Payment and Settlement System and Central Banking


20 Aug 2019

Payment and Settlement System and Central Banking

Need a health check?

1. “Would you like us to conduct a health check, on a pro bono basis, of your interbank payment and settlement system?” a payment specialist from the Bank of England, who was visiting Hong Kong for leisure, made this friendly offer in 1992. I quickly said yes as we hardly had any expertise within the Office of the Exchange Fund of the Hong Kong Government at that time. The key reason for this was that for decades the Hongkong and Shanghai Banking Corporation (called HSBC in this article) was the settlement institution for all other banks in Hong Kong either directly or indirectly. This meant that HSBC was the operator of the interbank payment and settlement system and the interbank payments were settled across its books.

2. The result of this health check wasn’t entirely encouraging. Out of the six of the then global standards for large value payment systems,1 Hong Kong passed two of them and failed the remaining four. Without being too technical, basically the failings were due to the fact that the interbank payment and settlement system had the following shortcomings:

  (a) across the books of a commercial bank instead of a central bank;
  (b) on a net rather than a gross basis;
  (c) settlement on a next-day basis instead of on the same-day or a real-time basis; and

without a well-founded legal basis, there was no certainty in the finality of settlement.

3. As we know, the large value interbank payment and settlement system is such a critical piece of financial market infrastructure that it is the very foundation of any vibrant and robust financial centre. Some would liken it to the “plumbing” of the financial system, but I would regard it more akin to the blood vessels of a human being – the health and even survival depend on its efficient operation. Faced with this disappointing “health check” results, we had no choice but to embark on a fundamental reform of the system.

Opportunity for Payment System Reform

4. Of course, there is another more fundamental reason why we had to revamp our interbank payment and settlement system, which was not widely understood at the time. There was a need to take back the role of the settlement institution for our banking system from HSBC. It must be understood that central banks possess the ability to create base money not only because they can print money (i.e. banknotes) but also their power to serve as the settlement institution of the banking system. A central bank can, through crediting or debiting commercial banks’ clearing balances (or known as reserves) in their settlement accounts with the central bank, create or reduce money supply (M0). In Hong Kong, for historical reasons, HSBC had been serving as the settlement institution for the banking system, hence it was dubbed Hong Kong’s “quasi central bank”. However, there was clearly an issue of HSBC, being a commercial entity, performing this central banking function for Hong Kong. So in 1988, the Hong Kong Government introduced the “New Accounting Arrangements”, which were designed to rein in HSBC’s ability to dictate money supply through an indirect means (i.e. HSBC opening an account with the Exchange Fund and incentivised to change the level of interbank liquidity in accordance with the level of the account balance, which was determined by the Monetary Affairs Branch of the Hong Kong Government). The “New Accounting Arrangement” provided a partial solution on monetary operation but it has not changed anything on the payment and settlement system. One of the key objectives of the interbank payment and settlement system reform in the 1990s, which was also one of the major initiatives undertaken by the newly formed Hong Kong Monetary Authority (HKMA), was to rectify this anomaly, thereby putting Hong Kong at par with the best contemporary international practices and standards.

RTGS Project

5. The reform was a daunting task full of challenges. First, the HKMA needed to recruit experts and consultants from the outside. The timeline for the project, which began in early 1995, was a very tight one as we didn’t believe that it was a good idea to have the project straddling 1997 for obvious reasons. So we aimed to finish and roll out the new system towards the end of 1996. Given the huge amount of programming work required, if we were to upgrade our system to a state-of-the-art Real Time Gross Settlement (RTGS) system that met the best international standards, the only workable option was to engage HSBC as the programme developer to build a new system on the basis of the existing Clearing House Automated Transfer System (CHATS) it operated.2 From the very beginning, we recognised the importance of getting the users closely involved in designing the functionalities of the new RTGS system. We also took the opportunity to include the optionality of providing DvP (Delivery vs Payment) linkages with the Central Moneymarkets Unit (CMU, the custodial and clearing system for debt instruments issued by the HKMA and other issuers) and PvP (Payment vs Payment) for foreign exchange transactions. In the end, we set up a joint venture private limited company with The Hong Kong Association of Banks (HKAB) to run the payment and settlement services, and HSBC agreed to assign all intellectual property rights of their CHATS to the newly set up joint venture. As the real time settlement nature of the system would naturally lead to a demand for intraday liquidity, we also introduced the intraday repurchase agreement (repo) facility for banks. This was made possible through a seamless, cost-effective and efficient interface with the CMU in clearing and settling the Exchange Fund Bills and Notes (EFBN).

