PAPER BY SRI LANKA ON CLEARING AND SETTLEMENT MECHANISM IN THE FINANCIAL SECTOR

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1 South Asian Association for Regional Cooperation Sixth Meeting of the Inter-Governmental Expert Group (IGEG) on Financial Issues SAARC Secretariat, Kathmandu April 2013 SAARC/IGEG.06/15 PAPER BY SRI LANKA ON CLEARING AND SETTLEMENT MECHANISM IN THE FINANCIAL SECTOR (Annex-VII of the Report of IGEG.05)

2 Annex-VII Fifth Meeting of Inter-Governmental Expert Group on Financial Issues SAARC Secretariat, Kathmandu, December 2011 PAPER BY SRI LANKA ON CLEARING AND SETTLEMENT MECHANISM IN THE FINANCIAL SECTOR

3 Payments and settlement systems in Sri Lanka Introduction Role of the central banks in the PSSs has been evolved from its manual primary function of providing payment, clearing and settlement services for banking systems to electronic systems. Furthermore, economic policy reforms, increasing complexities in the financial systems and payment mechanisms, changing role of central banks, advancement of information technologies have led the central banks to be in the center of the national payment system which is the back bone of the banking and financial systems in almost all countries in the world. More importantly, recently experienced financial crisis proved the necessity of central banks involvements in PSSs. Motivated by the desire to enhance the effectiveness of monetary policy, central banks typically seek to promote financial market development which in turn is facilitated by reforms in the national payment system. Central banks are playing the leadership role in payment systems, by owning and administering PSSs as well as designing of policies and procedures to mitigate the systematic risks which associated with PSSs. Since its inception, the Central Bank of Sri Lanka (CBSL) has also been given the authority to maintain PSS for the banking system under the Monetary Law Act No.58 of In its modernization programme which was implemented in 2001, the CBSL refocused on its core objectives i.e. economic and price stability, and financial system stability, which encompass a wide range of subjects with regard to the ultimate objective of the prosperity of the nation. Establishment of a safe and sound payment system was seen as crucial requirement, under the modernization programme, for the development of the financial sector which is also complementary to the maintenance of two prime objectives of the CBSL. In this context, with the objective of fulfilling the needs of the evolving banking, financial and economic activities in the country, the CBSL decided to undertake a comprehensive payment reform. In the meantime, in order to be in line with the internationally accepted standards and best practices, the development of the national payment system was benchmarked to the general guidelines and the core principles (2001) of Committee on Payment and Settlement Systems 1

4 (CPSS) of the Bank for International Settlement (BIS) 1. The broader objectives of the payment reform were to reduce transaction costs, increase efficiency, ensure safety and reduce the associated risks in PSS, i.e. credit risk, liquidity risk and system risk. The main elements of National Payment Systems have been enunciated by the CPSS in its 'General Guidance for National Payment System Development' as follows; Payment instruments used to initiate and direct the transfer of funds between the accounts of payers and payees at financial institutions; Payment infrastructures for transacting and clearing payment instruments, processing and communicating payment information and transferring the funds between the paying and receiving institutions (This includes all the specific individual payment transaction, clearing and settlement systems operating in a country); Financial institutions that provide payment accounts, instruments and services to consumers, and businesses and organizations that operate payment transaction, clearing and settlement service networks for those financial institutions including other organizations that provide payment services to users; Market arrangements such as conventions, regulations and contracts for producing, pricing, delivering and acquiring the various payment instruments and services; Legal and regulatory framework which includes standards, rules and procedures set by legislators, courts and regulators that define and govern the mechanics of the payment transfer process and the conduct of payment service markets. The rapid evolution of the national payment system in Sri Lanka commenced in 2001, deviating from the manual practices in PSSs and instead, introducing and promoting the advanced electronic mechanisms, thereafter, with the enhancement of the institutional arrangements and strengthening of legal framework. This progression, coupled with the necessity of the adherence to the internationally accepted standards and best practices led to the speed changes in the PSSs in the country, thereby arising the requirement of implementing several policy measures. 1 General guidelines and core principles (2001) of CPSS are given in Annex I 2

