New Technologies in Payments
Content
“New Technologies in Payments –
A Challenge to Monetary Policy”
PROFESSOR OTMAR ISSING,
MEMBER OF THE EXECUTIVE BOARD
OF THE EUROPEAN CENTRAL BANK
Lecture to be delivered at the Center for Financial Studies
Frankfurt am Main
28 June 2000
European Central Bank
Press Division
Kaiserstrasse 29, D-60311 Frankfurt am Main
Tel.: 0049 69 1344 7455, Fax: 0049 69 1344 7404
Internet: http://www.ecb.int
Reproduction is permitted provided that the source is acknowledged.
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1.
Introduction
A wide range of innovations has taken place over the last years in the field of banking and
payment systems. These have had, or are likely to have, significant consequences for
payment habits and for the structure and functioning of markets. Moreover, they will
influence the way monetary policy is conducted.
In this paper, I will discuss the potential effects of these innovations for monetary policy in
the euro area, and to which extent central banks and financial regulators should react to
these challenges. These are very topical issues, and of great interest to central bankers.
Of course, it is extremely difficult to predict in which direction and to what extent further
innovations in these areas might evolve. Some think it might be conceivable that in some
remote future, monetary policy might be meaningless, or that central banks will no longer
play an important role in economic policy making. However, predictions in this direction
would amount to pure speculation. Today, I do not want to enter the hypothetical world of
Fama and Hall1, in which central banks play no role in monetary policy and money loses its
role as a unit of account. I will be less farsighted, but more concrete. I want to focus on
foreseeable developments in payments technologies and possible effects of monetary policy.
My line of argument is as follows. I will first outline developments in the field of large value
payments, these being mainly interbank payments. Here, I am going to discuss consequences
both for systemic stability as well as for the demand for central bank reserves. The second
area that I will speak about today is electronic money. I shall discuss how this new
phenomenon might pose a threat to the conduct of monetary policy and what should be the
response of regulatory authorities to that.
In summary, it is my opinion that the challenges that arise from the new forms of payment
for banks and for financial systems in general are serious, but can be managed. As long as the
central bank revises the formulation of monetary policy as a response to these changes, and
its regulatory framework is adapted accordingly, the technological developments will pose
no threat to the ability of the central bank to conduct monetary policy.
1
See Fama (1980) and Hall (1983).
2
2.
Overview over New Technologies
A first area in which information and communication technologies have significantly affected
the payment and monetary system is the field of electronic interbank payments. Since long
ago, the ability to use electronic networks to store and handle funds instead of having to rely
on physical transfer has dramatically changed the financial system. As a result, the transfer of
funds has become much faster and safer. Similarly, the transfer and safekeeping of securities
has become significantly cheaper since the advent of book-entry systems. The traditional
safekeeping of paper-based securities in vaults has widely been replaced by such electronic
book-entry.
But, more recently, a new “quantum leap” was made possible by the exponential increase in
computer power. Traditionally, the most common way to handle large value payments
between banks was to accumulate outstanding payments during a certain period of time,
often a business day, and to transfer them in one batch at the end of the day. Usually, this
was done in the form of “netting”, where payments between two counterparties were
matched and only the net obligation was transferred. Netting had some advantages
compared to the transfer of the gross amounts. First, because a lower amount of reserves
was transferred, the transaction involved both lower costs and a higher degree of safety.
Second, fewer central bank reserves were needed in a netting system, and this was again
cheaper for the participating banks.
By reducing transaction costs and enhancing safety of the transactions, the new information
and communication technologies have reduced the advantages of net vis-à-vis gross
settlement. Moreover, they have made settlement in real time possible, i.e. the immediate
execution of a transfer once a payment order has been issued. Through these two
developments, the electronic systems dramatically tilted the balance of costs and benefits in
favour of gross settlement systems. Indeed, today in many countries, including the member
states of the European Union, Real Time Gross Settlement (RTGS) Systems have replaced
some of the net systems.
The immediacy of settlement in real time systems has one important advantage: the
outstanding obligations between parties are reduced to zero immediately after the payment
order has been issued. This has the advantage that credit risk is reduced. Credit risk is the
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risk that the debtor bank may be unable to settle his obligations vis-à-vis the creditor bank.
In a netting system, credit risk is much higher. Here, the outstanding obligations can
accumulate over the day because of the time lag between payment order and settlement
makes it possible that the debtor bank can fail prior to settlement. The receiving bank might
then not receive the expected payments.
Generally, credit risk in net settlement systems has increased because the value of
transactions made via payments systems has risen significantly. Indeed, in the large value
payment systems in the European Union, an amount equalling annual GDP is turned over
every six to seven days.2 As a consequence, the daily liabilities of banks versus each other
have increased dramatically and often exceed the banks’ capital. As a result, the banking
sector has become more exposed to systemic risk.
Suppose that a bank that is a net debtor to the banking community is unable to honour its
claims.3 Its failure might lead to the failure of several of its trading counterparties, and, by a
domino effect, potentially also induce losses for other banks. A well-known example for such
an event was the failure of the Bankhaus Herstatt in 1974. Herstatt was heavily engaged in
foreign exchange transactions. It was closed down by the German authorities after the
European markets had closed for the day, but while New York was still open. At the time of
its bankruptcy, it had received transfers in Deutsche Mark from its US trading partners but
had not delivered the corresponding amounts of US Dollars to them. As a consequence, its
American counterparties experienced significant liquidity problems, and the payment system
handling foreign exchange transactions in the US, CHIPS, was disrupted so severely that it
led to a collapse in the US dollar/Deutsche Mark trading.
A financial crisis can be very damaging for the economy because they disrupt the monetary
system and the execution of monetary policy. Indeed, because the payment system is one of
the major channels through which a crisis could propagate, systemic risk considerations
were central to two important recent initiatives in the field of payment systems taken by
international regulators. First, the Bank for International Settlement (BIS) issued a report4
2
3
4
The average daily value of payments processed via the largest five payments systems in the EU-15 countries in 1999 was 1.3 trillion
euro. In comparison, yearly GDP in the same area was roughly 8 trillion euro.
It does not matter for this example whether the bank cannot meet its obligations due to insolvency or illiquidity.
“Report on Interbank Netting Schemes”, also called “Lamfalussy Report”, BIS (1990).
4
which set out minimum standards for netting systems that should limit the risk exposure of
the systems to individual banking failures. Second, the EU central banks decided to promote
Real Time Gross Settlement (RTGS) systems.5 Since the beginning of Stage Three of the
Economic and Monetary Union, all monetary policy operations are processed through the
TARGET system, which links the RTGS systems of all EU countries. It is not the only
payments systems that operates on a cross-border basis in the euro area (another one is
Euro 1, organised by the European Banking Association), but it currently processes the
largest bulk of payments, both in terms of value and volume. TARGET therefore amounts to
an important step in reducing settlement risk for the European banking sector.
