5.2 To help focus its comparative analysis, the Working Group examined each of the service options in the context of the following seven broad policy issues:

1. The effect on monetary policy implementation: monetary policy implementation could be affected by the impact of the service on the ability of the central bank to control the supply of and to forecast the demand for reserve balances, and by the impact on open market operations, central bank lending and other operating procedures. This might affect interest rates and exchange rates.

2. The adequacy of private sector sources of liquidity to support settlement in each currency: this could be influenced by the availability during settlement of deep and liquid money markets, of final transfers into settlement accounts and of collateral to support funding transactions.

3. The impact on systemic risk: this could depend on the effect of the service on private sector motivation to design new methods to reduce settlement risks, on the ability and incentive of the public and private sectors to manage credit and liquidity risks, and on the degree of reliance on public and private sector credit and liquidity.

4. The well-founded legal basis of settlement arrangements and entities: this would depend in part on the legal status of settlements in each country and on the legal implications of the location and corporate form of settlement entities.

5. The likely competitive effects in private financial markets: this would depend on the markets to be served, on the participants and entities that would benefit from access to central bank services and on likely changes to correspondent banking relationships.

6. The cost-effectiveness of the service from the private sector perspective: this would reflect initial investment costs and the implementation timetable, the ongoing operating costs relative to the status quo and the costs of any required idle balances that might arise as a result of prefunding of debits or delayed access to credits.

7. The acceptability of the service from an individual central bank perspective: this would reflect initial investment costs (e.g. the cost of new technology) and the implementation timetable; ongoing operating costs; required legislative and policy changes; implications for central bank supervision or oversight; implications for the role of the central bank as liquidity provider; likely shifts in the loci of financial activity; and the required degree of coordination, cooperation and sharing of confidential information.

5.3 In examining these issues, it became apparent that each option might raise difficult policy issues. Furthermore, each central bank is likely to view these issues from a unique perspective shaped by different concerns, including the characteristics of its national payments systems and the impact of geographical distances, temporal differences and international developments (e.g. financial integration in the European Community). Overall, it is important for each central bank to recognise all of the possible side-effects of each service option and to weigh them carefully against the potential risk reduction and efficiency benefits.

Analysis

5.4 Monetary policy implementation. Each central bank service option might have some potential to affect current monetary policy operational procedures in one or more countries. For example, the introduction of intraday finality may affect the overall demand for clearing balances and possibly require an initial adjustment to the current timing of open market operations, central bank lending and other operating procedures in countries where this is relevant. However, central banks that choose to implement intraday final transfer capabilities for purely domestic payments purposes would face the same issues.

5.5 Beyond these concerns, it does not appear that any additional monetary policy issues would be raised if intraday final transfers, central bank settlement accounts or other currently available home-currency services were used to settle the home-currency legs of cross-border and multi-currency transactions during normal home-country business hours. As long as settlements in each currency continue to take place relatively independently of one another and during hours when the local money market is open and liquid, no special monetary policy effects would be likely to accompany any liquidity support that might be provided by central banks of issue in the face of home-currency settlement disruptions. Furthermore, to the extent that a moderate lengthening of the operating hours of a country's large-value funds` transfer system is accompanied by a similar expansion in the domestic money market, home-currency settlements that take place during an off-hour period would not appear to be problematic for monetary policy operations. DVP settlements among currencies with overlapping payments system and domestic money market operating hours would also not appear to complicate the implementation of monetary policy. Indeed, such settlement arrangements could be a significant stabilising force for money markets at times of financial stress.

5.6 By contrast, a multi-currency DVP settlement process involving currencies in Asia, Europe and North America, which would be specifically created or supported by a major extension of payments system operating hours, cross-border payments system links or multi-currency central bank services, might have implications for monetary policy implementation. For instance, individual banks may choose to adjust frequently their central bank clearing balances in individual currencies in response to fluctuations in their anticipated daily settlement obligations. Depending on the timing chosen for a multi-currency settlement, this might influence the volatility of the aggregate demand for central bank balances as measured for monetary policy purposes in some countries. The magnitude and duration of this impact on the monetary forecasting capabilities of the affected central banks of issue would depend on the size, distribution and predictability of settlement obligations among the banks that participate in such multi-currency settlements. Although this greater uncertainty could potentially reduce the ability of the affected central banks of issue to influence targeted domestic interest rates, in practice it might not be difficult for central banks to deal with the situation by making modest adjustments to their current monetary policy operating procedures.

5.7 Any central bank lending to support multi-currency DVP settlements might also have undesirable implications for the implementation of monetary policy. Depending on the timing of such settlements in relation to the timing of domestic reserve monitoring and open market operations, it might be difficult for central banks of issue to offset quickly the impact of settlement-related lending on monetary conditions. For instance, to support a multi-currency settlement it is possible that central bank liquidity in a major currency would have to be provided at a time when the market for immediately deliverable balances at the central bank of issue was closed. If this time also happened to be at or near the end of the reserve maintenance period for that currency, it might be impossible for the central bank of issue, given currently available monetary policy procedures, to neutralise the impact of this lending on banking system reserves, with possible implications, at least in the short run, for domestic interest rates and exchange rates. In general, some central banks might consider reviewing their specific monetary operating procedures, including those governing the availability of daylight credit, to offset any potential impact the various service options might have on the implementation of monetary policy. Other central banks might well regard as inappropriate any changes in central bank payment services that impinge to any degree on established monetary operating procedures.

