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					        Central Bank of Kenya

 (Framework and Strategy)

          August 2004

This document provides insights on Kenya payments system evolution and offers
an opportunity for all stakeholders to capitalise on the gains that accrue in terms
of reduced costs, risks and increased efficiency. It is through the careful
implementation of the strategies outlined in this document, that Kenya payments
system will reach international standards and ensure that Kenya maintains a lead
role in the region and remains a preferred investment destination for growth and

Andrew Mullei
Central Bank of Kenya


A silent revolution is taking place in the world’s entire payment system. Kenya,
along with the other East African countries, has joined the list of countries that
have realized the importance of managing an important aspect of national
economic life - the payments system. Citizens of East Africa are dealing with a
plethora of increasingly complex financial and transactional products and systems.

The National Payment System Project, currently a partnership between the Central
Bank of Kenya and the Kenya Bankers Association, is seeking to bring together all
the systems, mechanisms, institutions, agreements procedures, rules and laws that
enable the circulation of money. The scope is not limited to the exchange of value
only in cash terms, but encompasses non-cash payments, and, critically, the
inherent systemic risks underlying the payment system.

The vision and strategy articulated in this document is the first bold step to building
the payment system in Kenya, and the region, to world-class standards. The
benefits that will accrue include: -

• Reduction of risk arising from payment exposure, for both the public and banks.
• Safe and efficient means of exchanging value between transacting parties.
• Promotion of Kenya as an international market and a regional financial centre.

To attain this vision a lot of work will be required. In the coming months, the
National Payments System will critically examine: -

• Risk-reduction measures that support effective inter-bank exposure
• Legal and regulatory reforms that provide adequate protection for existing and
  envisaged payment practices.
• Shared payment systems that avoid duplication.
• Expanded payment systems that integrate both rural banking schemes and
  micro-finance arrangements.
• Integration of networks and activities with other service providers and
  regulatory bodies.
• Efficient and effective payment modes.

The above list is not exhaustive, but it does provide an important and useful
starting point.

In these endeavours, the National Payments System shall not lose sight of the
concerns and interests of the most important stakeholder, the banking public.
Recently, the Kenya Bankers Association launched The Banking Code, a set of
minimum service standards for personal customers across all banks. The
forthcoming challenges include the introduction of credit referencing for consumer
credit and direct debit for organizations that receive large volumes of payments.

Terry Davidson
Kenya Bankers Association

                                 TABLE OF CONTENTS
EXECUTIVE SUMMARY............................................................................ vii
1       INTRODUCTION ........................................................................ 1
1.1.    Preamble..................................................................................................1
1.2.    Introduction ..............................................................................................1
1.3.    Components of a Payment System .........................................................2
1.4.    Stakeholders in a Payment System .........................................................3
1.5.    Purpose of this document ........................................................................3
2.1.    Introduction ..............................................................................................5
2.2.    General Legal Aspects.............................................................................5
2.3.    Institutional aspects..................................................................................6
2.4.    The Role of Central Bank of Kenya .........................................................7
2.5.    Banking Associations and Groupings ......................................................8
2.6.    Payment Media: Means of payment used in NPS. ..................................9
2.7.    Automated Clearing House (ACH).........................................................10
2.8.    Securities Settlement Systems ..............................................................10
2.9.    Problems and Weaknesses in the Present Payment System:...............11
3            STRATEGIC FRAMEWORK...................................................... 13
3.1.    Primary Goal ..........................................................................................13
3.2.    Objectives ..............................................................................................13
3.3.    Vision .....................................................................................................13
3.4.    Critical Success Factors.........................................................................14
3.5.    Fundamental Principles .........................................................................15
3.6.    NPS Reform Strategies..........................................................................18
4.1.    Introduction ............................................................................................23
4.2.    Conceptualising the NPS Model ............................................................23
4.3.    The Payment Process............................................................................24
4.4.    The Clearing Process.............................................................................25
4.5.    The Settlement Process.........................................................................25
4.6.    Risk Monitoring ......................................................................................26
5            NPS STAKEHOLDERS AND ROLES........................................ 27
5.1.    Introduction ............................................................................................27
5.2.    Stakeholders ..........................................................................................27
6            IMPLEMENTATION STRATEGY............................................... 33
6.1.    Background ............................................................................................33
6.2.    Realisation of the vision .........................................................................33
6.3.    Implementation Approach ......................................................................33
6.4.    Phasing of the Implementation Process ................................................34
6.5.    Project Plan............................................................................................34
6.6.    Implementation Schedule ......................................................................34

