1.2 Central banks have common policy objectives with respect to netting systems. On the one hand, because of their interest in the efficient working of financial markets, they share market participants' interests in reducing settlement costs and credit and liquidity exposures. On the other hand, central banks also carry the responsibility for the integrity of the financial system as a whole and for the conduct of monetary policy. Their policies with respect to netting schemes therefore need to strike an appropriate balance between the requirements of market efficiency and of stability. In concrete terms this means that central banks are concerned to encourage developments that can increase the efficiency while maintaining and enhancing the integrity of the interbank settlement process. The wider interests of central banks are that this should not be achieved at the expense of the efficiency and integrity of the financial system generally and that changes in market practices and structures should not impair the effectiveness of either the instruments or the conduct of monetary policy.

1.3 Recent growth in the volume and value of interbank settlements, especially those associated with foreign exchange market activity, is straining the capacity of some existing interbank payment systems and of some central banks' own settlement services. Central banks have a general interest in promoting economies in the payment process through reductions in interbank payment flows, the associated transaction costs and interest expenses on correspondent balances. However, central banks are also concerned with the impact that changes in interbank payment and settlement systems may have on the structure and efficiency of the financial markets which these systems support. Central banks will be particularly interested in the impact such changes may have on the liquidity of foreign exchange and interbank markets and on competition among the participants in these markets.

1.4 The stability of interbank payment and settlement mechanisms is of critical importance to central banks. Disturbances in the settlement process can directly affect central banks as the ultimate providers of interbank settlements, as lenders of last resort to the banking system, and in their conduct of monetary policy. Central banks can seek to assure the stability of payment systems by an ongoing process of overseeing the prudence of the design and management of private payment and settlement arrangements as well as by the provision of their own payment and settlement services. In either case, the concern of central banks is to ensure that the credit and liquidity risks faced by participants are prudently managed and contained and not merely shifted to their other creditors or to central banks themselves.

1.5 This concern is a particular reflection of central banks' broader objective of limiting systemic risk in payment systems and financial markets. Systemic risk is the risk that the illiquidity or failure of one institution, and its resulting inability to meet its obligations when due, will lead to the illiquidity or failure of other institutions. In the context of payment and settlement systems, the size and duration of credit and liquidity exposures experienced by financial institutions in the course of settling their transactions contributes to systemic risk because as these exposures increase so too does the likelihood that some institutions may be unable to satisfy their obligations. Systemic risk is also related to the relative propensity of payment and settlement systems to transmit exposures suddenly or unexpectedly from one participant to another - and from one market to other markets - in ways that increase the difficulty all participants will have in managing and containing their exposures.

1.6 Central banks also have a common interest in seeking to ensure that their efforts to limit systemic risk do not lead to undesirable risk taking by banks. Banks' incentives to control the riskiness of their activities could be weakened if a perception that central banks will absorb risks or take action to limit their systemic consequences is generated. Indeed, as the perceived likelihood of central bank support grows market participants may engage in increasingly risky activities.

1.7 The design and operation of private interbank netting and settlement systems may be particularly susceptible to this problem of "moral hazard". The number of participants in such systems and the scope of their activities may lead the market to presume that central banks would act to avert a system's settlement failure. As a result, the moral hazard involved in privately-operated interbank netting systems is that, because of the possible presumption that central bank support will be forthcoming, such systems may be designed without sufficient regard to the need for built-in mechanisms and incentives to control risks and deal with the consequences of a settlement failure.

1.8 As markets and market practices evolve, central banks need to maintain the effectiveness of the means with which they discharge their responsibilities and pursue their policy objectives. The continued effectiveness of the instruments used in conducting monetary and exchange rate policy, both on a daily basis and in the long term, depends on central banks' ability to be aware of developments affecting the major participants in the interbank markets through which these policies are implemented. Thus, all central banks, whether or not they participate directly in banking supervision, have a continuing interest in the prudent management by individual banks of their credit and liquidity exposures and in the effectiveness of bank supervisory practices.