5.8 Private sector liquidity. Intraday final transfers between accounts at the central banks of issue would give financial institutions the technical ability to fund and to discharge their settlement obligations in each currency during the day, whether settlements in each currency take place independently or in a coordinated fashion. In addition, an extension of operating hours (with or without operational and informational links between central banks) or multi-currency payment and settlement services would facilitate multi-currency DVP settlements

5.9 In addition to the technical ability to effect settlement payments, however, financial institutions would need adequate clearing balances, credit or money markets to fund their settlement obligations. Central banks recognise that it is impossible to be certain that there would be sufficient private sector liquidity to support all settlements in all circumstances. In fact, recognition of this risk helps explain the existence of central bank lending facilities. Nevertheless, central banks expect that private sector liquidity resources would meet settlement needs in most situations.

5.10 If final transfers, central bank settlement accounts and other central bank services were used to settle the home-currency legs of cross-border and multi-currency transactions during normal home-country business hours, settlements in each currency would continue to take place in the country of issue when the local money market was open and most likely to be liquid. Accordingly, private sector sources of liquidity to support such settlements likely would be as available as they are at present. To the extent that these services were used to support the DVP settlement of two or more currencies in countries with overlapping payments system operating hours, it is possible that liquidity pressures that can otherwise arise at times of market stress due to heightened fear of incurring principal risk might also be reduced. For example, the availability of multi-currency DVP settlements may increase confidence that currency contracts will be settled as planned, thereby reducing strains on liquidity management for financial institutions and supporting the general liquidity of money markets.

5.11 By contrast, private sector sources of liquidity might not adequately support the multi-currency DVP settlements that would be specifically created or promoted by a major extension of payments system operating hours or multi-currency central bank services. For example, simultaneous settlements involving Asian and North American currencies would have to take place outside the current business hours of at least one of the respective money markets for immediately deliverable balances at the central bank of issue. Such multi-currency settlements would be particularly susceptible to liquidity problems if these off-hour money markets were not sufficiently deep and liquid to provide a reliable source of funds. In fact, many markets for balances at the central banks of issue are not uniformly liquid throughout the current operating periods of their respective payments systems. Inadequate private sector sources of liquidity could potentially lead to an unacceptable reliance on central bank liquidity facilities.

5.12 It is possible, or even probable, that money markets for immediately deliverable balances at the central banks of issue would eventually evolve into an adequate source of liquidity to support off-hour settlements in each currency. Even without the further development of money markets, multi-currency DVP settlement facilities could be used to alleviate liquidity pressures at times of financial stress. In the present circumstances, however, the private sector would need to build up on a regular basis adequate liquidity in advance or try to arrange special funding facilities to ensure the timely completion of settlements as required, for instance, under the Lamfalussy standards. This could involve costs in the form of lost interest resulting from prefunding requirements for debits and delayed access to or use of credits, as well as the expense of arranging sufficient backup liquidity facilities to deliver balances at the central bank of issue in an off-hour period.

5.13 In the case of simultaneous settlements facilitated by multi-currency central bank services, available sources of liquidity could also be constrained operationally if potential money market participants were unable to transfer funds from accounts at the central banks of issue to accounts at the common agent (or central bank operating the multi-currency settlement) during the settlement period. Under these circumstances, the only relevant market that would be available to support settlement would be limited to the purchase and sale of existing balances at the common agent (or central bank operating the multi-currency settlement).

5.14 Systemic risk. An important source of the systemic risk that can arise during the settlement of cross-border and multi-currency obligations can be traced to the variety of home-currency payments systems and conventions currently involved in the process. Central banks could eliminate one source of this risk by offering the ability to execute final transfers between accounts on their books at a time when their respective money markets for immediately deliverable central bank balances are open and liquid.

5.15 As described in Section 4, intraday final transfers could lower systemic risk by reducing the time lag and uncertainty that currently accompany the settlement of obligations in many individual currencies. By itself, however, the availability of intraday final transfers would not be sufficient to permit the simultaneous settlement of obligations in multiple currencies. Accordingly this home-currency service could not, per se, eliminate the credit and liquidity risks that exist in the absence of multi-currency DVP settlements. Nevertheless, the use of final transfers could significantly improve the ability of market participants to manage and control these and other settlement risks on both a bilateral and a multilateral basis. In particular, final transfers would enable financial institutions and clearing arrangements to quantify - and, hence, to monitor and limit - more precisely and efficiently than they can at present the exposures that may be incurred in the process of settling both gross and netted transactions in multiple currencies. It is apparent that the capability in each country's domestic large-value payments system to effect final transfers at any time of the business day between accounts at the central bank of issue is the foundation stone upon which risk reduction measures can be developed in respect of a range of domestic and cross-border transactions.

5.l6 Building on this capability, a modest lengthening of the operating hours of an individual payments system that creates or expands an operational overlap with payments systems for other currencies would increase the opportunity to conduct DVP settlements among those currencies. In the extreme, a major extension of the hours of certain home-currency payments systems or the development of central bank multi-currency services would create the technical ability to conduct a DVP settlement of all G-10 currencies on the same value date and thus could support the elimination of the current risks associated with non-DVP settlements. Multi-currency DVP settlements would eliminate the potential loss of principal that currently arises on a regular basis during the settlement of multi-currency transactions. Furthermore, if problems were to arise in international markets, a DVP mechanism could assure market participants that they would not incur principal risk in the settlement process, thereby encouraging them to honour their settlement obligations. Multi-currency DVP settlements might also lead to a shifting of risk if, for instance, market participants needed to borrow funds to meet their DVP settlement obligations. Such shifts may result in risks being managed and borne in a more efficient manner than they are at present.

5.17 However, while facilitating the elimination of important risks, multi-currency DVP settlements may also lead to new types of risk. For instance, simultaneous settlements that involve all of the major currencies would have to take place outside the current business hours of at least one of the respective money markets for immediately deliverable central bank balances. As discussed above, this means, at least in the near term, that the private sector would likely be a less reliable source of liquidity to support an off-hour settlement than a settlement during standard business hours.