Bank of Finland’s Payment And Settlement System Simulator (BoF-PSS2)
From Payment and Settlement System Simulator
The Bank of Finland provides a simulator called BoF-PSS2 for replicating payment and securities settlement systems. The simulator is adaptable for modelling multisystem setups that can be a combination of payment, securities settlement systems and CCP’s. The simulator is known to be unique and the first of its kind. Since its launch in 2002 it has been distributed to more than 90 countries and has contributed to numerous studies and research papers.
The simulator can be used to fulfill some of the regulatory requirements stated in the PFMI’s and BCBS requirements such as identifying the liquidity risks inpayment systems. Here under are topics the simulator can be used for:
Settlement, liquidity and credit risks in FMI’s
Systemic Risks and Counterparty risks in FMI’s
Identification of critical counterparts
Policy change impact evaluation
Liquidity dependency analysis
Relationship analysis of Monetary policy and liquidity needs for settlement of payments
Evaluation of sufficiency of liquidity buffers and margins
System merger effects on liquidity needs
System performance benchmarking
Netting algorithm testing and development
System development and prototyping
In comparison to static calculations of indicators, the simulation results naturally incorporate network (or systemic) effects rising from the payments flows and the technical properties of the infrastructures themselves. The results obtained from simulations are directly interpretable and have a self-evident meaning which is not always the case with all indicators. The results can directly be used for risk management purposes for example when evaluating the sufficiency of liquidity buffers and margins. Computer simulations take advantage of using the available information in full without losing micro-level information due to indicator aggregations.
The simulator is freely available for research purposes, and has already been introduced in numerous countries. It is possible to tailor and adapt the simulator to specific payment systems. Several adaptations of the simulator have already been made, eg. for TARGET2. The simulator team provides trainings, consultation and tailored adaptations which are priced for cost recovery. The training course aims at providing necessary skills for efficient use of BoF-PSS2 with hands on computer class exercises. It also presents numerous examples from real studies where the tool has been used. For more details see the training course outline. Minimum attendance to the session is four participants.
Basically, trainings are organised upon demand and it is also possible to order a training course to be held onsite outside the proposed dates.
From Payment and Settlement System Simulator / Product Page
From Payment and Settlement System Simulator / Documentation page
The Bank of Finland Payment and Settlement System Simulator, version 2 (BoF-PSS2), is a powerful tool for payment and securities settlement system simulations. The simulator supports multiple system structures and various settlement models.
The simulator is designed for analysing liquidity needs and risks in payment and settlement systems. Special situations, often difficult or impossible to test in a real environment, can be readily simulated with BoF-PSS2. Thus, users can study how behavioral patterns and changes in policy and conventions impact the payment and settlement systems and participants. The efficiency of gridlock-resolution and liquidity-saving measures can be analyzed as well.
The application is divided into three sub-systems:
Input sub-system for preparing and defining the input data,
Execution sub-system for running simulations,
Output sub-system for basic analyses of simulation results.
Different settlement logics are implemented into separate algorithms. To replicate specific systems, appropriate algorithms must be selected with appropriate parameters. Different algorithm combinations can be used to replicate a large number of current and potential settlement conventions and structures. Real-time gross settlement systems (RTGS), continuous net settlement systems (CNS), deferred net settlement systems (DNS) and hybrid systems can be implemented with the simulator as well as securities settlement and multicurrency systems. Inter-system connections and bridges make it possible to define multi- system environments consisting of various types of interdependent systems. E.g. it is possible to replicate the interaction of RTGS and securities settlement systems.
Advanced users of BoF-PSS2 can define and build their own user modules/algorithms and expand the basic features of the simulator to analyse new types of settlement processes. It is also possible to implement agent based modeling by adding algorithms replicating the participants’ behavior and decision making to control and alter the flow of submitted transactions. As a later addition, the simulator also has a network analysis module for generating networks and network indicators from either input data or results of simulations.
BoF-PSS2 has an easy to use graphical user interface. It is also possible to automate the use of the simulator via its command line interface (CLI).