5 Accordingly, a set of significant policy measures was implemented during the last decade in Sri Lanka in order to discharge the CBSL's obligation of establishing, developing and maintaining a robust, efficient and dynamic national payment system. Legal Framework on the National Payment System As the apex body in the financial system in the country, the CBSL has been authorized to be the centre of the national payment system in terms of the respective legal framework. With the commencement of the payment reform, the legal framework has been strengthened to ensure the legal soundness of the PSSs in line with the international standards and best practices. Major Acts Passed by the Parliament on Payments and Settlements 2 Monetary Law Act No. 58 of 1949 (as amended) (MLA) Under the Section 62A of the MLA, the CBSL has been vested with the authority of providing payment services to the banking system, since its inception. In 2002, in order to provide legal provisions for the modernization process, several amendments were made to the MLA, inter alia, empowering the CBSL with the responsibility for administration, supervision and regulating of monetary services and, financial and payment systems in Sri Lanka. Accordingly, the amendment to MLA empowered the CBSL, inter alia, - to establish and operate a system; a) for the transfer of funds by and between the CBSL, commercial banks and such other institutions or persons that maintain a settlement account with the CBSL and who are admitted as participants to such systems by the CBSL; b) for the transfer and settlement of scripless securities by and between the CBSL and direct participants of systems c) for the settlement of payment obligations in respect of transfer and settlement of scripless securities under above (a) 2 All the Acts and other legal documents mentioned in this section are available in the CBSL website: 3

6 - link the established system with other systems in Sri Lanka for the clearing or settlement of payment obligations or securities - enter into agreements with the participants of the system and issue system rules for the operation of the system - establish finality and irrevocability of transactions; Payment and Settlement Systems Act, No. 28 of 2005 (PSSA) The PSSA which is the specific Act established for the payments and settlement field in Sri Lanka provides wider powers to the CBSL to formulate, adopt and monitor the implementation of a payment system policy for Sri Lanka primarily to facilitate the overall stability of the financial system, promote payment system safety and efficiency and control risk. The objectives of the PSSA are; - to provide for the regulation, supervision and monitoring of payments, clearing and settlement systems; - to provide for the disposition of securities in securities accounts maintained at the Central Bank; - to provide for the regulation, supervision and monitoring of providers of money services; and - to facilitate the electronic presentment of cheques In terms of the PSSA, the CBSL shall be the authority responsible for the preparations of a plan for a national payment system and providing guidance and leadership for the establishment and development of payment, clearing and settlement systems in Sri Lanka. The CBSL has the power to formulate, adopt and monitor the implementation of a payment system policy to facilitate the overall stability of the financial system, promote payment system safety and efficiency and control risk. Further, in addition to the primary objectives, the CBSL shall design policies to enhance other aspects of the public interest and particularly contribute to the promotion of competition in the market for payment services and the protection of users of payment systems. In promoting safety and efficiency of the payment system the CBSL shall co-operate with central banks of other 4

7 countries and with other relevant domestic or foreign authorities. In exercising these powers the CBSL shall be guided by best international standards. The CBSL has been given extensive powers through the PSSA to execute the obligation entrusted in the MLA as well. Accordingly, the procedure on maintaining settlement accounts for banks and approved parties, making fund transfers and allocation of securities, regulating and supervising of money services and payment systems, operating clearing and settlements systems are entrusted to the CBSL. Banking Act No. 30 of 1988 The Banking Act No. 30 of 1988 describes the licensing of persons carrying on banking business in Sri Lanka. Further, this refers to all the banking functions including the application of payment systems for the settlement of transactions to be operated by commercial banks. Local Treasury Bills Ordinance as amended (LTBO) and Registered Stock and Securities Ordinance as amended (RSSO) The LTBO and RSSO provide the necessary legal provisions for the issue of government securities namely; Treasury bills and Treasury bonds which are the major instruments in the securities market and the prominent securities leg in the transmission of monetary policy measures. With the amendments made to MLA in 2002, LTBO and RSSO were also amended providing powers to CBSL to issue government securities in scripless form and to link the system developed to facilitate interbank transactions with the fund leg of the settlement of scripless securities transactions. Payment Devices Frauds Act, No 30 of 2006 The Payment Devices Frauds Act was enacted by the Parliament in September 2006 to deter illegal and hazardous practices relating to payment devices. This Act prohibits fraudulent and unauthorized productions, trafficking possession and use of payment devices. The word payment device covers all cards, plates, codes, account numbers, micro chips, optical instruments or documents whereas magnetised encoding has taken 5

