Author: | Published: 9 Jul 2001
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The stability of a financial system depends on various factors, the most important of which are: (i) the stability of macroeconomic conditions; (ii) adequate prudential regulation; (iii) efficient banking supervision; and (iv) a well-structured payment system.

The Brazilian government has focused on the first three factors, and despite of the fact that there is still a lot to be done, significant changes have been made in the last few years.

As far as the payment system is concerned, although the one presently in force in Brazil presents some remarkable aspects, it also contains serious problems. The positive aspects include: (i) high levels of automation, enabling the quick processing of transactions; and (ii) electronic custody, avoiding the necessity of further controls or security in relation to certain instruments commonly traded in the market, whereas the main problem posed by the system refers to stability issues.

The existing system

Nowadays, the payment system interconnects - through a non-coordinated payment orders' network - banks, non-bank agents and the Central Bank of Brazil (BACEN). All the daily payment order transfers are transformed, at the end of the day, into just a few and very high interbank fund transfers which are made into the bank reserve accounts that the banks are required to maintain with BACEN. This generates a lag (gap) between the time the transaction was contracted and its clearing and settlement.

Such a lag is the main source of risks in the system. It creates the possibility of the counterparty becoming insolvent before the financial clearing effectively occurs or even the possibility of the payment being revoked or conditioned to another event. And the overdraft (saque a descoberto) in the bank reserve accounts is only characterized and identified on the following day (D1). This means that neither BACEN nor the financial institutions have a clear position of each financial institution's reserves in real time. Therefore, the clearing lag may cause credit risk – whenever the counterparty does not perform its obligation on its term or in any other future date – and liquidity risk – when the funds are transferred on a date later than the one agreed. Both credit and liquidity risk may result in systemic risk, which is crucial for the stability of the financial markets.

Because the existing clearings do not have risk control instruments, to avoid further problems BACEN performs obligations for the defaulting bank, through the mechanism of overdrafts from the reserve accounts (as discount window loans), without any guarantee or contract. At the end of the day, therefore, BACEN assumes the risks that may be originated by any and all the participants of the market.

The clearing system is now formed by four basic clearings that directly settle the transactions with BACEN. None of them has mechanisms to manage risks and to absorb the default of any of their members. They are divided as follows:

  • Special system for settlement and custody (Selic). Selic clears primary and secondary transactions involving treasury bonds and DI Reserva. To avoid default, transactions are made through the mechanism of delivery versus payment. It is possible to reverse transactions upon the occurrence of settlement problems;
  • Clearing house for the custody and financial settlement of securities (Cetip). Cetip clears privately issued securities and some treasury bonds. Transactions are also made through the mechanism of delivery versus payment. Stock Exchanges and Futures & Commodities Exchange (BM&F) transactions are cleared by using messages sent through Cetip. The settlement lag is five days (international standard is three days);
  • Checks and other instruments clearing system (Compe). Compe clears checks and other instruments. High amount transactions are mixed with wholesale transactions. The settlement normally occurs on the following day; and
  • Foreign exchange system. This clears foreign exchange transactions and the settlement normally occurs two days after the transaction is effected.

Issues to be covered by the new system

For all the reasons mentioned above and following the attention which has been given to this topic by the International Monetary Fund, the Bank for International Settlements and the central banks of the G10 countries, since 1998 a group of technicians from BACEN has been studying the restructuring of the Brazilian payment system.

According to international experience, the core issues that must be addressed by any payment system are:

  • adequate legal framework;
  • possibility of implementing real time gross settlement;
  • existence of a large value transfer system;
  • existence of clearings with mechanisms that enable them to assure the clearing and settlement of the transactions carried out through their intermediation; and
  • irrevocability and unconditionality of transactions and payments (finality), as well as the use of the systems delivery versus payment and payment versus payment.

After having deeply studied the systems in force in the main financial markets in the world, BACEN finally prepared a new structure to be implemented in Brazil which takes into account the country's culture and necessities.

The most important step towards the implementation of a new system was the approval, by the National Congress, of Law No. 10,214 of March 27 2001 that regulates the operation of the clearings and the new payment system. Its aims include: (i) the development and increased application of risk management; (ii) a better payment system tailored to agents' needs; (iii) a decrease in the float caused by the clearing lag; (iv) the reduction of operational costs; and (v) the creation of mechanisms that reduce the possibilities of losses while the payments are not finally cleared, thereby avoiding a systemic risk.