From Payment and Settlement System Simulator / Product Page
A separate TARGET2 simulator version of BoF-PSS2 has been developed and delivered for the European System of Central Banks. It is based on the same basic software architechture and features of BoF-PSS2. Additional features are implemented as separate algorithm modules which replicate the proprietary algorithms of actual TARGET2 system. It is used by Eurosystem for quantitative analyses and numerical simulations of TARGET2.
TARGET2 simulator has been jointly delivered by Suomen Pankki (Bank of Finland) and the 3CB (Banca d’Italia, Deutsche Bundesbank, Banque de France) based on a decision of ECB Governing Council.
Cascades of Failures
Congestions and Delays
Financial Market Infrastructures
Key Sources of Research:
Payment and Settlement System Simulator – A tool for analysis of liquidity, risk and efficiency
Bank of Finland Payment and Settlement Simulator
BoF-PSS2 Technical structure and simulation features
Financial Stability and Systemically Important Countries -IMF-FSAP
IMF – FSAP
Assess financial stability and development
From The Financial Sector Assessment Program (FSAP)
The goal of FSAP assessments is twofold: to gauge the stability and soundness of the financial sector, and to assess its potential contribution to growth and development.
To assess the stability of the financial sector, FSAP teams examine the resilience of the banking and other non bank financial sectors; conduct stress tests and analyze systemic risks including linkages among banks and nonbanks and domestic and cross border spillovers; examine microprudential and macroprudential frameworks; review the quality of bank and non bank supervision, and financial market infrastructure oversight against accepted international standards; and evaluate the ability of central banks, regulators and supervisors, policymakers, and backstops and financial safety nets to respond effectively in case of systemic stress. While FSAPs do not evaluate the health of individual financial institutions and cannot predict or prevent financial crises, they identify the main vulnerabilities that could trigger one.
To assess the development aspects of the financial sector, FSAPs examine the development needs in terms of institutions, markets, infrastructure, and inclusiveness; quality of the legal framework and of payments and settlements system; identify obstacles to the competitiveness and efficiency of the sector; topics relating to financial inclusion and retail payments; and examine its contribution to economic growth and development. Issues related to development of domestic capital markets are particularly important in developing and low-income countries. While focusing on development issues, FSAPs also keep in view financial stability dimensions .
Since 1999 the IMF has monitored countries’ financial sectors on a voluntary basis through the Financial Sector Assessment Program. In developing and emerging market countries, the World Bank participates in these assessments, focusing on long-term financial development issues.
In the context of these financial sector assessments, the IMF examines three key components in all countries:
• the soundness of banks and other financial institutions, including stress tests;
• the quality of financial market oversight in banking and, if appropriate, insurance and securities; and
• the ability of supervisors, policymakers, and financial safety nets to respond effectively in case of a crisis.
One size does not fit all in these assessments. The IMF tailors its focus in each of these areas to a country’s individual circumstances, and takes into account the potential sources that might make the country in question vulnerable.
The objective is to assess countries’ crisis prevention and management frameworks, with the goal of supporting both national and global financial stability.
Based on 2010 IMF-FSAP, these are the counties having the systemically important Financial Sectors:
Hong Kong SAR
the United Kingdom
the United States
In 2014, Four new countries were added to the list based on expanded criteria for financial stability:
Expanded criteria emphasize connections between financial sectors, institutions
More emphasis on how problems in one country affect others
From Press Release: IMF Expanding Surveillance to Require Mandatory Financial Stability Assessments of Countries with Systemically Important Financial Sectors
September 27, 2010
Press Release No. 10/357
September 27, 2010
The Executive Board of the International Monetary Fund (IMF) has approved making financial stability assessments under the Financial Sector Assessment Program (FSAP) a regular and mandatory part of the Fund’s surveillance for members with systemically important financial sectors. While participation in the FSAP program has been voluntary for all Fund members, the Executive Board’s decision will make financial stability assessments mandatory for members with systemically important financial sectors under Article IV of the Fund’s Articles of Agreement.