8 place and devices in which information is recorded by mechanical, electronic, optical or other means, whereby account numbers and other data are stored which are recognized by the issuers for the purpose of completing transactions. Under this Act, wrongdoers could be arrested without a warrant. These offences have been made extraditable to promote cooperation among different jurisdictions. Sri Lanka Companies Act, No. 7 of 2007 The introduction of the Companies Act, No.7 of 2007 is considered a major achievement in the legislative history of the country. The new Companies Act provides greater freedom in almost all aspects, from formation of a company to liquidation. In all these areas this Act is more purpose driven and therefore is seen as a more business friendly statute. The Companies Act introduces a salutary provision where it requires that a company should satisfy the solvency test in order to declare dividends. Finance Leasing Act, No. 56 of 2000 Finance Leasing (Amendment) Act, No. 56 of 2000 has been enacted with a view to enable registered leasing companies to issue debt instruments, subject to prudential controls imposed by the Central Bank of Sri Lanka. Changes have been initiated to amend legal provisions to accommodate changes to the payment industry and for enhancing regulatory powers. The Electronic Transactions Act No.19 of 2006 The Electronic Transactions Act No.19 of 2006 recognizes and facilitates the formation of contracts, the creation and exchange of data messages, electronic documents, electronic records and other communications in electronic form in Sri Lanka; and provides for the appointment of a certification authority and accreditation of certification service providers; and provides for matters connected therewith or incidental thereto. Finance Companies Act (FCA) No. 78 of 1988 This Act has facilitated to carry out the finance business in Sri Lanka by safeguarding the rights of the depositors. CBSL has taken several policy measures to improve the 6

9 public confidence on the Finance companies and related business based on the provisions available in this Act. As the existing FCA has several limitations and deficiencies, a new regulation of Finance Business Act will replace the FCA. This is a timely requirement to expedite the finance business in Sri Lanka and to include the modern technology which use in the banking system in Sri Lanka Institutional Framework Central Bank of Sri Lanka - The CBSL is statutorily given authority, inter alia, for the implementation of a PSS policy and has wider powers to establish, administer, maintain, supervise, oversee and regulate PSSs in the country. Accordingly, the CBSL is responsible to regulate, oversee/supervise, operate (where necessary) and promote large value PSS, government securities settlement systems and the retail payment systems and any other money services including electronic fund transfer mechanisms which the CBSL deems necessary to regulate in order to mitigate the potential risks. The CBSL, with the intention of discharging these responsibilities, has established a proper institutional arrangement, considering the requirements of the financial system, the public interest and the potential risks on PSS in the country. The CBSL handles following functions on PSS development directly and indirectly depending on the situation. Licensed Commercial Banks (LCBs) Licensed Commercial banks have been engaging in payment systems in the country since before the independence of the country. The CBSL has been facilitating commercial banks for interbank financial transactions since its inception in 1950 being the banker to banks and last resort of the commercial banks. The CBSL maintains settlement accounts for LCBs in order to facilitate fund transfers among banks. With the evolution of the payment systems under the reform, commercial banks have become major participants in the payment systems operations. The CBSL executes its monetary policy transmission to the economy through commercial banks as well as facilitate the smooth functions of the payment systems by appointing commercial banks as the participants in the payment, clearing and 7

10 settlement systems. As a result commercial banks provide the interconnection between the regulator and the users of PSSs. Commercial banks have formed the Sri Lanka Banks Association (Guaranteed) Ltd. (SLBA) to represent them collectively and to support the Licensed Commercial Banks (LCB s) and Licensed Specialized Banks (LSB s) in Sri Lanka and banking in Sri Lanka. The association maintains an excellent rapport with the CBSL through constant dialog to greatly facilitate supervision and compliance issues. The primary objectives of the SLBA are as follows. To assist to maintain and develop a sound banking structure in Sri Lanka. To encourage co-operation and co-ordination between Banks and the public, the government and Provincial or Administrative authorities. To liaise with other national and international bodies, entities and institutions which have common or similar interests of relevance to banks. To render where possible such advice or assistance as may be deemed necessary and expedient to members of the Association. To take note of events, statements and expressions of opinion effecting members, to advise them thereon and to represent their interests. With the introduction of on-line computerized system to automate the maintenance of settlement accounts, the relationship between LCBs and the CBSL as well as among LCBs were strengthened since each institution has a responsibility to maintain standards in order to ensure the efficient operations of the system. Selected senior officials of the LCBs are participants/members of high level meetings and committees set up by the CBSL and they provide significant contribution to the enhancement of the PS infrastructure through such meetings and committees. Primary Dealers With the introduction of an electronically operated real time gross settlement system and scripless securities settlement system for funds transfers and securities transfers, primary 8