The new system

The new payment system is formed by the entities, the systems and the procedures related to the transfer of funds, financial assets and securities, as well as the processing, clearing and settlement of payments, interconnecting the real economy sector, financial institutions and BACEN. Law 10,214 brought three main innovations, namely: (i) multilateral clearance of obligations; (ii) the necessity of clearings – which will be private entities – acting as counter-parties for settlement purposes; and (iii) the exclusion of obligations arising out of contracts executed by the participants of clearings from the effects of either judicial or administrative insolvency proceedings (bankruptcy, extra-judicial liquidation, intervention and others).

Multilateral clearing

As a consequence of the new role to be played by the clearings, it was decided that the rights and obligations arising out of several transactions should be reduced, after many clearing operations, to a sole right of the participant (and consequently of a sole obligation of another participant) whose credit would be object of an entry in the respective bank reserve account.

Such procedure is authorized and defined by Section 3 of Law 10,214. The position of the clearing in relation to its participants is what really matters. In cases where three or more participants are involved, the clearing will place itself among them to verify the credits and debits among them, and then promote the corresponding off-setting. This will reduce the volume of the inter-financial transfers, since the credit or the debit at the bank reserve account from each participant will only represent the net difference among all its credits and debits.

Law 10,214 grants the clearings legal instruments to furnish its participants with the net positions resulting from the clearance of the totality of credits and debits related to all the transactions they executed in a certain period.

Clearings assuming the position of the contracting party

In the systems where the volume and the nature of the deals, according to BACEN's discretion, may present risk to the solidity and normal functioning of the financial system, the clearings will assume the position of contracting party for the purpose of settling the obligations which were contracted through such clearing by the participant.

Those systems will count on protection mechanisms enabling the clearings to have confidence in the settlement of the operations cleared and settled within them. Such mechanisms include, among others, rules on risk control, contingencies and loss sharing among the participants; direct enforcement of custody positions, contracts and guarantees; and adequate security provisions.

The clearings responsible for one or more relevant systemic environment will be required to segregate special assets, comprising properties and rights required to guarantee the compliance with the obligations existing in each of the systems where they are operating. Those assets and rights, together with those offered by the participants as guarantee, must not be pledged, encumbered or have any other lien of whatever nature, other than for the obligations assumed with the clearing.

The exemption of the participants' transactions carried out through the clearings from judicial or administrative insolvency proceedings

The obligations arising out of the transactions executed by the participants through the clearings are not subject to the effects of moratorium, bankruptcy, extra-judicial liquidation or intervention to which a participant may be submitted to.

Law 10,214 created a segregation between the financial obligations to which the clearings must give normal course and the other obligations of the same participant. By having the tools herein described, clearings will be able to help in the prevention of potential systemic risks.

Because this law is very recent, we do not know yet whether the courts will enforce or not this segregation provision particularly because it may be considered harmful to other credits, such as labour, tax and social security credits.

Finally, the law defines the steps to be followed by the clearings in order to make the payment of the obligations which were carried out through its system, in case of extra-judicial liquidation or intervention of one of its participants. Before the approval of Law 10,214, there was no rule on this matter – everything was based on ad hoc procedures – which in fact makes this new regulation more than welcome.

Other innovations

Some additional rulings, including a circular to be issued by BACEN which is already drafted but still waiting for its final approval, establish the new procedures for the financial settlement of the results verified at the checks and other negotiable instruments clearing system (Serviço de Compensação de Cheques e Outros Papéis – SCCOP) and the necessity of a prior deposit for the participation in its daily sessions.

To be able to participate in the daily sessions of SCCOP, commercial banks, multiple banks with commercial portfolio and savings and loans banks must make a prior deposit from their reserve accounts into a special account held with BACEN called settlement account. The amounts deposited will be used either totally or partially for the settlement of the obligations cleared in the same day. Such amounts will not receive any remuneration and must not be used for any further purpose.

The amount to be deposited will be calculated based on the arithmetic average of the daily value of the total amount of checks and other documents withdrawn against the institution, considering exclusively checks and other documents in amounts equivalent to or in excess of R$5,000 ($2,083) in the previous two weeks.

This R$5,000 limit was established after a study conducted by BACEN which showed that cleared cheques and the so-called DOCs represent more than 86% of all the clearings made through the system (Compe). From April to July 2000, 98.8% of the cheques and 85.3% of the DOCs cleared represented individual amounts of less than R$5,000. Cheques and documents below this limit will remain in clearing process, while the others will be cleared on real time through the Reserves Transfer System (Sistema de Reservas Bancárias) to which the clearings will be linked.