6. During the entire project life, every Monday I convened at the HKMA a steering group meeting attended by around 20 odd team leaders from the key stakeholders: project advisers/consultants, programme developers, HKAB and HKMA project team. In order to coordinate and resolve the many differences and arguments amongst the stakeholders, I resorted to a method that proved to work well: the meeting would continue as long as there were still outstanding disputes. Once the team leaders realised that they would be stuck at the meeting indefinitely unless a solution, albeit a compromised one, could be reached, the spirit of collaboration and mutual understanding were greatly enhanced.

Launch of RTGS system in December 1996

7. It was with great dedication and tireless efforts by all the project participants that we were able to overcome numerous challenges, especially during the User Acceptance Test and Simulation Test stages. For some important technical reasons that I do not propose to elaborate here, it was not feasible to do a parallel run when we cut over to the new real time system. This meant that, once we decided to roll out the new system in a “big bang” manner, there was no going back to the old system, even if the new system didn’t quite work as planned for whatever reasons. It was a mind boggling task because the daily turnover of the interbank payment system was around HK$300 billion. Once we cut over and if the new system failed to work, the entire banking system would be disrupted as money could no longer flow from the payers to the payees, just like blood vessels getting blocked, which would be life threatening.

8. The final few weeks prior to the scheduled cut over time were very tense if not troubling. There were many more bugs than expected found in the testing phase. This is both good and bad news. Good news because we knew what was wrong and needed to be fixed. Bad news because it necessitated enormous amount of bug fixing work by the teams. Old bugs were fixed but new bugs kept on emerging. On the final day, Sunday 8 December 1996, we needed to decide whether the new system should be cut over the next day, Monday 9 December. We had by then fixed all the bugs that were identified except one that cropped up very late. It related to a function for bank users to recap all transaction records, which was hardly ever used and if implemented in the new system would slow down the speed of the server significantly. The team told me that the bug on “recap all transaction records” had been fixed but the processing capacity of the computer would require some enhancement to cater for exceptionally high volume of transactions which was encountered during one of the simulation tests when all bank users input real time DvP transactions for the Exchange Fund Bills and Notes at the same time according to the testing schedule. However remote the possibility of this happening in practice, it was nonetheless a risk. After some struggling, we decided to cut over on Monday, 9 December as planned.3 If things didn’t quite work out, “heads will roll, including mine,” I told my lieutenants.

World Class Payment and Settlement System

9. Looking back, all the project participants can take a great pride in helping launch in December 1996 one of the most modern RTGS systems in the world. Hong Kong’s RTGS system was the fourth in the world after the US, Switzerland, and the UK, which was launched only a few months ahead of Hong Kong. The system has gone from strength to strength not only with regular upgrading in functionalities but with a perfect 100% uptime (i.e. no downtime whatsoever since launch), providing an efficient and safe platform for huge amount of funds to flow through the banking system. The turnover of Hong Kong dollar RTGS system now amounts to HK$1 trillion everyday on average. It is worth mentioning that our RTGS system was expanded to cover renminbi (RMB) in 2007, two years ahead of the beginning of the internationalisation of RMB in 2009. As Hong Kong has now become the global hub of offshore RMB businesses, the average turnover of RMB RTGS system is over RMB1 trillion every day. Based on the statistics published by SWIFT, around 70% of global RMB payments go through Hong Kong’s payment system.

10. The payment and settlement system is a critical piece of market infrastructure for maintaining Hong Kong’s position as the premiere international financial centre in Asia. The introduction of the RTGS system in 1996 greatly contributed to the safe and efficient settlement of interbank payments in Hong Kong in the ensuing years. Some 20 years later, we entered into a new era with the launch of the Faster Payment System (FPS) in September 2018. It is the first in the world in providing instant, convenient, safe and low-cost means of small value person-to-person or person-to-merchant payments in dual currencies (Hong Kong dollar and RMB). The FPS will certainly help promote financial innovation and provide great convenience to customers. It also provides a level playing field between banks and e-wallet operators in offering efficient and safe small payment services.


Norman Chan
Chief Executive
Hong Kong Monetary Authority

20 August 2019


1 The global standards were often called “Lamfalussy Standards”, named after the General Manager of the Bank for International Settlements.

2 CHATS was a multi-tier interbank payment and settlement system in Hong Kong designed and operated by HSBC.

3 Hong Kong satisfied all the Lamfalussy Standards in 2004, when the Clearing and Settlement Systems Ordinance was enacted to, among other things, provide statutory backing to the legal finality of payments made through the RTGS system. The ordinance was subsequently amended and renamed as the Payment Systems and Stored Value Facilities Ordinance in 2015.

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Last revision date : 20 August 2019