The decision adopted on September 21, 2010 to raise the profile of financial stability assessments under the FSAP for members with systemically important financial sectors is a recognition of the central role of financial systems in the domestic economy of its members, as well as in the overall stability of the global economy. It is a major step toward enhancing the Fund’s economic surveillance to take into account the lessons from the recent crisis, which originated in financial imbalances in large and globally interconnected countries.
The FSAP provides the framework for comprehensive and in-depth assessments of a country’s financial sector, and was established in 1999, in the aftermath of the Asian crisis. FSAP assessments are conducted by joint IMF-World Bank teams in developing and emerging market countries, and by the Fund alone in advanced economies. FSAPs have two components, which may also be conducted in separate modules: a financial stability assessment, which is the responsibility of the IMF and, in developing and emerging market countries, a financial development assessment, the responsibility of the World Bank.
These mandatory financial stability assessments will comprise three elements: 1) An evaluation of the source, probability, and potential impact of the main risks to macro-financial stability in the near term, based on an analysis of the structure and soundness of the financial system and its interlinkages with the rest of the economy; 2) An assessment of each countries’ financial stability policy framework, involving an evaluation of the effectiveness of financial sector supervision against international standards; and 3) An assessment of the authorities’ capacity to manage and resolve a financial crisis should the risks materialize, looking at the country’s liquidity management framework, financial safety nets, crisis preparedness and crisis resolution frameworks.
“The FSAP program has been a key tool for analyzing the strengths and weaknesses of the financial systems of IMF member countries. This is why more than three-quarters of the Fund’s members have volunteered for these assessments, some more than once. However, the recent crisis has made clear the need for mandatory and regular assessments of financial stability for countries with large and interconnected financial systems. The Board’s decision represents an important part of the international community’s response to the recent crisis and will buttress our ability to exercise surveillance over a key aspect of the global economic machinery – the financial system,” said John Lipsky, First Deputy Managing Director of the IMF.
A total of 25 jurisdictions were identified as having systemically important financial sectors, based on a methodology that combines the size and interconnectedness of each country’s financial sector.
They are in alphabetical order: Australia, Austria, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, Italy, Japan, India, Ireland, Luxembourg, Mexico, the Netherlands, Russia, Singapore, South Korea, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.
This group of countries covers almost 90 percent of the global financial system and 80 percent of global economic activity. It includes 15 of the Group of 20 member countries, and a majority of members of the Financial Stability Board, which has been working with the IMF on monitoring compliance with international banking regulations and standards. Each country on this list will have a mandatory financial stability assessment every five years. Countries may undergo more frequent assessments, if appropriate, on a voluntary basis. The methodology and list of jurisdictions will be reviewed periodically to make sure it continues to capture the countries with the most systemically important financial sectors that need to be covered by regular, in-depth, mandatory financial stability assessments.
“Going forward, regular stability assessments of systemically important financial sectors should contribute to a deeper the public understanding of the risks to economic stability arising from the financial sector. Financial instability can have a major impact on economic activity and job creation.” Mr. Lipsky said. “At the same time, we are committed—with the World Bank—to ensuring that this new mandate does not crowd out FSAP assessments in other countries.”
From IMF Survey : IMF Broadens Financial Surveillance
New methods for new risks
In the wake of the crisis, the IMF has strengthened the framework for surveillance of countries’ financial systems.
In 2010, the IMF made financial sector assessments mandatory for the countries with most important financial sectors in the global system, initially 25 and now 29.
The IMF is also focusing on how problems in one country can affect others, and on the connections between financial institutions. The IMF, among others, has developed what are known as network models to try and understand how events in one financial institution, market, or country will impact others.
Given the growing reach of global banks, the IMF also closely examines cross-border supervisory cooperation arrangements. In countries where foreign-owned banks are systemically important, it is essential that the host country supervisor has enough tools and good communications with the parent banks’ regulators.