11 dealers were appointed as dealer direct participants in such systems under the provisions given in the LTBO and RSSO. The Primary Dealers Association is a collective body of PDs in Government Securities. It formulates guidelines and establishes professional ethics for its member firms. At present there are six PDs in the Sri Lankan financial markets and they maintain a close relationship with the CBSL being the participants of the LankaSettle system. National Payment Council (NPC)- The CBSL established the National Payments Council (NPC) in 2006 as the apex body in the institutional framework in the field of payments and settlements, having all stakeholders of PSS as members in order to have a collective decision making process in enhancing the payment infrastructure of PSSs. The objective of the NPC is to ensure active representation of all PSS stakeholders in the development and modernization of PSS, particularly in the areas of designing policies/standards/regulations/projects, monitoring such projects, and supervision and oversight of PSS etc. This industry wide institutional framework has helped the CBSL to promote innovation and competition in PSS, while promoting the adoption of international standards in PSS in Sri Lanka. The NPC meets once in two months on regular basis and discuss the current issues relating to the PSS, reviews the progress of the PSS development projects that come under the supervision of the NPC and, makes policy decisions and advices the authorities/stakeholders who are responsible for implementing such policy measures. Payments Reform Steering Committee (PRSC)- The CBSL has formed the Payments Reform Steering Committee which comprises the representatives of the participants of the high level payment system. Meetings of the committee are conducted on requirement basis to resolve technical, operational and procedural issues relating to the system and other retail PSS and when decisions have to be taken collectively to resolve such issues. One to one meetings are also held when there is a specific issue for a participant. In addition, the CBSL also uses moral suasion to resolve issues/problems in PSS development. Communications relating to PSS development is also made through press releases, media conferences, seminars etc. 9

12 LankaClear (Pvt) Ltd. (LCPL) Under the CBSL Modernization Project, the CBSL divested its clearing operations to LCPL in April 2002, subject to terms and conditions imposed by the relevant Acts. The objective of divesture was to improve efficiency of clearing by utilizing new management and introducing new technology to achieve a cost effective operating system with the close cooperation of its stakeholders i.e. LCBs and the CBSL. The LCPL is an organization jointly owned by the CBSL (20 %of the share capital), state LCBs (28%) and local private and foreign LCBs (52 %). The Board of Directors of LCPL comprises of eight non-executive directors. The chairman is appointed by the Governor of the CBSL. The LCPL currently operates following clearing systems: Cheque Imaging and Trancation System; Sri Lanka Interbank Payment Systems (SLIPS); Sri Lanka Rupee Draft Clearing; and US dollar Cheque Clearing System. The LCPL calculates net positions of cheque, SLIPS and draft clearing and send the net positions to the CBSL to be finally settled through the real time gross settlement system. Net clearing obligations of the US dollar cheque clearing system are settled at an LCB that serve as the settlement bank. LCPL has introduced several upgrades to the retail payment systems as an operator of such systems as well. Further, LCPL is the certification authority for the authentication of electronic financial transactions of banks. Colombo Stock Exchange (CSE) The Colombo Stock Exchange (CSE) is the only stock exchange in Sri Lanka. The CSE was established and took over the stock market operations from the Colombo Share Brokers Association in The policy making body of the CSE is the nine member Board of Directors consisting five members elected by the member firms, 4 members appointed by the Minister of Finance. The CSE operates as a self regulatory organization subject to the regulation and supervision of the Securities Exchange Commission which was established under the Securities Council Act No. 36 of 1987 to regulate the securities market in Sri 10