A second and more recent innovation I would like to focus on concerns retail payment
structures, and specifically, electronic money. The term Electronic Money can be broadly
defined as electronic storage of monetary value on a technical device, which may be used to
make payments not only to the issuer but also to other agents. Note that cards that are
accepted as a mean of payments only by the issuer itself (for instance, telephone cards), so
called single-purpose cards, are not considered electronic money. Only multi-purpose cards,
that is, cards that can be used with a multiplicity of merchants, should properly be
considered as electronic money.
We can distinguish two main forms of e-money. Stored-value cards (SVC) are plastic cards
that contain purchasing power, which has been transferred to the card by a pre-payment.
Network money is monetary value stored in computer memory, and can be transferred over a
communications network such as the Internet.
Both of them entail several advantages compared to both cash and to traditional debit or
credit cards. First, SVCs facilitate small value payments that could have been done with cash,
but in a more cumbersome way. Thus, fewer banknotes and coins would be needed.
Similarly, network money can simplify payments made for purchases on the Internet. By
using network money, the amount that can potentially be lost due to misuse of transmitted
information is limited to the nominal value of money stored in the memory. Therefore,
possibilities for abuse seem to be smaller than with credit card payments. Finally, a further
5
European Monetary Institute (1993).
5
advantage of electronic money over cash would arise if interest were to be paid on the
outstanding balances.
Second, merchants can profit from accepting electronic money. As far as SVCs replace
payments in cash, they will face lower costs of handling notes and coins. To the extent that
electronic money substitutes for debit or credit card payments, the processing costs of
payments are reduced. A payment with a debit card usually involves the electronic
verification of sufficient account balances. To achieve this, the system relies on some
communication network. In case of electronic money, any expenses are debited to the
balance available on the device itself. Thus, no such communication network is needed as all
the relevant information is contained on the card or in the computer memory.
3.
Monetary Policy Implications
Having described some forms in which new technologies influence our ways of making
payments let me now turn to the impact of these developments on monetary policy. I will
first discuss large value payment systems, and then turn to electronic money.
3.1. Implications of Electronic Interbank Payments
Smoothly operating financial markets are essential to the functioning of monetary policy. A
financial crisis might have very destabilising effects, such as rapid price changes, a high level of
uncertainty, or a general liquidity shortage in the markets. Should such a crisis happen, the
rapid transmission of monetary impulses throughout the currency area might be hampered
or even prevented. Moreover, the ECB, like most other central banks, has statutory
responsibility over the well-functioning of payments systems. Hence, the central bank has an
interest in ensuring that certain safety standards are in place that limit the impact of a
systemic crisis and therefore reduce the possibility of a disruption of the financial system.
With TARGET, the Eurosystem has successfully implemented real time gross settlement and
thereby contributed to an environment of financial stability.
Let me turn to a second area in which payment arrangements have an impact on monetary
policy: they influence the demand for central bank reserves. In real-time gross settlement
systems, the demand for reserves is proportional to the volume of transfers made, but these
reserves can be used for several transactions on a given day. On the other hand, in a net
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settlement system, the netting-out of outstanding obligations between several banks reduces
the reserves that the banks need for settlement. Also, the relationship between money
demand and transfer volume is more complex in a net system. It depends on the number of
participants in a netting system as well as on the duration of the settlement cycle.
The effect on the demand for reserves of a switch from gross to net settlement is therefore
ambiguous. In Europe, the adoption of RTGS systems in preparation for Stage Three of the
Monetary Union led to a small increase in reserve holdings.
Additionally, a recent trend in private netting systems is to replace the traditional net
settlement systems by hybrid settlement systems. These systems6 combine features of RTGS
and net systems, essentially by providing net settlement with very short settlement lags. This
means that fewer payments will accumulate during this shorter cycle. Again, this trend
influences the demand for central bank reserves.
The transfer volume processed through large value systems is substantial. Therefore, the
organisation of these systems is a significant determinant for the size of the demand for
central bank money. A central bank should be concerned with effects on the demand for
central bank money since this demand and also its interest rate elasticity are key variables
for the transmission process of monetary policy. I will elaborate on this relationship in the
following section.
3.2 Implications of Electronic Money
3.2.a Free banking
Electronic money is private money that competes against central bank money as a medium
of exchange. This phenomenon immediately calls to mind the historical experience of free
banking where private banks were allowed to issue private currencies. One of the strongest
advocates of abolishing the central bank’s monopoly in the creation of money was von
Hayek7. He proposed to enable private banks to issue their own currency, thereby creating
competition. Banks could issue non-interest-bearing certificates and open cheque accounts
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7
These are EAF in Germany and PNS in France.
von Hayek (1976). See also Issing (1999).
7
on the basis of their own distinct registered trademark. Different banks would issue different
certificates. These currencies would then trade at variable exchange rates.
Von Hayek believed competition between different currencies to be particularly conducive
to price stability. This would be achieved via a discovery process. Only those currencies that
built up a reputation for providing stable purchasing power could survive competition. On
the other hand, banks that failed to build up such a reputation would lose consumers and be
driven out of business. Consequently, such a system would eventually only leave room for
stable currencies, and lead to a non-inflationary outcome. Electronic money bears some
similarities to this vision. Issuers of different types of electronic money may indeed compete
against each other to attract customers, and could do so in a way closely resembling the one
envisaged by von Hayek.
Nevertheless, there are arguments opposing this view. Let me mention a few. First, in the
discovery process envisaged by von Hayek, bad issuers are driven out by the fact that they
have recourse to inflationary issuance. This suggests that the discovery process itself could
be characterised by inflation. Second, if the discovery process was successful such that a
single stable currency did emerge, there is no guarantee that the new monopolist would not
engage in inflationary over-issue, with the aim of maximising seigniorage. Last, but certainly
not least, the role of the currency as a unit of account would be undermined: there would
be not just one price for each given good, but n prices, where n is the number of existing
monies. This would unduly complicate the price system, whereas one of the principal
benefits of monetary economies is that of making prices transparent, thereby facilitating
exchanges. Money should be the numeraire, that is the unit for quoting prices, for
negotiating contracts, and for performing any economic calculations. A unique numeraire is
the most efficient solution to this co-ordination problem. The loss of a unique unit of
account could therefore induce significant efficiency losses for the economy.
I conclude that, while Hayek’s ideas are stimulating, the merits of unregulated competition of
electronic monies are, to say the least, ambiguous.
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3.2.b Will the increase in electronic money become significant?
As many as 19 electronic money schemes were operating in the euro area in 1999. Most of
them were launched between 1995 and 1997, and their use is still very limited. Daily
turnover in electronic money was only about EUR 800,000 for the entire euro area. Neither
seems electronic money a preferred form of payment for consumers, nor do many
merchants accept it widely at the present time. In most countries, the use of stored value
cards is still at a relatively experimental stage. For network money, usage is much scarcer
still. Such slow progress may seem surprising considering that successful IT related
applications usually have a very fast development.
The reluctance by merchants can be explained by the technical adaptations that need to be
made to offer this service. These require initial investments into new equipment that is able
to read the devices on which money is stored, and to transfer the funds to an own
electronic storage facility. Also, personnel need to be trained to use the new money. While
marginal costs from processing electronic payments are rather low, these initial investments
might be substantial. On the other hand, returns from the investment arise proportionally to
its usage. Consequently, if the expected number of customers wishing to pay with electronic
money is low, the benefits from e-money are unlikely to outweigh the initial investment cost.
