counterparty limits with each other. These are based on risk. Where a counterparty in surplus has no limit with a bank which is short or in deficit, no trade would occur. The last resort would be the central bank, which in our case is still hamstrung.
Nonetheless, central banks also require acceptable securities for a bank to borrow from them.
Support from central bank cannot be incessant; banks with structural challenges will need, in the long run, to seek funding from their shareholders.
Thus far, it should be clear for the customer to note that it is not enough for a customer to have a funded account. The bank has to be funded too in order to facilitate the remittance as per the depositor’s instruction.
There is, however, the operational side of the RTGS payments cycle. When a customer makes an instruction to the bank for a transfer to be made to another bank, the remitting bank has to capture that payment instruction on the platform with correct details. Upon receipt of the funds the other bank will do the same, they will capture the correct details into the beneficiary’s account. These processes, despite sounding simple, do take human capital and time. Yet they are reflective of the prior era in banking before straight-through processing (STP).
Banks invest heavily in technology voluntarily or due to the force of regulation so that customers can easily and securely transact. STP is a seamless end to end process which eliminates the operational bottlenecks including that of having counterparty banks to capture details of a transaction multiple times. An interface is also created with the bank’s operating system so that data can be integrated into the system. This ensures accuracy and speed of transactions from the moment of capture to finalisation. Redundant systems are eliminated as STP helps in streamlining processes. This also entails that there will be reductions in cost related to labour and systems as well as reductions in the total head count assigned to processing of the transactions at hand while ensuring data integrity. Thus STP helps in timeliness and customer satisfaction. It is designed to handle large volumes of transactions.
As banks are now on STP, the large volumes of transactions cannot explain the RTGS backlogs. There must be another explanation possibly linked to the funding of the accounts. The volume based backlog can easily be solved by the STP. Banks owe it to their customers to quickly smoothen operational bottlenecks so that customers can easily transact. While ordinarily RTGS is designed for low volume, high value transactions, the advent of STP is a key feature that helps in processing larger volumes at higher speeds.
It is important that the national payments system’s integrity be protected as it is paramount in facilitating trade. Backlogs on the national payments system serve to weaken the payments system and tend to erode the trust economic agents have in a country’s financial system. In the end, people devise transmission mechanisms that are both inefficient and risky. This is counterproductive since these are the same challenges RTGS sought to reduce or eliminate.
Ngwira is a chartered accountant, former bank treasurer and former university lecturer. He holds finance and business qualifications. — firstname.lastname@example.org/ cell: +267 73 113 161.