13 Lanka, grant licenses to stock exchanges, stockbrokers, stock dealers and unit trusts who engage in the business of trading in securities. The CSE presently operates 4 regional offices in the southern (Matara), Central (Kandy), North Western (Kurunegala) and Northern (Jaffna) provinces and Western Province (Negombo). The CSE also operates a Public Gallery at the World Trade Center, Colombo 01.The CSE involves in improving the market infrastructure and the regulatory framework to integrate and strengthen the securities market in Sri Lanka. The implementation of the policy decisions in the area of cooperate securities (equity and debt security) lies with the Securities and Exchange Commission of Sri Lanka (SEC). Accordingly, the SEC is responsible to supervise/oversee the clearing and settlement systems for corporate securities, the CSE, stock brokers, unit trusts, venture capital companies and investment managers and to make policy decisions and enforce such decisions. The CBSL also represents the Board of Directors of the SEC. Senior officials of the CSE and SEC are the members of the NPC. The Central Depository Systems (Pvt) Ltd. (CDS) The CDS, is a fully owned subsidiary of the Colombo Stock Exchange (CSE). The CDS is responsible for clearing and settlement process of secondary market transactions at the CSE. The CDS was incorporated in 1991 and became fully operational in All listed securities at the CSE are not fully dematerialized. Therefore, it is mandatory for all listed securities issued by companies in scrip form to be lodged in the CDS for trading at the CSE. When an investor lodges his securities in the CDS, he effectively transfers the legal ownership to CDS, while retaining the beneficial interest. The beneficial interest is recorded in his account at CDS. The CDS clears equities traded in the automated trading system (ATS) and the beneficial interest of government securities and corporate debt securities traded in the Debt Securities Trading System (DEX) at the CSE. Lanka Financial Service Bureau Ltd (LFSB) The CBSL uses the SWIFT 3 service for transmission of payment messages in the high value payment system. SWIFT is an internationally accepted communication system for financial transactions and Sri Lanka has been using SWIFT services for more than twenty years. Until 3 SWIFT stands for Society for Worldwide International Financial Telecommunication 11

14 2008 June, each institution had to have own international lease circuit incurring a high cost for the convenience and security offered by the SWIFT service. LCBs, PDs, CBSL, CDS came together to form a SWIFT Service Bureau for Sri Lanka; after evaluating the national importance of the project and the cost effectiveness it can offer. Thus, Lanka Financial Services Bureau Ltd (LFSBL) was formed in December 2006 with an initiative of SWIFT User Group in Sri Lanka, banking community and led by the regulator; Central Bank of Sri Lanka. It was incorporated in June 2007 under the Companies Act 2007 of the Democratic Socialist Republic of Sri Lanka. LFSB was established as a SWIFT Services Bureau to mitigate the costs of financial messaging of Sri Lanka Swift Users. This is a major initiative by Sri Lankan Financial community. LFSB is responsible and accountable for service availability (reliability) and support services for the users in Sri Lanka Other Arrangements The CBSL maintains a close relationship with participants of PSSs. The Governor and senior officials of the CBSL monthly meet the chief executive officers of the licensed banks and the LCPL to discuss issues with regard to the financial sector and PSS and to take appropriate measures promptly to resolve such issues. The arrangement made by the CBSL covers all major PSS in the country except equity and debt securities transactions taken place at the Colombo Stock Exchange (CSE). High Value Payment Systems LankaSettle System LankaSettle system is the integrated high value payment system in the country with two systems namely; Real Time Gross Settlement (RTGS) system and Scripless Securities Settlement (SSS) system. The participation in the LankaSettle System is limited to LCBs and PDs in principle to act as direct participants and the CBSL itself participates in the system. The CBSL may appoint an entity giving the facility to maintain a settlement account with the CBSL as a participant for limited purposes, provided that it satisfies the requirements for participation in the LankaSettle system. The terms and conditions that shall be followed by the participants have been documented in the LankaSettle System Rules which is updated annually depending on the requirements and changes made to the system. 12

15 Foreign participants in the system are the local branches of the foreign commercial banks incorporated outside Sri Lanka. Under Sri Lankan law, the licensing requirement for these participants is recognized in the Banking Act No. 30 of Under Section 3 (1) (c) (i) of the Banking act, a written undertaking supported by a resolution of the board of Directors of a foreign bank (a company or a body corporate incorporated outside Sri Lanka) is submitted to the Monetary Board, stating that they shall on demand by the central bank provide such funds as may be necessary to meet all obligations incurred in or in connection with, its business in Sri Lanka. (Vide annexed Section 3(1) (c) (i) of the Banking Act No. 30 of 1988, as amended.) Accordingly, maximum legal protection against any legal risk is provided. In further support of the above and to fulfil all payment and settlement transactions, agreements (Mandate, Accession, RTGS, Repo and reverse Repo agreements etc.) and contracts are in place between the Regulator and the participant commercial bank, be it local or foreign As of end 2010, there were 31 participants in the RTGS System, which included the CBSL, 22 LCBs, 6 non-bank PDs, the Employees Provident Fund (EPF) and the CDS. The EPF is regarded as a Designated Non Dealer participant. RTGS System The RTGS System which is a component of the LankaSettle System is the systemically important large value payment system in Sri Lanka. The system has been in live operation since September 2003 and provides its participants with following facilities: real time gross settlement of inter-participant payments in financial markets as well as their customer payments; Intraday Liquidity Facility (ILF); sound liquidity management; settlement of net clearing balances of clearing systems operated by LCPL; settlement of the fund leg of securities transactions settled in the LankaSecure; 13