Last December, the IMF Board reviewed the methodology that determines whether a country’s financial sector is systemically important. In light of the experience since the crisis, it agreed to place even more emphasis on the connections between financial sectors and institutions, expand the coverage of cross-border linkages to cover not only banking but also equity and debt exposures, and capture the potential for pure price contagion. Based on these revamped criteria, the IMF added the four countries to the original 25.
From Systemic Risk: From measurement to the New Financial Stability Agenda
Broad coverage of possible cross-border transmission channels for shocks:
A notable feature of the modern Financial world is its high degree of interdependence. Banks and other Financial institutions are linked in a variety of ways. The mutual exposures that Financial institutions adopt towards each other connect the banking system in a network. Despite their obvious benefit, the linkages come at the cost that shocks, which initially affect only a few institutions, can propagate through the entire system. Since these linkages carry the risk of contagion, an interesting question is whether the degree of interdependence in the banking system sustains systemic stability.
From Contagion Risk in Financial Networks
Recently, there has been a substantial interest in looking for evidence of contagious failures of Financial institutions resulting from the mutual claims they have on one another. Most of these papers use balance sheet information to estimate bilateral credit relationships for different banking systems. Subsequently, the stability of the interbank market is tested by simulating the breakdown of a single bank.
From Contagion in Financial Networks (PG and SK)
In modern financial systems, an intricate web of claims and obligations links the balance sheets of a wide variety of intermediaries, such as banks and hedge funds, into a network structure. The recent advent of sophisticated financial products, such as credit default swaps and collateralised debt obligations, has heightened the complexity of these balance sheet connections still further, making it extremely di¢ cult for policymakers to assess the potential for contagion associated with the failure of an individual financial institution or from an aggregate shock to the system as a whole.
The interdependent nature of financial balance sheets also creates an environment for feedback elements to generate amplified responses to any shock to the financial system.
From Contagion in Financial Networks (PG and SK)
The interactions between financial intermediaries following shocks make for non-linear system dynamics, and our model provides a framework for isolating the probability and spread of contagion when claims and obligations are interlinked. We find that financial systems exhibit a robust-yet-fragile tendency. While greater connectivity reduces the likelihood of widespread default, the impact on the financial system, should problems occur, could be on a significantly larger scale than hitherto. The model also highlights how a priori indistinguishable shocks can have very different consequences for the financial system. The resilience of the network to large shocks in the past is no guide to future contagion, particularly if shocks hit the network at particular pressure points associated with underlying structural vulnerabilities.
From Contagion in Financial Networks (PG and SK)
The intuition underpinning these results is straightforward. In a more connected system, the counterparty losses of a failing institution can be more widely dispersed to, and absorbed by, other entities. So increased connectivity and risk sharing may lower the probability of contagion. But conditional on the failure of one institution triggering contagious defaults, a higher number of Financial linkages also increases the potential for contagion to spread more widely. In particular, greater connectivity increases the chances that institutions which survive the effects of the initial default will be exposed to more than one defaulting counterparty after the first round of contagion, thus making them vulnerable to a second-round default. The impact of any crisis that does occur could, therefore, be larger.
Key Sources of Research:
Kiyotaki and Moore
Credit Chains and Sectoral Comovement: Does the Use of Trade Credit Amplify Sectoral Shocks?
A flow network analysis of direct balance-sheet contagion in financial networks
Contagion in Financial Networks
Paul Glasserman H. Peyton Young
October 20, 2015
Contagion in Financial Networks
Prasanna Gai and Sujit Kapadia
The Effect of the Interbank Network Structure on Contagion and Financial Stability
Contagion Risk in Financial Networks
Financial Fragility and Contagion in Interbank Networks
Complexity, concentration and contagion
Prasanna Gai , Andrew Haldane , Sujit Kapadia
Contagion in financial networks : a threat index
May 23, 2011
Liquidity and financial contagion
TOBIAS ADRIAN HYUN SONG SHIN
Financial globalization, financial crises and contagion
$ Enrique G. Mendoza Vincenzo Quadrini
The International Finance Multiplier
How Likely is Contagion in Financial Networks?