APPENDIX I:   COUNTRY PROFILE..................................................... 35
             RESPONSIBILITIES ....................................................... 39

                             EXECUTIVE SUMMARY


This Framework and Strategy provides an overview of the Kenyan National
Payment System and lays a strategy for the future. A payment system is an
essential part of the financial infrastructure in a market economy where the
organisation and operation of monetary, banking and payment systems are
largely determined by the needs of the market.

The document further articulates an overview of the NPS conceptual design. The
benchmark is to focus in the present and the future payment systems needs of
the economy and the milestones for their accomplishment based on best
international standards and practices. Furthermore, the NPS vision aims at
reducing the dominance of cash instrument usage and promoting “minimal” risk
and irrevocable non-cash based instruments of exchange.


Kenya is rich in number and type of financial institutions, with the Central Bank at
its apex, it has a well-developed financial market with over sixty financial
intermediaries providing payments services and credit facilities to the public and
businesses. In addition, there is a Capital Market Authority, Stock Exchange and
a developed Money and Capital market with all the attendant traditional financial
instruments available in an international centre.

The clearing of payment between banks has been efficiently processed through
the Automated Clearing House for clearing of Magnetic Ink Character
Recognition (MICR) based technology cheques and Electronic Funds Transfer
(EFT) payments.

Cash is the most common form of payment media used. However, it has the
major disadvantage of being insecure, bulky and costly to produce. The Central
Bank of Kenya is encouraging the population to move to non-cash payment
instruments such as payment cards and electronic money.

The development of financial infrastructure has become a top priority in the
economy and the Central Bank is at the forefront to ensure that an efficacious
system is developed and maintained to facilitate smooth operations of payment
systems and the stability of the financial markets.


This document provides the basis and strategy for the reform and modernisation
of the Kenya’s NPS. It is modelled along the vision described herein, of achieving
a diversified, resilient, effective and secure payment environment for all sectors of
the Kenyan economy. The efforts of the NPS Project team in documenting the
Framework and Strategy is motivated by the importance attached to an efficient,
secure and robust NPS to the modernisation of the economy and its impact on
monetary policy execution and financial stability.


The envisaged vision for the NPS is to put in place a developed and modern
payment system that is effective, efficient, secure, accessible, reliable, robust,
viable and demand-driven. The kind of payment system that facilitates the flow of
money within all sectors of the economy in the face of technological advancement
is target. This will entail having an open competitive NPS architecture with varied
financial instruments, rules and regulations available to all players in the system.

The NPS development will be geared towards the exploration of an explicit legal
framework to support the payment systems modernisation process by introducing
regulations and laws in relation to Electronic Funds Transfer, E-Banking, E-
Money Schemes and Products, and Anti-Money Laundering Laws etc, that
support NPS practices and agreements, so as to enhance international
recognition of Kenya as a viable regional and an international financial centre.

A review of the legal and regulatory framework will support the statutory powers
of CBK regarding payment systems and adaptation of a legal framework. This will
ensure legal enforceability and sole overseeing of payment service agreements
and legal certainty in respect of industry practices especially in areas of risk
containment within the clearing and settlement circuits.

All inter-bank exchange functionalities will be settled at the centralised accounts
held at Central Bank where risks related to finality and irrevocability of clearing
and settlement arrangements will be contained by way of having mandatory
collateralisation practices and a move towards real time settlement using Real
Time Gross Settlement (RTGS).