16 OMO transactions; and settlement of rupee leg of forex deals.. LankaSecure System LankaSecure system, a state of the art settlement system for government securities has been in operation since February 2004 and it facilitates settlement of scripless securities among participants and the Scripless Securities Depositary system (SSDS) which maintains securities accounts of the system s participants and individual investors. The LankaSecure System is interfaced with the RTGS System to facilitate delivery of securities against payment. Each participant is given a browser workstation which provides queue management and enquiring facilities. Browser interface to the LankaSecure are connected through CBSLNet wide area network. The mode of communication of the system is the SWIFT messaging system. The LankaSecure System provides T+0 to T+10 settlement while, intraday liquidity is provided to participants against securities available at the LankaSecure System. Securities taken for ILF are valued at official prices issued by the CBSL on a daily basis. LankaSecure provides customer services such as monthly transactions statements, semi annual holding statements, web based viewing facilities. Settlement Process Treasury bills, Treasury bonds and the CBSL Securities are issued in scripless form in the LankaSecure. Securities in LankaSecure is made by units and uniquely identified by the International Securities Identification Number (ISIN). Minimum marketable volume in LankaSecure is one unit which has a face value of one rupee. If the sufficient securities are not available in the specified accounts, securities instructions are queued. The SSDS maintains a central record of scripless securities issued to participants and their customers with legal effect of the ownership. Interest and maturity proceeds of securities kept in SSDS are paid to the RTGS settlement account of the participants. LankaSecure processes securities transactions between participants and their customers and, between participants and the CBSL. Transactions that are to be settled against payments are effected on delivery versus payment basis as it is fully integrated with the RTGS. 14

17 Retail/Small Value Payment Systems Cheque Imaging and Truncation (CIT) System The Payment & Settlement System Act No. 28 of 2005 has laid down the procedure for the payment of cheques presented electronically. Cheque Imaging & Truncation (CIT) System is an image-based cheque clearing system which replaces the physical cheque with electronic information flowing throughout the clearing cycle. This process eliminates the actual cheque movement in cheque clearing process and reduces the delays associated with the physical movement of cheques. CIT system is designed to accept physical cheques or images and MICR data of physical cheques submitted through direct electronic transfer. Banks have upgraded necessary technology to generate images of cheques for outward delivery and submit cheque data and images to LCPL. As such, the physical movement of cheques has been truncated at the point of image capture at bank branches and hence, the paying bank will not receive a physical cheque during the entire clearing process. Sri Lanka Interbank Payment (SLIP) System SLIP system is an on-line retail fund transfer system operated by LCPL to facilitate interbank retail fund transactions under the observations of the CBSL. The SLIP system was introduced in August, 1994 as an off-line retail fund transfer system. The system was upgraded by LCPL in 2010 to provide on-line service to banks and the same day settlement for customers. The SLIPS handles small value bulk payments including credit transfers and direct debits. All LCBs (22) and the CBSL are direct participants of the SLIPS. The National Savings Bank and SANASA Development Bank which are, licensed specialised banks have received the direct access status as secondary participants through selected LCB. Other financial institutions, corporate bodies and individuals can participate in the SLIPS only through their correspondent LCBs. 15