Paul Glasserman,1 and H. Peyton Young
Capital and Contagion in Financial Networks
S. Battiston G. di Iasio L. Infante F. Pierobon
Contagion in the Interbank Network: an Epidemiological Approach
Complex Financial Networks and Systemic Risk: A Review
Spiros Bougheas and Alan Kirman
Systemic Risk, Contagion, and Financial Networks: a Survey
Matteo Chinazzi∗ Giorgio Fagiolo†
June 4, 2015
Systemic Risk and Stability in Financial Networks†
By Daron Acemoglu, Asuman Ozdaglar, and Alireza Tahbaz-Salehi
The payment system – which includes financial market infrastructure for payments, securities and derivatives – is a core component of the financial system, alongside markets and institutions. If modern economies are to function smoothly, economic agents have to be able to conduct transactions safely and efficiently. Payment, clearing and settlement arrangements are of fundamental importance for the functioning of the financial system and the conduct of transactions between economic agents in the wider economy. Private individuals, merchants and firms need to have effective and convenient means of making and receiving payments. Moreover, funds, securities and other financial instruments are traded in markets, providing a source of funding and allowing households, firms and other economic actors to invest surplus funds or savings in order to earn a return on their holdings. Active markets facilitate price discovery, the efficient allocation of capital and the sharing of risk between economic actors.
Public trust in payment instruments and systems is vital if they are to effectively support transactions. In financial markets, market liquidity is critically dependent on confidence in the safety and reliability of clearing and settlement arrangements for funds and financial instruments. If they are not managed properly, the legal, financial and operational risks inherent in payment, clearing and settlement activities have the potential to cause major disruption in the financial system and the wider economy.
Banks and other financial institutions are the primary providers of payment and financial services to end users, as well as being major participants in financial markets and important owners and users of systems for the processing, clearing and settlement of funds and financial instruments. The central bank, as the issuer of the currency, the monetary authority and the “bank of banks”, has a key role to play in the payment system and possesses unique responsibilities. It is therefore no coincidence that one of the basic tasks of the ESCB and the ECB is to promote the smooth operation of payment systems. A safe and efficient payment system is of fundamental importance for economic and financial activities and is essential for the conduct of monetary policy and the maintenance of financial stability.
From The Payment System
The complexity and – in particular – importance of market infrastructure for the handling of payments and financial instruments has increased greatly in recent decades, owing not only to the tremendous increases observed in the volume and value of financial transactions, but also to the wealth of financial innovation and the advances seen in information and communication technologies. Bilateral barter trade is now largely a thing of the past, and instead economic agents buy and sell goods and services (including financial instruments) in markets, making use of the transfer services made available by market infrastructure.
Payment, clearing and settlement systems may differ from country to country in terms of their type and structure, both for historical reasons and on account of differences between countries’ legal, regulatory and institutional environments. Furthermore, rather than being static, payment, clearing and settlement systems and arrangements are dynamic constructions which have evolved over time and will continue to do so in the future. A key priority for central banks is to contribute to the development of modern, robust and efficient market infrastructure which serves the needs of their economies and facilitates the development of safe and efficient financial markets.
All transactions are exposed to a variety of risks, and this is particularly true for financial transactions. Thus, in order to facilitate enhanced risk management, many countries have introduced real-time gross settlement systems for the handling of critical payments. Progress has been made in the implementation of safer and more efficient systems and procedures for the clearing and settlement of securities. Modern securities settlement systems offer delivery-versus-payment mechanisms and allow the effective management of collateral, while foreign exchange transactions are increasingly being settled on a payment-versus-payment basis. In parallel, stronger international trade links, the increased integration of international financial markets (including global derivatives markets) and large migrant flows have all contributed to increased demand for arrangements allowing the cross-border handling of wholesale and retail transactions, raising new issues from a policy and risk perspective.