Only once a critical mass of usage has been reached might electronic money become
profitable for merchants.
Similar economies of scale exist on the customer side. Consumers might be unwilling to
adapt stored value cards while the number of vendors accepting these cards remains small.
Concerning network money, related considerations apply. Additionally, consumers might be
reluctant to purchase electronic money because they are unfamiliar with it, and uncertain
about the risks and benefits it brings along. Confidence in the technology and the issuing
institution are essential for the acceptance. This argument might be particularly strong for
the case of network money, where the degree of anonymity of issuers or merchants is
higher.
These network effects both on the demand and the supply side suggest that electronic
money might become widespread only when the network of buyers and sellers that are
willing to accept this form of payment has become large enough. Rapid growth of this
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payment form is therefore expected to take place once a critical mass of acceptance and
dissemination has been reached.
In summary, the fact that the use of electronic money is not widespread up to this date does
not imply that a rapid growth of this payment medium might not take place at some stage.
The question of whether e-money will become, in the not too distant future, the dominant
(or finally the only) used form of payment, is however still open. I do not want to speculate
too much on this here. I am concerned, however, that monetary policy makers must be
ready to face all conceivable scenarios. Therefore, in the following I will comment on the
implications that such a development could have for monetary policy.
3.2.c Consequences for the formulation of monetary policy
The primary objective of the European Central Bank (ECB) is to maintain price stability in
the euro area over the medium term. The price level is, as we all know, the inverse of the
price of money in terms of goods. Therefore, developments that affect the money supply
mechanism, such as electronic money, are very relevant from the viewpoint of the ECB’s
primary goal.
A central bank, however, cannot directly control the price level. Monetary policy operates
through a complex transmission process that involves the financial system and the real
economy, and in which substantial time lags exist. A forward-looking monetary policy must
therefore be based on some indicators in order to achieve its goal of price stability. Money is
an important variable in this process. For this reason, the Governing Council of the ECB has
given monetary aggregates a prominent role in its monetary policy strategy.
As you all know, the monetary aggregate chosen by the ECB within its strategy is M3.8 This
is a broad aggregate that includes a wide range of relatively liquid assets. Among other
reasons, it was chosen because it is least affected by substitution between various liquid
assets, and because of its empirically stable relationship with the price level.9
8
9
For a general description of the monetary policy strategy of the ECB , see ECB (1999b)
See ECB (1999c).
10
The advent and spread of electronic money may affect the properties of monetary
aggregates. Specifically, since stored value cards are likely to substitute largely for cash
payments, the effect of their spread will be largest on the narrower aggregates such as base
money and M1. On the other hand, cash constitutes only a small fraction of the broader
aggregates. Therefore, in relative terms the spread of e-money will have a less pronounced
effect on these variables.10 Nevertheless, with the further development of new payment
technologies, I cannot exclude the possibility that M3, as presently defined, may also be
influenced to a relevant degree.
Network money is likely to substitute mostly for credit card payments, which are at present
the most common forms of payment for Internet transactions. It will probably – at least for
some time to come - not affect the use of cash to a great extent, and is thus not likely to
have a major primary impact on the aggregates. However, it remains to be seen for which
market segments and to which extent e-business will replace traditional merchandising and
the corresponding payment habits.
Another potential reduction in the information content of M3 could result if the new
technologies are bringing about efficiency gains in the usage of payments instruments. The
experience with credit cards was that households were able to economise on their money
holdings through more efficient payment handling. Similarly, one could expect that also
electronic money could contribute to a more efficient payment structure. If this were the
case, then even the augmented monetary aggregates that include electronic money would be
subject to a decrease that reflects the efficiency gain and the resulting increase in velocity of
money. This development can also be interpreted as an increase in the money multiplier, as
it amounts to a higher level of money creation for a given level of base money. Again, the
effect is likely to be stronger for the narrower aggregates than for the broader ones. The
effect on M3 for the foreseeable future might therefore be rather small.
For the monetary aggregates to maintain their function in monetary policy, the aggregates
should be defined appropriately to include all means of payments and their close substitutes,
including electronic money. For the appropriate calculation of these aggregates, it is
therefore essential that data on the amount of outstanding balances are available to the
10
See Freedman (2000).
11
central bank. Issuers of e-money must be required to provide the necessary statistics to the
central bank or another authority in charge of supervision.
3.2.d Consequences for the effectiveness of monetary policy
Reduction of the central bank’s balance sheet
To the extent that electronic money reduces the demand for cash, it will affect the central
bank’s balance sheet. However, cash is a substantial component of a central bank’s liabilities.
Currency in circulation now constitutes more than one third of the Eurosystem’s liabilities.
Consequently, a significant reduction of its balance sheet could result once the use of
electronic money becomes widespread.11
Changes in asset holdings are the principal means by which central banks adjust the supply of
reserves. Depending on the extent to which electronic money leads to a reduction in the
size of the balance sheet takes place, the central bank’s capacity to control short-term
interest rates via monetary intervention operations could potentially be limited. Under
normal circumstances, a relatively small balance sheet will be sufficient to carry out open
market operations. However, should special circumstances arise in which the central bank
needs to intervene on a larger scale, then a small balance sheet might constitute a problem.
Reduction in the demand for central bank money
The central bank’s ability to influence money market rates rests on its monopoly in the
creation of base money. This monopoly matters because banks need to hold central bank
money to undertake economic transactions with their customers. If the central bank reduces
the supply of reserves, short-term interest rates are affected. Banks would tend to lower the
amount of credit given to customers, which in turn indirectly affects economic activity. The
advent of electronic money or any other new payment form will not change this monopoly
position, because central banks will continue to be the unique providers of central bank
money to the banking sector. Electronic money poses no threat to this position.
The question is, however, whether new payment technologies will reduce the necessity for
banks to hold central bank reserves, and in the extreme reduce the demand for base money
11
See BIS (1996).
12
to zero.12 In the latter scenario, the central bank would maintain its monopoly, but it would
be useless. The ability to steer the price level in the economy through the supply of central
bank money would be lost.
But how do new developments in the area of retail payments affect the demand for money?
To take an example, consider the use of credit cards. Any credit card payment involves the
transfer of funds from the consumers to the issuer of the credit card and further to the
merchant who accepted the card. Usually, the settlement of this transaction requires the
corresponding movements on the involved parties’ checking accounts. But this implies that
the bank needs to hold central bank reserves as a means of settling this transaction. Any
transaction made must correspond to a movement in central bank reserves. Credit cards
therefore pose no threat to the efficacy of the central bank’s monopoly. Other schemes,
such as debit cards and electronic money in its present form, share these properties.