To embrace the virtues of the envisaged NPS, many changes to the existing
payment practices will have to be made especially in the areas of systematically
important payments system arrangements. It is in this context that the NPS
Project is articulating the following objectives: -

• To promote the efficiency and effectiveness of the payments, clearing and
  settlement systems.
• To provide a variety of instruments and mechanisms for an integrated,
  modern and technologically sound payment system for transfer of funds
  between transacting parties.
• To facilitate irrevocability of payment and finality of settlement arrangements.
• To reduce the length of payment cycles for high value payments to same day
  settlement by implementing Real Time Gross Settlement (RTGS) system.
• To enable the management, reduction and containment of systemic and other
  payment-related risks.
• To develop and put in place a sound legal framework that will support the
  reformed payment regime.
• To promote the emergence of Kenya as a competitive regional and
  international financial market.
• To create public awareness on the various available options in the payments

The roles and responsibilities of all the stakeholders are also discernibly defined
and specified in the document.


The National Payment System strategy will involve all the stakeholders whose
roles and responsibility will need to be clearly defined. The NPS Council will be
the supreme policy organ and will be chaired by the Governor of the Central
Bank. The NPS Operations (Steering) Committee will transform itself into a policy
body called NPS Steering Committee that will keep consulting other NPS-related
service providers, e.g.: Telkom Kenya Ltd., Kenya Power Ltd., Nairobi Stock
Exchange, Giro Banks, Postal services and other Information Communication
Technology (ICT) regulatory bodies, such as The Communication Commission of
Kenya (CCK). This Committee will be mandated to steer the NPS Project as
elaborated in this document.


The designing and development of the Payment System will need to consider
several factors that will act as guiding principles in the development of a National
Payments System. The guiding principles will form the basis on which the
payment needs of the country will be developed and managed.

All banks will thus be required to have settlement facilities at the Central Bank of
Kenya and participate in inter-bank clearing. Every bank participating in the NPS
will need to take responsibility for the risk it introduces into the payment system.
Risk control measures and the legal framework will therefore need to be put in

place so as to support NPS practices and agreements. The ultimate responsibility
for overseeing the NPS will be vested on the Central Bank of Kenya.

Finally, the strategic approach will be followed based on the understanding of the
following assumptions and fundamental principles:


The main strategies for aligning the current and rudimentary payment system with
the envisaged NPS includes Systemic Risk Reduction measures; Legal and
Regulatory framework adequacy; measures towards interfacing trading practices
and financial markets and NPS and payment practices; a structured NPS
Governance structure and lastly making Nairobi a regional and international
financial centre.


The NPS major objectives in the reform and modernisation as articulated in this
strategy document will be undertaken in phases with a migration plan that
combines both short and long term upgrading parameters. A phased and
evolutionary approach will continue to be followed via short-term
strategies/projects and medium/long term strategies/ projects.


The NPS modernisation and Reform process is a daunting task full of challenges.
Its evolution will take the concerted effort by all stakeholders for the benefit of all
Kenyans. With improvements in the NPS, the volumes of payment transactions
executed through the banking system are predicted to increase tremendously
after the year 2005. By strengthening the operational capacities of banks, and
enabling them to provide a range of new innovative banking products and
services to their customers, the future of payment system will meet the demands
of a fast growing market-oriented economy and align itself to the internationally
accepted best practice.

The success of the NPS vision hinges on the expected high level of cooperation
from payment service providers, regulatory authorities, the banking industry as a
whole and the public at large.

                            1      INTRODUCTION

       Efficient payment systems are vital for the proper functioning of financial
       markets. A well-functioning payment system is essential for both an
       efficient financial sector development and increasing confidence in the
       banking sector.

       The Central Bank has the overall responsibility of achieving financial
       stability in the financial sector. In this regard, the Central Bank has to
       ensure that banks and other stakeholders operate in a stable and efficient
       financial market and that the payment, clearing and settlement system
       functions smoothly. A well functioning payment system will facilitate the
       effective execution of monetary policy, bank supervision, currency
       issuance and distribution functions, financial stability and confidence.