From The interdependencies of payment and settlement systems
The global payment and settlement infrastructure has changed significantly over the last decade. The myriad of domestic and cross-border systems that make up the global infrastructure are increasingly interconnected through a web of direct and indirect relationships. Through these relationships, the smooth functioning of a single system often becomes contingent on the performance of one or more other systems. In addition, individual systems are often reliant on common third parties, financial markets or other factors. Consequently, the settlement flows, operational processes and even risk management procedures of individual systems are often materially interdependent with those of other systems. As a result, the numerous systems that make up the global clearing and settlement infrastructure have become more tightly interdependent.
This increasing interdependence is driven by several interrelated factors, including technological innovations, globalisation and financial sector consolidation. In addition, a number of initiatives by the financial industry and by public authorities to reduce the costs and risks of settlement have purposely promoted greater integration among the numerous components of the global payment and settlement infrastructure. For example, the 1989 G30 recommendations for T+3 securities settlement, central bank policies encouraging the development and reliance on systems with intraday finality, and the CPSS focus on reducing foreign exchange settlement risk have provided incentives for more straight through processing and tighter relationships among individual systems.3 While these explicit initiatives explain one aspect of tightening interdependencies, institutions’ profit-seeking and cost management incentives also foster interdependencies.
Interdependencies have important implications for the safety and efficiency of the global payment and settlement infrastructure. Some forms of interdependencies have facilitated significant improvements in the safety and efficiency of payment and settlement processes. At the same time, interdependencies increase the potential for a given disruption to spread quickly to many different systems. This potential was noted in the 2000 G10 report on Financial sector consolidation (the Ferguson report), which suggested that interdependencies might accentuate the role of payment and settlement systems in the transmission of disruptions across the financial system, and is further analysed in this report.
The potential for interdependencies to reduce key sources of risk, and yet create new sources of risk, highlights the numerous trade-offs faced by payment and settlement systems, their participants and public authorities. The reduction of one form of risk often comes at the expense of increasing another source of risk, or of increasing costs.
From Congestion and Cascades in Interdependent Payment Systems
The report identifies three different types of interdependencies. System-based interdependency, which includes payment versus payment (PvP) or delivery versus payment arrangements (DvP)4 as well as liquidity bridges between systems. Institution-based interdependence which arises when, for example, a single institution participates in, or provides settlement services to, several systems. The third type is environmental-based interdependency which can emerge if multiple systems depend on a common service provider, for example the messaging service provider SWIFT.
From Illiquidity in the Interbank Payment System following Wide-Scale Disruptions
At the apex of the U.S. financial system are a number of critical financial markets that provide the means for both domestic and international financial institutions to allocate capital and manage their exposures to liquidity, market, credit and other types of risks. These markets include Federal funds, foreign exchange, commercial paper, government and agency securities, corporate debt, equity securities and derivatives. Critical to the smooth functioning of these markets are a set of wholesale payments systems and financial infrastructures that facilitate clearing and settlement.1 Operational difficulties of these entities or their participants can create difficulties for other systems, infrastructures and participants. Such spill overs might cause liquidity shortages or credit problems and hence potentially impair the functioning and stability of the entire financial system.
Key Sources of Research:
The interdependencies of payment and settlement systems
The Payment System
Interdependencies of payment and settlement systems: the Hong Kong experience
HONG KONG MONETARY AUTHORITY QUARTERLY BULLETIN
Congestion and Cascades in Interdependent Payment Systems
Fabien Renault, Walter E. Beyeler, Robert J. Glass, Kimmo Soramäki, Morten L. Bech
March 16, 2009
Eurozone payment and securities settlement systems interdependence:
Will consolidation initiatives lead to contagion; who is accountable?
Recent developments in intraday liquidity in payment and settlement systems
Payment systems and Market Infrastructure Directorate
Precautionary Demand and Liquidity in Payment Systems
Gara M. Afonso and Hyun Song Shin
Banque de France – European Central Bank: Liquidity in interdependent transfer systems