However, it is conceivable that at some point in the future the settlement might take place
without regular recourse to central bank reserves. To see this, consider a situation in which
a certain stored value card is widely accepted as payment form among merchants other than
the issuer. Suppose that instead of transferring bank balances, the merchants could reduce
their outstanding claims vis-à-vis each other by swapping their claims on the books of the
card issuer. If this was possible, payments could be made without involving any bank
transfers. Consequently, the new means of payment would be independent of any central
bank reserve holdings of the credit institutions. 13
This scenario mirrors the net settlement procedures that I have described for electronic
interbank payments. To the extent that private obligations are “swapped” or “netted”
against each other, demand for central bank money will be reduced. 14
Can such a development pose a threat to the conduct of monetary policy? How likely is such
a scenario? I believe: not very much, as both private agents and public authorities are likely
to have an interest in maintaining to some extent more traditional forms of payment.
12
13
14
Significant changes in the demand for central bank money have also taken place in the past. In Germany, for instance, a reduction in
reserve holdings in the early 1970s was a consequence of intensified interbank relations. This development has later forced the
Bundesbank to give up its concept of “free liquidity reserves” (see Issing, 1977).
This argument is based on Friedman (1999).
King (1999) discusses the possibility of a “cashless society” in which the central bank monopoly over base money loses its efficacy.
13
First, consumers might want to maintain some degree of anonymity when making payments.
Complete anonymity, however, can only be guaranteed when paying with cash. Consumers
might thus rather hold a combination of both cash and other types of payment devices.
Second, settlement in central bank money has an advantage over settlement on an issuer’s
books in both its safety and finality. True finality can only be achieved when settlement
occurs in central bank money. Security is a key feature of any payment system. Especially for
payments of larger value, I believe that the uniqueness of central bank money in providing
immediate finality will remain an important advantage over the new forms of payment.
Nevertheless, I believe that central banks should have the adequate tools to meet any
challenges that arise from the new technologies, even if today they seem remote. I will now
present the regulatory tools that the ECB considers adequate to meet these challenges.
4
Regulatory Responses
Preserving the essential role of money in the economy requires a minimal, but effective,
regulatory framework. Above all, it must be ensured that price stability and the unit of
account function of money are not endangered. The ECB’s position in the field of regulation
of electronic money can be summarised in five points: 15
A.
Prudential Supervision
Issuers of electronic money must be subject to prudential supervision. In order to preserve
the stability of and to maintain confidence in the financial system, the ECB requires an
adequate level of financial soundness, sound risk management, and ongoing supervision by
respective authorities.
B.
Solid and transparent legal arrangements; technical security; protection
against criminal abuse
The issuance must be subject to solid and transparent legal arrangements. The rights and
obligations of the respective participants, including issuers, merchants, and customers, must
be clearly defined and be enforceable. The need for well-defined legal structure is especially
evident when a scheme operates on a cross-border basis.
15
European Central Bank, (1998) and (1999a).
14
Adequate technical and organisational safeguards should be maintained to prevent threats to
the security of the scheme such as counterfeit. Similarly, protection against criminal abuse
should be taken into account in the design and implementation of the scheme.
C.
Monetary statistics reporting
Information about the amount of money available in the economy is indispensable for the
conduct of monetary policy. Electronic money schemes should therefore supply the central
bank with adequate statistical information.
D.
Redeemability
Issuers of electronic money must be legally obliged, at request of the holders, to redeem
electronic money against central bank money at par. This requirement ensures that the unitof-account function of money is maintained. Furthermore, without a close link to central
bank money, there could potentially be an unlimited creation of electronic money, which
could, in turn, lead to inflationary pressure.
E.
Reserve Requirements
The possibility must exist for central banks to impose reserve requirements on all issuers of
electronic money, in particular in order to be prepared for a substantial growth of electronic
money with a material impact on monetary policy. Such a reserve requirement could limit
the risk of unrestricted growth in electronic money and help to maintain price stability.
Furthermore, it ensures equal treatment in comparison with issuers of other forms of
money.
5.
Conclusion
To sum up, recent technological developments have changed and continue to change
payments habits. These developments have the potential to improve the efficiency of the
financial system. However, they pose challenges to central banks in their conduct of
monetary policy.
15
Some of these challenges are not new. Central banks have before experienced competition
from private issuers of money, for instance in the free-banking episode. Thus, the spread of
electronic money poses an old problem, but in a different form.
New developments in electronic interbank payments have paved the way for a change from
net to real time gross settlement. By this, the payment mechanism has become more reliable
for users, and at the same time much safer in terms of systemic risk.
Electronic money is being considered by some the main future challenge to central banking. I
believe this is only partly true. There will always be a need for the element of security,
confidence, and information that central bank money contains. Unregulated electronic
money cannot provide such a fundamental precondition, which is, I believe, at the heart of
the well functioning of a market economy. Therefore, I do not believe that electronic money
will become a threat to monetary policy in the near future.
Nevertheless, in order to ensure that under no circumstance the central bank loses its
ability to preserve price stability and to maintain the unit of account function of money, a
certain degree of regulation is indispensable. With the regulatory requirements that I have
outlined, the ECB will continue to provide a monetary framework in which the goal of
maintaining price stability can be achieved.
6.
References
Bank for International Settlements
(1990): “Report of the Committee on Interbank Netting
Schemes of the central banks of the Group of Ten countries” (Lamfalussy Report), Basel.
Bank for International Settlements (1996): “Implications for Central Banks of the Development of
Electronic Money”, Basel.
Deutsche Bundesbank (1999), “Neue Entwicklungen beim Elektronischen Geld”, in Deutsche
Bundesbank Monatsbericht, Juni 1999.
European Central Bank (1998): “Report on Electronic Money”.
European Central Bank (1999a): “Opinion of the European Central Bank on Electronic Money and
on Credit Institutions”.
16
European Central Bank (1999b): “The Stability-oriented monetary policy strategy of the
Eurosystem”, in ECB Monthly Bulletin January 1999, 39-50.
European Central Bank (1999c): ”Euro area monetary aggregates and their role in the Eurosystem’s
monetary policy strategy”, in ECB Monthly Bulletin February 1999, 29-40.
European Monetary Institute (1993): “Minimum Common Features for Domestic Payment
Systems”.
Fama, Eugene (1980): “Banking in the Theory of Finance”, in Journal of Monetary Economics 6, 3957.
Freedman, Charles (2000): “Electronic Money: Monetary Policy and seigniorage Issues”, OECD.
Friedman, Benjamin (1999): ‘The Future of Monetary Policy: The Central Bank as an Army with Only
a Signal Corps?” in International Finance 2:3, 321-338.
Hall, Robert (1983): “Optimal Fiduciary Monetary Systems”, in Journal of Monetary Economics 12,
33-50.
von Hayek, Friedrich (1976): “Choice in Currency: A Way to Stop Inflation”, Institute of Economic
Affairs Occasional Paper 48.
Issing, Otmar (1977): “Zur Rolle der Interbankbeziehungen”, in Kredit und Kapital 4-1977, 408420.
Issing, Otmar (1999): “Hayek – Currency Competition and European Monetary Union” speech at
the annual Hayek memorial lecture hosted by the Institute of Economic Affairs, London, 27 May
1999.
King, Mervyn (1999): “Challenges for Monetary Policy: New and Old”, Paper prepared for the
Symposium on “New Challenges for Monetary Policy” in Jackson Hole, WY.
