Britain’s payment structure has proved resilient so far but the financial crisis has highlighted the risks if banks are not direct members of such a system, the Bank’s Chief Cashier and Executive Director for Banking Services Chris Salmon said at an event in Leeds according to the text of the speech.
Currently, only 18 direct members of the real-time settlement system CHAPS serve the entire sterling banking industry, Salmon said.
Indirect membership, where banks make use of one of the CHAPS members as correspondent bank to submit and receive payments on their behalf, is the norm in the UK.
“The Bank believes that excessive tiering in the UK payment systems introduces unnecessary risk and change is needed,” he said. By adding the 10 largest second-tier banks to the system, indirect flows would be reduced by more than a third, he said.
“In the first instance the Bank will engage with the correspondent and the customer banks directly, together with their respective supervisors at the FSA, to encourage the change we want to see,” Salmon said.
“But if membership does not increase, and tiering continues to be a significant issue for the UK, the Bank may consider recourse to more formal actions,” he added.
Salmon said the fact that many banks relied on CHAPS member institutions to settle their payments often leads to unsecured lending until accounts are squared at the end of the day, leaving the settlement bank exposed to credit risk.
“Where a customer (bank) is larger than its correspondent, these credit risks can become material enough to threaten the correspondent,” he said.
“Precisely because of this type of risk, correspondent banks are likely to seek additional protection during periods of stress, in particular by asking for previously uncollateralized lines to become collateralized,” he said.
“This could happen at very short notice, acting as an adverse liquidity shock to affected customer banks,” Salmon said, adding that this happened to Lehman Brothers in the weeks leading up to its bankruptcy.