Box C: Changes to the settlement of retail payments
The processing of retail payments in New Zealand has recently undergone a number of important changes. The most noticeable change for customers has been a move to processing payments throughout the day, increasing the speed of payments. And work is currently being undertaken to achieve further improvement.
The first major overhaul of the retail payment systems was in 2012, when Settlement Before Interchange (SBI) was introduced. This replaced the previous model in which payments were centrally cleared throughout the business day and participant banks settled with each other once, the following business day. Instead, the SBI model allowed participants to exchange payment instructions with each other multiple times throughout a business day, with payments combined into smaller batches. The main improvement was the significant reduction of inter-participant settlement risk – the risk that one participant fails to meet its payment obligations to another participant. Under SBI, inter-participant obligations are established and discharged just before the payment instructions are exchanged.
Although the introduction of SBI was a major step forward, the Reserve Bank was concerned about the settlement risk between underlying customers. There was little incentive for banks to process payment instructions soon after they were received (given SBI significantly reduced inter-participant settlement risk), so the processing of payments was heavily skewed towards the evening. A payer still faced the risk that their bank might fail in the period between their account being debited and the payment being processed, causing the payment to not reach the payee.
Delaying payment processing could also increase banks’ liquidity risk, as banks need to ensure that they have sufficient funds to settle more payments towards the end of the day. It also increases operational risk as it limits the time available to resolve outages or disruptions before the end of the day.
To address these risks, since 2014, the Reserve Bank has been working with participant banks to reduce the delay between a payment instruction being issued by a customer and it being processed and settled by banks. The project is expected to conclude by the end of December 2016, with the following changes implemented:
- Payment instructions issued by a customer during the business day will be processed without undue delay. Banks will download payment instructions into SBI files at least hourly and submit those files for settlement. This is expected to mitigate customer-to-customer settlement risk.
- Existing recurring instructions, such as automatic payments for rent, will be processed earlier in the day to reduce customers’ uncertainty over whether payments will be settled on the day they are due.
- Customers’ accounts will reflect payments in a timely manner, including both funds entering and leaving an account.
A parallel project led by Payments NZ will also ensure funds posted to customer accounts are ‘cleared funds’, meaning they cannot be unwound (unless due to fraud), reducing uncertainty around the status of funds. This essentially removes the ability for banks to dishonour an electronic credit due to insufficient funds. The change will only apply to electronic credits (direct credits, bill payments and automatic payments) and not to direct debits.
Banks involved in this project have made significant changes to their systems in the past two years to ensure they can deliver these changes. The share of transactions that are settled early in the day has been increasing since 2012, and we expect this trend to continue (figure C1).
Figure C1: Distribution of payment settlement times (% of total settlements, by value)
Note: 2012 data are based on March to December 2012, and 2016 data are based on January to October 2016.
These changes will benefit banks by reducing both liquidity and operational risks. Customers will also benefit as payments will be processed and settled within a couple of hours, during a business day.