17
A Challenge to Monetary Policy”
PROFESSOR OTMAR ISSING,
MEMBER OF THE EXECUTIVE BOARD
OF THE EUROPEAN CENTRAL BANK
Lecture to be delivered at the Center for Financial Studies
Frankfurt am Main
28 June 2000
European Central Bank
Press Division
Kaiserstrasse 29, D-60311 Frankfurt am Main
Tel.: 0049 69 1344 7455, Fax: 0049 69 1344 7404
Internet: http://www.ecb.int
Reproduction is permitted provided that the source is acknowledged.
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1.
Introduction
A wide range of innovations has taken place over the last years in the field of banking and
payment systems. These have had, or are likely to have, significant consequences for
payment habits and for the structure and functioning of markets. Moreover, they will
influence the way monetary policy is conducted.
In this paper, I will discuss the potential effects of these innovations for monetary policy in
the euro area, and to which extent central banks and financial regulators should react to
these challenges. These are very topical issues, and of great interest to central bankers.
Of course, it is extremely difficult to predict in which direction and to what extent further
innovations in these areas might evolve. Some think it might be conceivable that in some
remote future, monetary policy might be meaningless, or that central banks will no longer
play an important role in economic policy making. However, predictions in this direction
would amount to pure speculation. Today, I do not want to enter the hypothetical world of
Fama and Hall1, in which central banks play no role in monetary policy and money loses its
role as a unit of account. I will be less farsighted, but more concrete. I want to focus on
foreseeable developments in payments technologies and possible effects of monetary policy.
My line of argument is as follows. I will first outline developments in the field of large value
payments, these being mainly interbank payments. Here, I am going to discuss consequences
both for systemic stability as well as for the demand for central bank reserves. The second
area that I will speak about today is electronic money. I shall discuss how this new
phenomenon might pose a threat to the conduct of monetary policy and what should be the
response of regulatory authorities to that.
In summary, it is my opinion that the challenges that arise from the new forms of payment
for banks and for financial systems in general are serious, but can be managed. As long as the
central bank revises the formulation of monetary policy as a response to these changes, and
its regulatory framework is adapted accordingly, the technological developments will pose
no threat to the ability of the central bank to conduct monetary policy.
1
See Fama (1980) and Hall (1983).
2
2.
Overview over New Technologies
A first area in which information and communication technologies have significantly affected
the payment and monetary system is the field of electronic interbank payments. Since long
ago, the ability to use electronic networks to store and handle funds instead of having to rely
on physical transfer has dramatically changed the financial system. As a result, the transfer of
funds has become much faster and safer. Similarly, the transfer and safekeeping of securities
has become significantly cheaper since the advent of book-entry systems. The traditional
safekeeping of paper-based securities in vaults has widely been replaced by such electronic
book-entry.
But, more recently, a new “quantum leap” was made possible by the exponential increase in
computer power. Traditionally, the most common way to handle large value payments
between banks was to accumulate outstanding payments during a certain period of time,
often a business day, and to transfer them in one batch at the end of the day. Usually, this
was done in the form of “netting”, where payments between two counterparties were
matched and only the net obligation was transferred. Netting had some advantages
compared to the transfer of the gross amounts. First, because a lower amount of reserves
was transferred, the transaction involved both lower costs and a higher degree of safety.
Second, fewer central bank reserves were needed in a netting system, and this was again
cheaper for the participating banks.
By reducing transaction costs and enhancing safety of the transactions, the new information
and communication technologies have reduced the advantages of net vis-à-vis gross
settlement. Moreover, they have made settlement in real time possible, i.e. the immediate
execution of a transfer once a payment order has been issued. Through these two
developments, the electronic systems dramatically tilted the balance of costs and benefits in
favour of gross settlement systems. Indeed, today in many countries, including the member
states of the European Union, Real Time Gross Settlement (RTGS) Systems have replaced
some of the net systems.
The immediacy of settlement in real time systems has one important advantage: the
outstanding obligations between parties are reduced to zero immediately after the payment
order has been issued. This has the advantage that credit risk is reduced. Credit risk is the
3
risk that the debtor bank may be unable to settle his obligations vis-à-vis the creditor bank.
In a netting system, credit risk is much higher. Here, the outstanding obligations can
accumulate over the day because of the time lag between payment order and settlement
makes it possible that the debtor bank can fail prior to settlement. The receiving bank might
then not receive the expected payments.
Generally, credit risk in net settlement systems has increased because the value of
transactions made via payments systems has risen significantly. Indeed, in the large value
payment systems in the European Union, an amount equalling annual GDP is turned over
every six to seven days.2 As a consequence, the daily liabilities of banks versus each other
have increased dramatically and often exceed the banks’ capital. As a result, the banking
sector has become more exposed to systemic risk.
Suppose that a bank that is a net debtor to the banking community is unable to honour its
claims.3 Its failure might lead to the failure of several of its trading counterparties, and, by a
domino effect, potentially also induce losses for other banks. A well-known example for such
an event was the failure of the Bankhaus Herstatt in 1974. Herstatt was heavily engaged in
foreign exchange transactions. It was closed down by the German authorities after the
European markets had closed for the day, but while New York was still open. At the time of
its bankruptcy, it had received transfers in Deutsche Mark from its US trading partners but
had not delivered the corresponding amounts of US Dollars to them. As a consequence, its
American counterparties experienced significant liquidity problems, and the payment system
handling foreign exchange transactions in the US, CHIPS, was disrupted so severely that it
led to a collapse in the US dollar/Deutsche Mark trading.
A financial crisis can be very damaging for the economy because they disrupt the monetary
system and the execution of monetary policy. Indeed, because the payment system is one of
the major channels through which a crisis could propagate, systemic risk considerations
were central to two important recent initiatives in the field of payment systems taken by
international regulators. First, the Bank for International Settlement (BIS) issued a report4
2
3
4
The average daily value of payments processed via the largest five payments systems in the EU-15 countries in 1999 was 1.3 trillion
euro. In comparison, yearly GDP in the same area was roughly 8 trillion euro.
It does not matter for this example whether the bank cannot meet its obligations due to insolvency or illiquidity.
“Report on Interbank Netting Schemes”, also called “Lamfalussy Report”, BIS (1990).
4
which set out minimum standards for netting systems that should limit the risk exposure of
the systems to individual banking failures. Second, the EU central banks decided to promote
Real Time Gross Settlement (RTGS) systems.5 Since the beginning of Stage Three of the
Economic and Monetary Union, all monetary policy operations are processed through the
TARGET system, which links the RTGS systems of all EU countries. It is not the only
payments systems that operates on a cross-border basis in the euro area (another one is
Euro 1, organised by the European Banking Association), but it currently processes the
largest bulk of payments, both in terms of value and volume. TARGET therefore amounts to
an important step in reducing settlement risk for the European banking sector.
