Instant Settlement

What is Instant Settlement and how it addresses the Gaps in Deferred Net Settlement

Modern systems such as Instant or Faster Payment Platforms allow us to address some of the risks that were highlighted in Section 2.1 Deferred Settlement through the implementation of several technical checks at the time of transaction clearing. These include capabilities such as checking a Sending participant's Net Debit Position and if required, also making sure that it is backed up by sufficient collateral in real-time. Checking the net debit cap in real-time ensures that no participant could ever be exposed to more than a defined level of exposure. If we take this one step further and ensure that the net-debit cap is collateralized, we ensure that there can never be liquidity risk in the system. We can remove credit risk as well since net-debit positions are calculated in real-time, this implies that any receiving institution when it settles the end-user is also settled by the scheme since its net debit cap increases while that of the sender participant decreases.

Net Debit Cap

Maximum Net Debit Cap & Dynamic Multilateral Net Position

A Net Debit Cap is a limit on the amount of money that a participant in a settlement system can owe to other participants in the system. The limit is typically calculated based on the participant's net debit position, which is the difference between the total amount of money owed to other participants and the total amount owed by them.

The Net Debit Cap can be set by looking at previous trends as well as expectations of inflow and outflow of each participant, the Net Debit Cap is then a hard stop for the switch to stop transactions from a participant so that it can not exceed a defined level of exposure. That is if a participant's net debit position exceeds the Net Debit Cap, their transactions will be rejected or queued until the position is reduced (either by an inflow of funds, or topping up the Net Debit Cap from other sources of funds).

Scenario where A sends B funds and the Net Debit Cap check allows the transaction to go through.

Scenario where A sends B further funds and the Net Debit Cap check still allows the transaction to go through.

Scenario where A sends B further funds but the Net Debit Cap check stops the transaction from going through.

Fully Collateralized Net Debit Cap

An even better practice to completely remove settlement risk is that scheme operating rules require participating DFSPs to have 100% of their Net Debit Cap held in collateral at a financial institution. A fully collateralized Net Debit Cap system has no potential for an uncovered loss. To do this, there are several options available to collateralize a Net Debit Cap (NDC) in a settlement system, these can be;

1. Cash: Participants can deposit cash with the settlement system to cover any potential net debit balance. This could be in the Treasury Single Account or in the RTGS.

2. Securities: Participants can pledge securities or other eligible collateral to cover any potential net debit balance. This could be nominated and held in the Central Securities Depository.

3. Guarantees: Participants can provide guarantees from third-party entities, such as banks or insurance companies, to cover any potential net debit balance.

Final Settlement

The Instant Payments Switch maintains the Net Position of each participant, this net position is a real-time and dynamically updated value of an FSPs current obligations to the system. At pre-determined intervals (usually more than once a day, but could be much more frequent), the Instant Payment Platform shares the Net Positions of each FSP to the settlement agent much the same as deferred net-settlement systems.

Representation of a Net Settlement Instruction to be shared with Settlement Agent

Exactly the same as in Deferred Settlement, at pre-determined intervals and at an exact cut-off, the above constantly calculated net positions are shared with the settlement agent for them to affect the net positions on the single treasury account or settlement account that all FSPs hold with the settlement agent.

The key similarity between a Deferred Net Settlement Model and a Retail Instant Payment Settlement Model is that both rely on sharing of an MNSB or Multi-lateral Net Settlement Batch, in both cases this batch is executed on Participant or Sponsor Settlement Accounts held at the Settlement Agent.

The key difference is in the clearing of transactions, as payment messages come through for clearing, the net debit cap and net position ensure that no transaction is committed which can not be later settled. However, once a transaction is cleared, it is settled at the Settlement Agent through an MNSB similar to deferred settlements.