BACEN's immediate goal is to remove from Compe, as soon as possible, critical and high amount payments as well as those whose financial settlement may be done through the Reserve Transfer System (STR) to be offered by BACEN or private clearings. The expectation is that Compe will primarily clear wholesale transactions that involve lots of clearings of small values.

If a financial institution does not make the prior deposit, or even in case it deposits only part of the required amount, it will be excluded from SCCOP. If the amounts deposited are not sufficient to cover the settlement of the daily session, in the evening session, BACEN will declare the default of such participant and the financial result of the daily session will correspond, for each participant, to its net multilateral result in relation to the other non-defaulting participants. In such cases, the non-defaulting participants will be able to make additional deposits to their settlement accounts, if the amount already deposited is not sufficient to cover the results of the clearing session which was re-calculated as mentioned before.

BACEN will help the banks with a same day overdraft facility duly guaranteed by treasury bills held by the relevant borrower provided also that BACEN will not charge anything for such loan if it is repaid on the same day.

The restructuring process

In addition to Law 10.214, BACEN is also issuing related regulations in order to implement the new payment system. All such regulations are being largely discussed by financial institutions, BACEN and the market. All the process is counting on lots of transparency. The drafts of the regulations are under public consultation in the homepage of BACEN in the Internet and the restructuring project report may also be accessed.

The restructuring project presents all the points that will be addressed in the implementation of the new system. The initial idea of BACEN was to operate exclusively real time gross settlement as of August 1 2001 so that, as of October 1 2001, the balance of bank reserve accounts could not to be negative at any time during the day.

However, because all this restructuring will bring many operational changes to financial institutions and their clients, this initial schedule was postponed for some months.

Starting on June 1 2001 all financial institutions are required to test the new system by simulating transactions according to the instructions given by BACEN. But still there are many adjustments to be made before the new system becomes effective. The forecast is that it will only be completely operational and effective as of January 2 2002.

The new system will use an exclusive telecommunications network and messages standard (the so-called mensageria). BACEN will start operating real time settlement exclusively. Additionally it will process on real time and transaction-by-transaction, the transfer of funds among the bank reserve accounts, under the command of its respective holder and those orders will be final and irrevocable, and will only be settled if the debited institution has sufficient balance in its bank reserve account. BACEN will have constant monitoring of the bank reserve accounts, on real time, which does not happen at present.

The observance of the new rules represents a high cost for Brazilian financial institutions, specially to smaller institutions. The expenditures will include the purchase of equipment, the development of software and training, among other things. The financial institutions are also running against time in order to be ready on time to start operating in the new system.

There are 175 financial institutions in Brazil and they have been interviewed by BACEN on the status of the implementation of the changes necessary to adapt the equipment, programmes and others to the new system.

One of the issues which has been constantly addressed in this process is that the use of the private clearings to clear and settle the obligations of the participants will represent an additional cost which will probably be transferred to the clients of the financial institutions as another bank fee.

There are three clearings which are being formed to operate the new system. The most important one will be the payments clearing that is being formed by the Brazilian Federal Association of Banks (FEBRABAN) – Câmara Interbancária de Pagamentos (CIP). As of May 15 2001, 44 banks, divided into seven groups in accordance with their participation (in percentage terms, varying from 10% to 0.5%) were already participants of this clearing. CIP will clear payments made through cheques, credit transfers, collecting bills, credit cards and other means, which corresponds to approximately R$305.5 billion per month. It is estimated that its initial fees will cost between R$0.25 and R$0.65 for each message.

BM&F will start the tests of its foreign exchange clearing. In order to ensure the proper functioning of the payment versus payment system, the clearing will open bank accounts with BACEN and at least six other banks in New York. It will start working with deals in US dollars, which represent 99% of the transactions and, later, start working with other currencies. The main feature of the clearing is to guarantee not only the principal, but also the market volatility, in exchange for the payment of a fee.

The Brazilian Company of Settlement and Custody (CBLC) will be in charge of the multilateral clearance of the transactions involving treasury bills and bonds (títulos públicos). The clearing will receive online information on the purchase and sales of treasury bills and bonds among the investors in the market. At the end of the day it will calculate each participant's net position and send the information to BACEN so that it proceeds the adjustments that need to be made among the institutions (credits and debits).

Machado, Meyer, Sendacz e Opice

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