A second and more recent innovation I would like to focus on concerns retail payment
structures, and specifically, electronic money. The term Electronic Money can be broadly
defined as electronic storage of monetary value on a technical device, which may be used to
make payments not only to the issuer but also to other agents. Note that cards that are
accepted as a mean of payments only by the issuer itself (for instance, telephone cards), so
called single-purpose cards, are not considered electronic money. Only multi-purpose cards,
that is, cards that can be used with a multiplicity of merchants, should properly be
considered as electronic money.
We can distinguish two main forms of e-money. Stored-value cards (SVC) are plastic cards
that contain purchasing power, which has been transferred to the card by a pre-payment.
Network money is monetary value stored in computer memory, and can be transferred over a
communications network such as the Internet.
Both of them entail several advantages compared to both cash and to traditional debit or
credit cards. First, SVCs facilitate small value payments that could have been done with cash,
but in a more cumbersome way. Thus, fewer banknotes and coins would be needed.
Similarly, network money can simplify payments made for purchases on the Internet. By
using network money, the amount that can potentially be lost due to misuse of transmitted
information is limited to the nominal value of money stored in the memory. Therefore,
possibilities for abuse seem to be smaller than with credit card payments. Finally, a further
5
European Monetary Institute (1993).
5
advantage of electronic money over cash would arise if interest were to be paid on the
outstanding balances.
Second, merchants can profit from accepting electronic money. As far as SVCs replace
payments in cash, they will face lower costs of handling notes and coins. To the extent that
electronic money substitutes for debit or credit card payments, the processing costs of
payments are reduced. A payment with a debit card usually involves the electronic
verification of sufficient account balances. To achieve this, the system relies on some
communication network. In case of electronic money, any expenses are debited to the
balance available on the device itself. Thus, no such communication network is needed as all
the relevant information is contained on the card or in the computer memory.
3.
Monetary Policy Implications
Having described some forms in which new technologies influence our ways of making
payments let me now turn to the impact of these developments on monetary policy. I will
first discuss large value payment systems, and then turn to electronic money.
3.1. Implications of Electronic Interbank Payments
Smoothly operating financial markets are essential to the functioning of monetary policy. A
financial crisis might have very destabilising effects, such as rapid price changes, a high level of
uncertainty, or a general liquidity shortage in the markets. Should such a crisis happen, the
rapid transmission of monetary impulses throughout the currency area might be hampered
or even prevented. Moreover, the ECB, like most other central banks, has statutory
responsibility over the well-functioning of payments systems. Hence, the central bank has an
interest in ensuring that certain safety standards are in place that limit the impact of a
systemic crisis and therefore reduce the possibility of a disruption of the financial system.
With TARGET, the Eurosystem has successfully implemented real time gross settlement and
thereby contributed to an environment of financial stability.
Let me turn to a second area in which payment arrangements have an impact on monetary
policy: they influence the demand for central bank reserves. In real-time gross settlement
systems, the demand for reserves is proportional to the volume of transfers made, but these
reserves can be used for several transactions on a given day. On the other hand, in a net
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settlement system, the netting-out of outstanding obligations between several banks reduces
the reserves that the banks need for settlement. Also, the relationship between money
demand and transfer volume is more complex in a net system. It depends on the number of
participants in a netting system as well as on the duration of the settlement cycle.
The effect on the demand for reserves of a switch from gross to net settlement is therefore
ambiguous. In Europe, the adoption of RTGS systems in preparation for Stage Three of the
Monetary Union led to a small increase in reserve holdings.
Additionally, a recent trend in private netting systems is to replace the traditional net
settlement systems by hybrid settlement systems. These systems6 combine features of RTGS
and net systems, essentially by providing net settlement with very short settlement lags. This
means that fewer payments will accumulate during this shorter cycle. Again, this trend
influences the demand for central bank reserves.
The transfer volume processed through large value systems is substantial. Therefore, the
organisation of these systems is a significant determinant for the size of the demand for
central bank money. A central bank should be concerned with effects on the demand for
central bank money since this demand and also its interest rate elasticity are key variables
for the transmission process of monetary policy. I will elaborate on this relationship in the
following section.
3.2 Implications of Electronic Money
3.2.a Free banking
Electronic money is private money that competes against central bank money as a medium
of exchange. This phenomenon immediately calls to mind the historical experience of free
banking where private banks were allowed to issue private currencies. One of the strongest
advocates of abolishing the central bank’s monopoly in the creation of money was von
Hayek7. He proposed to enable private banks to issue their own currency, thereby creating
competition. Banks could issue non-interest-bearing certificates and open cheque accounts
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7
These are EAF in Germany and PNS in France.
von Hayek (1976). See also Issing (1999).
7
on the basis of their own distinct registered trademark. Different banks would issue different
certificates. These currencies would then trade at variable exchange rates.
Von Hayek believed competition between different currencies to be particularly conducive
to price stability. This would be achieved via a discovery process. Only those currencies that
built up a reputation for providing stable purchasing power could survive competition. On
the other hand, banks that failed to build up such a reputation would lose consumers and be
driven out of business. Consequently, such a system would eventually only leave room for
stable currencies, and lead to a non-inflationary outcome. Electronic money bears some
similarities to this vision. Issuers of different types of electronic money may indeed compete
against each other to attract customers, and could do so in a way closely resembling the one
envisaged by von Hayek.
Nevertheless, there are arguments opposing this view. Let me mention a few. First, in the
discovery process envisaged by von Hayek, bad issuers are driven out by the fact that they
have recourse to inflationary issuance. This suggests that the discovery process itself could
be characterised by inflation. Second, if the discovery process was successful such that a
single stable currency did emerge, there is no guarantee that the new monopolist would not
engage in inflationary over-issue, with the aim of maximising seigniorage. Last, but certainly
not least, the role of the currency as a unit of account would be undermined: there would
be not just one price for each given good, but n prices, where n is the number of existing
monies. This would unduly complicate the price system, whereas one of the principal
benefits of monetary economies is that of making prices transparent, thereby facilitating
exchanges. Money should be the numeraire, that is the unit for quoting prices, for
negotiating contracts, and for performing any economic calculations. A unique numeraire is
the most efficient solution to this co-ordination problem. The loss of a unique unit of
account could therefore induce significant efficiency losses for the economy.
I conclude that, while Hayek’s ideas are stimulating, the merits of unregulated competition of
electronic monies are, to say the least, ambiguous.
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3.2.b Will the increase in electronic money become significant?
As many as 19 electronic money schemes were operating in the euro area in 1999. Most of
them were launched between 1995 and 1997, and their use is still very limited. Daily
turnover in electronic money was only about EUR 800,000 for the entire euro area. Neither
seems electronic money a preferred form of payment for consumers, nor do many
merchants accept it widely at the present time. In most countries, the use of stored value
cards is still at a relatively experimental stage. For network money, usage is much scarcer
still. Such slow progress may seem surprising considering that successful IT related
applications usually have a very fast development.
The reluctance by merchants can be explained by the technical adaptations that need to be
made to offer this service. These require initial investments into new equipment that is able
to read the devices on which money is stored, and to transfer the funds to an own
electronic storage facility. Also, personnel need to be trained to use the new money. While
marginal costs from processing electronic payments are rather low, these initial investments
might be substantial. On the other hand, returns from the investment arise proportionally to
its usage. Consequently, if the expected number of customers wishing to pay with electronic
money is low, the benefits from e-money are unlikely to outweigh the initial investment cost.
