Why Central Banks’ Mandates Include Payment Systems

Payments connect buyers and sellers, borrowers and lenders, governments and citizens, corporates and businesses, and all economic agents within an economy. Payments also provide diverse financial services with the vessels, channels, and tools to ensure the movement of funds. Therefore, efficient, operational payment systems are critical indicators for the performance and health of any economy. Hence, central banks around the globe are investing more than ever in the safety and efficiency of payment systems, given their interconnectedness with the overall monetary policy framework.

The issuance of coins and banknotes is a key mandate of central banks, complemented by ensuring the confidence and legal acceptability of these monetary instruments across their jurisdictions. However, with the evolution of payment instruments and systems to compete with coins and banknotes, the central bank’s role in facilitating and safeguarding the operations of cashless payment systems persists, grounded in their commitment to safety and efficiency with the aim of ensuring smooth functionality of payment systems that meet the economy’s needs.Throughout the evolution of payment systems and instruments, payment innovations have been driven by the private sector, such as the merchants who invented promissory notes, cheques, and gold coins to be followed by privately issued banknotes.

None of the aforementioned can be considered ‘real’ money, but rather a claim on money. When governments stepped in to guarantee and issue their money, confidence and security were improved and ultimately trade prospered and flourished reflecting the nations’ welfare and prosperity.

Similarly, with the introduction of debit and credit cards, electronic cheque clearing systems, EFTs (electronic fund transfer systems), and mobile payments, the payments arena witnessed another round of innovative solutions to facilitate and accelerate payments. However, each bears their own costs and risks, such as credit, liquidity and settlement risks, which could undermine confidence in cashless payment instruments. The understanding of these risks created the absolute necessity for central banks’ regulatory role in the cashless payments’ arena, as only the central bank can ensure finality of settlements and irrevocability of funds, effectively reducing payment-related risks.

Through the Real-Time Gross Settlement (RTGS) system, where banks hold settlement accounts and collaterals, credit transfers and debit authorizations are booked directly to banks’ accounts held at the Central Bank, making the settlement of electronic central bank money final and irrevocable and safer, faster and more efficient than settling in cash.

RTGS systems are a monumental milestone and the hallmark in the evolution of cashless payments enhancing safety and efficiency within payment ecosystems. Retail and micropayment systems post their net clearing positions to be finally and irrevocably settled in the banks’ settlement accounts held at the RTGS (this is specifically referred to as ‘central bank electronic money’). Moreover, central banks manage liquidity in their markets and transmit their monetary policy actions through the RTGS.

But with more developments in digital payments, new and continuous challenges and risks are emerging and putting more pressure on central banks, from fintech innovative solutions to cyber attackers, fraudsters, gigantic platforms, and cryptocurrencies, etc.

Albeit driven by private sector innovation, digital economies owe their success, maturity, and sophistication to central banks around the world. Their adoption of a safety- and stability-first ethos has safeguarded the evolution of the payment sector and overall economy. Private sector entities operating in the realm of digital financial services, therefore, would be all-but-wise to neglect the importance of the central banks’ role, as the private sector would struggle to evolve without the protection and stability extended by central banks. 

Jordan

The Central Bank of Jordan is a pioneer in payments-related risk management. It has mandated all retail and micro digital payments to be settled at the RTGS (central bank electronic money) eliminating settlement, credit, and liquidity risks.