The development of settlement systems in Estonia
Today, bank customers take it for granted that money is transferred from one bank to another within a few hours on working days, but things were completely different only twenty years ago. Here is a short history of how interbank settlements have evolved in Estonia.
Before the monetary reform: paper-based payment documents
In the early 1990s, Estonian interbank settlements were carried out through correspondence accounts opened for banks and their branches in the Clearing Division of Eesti Pank. The whole process was labour-intensive and time-consuming as payment documents were brought to Eesti Pank on paper, then the data were transferred to a punched card or tape and fed into the computer. Account statements were sent to banks on the following day and settlements with distant branches took days. Eesti Pank provided an automatic overdraft facility with a daily interest rate of 0.1%, so the banks did not have to worry about the state of their accounts. In any case, it was advantageous for them as the interest rate on the credit they were offering to companies was even higher.
After the monetary reform: preparations for electronic settlements
New settlement rules were written during the preparations for monetary reform, and preparations were made for electronic settlements to start. There was a transition period from 1 April to 1 October 1992 for the move from paper settlements to electronic interbank settlements. During this period, the banks that had computer communication were gradually linked to a common network. Under the new rules, settlements could only be made within the limits of the credit balance of the bank’s correspondence account. To speed up settlements, it was decided that domestic settlements had to be carried out within 48 hours. Up until then branch offices had been treated as separate entities with independent correspondence accounts, but from 1 October the parent bank and its branches were considered as one entity and settlements were carried out within the limits of a general credit balance. This decision allowed parent banks to control the activity of branch offices and regulate money flows between branches.
Electronic settlements in Eesti Pank’s net settlement system EPNAS
EPNAS was launched on 1 October 1992. All of the payment information was passed via a modem and payment orders were accepted until 14:00. After that, the settlement system started the clearing process of calculating the net claims and liabilities of the banks against each other from the payment orders received. The first interim summary of set-offs was sent to the banks one hour later. Banks carried out money market operations from 15:00 to 17:00, after which the final set-off was carried out. The settlement department monitored the balances of the banks’ settlement accounts constantly so that they would not fall below the reserve requirement level. The settlement system EPNAS was used for settling both high-value and retail payments. EPNAS functioned until the launch of the new interbank settlement systems in January 2002.
At the beginning of 2002, the new EP RTGS and DNS interbank settlement systems were launched
In order to offer banks and their customers a better and faster settlement service, Eesti Pank launched two new settlement systems, the EP RTGS and DNS. The new systems were fully compatible with international standards.
The real-time gross settlement system (EP RTGS) was meant for large-value and urgent domestic payments. Payments from one bank to another took a few minutes. All payments of 15 million kroons (about 1 million euros) or more were considered large-value payments and had to be processed through the EP RTGS. Smaller payments could also be settled through EP RTGS. The limit was removed in 2005 when the ESTA retail payments settlement system was launched. EP RTGS processed all its payment orders one by one and payments could be sent up to ten banking days in advance.
EP RTGS added cross-border euro payments to domestic payments from November 2006 when Eesti Pank joined TARGET, the forerunner of TARGET2.
EP RTGS was closed when the euro became the currency of Estonia on 31 December 2010. Payments settled in EP RTGS were now settled in the TARGET2-Eesti system. The banks also started to use TARGET2-Eesti to make cross-border payments and for payments related to the monetary policy transactions of the Eurosystem.
The Designated Time Net Settlement System (DNS) was meant for payments of less than 15 million kroons. Payments were transmitted to the DNS in batches of payment orders. Multilateral nettings in the DNS were continuous, but the payment orders received were transferred to the banks three times a day, at 11:00, 14:00 and 16:00. The set-offs were made from the collateral deposited by the system participants, which meant that all settlements were final.
TARGET was created in January 1999, when the euro became the accounting currency of the European Union. TARGET operated on a decentralised principle and connected the RTGS systems of the countries of the European Union, so the central banks of the member states of the European Monetary Union had to be members of TARGET. Central banks of member states of the European Union that were not members of the European Monetary Union had the choice of whether to join, and the UK, Denmark, Sweden, Poland and Estonia all did so.