Only once a critical mass of usage has been reached might electronic money become
profitable for merchants.
Similar economies of scale exist on the customer side. Consumers might be unwilling to
adapt stored value cards while the number of vendors accepting these cards remains small.
Concerning network money, related considerations apply. Additionally, consumers might be
reluctant to purchase electronic money because they are unfamiliar with it, and uncertain
about the risks and benefits it brings along. Confidence in the technology and the issuing
institution are essential for the acceptance. This argument might be particularly strong for
the case of network money, where the degree of anonymity of issuers or merchants is
higher.
These network effects both on the demand and the supply side suggest that electronic
money might become widespread only when the network of buyers and sellers that are
willing to accept this form of payment has become large enough. Rapid growth of this
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payment form is therefore expected to take place once a critical mass of acceptance and
dissemination has been reached.
In summary, the fact that the use of electronic money is not widespread up to this date does
not imply that a rapid growth of this payment medium might not take place at some stage.
The question of whether e-money will become, in the not too distant future, the dominant
(or finally the only) used form of payment, is however still open. I do not want to speculate
too much on this here. I am concerned, however, that monetary policy makers must be
ready to face all conceivable scenarios. Therefore, in the following I will comment on the
implications that such a development could have for monetary policy.
3.2.c Consequences for the formulation of monetary policy
The primary objective of the European Central Bank (ECB) is to maintain price stability in
the euro area over the medium term. The price level is, as we all know, the inverse of the
price of money in terms of goods. Therefore, developments that affect the money supply
mechanism, such as electronic money, are very relevant from the viewpoint of the ECB’s
primary goal.
A central bank, however, cannot directly control the price level. Monetary policy operates
through a complex transmission process that involves the financial system and the real
economy, and in which substantial time lags exist. A forward-looking monetary policy must
therefore be based on some indicators in order to achieve its goal of price stability. Money is
an important variable in this process. For this reason, the Governing Council of the ECB has
given monetary aggregates a prominent role in its monetary policy strategy.
As you all know, the monetary aggregate chosen by the ECB within its strategy is M3.8 This
is a broad aggregate that includes a wide range of relatively liquid assets. Among other
reasons, it was chosen because it is least affected by substitution between various liquid
assets, and because of its empirically stable relationship with the price level.9
8
9
For a general description of the monetary policy strategy of the ECB , see ECB (1999b)
See ECB (1999c).
10
The advent and spread of electronic money may affect the properties of monetary
aggregates. Specifically, since stored value cards are likely to substitute largely for cash
payments, the effect of their spread will be largest on the narrower aggregates such as base
money and M1. On the other hand, cash constitutes only a small fraction of the broader
aggregates. Therefore, in relative terms the spread of e-money will have a less pronounced
effect on these variables.10 Nevertheless, with the further development of new payment
technologies, I cannot exclude the possibility that M3, as presently defined, may also be
influenced to a relevant degree.
Network money is likely to substitute mostly for credit card payments, which are at present
the most common forms of payment for Internet transactions. It will probably – at least for
some time to come - not affect the use of cash to a great extent, and is thus not likely to
have a major primary impact on the aggregates. However, it remains to be seen for which
market segments and to which extent e-business will replace traditional merchandising and
the corresponding payment habits.
Another potential reduction in the information content of M3 could result if the new
technologies are bringing about efficiency gains in the usage of payments instruments. The
experience with credit cards was that households were able to economise on their money
holdings through more efficient payment handling. Similarly, one could expect that also
electronic money could contribute to a more efficient payment structure. If this were the
case, then even the augmented monetary aggregates that include electronic money would be
subject to a decrease that reflects the efficiency gain and the resulting increase in velocity of
money. This development can also be interpreted as an increase in the money multiplier, as
it amounts to a higher level of money creation for a given level of base money. Again, the
effect is likely to be stronger for the narrower aggregates than for the broader ones. The
effect on M3 for the foreseeable future might therefore be rather small.
For the monetary aggregates to maintain their function in monetary policy, the aggregates
should be defined appropriately to include all means of payments and their close substitutes,
including electronic money. For the appropriate calculation of these aggregates, it is
therefore essential that data on the amount of outstanding balances are available to the
10
See Freedman (2000).
11
central bank. Issuers of e-money must be required to provide the necessary statistics to the
central bank or another authority in charge of supervision.
3.2.d Consequences for the effectiveness of monetary policy
Reduction of the central bank’s balance sheet
To the extent that electronic money reduces the demand for cash, it will affect the central
bank’s balance sheet. However, cash is a substantial component of a central bank’s liabilities.
Currency in circulation now constitutes more than one third of the Eurosystem’s liabilities.
Consequently, a significant reduction of its balance sheet could result once the use of
electronic money becomes widespread.11
Changes in asset holdings are the principal means by which central banks adjust the supply of
reserves. Depending on the extent to which electronic money leads to a reduction in the
size of the balance sheet takes place, the central bank’s capacity to control short-term
interest rates via monetary intervention operations could potentially be limited. Under
normal circumstances, a relatively small balance sheet will be sufficient to carry out open
market operations. However, should special circumstances arise in which the central bank
needs to intervene on a larger scale, then a small balance sheet might constitute a problem.
Reduction in the demand for central bank money
The central bank’s ability to influence money market rates rests on its monopoly in the
creation of base money. This monopoly matters because banks need to hold central bank
money to undertake economic transactions with their customers. If the central bank reduces
the supply of reserves, short-term interest rates are affected. Banks would tend to lower the
amount of credit given to customers, which in turn indirectly affects economic activity. The
advent of electronic money or any other new payment form will not change this monopoly
position, because central banks will continue to be the unique providers of central bank
money to the banking sector. Electronic money poses no threat to this position.
The question is, however, whether new payment technologies will reduce the necessity for
banks to hold central bank reserves, and in the extreme reduce the demand for base money
11
See BIS (1996).
12
to zero.12 In the latter scenario, the central bank would maintain its monopoly, but it would
be useless. The ability to steer the price level in the economy through the supply of central
bank money would be lost.
But how do new developments in the area of retail payments affect the demand for money?
To take an example, consider the use of credit cards. Any credit card payment involves the
transfer of funds from the consumers to the issuer of the credit card and further to the
merchant who accepted the card. Usually, the settlement of this transaction requires the
corresponding movements on the involved parties’ checking accounts. But this implies that
the bank needs to hold central bank reserves as a means of settling this transaction. Any
transaction made must correspond to a movement in central bank reserves. Credit cards
therefore pose no threat to the efficacy of the central bank’s monopoly. Other schemes,
such as debit cards and electronic money in its present form, share these properties.