1.2.1. Definition: A Payment System can be defined as a system that facilitates
       the process of making payments. It consists of a set of payment
       instruments, banking procedures and inter-bank funds transfer that enable
       the circulation of money in an economy.

       A National Payments System (NPS) comprise of the Central Bank, the
       Government, Commercial Banks, and Financial Institutions, Payments
       System Providers, Laws, Rules and Regulations governing the payment
       system, technology and physical infrastructure and users.

1.2.2. Terminology: The term NPS is used to describe all payment mechanisms
       and encompasses the underlying role players (stakeholders) systems,
       agreements, associates, technology and legislation. It encompasses all
       payments-related activities, processes, mechanisms, institutions and
       users. The term NPS thus refers to payment systems in the widest
       context and is not restricted to NPS mechanisms only as the term NPS
       mechanism is strictly used to refer to the physical infrastructure, for
       example, payment processing utilities, networks, computer systems etc.

       The components of a payments system include:

1.3.1 Banks and Financial Institutions: banks, post office savings banks,
      building societies, mortgage finance companies, forex bureaus and co-
      operative societies (SACCOS).

1.3.2 Providers of access to payment related services: e.g. Information
      Technology Solution Providers, SWIFT, etc.

1.3.3 Customers: individuals,       companies,    organisations,   institutions,
      governments, etc.

1.3.4 Legal and statutory framework: appropriate legislative provisions
      governing the system.

1.3.5 Rules, Regulations and Agreements: govern the rights, duties and
      obligations of the participants in the system.

1.3.6 Payment and Settlement Transactions: represent the various activities
      undertaken that will require the exchange of values between the
      transacting parties.

1.3.7 Payment and Settlement Systems: represent the various processes and
      channels undertaken to realise the exchange of values between the
      transacting parties.

1.3.8 Payment Instruments and Streams: consist of cash, cheques, debit and
      credit cards, ATM cards, postal and money orders, Electronic Funds
      Transfers, Electronic Funds Transfer Point of Sale (EFTPOS), smart cards
      and vouchers.

1.3.9 Clearing instruments: cheques, Electronic Funds Transfer (EFTs) and
      both direct credits and debits.

1.3.10 Infrastructure: These are systems processes and procedures. They
       support the functioning of the payment systems and consist of
       telecommunication, power and transport systems.


       This includes everyone that has an interest in the payment system. This
       interest can be through ownership, use or service provision to any
       component(s) of the system. The stakeholders include:

       • Central Banks

       • Banking Industry

       • Infrastructure Providers e.g. Automated Clearing House, Telkom
         International Card Operators e.g. VISA, transaction switches.

       • Service Providers and End-Users/Customers (Individuals and

       • Regulatory Bodies and Government.

       • International Monetary bodies such as Bank for International
         Settlements (BIS), International Monetary Fund (IMF), etc.


   This document is the result of a joint effort of the Central Bank of Kenya and
   the Kenya Bankers Association. It reviews the current status of the NPS, the
   reform agenda undertaken since the mid 1990s when the automation of the
   cheque clearing system started; the limitations and obstacles to the
   modernisation process, the pronounced NPS goal, vision and the strategic
   approach to its realisation.



      The Central Bank of Kenya is aware of the numerous benefits that can
      accrue from an efficient payment system, especially in its role in the
      effective implementation of the monetary policy operations, and ensuring
      financial stability. It is jointly collaborating with Kenya Bankers Association
      in coordinating the modernisation and the reform programme of the
      payment systems in Kenya. Other stakeholders will be incorporated at
      various stages of implementation of this strategy.


      Banking business and the conditions in which banks operate in Kenya are
      governed by the Banking Act and Central Bank of Kenya (CBK) Act. Other
      legislations include Bills of Exchange Act, Companies Act (Insolvency Law
      included therein), Building Societies Act and Cheques Act, among others.
      Laws relating to the use of cheques are derived from the English law
      mainly the Cheques Act of 1957 and the Bills of Exchange Act 1882.

