2005 Self-assessment of the Reserve Bank Information and Transfer System Core Principle III

The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks.

3.1 Assessment of Compliance

RITS complies with this principle. RTGS does not give rise to credit risk that can occur in deferred net systems. RITS provides tools to permit participants to manage and conserve liquidity. The Reserve Bank provides liquidity by intraday repurchase agreements.

3.2 Credit Risk

Credit risk in a payment system is defined as arising where participants accept that final settlement of a payment has occurred (such as a payment instruction to credit a customer account) before any associated interbank obligations have been settled. In RTGS systems there is no credit risk as interbank obligations are settled simultaneously with acceptance for settlement of the payment instruction.

3.2.1 Credit Risk to Participants

RITS is a RTGS system. There is no credit risk to participants receiving payments. A funds transfer through RITS is settled by funds held in ESAs at the Reserve Bank with immediate finality.

3.2.2 Credit Risk to the Central Bank

ESAs cannot be overdrawn. Liquidity is provided by intraday repurchase agreements. All securities taken under repurchase agreements are of a very high credit quality. Eligible securities include: debt securities and discount instruments issued by the Australian Government, the central borrowing authorities of the state and territory governments and select issues by supranational organisations, foreign governments and government agencies that have an explicit government guarantee; and select bank bills and certificates of deposit (issued by third parties). All issues must be denominated in Australian dollars. A full description of this facility and eligible securities is provided on the Reserve Bank's website.

The Reserve Bank takes a two per cent margin on all repurchase agreement trades. In them event of a very large price movement, the Reserve Bank requires additional securities to be provided as overcover.

3.3 Liquidity Risk

Liquidity risk is mitigated by the design of the system queue (which uses a liquidity efficient ‘next-down looping’ algorithm that helps prevent gridlock and incorporates a bilateral offset mechanism) and by the ready provision of intraday liquidity by the Reserve Bank.^[1]

The Reserve Bank provides an intraday liquidity facility limited only by the availability of eligible securities. Participants provide eligible securities for intraday repurchase agreements.^[2]

In unusual circumstances where a participant is unable to reverse an intraday repurchase agreement with the Reserve Bank by the end of the day, the transaction can be converted to an overnight repurchase agreement by agreement with the Reserve Bank.^[3]

3.3.1 Management of Liquidity Risk

While the Reserve Bank ensures that system liquidity is adequate to ensure that the cash rate is at target, individual institutions are responsible for managing their own liquidity. The level of system liquidity (aggregate end-of-day ESA balances) is determined by the Reserve Bank's market operations. Holdings of securities eligible for repurchase agreement are a commercial decision by each participant. There is no limit on the amount of liquidity the Reserve Bank may supply by repurchase agreement, other than the value of eligible securities held by the private sector.

Liquidity is monitored both by the Domestic Markets Department of the Reserve Bank and in the RITS operational area of the Reserve Bank (Payments Settlements Department). These areas are in contact throughout the day.

In Domestic Markets Department, staff monitor the settlement of transactions initiated at the morning's open market operations and the level of total liquidity (including intraday repurchase agreements) throughout the day. Projected end-of-day liquidity is also monitored throughout the day.

Payments Settlements Department operations staff continuously monitor RITS in real time for any functional problems, including those that may impact on liquidity. Monitoring includes checks as to whether a participant's payments are consistent with previously observed patterns and viewing queued payments information to ensure bottlenecks are not occurring.

Some payment systems impose throughput guidelines and pricing policies designed to ensure that a backlog of payments on the system queue, or gridlock, does not occur. Gridlock has not been a problem for RITS; the operation of the system queue is aimed at gridlock prevention and participants are alert to the development of payment loops or chains. By number, over half of each day's settlements occur before noon; as such, the Reserve Bank does not believe it is necessary to impose throughput guidelines. However, throughput is monitored continuously throughout the day and on occasion individual participants have been advised that the pattern of their payments behaviour may cause problems. At present it is felt that this informal approach is sufficient to ensure smooth operation of the system.

3.3.2 Tools for Managing Liquidity

ESA holders have several tools available to them to manage their liquidity.

Participants can determine the way in which individual transactions draw upon liquidity setting a status of ‘deferred’, ‘active’ or ‘priority’. Queued payment instructions with a status ctive or priority are tested for settlement by the system queue. An active payment instruction will be processed unless it would cause the level of the paying institution's ESA balance to fall below an amount specified by each member (this ‘sub-limit’ is set within the system by the participant to reserve a tranche of liquidity for important payments and can be changed during the day). Priority payment instructions ignore any sub-limit and are tested against the full ESA balance. The use of sub-limits and the priority status provide a means by which funds can be reserved so that time critical or priority payments can be processed efficiently and when required.

The payment status and sub-limit functionality is available to all ESA holders via manual entries on their RITS terminals. This functionality is also available via SWIFT (Society for Worldwide Interbank Financial Telecommunications) messages, which allow participants to automate use of these functions in their own systems. This Automated Information Function (AIF) allows participants to submit commands (including a command to change a payment status or sub-limit), make enquiries and receive advice about payments (when specified types of payments arrive on the system queue and when payments settle) in SWIFT FIN messages. The AIF is also used for client credit management, and is mainly used by the banks whose clients undertake relatively large volumes of Austraclear settlements.

ESA holders can also use their payment management functions to create the conditions for the auto-offset feature to settle a particular payment. This is more frequently used for client credit reasons, but could also be used to assist in liquidity management.

Footnotes

Under next-down looping, the queue processor tests payments for settlement in order of receipt by the queue, settling or leaving each payment as it continues a traversal down to the end of the queue before looping back to the top. Payments are tested in order of receipt but may not settle in the same order. [1]

See section 3.2.2. [2]

The Bank offers an overnight repurchase agreement facility as a liquidity safety valve. [3]