18 US Dollar Cheque Clearing System The US Dollar Cheque Clearing System was launched by the LCPL in October This is a semi-computerised retail clearing system for cheques and drafts drawn in US dollars. All LCBs in Sri Lanka are eligible to participate in the US Dollar Cheque Clearing System. An in-house developed software application package is used for processing and clearing of US dollar cheques/drafts. Locally incorporated private LCB, performs as the settlement bank for this system. Each participating LCB should maintain a US dollar (nostro) account with the settlement bank and the net positions are settled on T+2. Main objectives of this system are to: Reduce the time lag for clearing and settlement of US dollar cheques/drafts from about three weeks to about 4 working days; Reduce delays in receiving the funds for US dollar cheques/drafts by depositors in Sri Lanka; and Reduce costs on foreign exchange payments involved in clearing and settlement of cheques/drafts by introducing multilateral net clearing mechanism This system clears following categories of US dollar cheques/drafts: o US dollar cheques/drafts issued by LCBs in Sri Lanka payable to Sri Lankan individuals and institutions; and o US dollar cheques/drafts issued by banks and money exchangers outside Sri Lanka drawn on LCBs in Sri Lanka. Before introducing the US Dollar Cheque Clearing System, a substantial number of such cheques/ drafts were despatched to correspondent banks abroad for realisation and the value was credited to LCBs accounts. But this settlement process took as long as about 3 weeks to make the final credit to depositors. In addition to that, the charges were relatively high (i.e. about US dollars 5 to 25 per cheque/draft). Other Electronic Payment Instruments With the advancement of information technology, complexities of the economic activities, upgrading of payment mechanisms and changing of user requirements, electronic fund transfer mechanisms such as credit cards, debit cards, ATM facilities and phone based 16

19 payment methods have been gradually introduced to the community by various service providers in Sri Lanka throughout last two- three decades. Having considered the increasing trend in introducing and using electronic payment instruments and the possible risks on such payment mechanisms, the CBSL, under the provisions of the PSSA took steps in 2009 to issue Service Providers of Payment Cards Regulations No. 01 of 2009 (Regulations) with the objective of regulating Payment Card industry. Accordingly, card issuers, financial acquirers, phone based payment system operators and settlement system operators are regulated by the CBSL under the provisions of the Regulations. Considering the urgent requirement of regulating the credit card industry, in March, 2010 the CBSL issued the guidelines for credit card issuers. Further, having observed the global trend in introducing mobile payment means and the risk associated with such systems, guidelines for two types of mobile payment models; namely account based model and custodian bank model were issued in March, In addition, the CBSL with the assistance of LCBs expecting to issue guidelines for internet payment systems in near future, in order to mitigate the risk of users of such payment modes. In terms of the Regulations LCBs Registered Financial Companies, Licensed Specialized Banks and Public Companies are eligible to carry on payment card businesses and they are required to obtain licences from CBSL to act as service providers of payment cards Payment System Oversight and Monitoring Overseeing the Payment and Settlement System Payment and settlement systems enable the transfer of money in the accounts of financial institutions to settle financial obligations between individuals and institutions. In a systemically important PSS, a significant proportion of transactions by value consist of transactions conducted in financial markets. Although disruptions to operations of such systemically important PSS are rare, the potential consequences of such a disruption are substantial and widespread and could lead to a systemic disruption and financial shock even beyond the system and its participants, which could adversely affect the stability of the financial sector. Therefore, the safety and efficiency of the PSS, particularly systemically important ones, is critical for the effective functioning and stability of the financial system. 17

20 Oversight of Systemically Important Payment Systems(SIPS) Independently from ensuring the operation of interbank payment systems, the CBSL oversees systemically important payment system in the country in order to ensure timely and efficient fund transfers thereby, expiditing the economic activities of the countrty. In addition, the CBSL oversees each individual payment system as well as national clearing house operations and functions of LFSB to help participants and operators to get a clear understanding of potential risks associated with payment systems and means to reduce such risks. There has been an increased international emphasis on the oversight of systemically important payment systems. In order to promote the development of safe and efficient payment systems, the Committee on Payment and Settlement Systems of BIS has published the Core Principles for Systemically Important Payment Systems accepted by the governors of G-10 countries' central banks. This document sets out the core criteria that must be met by any systemically important payment system to be declared as sufficiently safe and efficient on the international scale. The CBSL oversees the operation of systemically important payment systems in Sri Lanka in accordance with the Core Principles for Systemically Important Payment Systems, establishing their compliance with these core principles and requiring payment system operators to take all reasonable measures to achieve full compliance with the said principles. According to international standards and practices, currently the RTGS is regarded as a systemically important payment system in Sri Lanka and the CBSL conductes self assessments of the system to ensure the adherence to the core principles for systematically important payment systems. Further, the CBSL also oversees the CITS in accordance with the principles for the oversight of systemically important systems. In Sri Lanka, the CITS is the only retail payment clearing system for settlement in the national currency that processes a large number of retail payments, and disruptions in its functioning may affect numerous customers, leaving them without opportunity to make or receive payments in due time. 18

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