However, it is conceivable that at some point in the future the settlement might take place
without regular recourse to central bank reserves. To see this, consider a situation in which
a certain stored value card is widely accepted as payment form among merchants other than
the issuer. Suppose that instead of transferring bank balances, the merchants could reduce
their outstanding claims vis-à-vis each other by swapping their claims on the books of the
card issuer. If this was possible, payments could be made without involving any bank
transfers. Consequently, the new means of payment would be independent of any central
bank reserve holdings of the credit institutions. 13
This scenario mirrors the net settlement procedures that I have described for electronic
interbank payments. To the extent that private obligations are “swapped” or “netted”
against each other, demand for central bank money will be reduced. 14
Can such a development pose a threat to the conduct of monetary policy? How likely is such
a scenario? I believe: not very much, as both private agents and public authorities are likely
to have an interest in maintaining to some extent more traditional forms of payment.
12
13
14
Significant changes in the demand for central bank money have also taken place in the past. In Germany, for instance, a reduction in
reserve holdings in the early 1970s was a consequence of intensified interbank relations. This development has later forced the
Bundesbank to give up its concept of “free liquidity reserves” (see Issing, 1977).
This argument is based on Friedman (1999).
King (1999) discusses the possibility of a “cashless society” in which the central bank monopoly over base money loses its efficacy.
13
First, consumers might want to maintain some degree of anonymity when making payments.
Complete anonymity, however, can only be guaranteed when paying with cash. Consumers
might thus rather hold a combination of both cash and other types of payment devices.
Second, settlement in central bank money has an advantage over settlement on an issuer’s
books in both its safety and finality. True finality can only be achieved when settlement
occurs in central bank money. Security is a key feature of any payment system. Especially for
payments of larger value, I believe that the uniqueness of central bank money in providing
immediate finality will remain an important advantage over the new forms of payment.
Nevertheless, I believe that central banks should have the adequate tools to meet any
challenges that arise from the new technologies, even if today they seem remote. I will now
present the regulatory tools that the ECB considers adequate to meet these challenges.
4
Regulatory Responses
Preserving the essential role of money in the economy requires a minimal, but effective,
regulatory framework. Above all, it must be ensured that price stability and the unit of
account function of money are not endangered. The ECB’s position in the field of regulation
of electronic money can be summarised in five points: 15
A.
Prudential Supervision
Issuers of electronic money must be subject to prudential supervision. In order to preserve
the stability of and to maintain confidence in the financial system, the ECB requires an
adequate level of financial soundness, sound risk management, and ongoing supervision by
respective authorities.
B.
Solid and transparent legal arrangements; technical security; protection
against criminal abuse
The issuance must be subject to solid and transparent legal arrangements. The rights and
obligations of the respective participants, including issuers, merchants, and customers, must
be clearly defined and be enforceable. The need for well-defined legal structure is especially
evident when a scheme operates on a cross-border basis.
15
European Central Bank, (1998) and (1999a).
14
Adequate technical and organisational safeguards should be maintained to prevent threats to
the security of the scheme such as counterfeit. Similarly, protection against criminal abuse
should be taken into account in the design and implementation of the scheme.
C.
Monetary statistics reporting
Information about the amount of money available in the economy is indispensable for the
conduct of monetary policy. Electronic money schemes should therefore supply the central
bank with adequate statistical information.
D.
Redeemability
Issuers of electronic money must be legally obliged, at request of the holders, to redeem
electronic money against central bank money at par. This requirement ensures that the unitof-account function of money is maintained. Furthermore, without a close link to central
bank money, there could potentially be an unlimited creation of electronic money, which
could, in turn, lead to inflationary pressure.
E.
Reserve Requirements
The possibility must exist for central banks to impose reserve requirements on all issuers of
electronic money, in particular in order to be prepared for a substantial growth of electronic
money with a material impact on monetary policy. Such a reserve requirement could limit
the risk of unrestricted growth in electronic money and help to maintain price stability.
Furthermore, it ensures equal treatment in comparison with issuers of other forms of
money.
5.
Conclusion
To sum up, recent technological developments have changed and continue to change
payments habits. These developments have the potential to improve the efficiency of the
financial system. However, they pose challenges to central banks in their conduct of
monetary policy.
15
Some of these challenges are not new. Central banks have before experienced competition
from private issuers of money, for instance in the free-banking episode. Thus, the spread of
electronic money poses an old problem, but in a different form.
New developments in electronic interbank payments have paved the way for a change from
net to real time gross settlement. By this, the payment mechanism has become more reliable
for users, and at the same time much safer in terms of systemic risk.
Electronic money is being considered by some the main future challenge to central banking. I
believe this is only partly true. There will always be a need for the element of security,
confidence, and information that central bank money contains. Unregulated electronic
money cannot provide such a fundamental precondition, which is, I believe, at the heart of
the well functioning of a market economy. Therefore, I do not believe that electronic money
will become a threat to monetary policy in the near future.
Nevertheless, in order to ensure that under no circumstance the central bank loses its
ability to preserve price stability and to maintain the unit of account function of money, a
certain degree of regulation is indispensable. With the regulatory requirements that I have
outlined, the ECB will continue to provide a monetary framework in which the goal of
maintaining price stability can be achieved.
6.
References
Bank for International Settlements
(1990): “Report of the Committee on Interbank Netting
Schemes of the central banks of the Group of Ten countries” (Lamfalussy Report), Basel.
Bank for International Settlements (1996): “Implications for Central Banks of the Development of
Electronic Money”, Basel.
Deutsche Bundesbank (1999), “Neue Entwicklungen beim Elektronischen Geld”, in Deutsche
Bundesbank Monatsbericht, Juni 1999.
European Central Bank (1998): “Report on Electronic Money”.
European Central Bank (1999a): “Opinion of the European Central Bank on Electronic Money and
on Credit Institutions”.
16
European Central Bank (1999b): “The Stability-oriented monetary policy strategy of the
Eurosystem”, in ECB Monthly Bulletin January 1999, 39-50.
European Central Bank (1999c): ”Euro area monetary aggregates and their role in the Eurosystem’s
monetary policy strategy”, in ECB Monthly Bulletin February 1999, 29-40.
European Monetary Institute (1993): “Minimum Common Features for Domestic Payment
Systems”.
Fama, Eugene (1980): “Banking in the Theory of Finance”, in Journal of Monetary Economics 6, 3957.
Freedman, Charles (2000): “Electronic Money: Monetary Policy and seigniorage Issues”, OECD.
Friedman, Benjamin (1999): ‘The Future of Monetary Policy: The Central Bank as an Army with Only
a Signal Corps?” in International Finance 2:3, 321-338.
Hall, Robert (1983): “Optimal Fiduciary Monetary Systems”, in Journal of Monetary Economics 12,
33-50.
von Hayek, Friedrich (1976): “Choice in Currency: A Way to Stop Inflation”, Institute of Economic
Affairs Occasional Paper 48.
Issing, Otmar (1977): “Zur Rolle der Interbankbeziehungen”, in Kredit und Kapital 4-1977, 408420.
Issing, Otmar (1999): “Hayek – Currency Competition and European Monetary Union” speech at
the annual Hayek memorial lecture hosted by the Institute of Economic Affairs, London, 27 May
1999.
King, Mervyn (1999): “Challenges for Monetary Policy: New and Old”, Paper prepared for the
Symposium on “New Challenges for Monetary Policy” in Jackson Hole, WY.
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