Eesti Pank joined TARGET for strategic reasons on 20 November 2006 before it became a member of the Monetary Union. This helped reduce the risks associated with the adoption of the euro in Estonia and the launch of TARGET2, which were both supposed to happen earlier than they eventually did. Estonia was connected to TARGET through the Banca d’Italia, and the connection to TARGET allowed EP RTGS to provide euro settlements, so that there was an alternative channel for market participants using the service to make euro payments. At first this option was only taken up by four market participants, and ultimately by five.
TARGET was replaced by TARGET2 on 19 November 2007, and Eesti Pank changed over to it on 19 May 2008 when TARGET2-Eesti was created. This meant that for more than two years Eesti Pank was managing three payment systems, EP RTGS, ESTA and TARGET2-Eesti. At first, there were seven market participants in TARGET2-Eesti, and until the euro was introduced as currency in 2011, Estonian market participants did not use TARGET2-Eesti very much, even though they had all joined it before then.
The ESTA Settlement System of Ordinary Payments
The ESTA retail payments settlement system was launched on 3 October 2005. ESTA was a further development of the DNS retail payments system that was used until then, and it was a replacement for that system. The limit of 15 million kroons for each payment order in the DNS was removed in ESTA. The greatest change for banks and bank customers was that interbank transfers were now made nine times a day on the hour instead of three times, while the working hours of the system were also extended by two hours. The working day was extended again by one hour when Eesti Pank joined TARGET in 2006 and interbank settlements were now made ten times a day. Interbank payments were not settled on national holidays or weekends.
The settlement principle also changed. The DNS had functioned as a net settlement system, but the payments in ESTA were settled on a gross basis against the collateral deposited by the system participants, which guaranteed the finality of the settlements.
After the euro was introduced as the currency of Estonia on 1 January 2011, ESTA only settled payments initiated in euros.
Eesti Pank closed ESTA on 31 January 2014 because it did not meet the requirements of the pan-European SEPA and the Estonian banks started to use the pan-European STEP2 system run by EBA-Clearing to settle payments between themselves.
The Settlement System of Ordinary Payments (ESTA) of Eesti Pank
ESTA settled payments immediately after they arrived by sending settled payments to payees using a fixed time schedule. ESTA was open every working day from 8:30 to 18:00 except on national holidays and weekends. Banks were notified of incoming payments on the hour ten times a day from 9:00 to 18:00. The payment was transferred to the payee’s account within 30 to 90 minutes on working days depending on the time it was initiated.
Collateral account payments
Reimbursement of cash collateral
File exchange opens
File exchange closes
Figure 1. Operation of the ESTA system
Principles of payment settlement in ESTA
ESTA settled payments in batches. Each batch of payment orders from an ESTA participant first passed technical validation to check that each payment order was formatted accurately. The batch of payment orders could be validated, partially validated, or rejected. It was validated if all the payment orders in the batch had been entered correctly, and was partially validated if fewer than a predefined number set by the participant of payment orders in the batch were incorrect.
After technical validation, a financial validation of the payment orders was done to check if the participant had sufficient cash collateral with ESTA to settle the payments in the batch.
If there was sufficient cash collateral, the collaterals of the credit institution were updated to reflect the validated payment orders, with the payer’s collaterals reduced and the payee’s bank collaterals increased.
When the collaterals had been changed, the payments in the payments order batch were considered settled and finalised, and the credit institution that sent the batch was informed which payment orders had been accepted and settled, and which had been rejected.
At the end of the ESTA working day, Eesti Pank as operator of ESTA returned each participant’s cash collateral balance to their account in TARGET2-Eesti.
ESTA was a 100% secured system. This meant that the settlements of the credit institutions participating in the system were processed using cash collaterals that they had initially deposited into the collateral account of ESTA through TARGET2-Eesti. The payee was only informed of the incoming payment after it had been settled. Credit and liquidity risks were kept to a minimum through the system’s functionality, and operational risks were managed on a daily basis.