      In Kenya, there is no law that explicitly and exclusively deals with payment
      systems. However, in its current form, The Central Bank of Kenya (CBK)
      Act, as amended in 1996, gives the Bank powers to oversee and regulate
      the payments systems. Section 4A (d) of the Central Bank of Kenya Act
      provides that the Bank shall “promote the smooth operations of payments,
      clearing and settlement systems”. Section 4A (f) further stipulates that the
      Bank has the sole right to “issue currency notes and coins”. The new
      statutes recognise these two tasks as part of the fundamental
      responsibilities of the Central Bank.

      To promote public confidence in the banking system, a legal mechanism
      for liquidating the assets and paying off the liabilities of the failed banks
      and financial institutions has been bestowed upon the Deposit Protection
      Fund Board within the Banking Act.

      There is also an Act of Parliament governing the Central Depository
      System for trading in equities debt instruments on the Nairobi Stock

      The CBK is already exploring the need for an explicit legal framework to
      support the modernisation process of payments systems. This includes
      introducing regulations and laws in relation to Electronic Funds Transfer,
      E-Banking, E-Money Schemes and Products, Money Laundering Law etc.


2.3.1 Financial intermediaries that provide payment services

      Major institutions which provide payment services in Kenya are
      Commercial Banks, Non-Bank Financial Institutions, Post Office Savings
      Bank, Specialised Financial Institutions, Building Societies and Mortgage
      Finance Companies, Forex Bureaus.

2.3.2 Credit Institutions

      Kenya is rich in variety and number of financial institutions, and has a
      good depth of financial assets compared to most Sub-Sahara African
      countries. With the Central Bank regulating and supervising the banking
      system and managing monetary policy operation, at the apex, the industry
      is a pyramid of financial activity comprising 48 commercial banks, 13 non-
      bank financial institutions and 2 mortgage finance companies. There is
      also a large number of non-bank financial institutions segment comprising
      4 Building Societies, 37 insurance companies, 20 micro-finance
      institutions, 57 hire-purchase companies, and some 2,670 Savings and
      Credit Co-operatives Societies.

2.3.3 Specialised Financial Institutions

      There are about 10 or so specialised organisations set up by the
      Government to assist the specific sectors of the economy; these include
      the Agricultural Finance Corporation, Agricultural Development
      Corporation, Industrial and Commercial Development Corporation, Kenya
      Industrial Estates, and the Industrial Development Bank among others.

2.3.4 Other Institutions
      Currently there about 1300 registered administrators of pension schemes
      in Kenya with an estimated portfolio of Kshs 140 billion, which is 27% of
      GDP. Kshs 59 billion is held by the National Social Security Fund (NSSF),
      which is a mandatory pension scheme. There are about 1100 other private
      registered pension and provident fund providers countrywide. The
      Retirement Benefits Authority Act, 1997 governs operations within the

2.3.5 The Post Office

       The Post Office has three main instruments:
       • The Ordinary Money Orders that can be drawn for any sum up to a
          prescribed maximum per order and which identify the recipient and are
          en-cashable only at specified Post Offices.
       • The Telegraphic Money Order which guarantees customers same day
       • The Postal Order is a bearer instrument which can be encashed at any
          Post Office.

       The main advantage of the Post Office is accessibility by virtue of having a
       large network reaching almost every township in the country.


       The Central Bank of Kenya Act empowers it to "promote smooth operation
       of Payments, Clearing and Settlement Systems". The CBK participates in
       the payment system in the following ways:

2.4.1 As a user of payments system: The Central Bank has its own
      transactions to carry out requiring the movement of funds.

2.4.2 As a member of payments system: It is both a member and supervisor
      of the Clearing House.

2.4.3 As a provider of payments system: The Central Bank of Kenya provides
      clearing and settlement services on a net-multilateral arrangement at the
      Nairobi Clearing House. This is done on behalf of Kenya Bankers
      Association (KBA).

2.4.4 As a guardian of public interest: Acting as a systems regulator,
      arbitrating in the event of complaints and handling compensation

2.4.5 As a facilitator of daily settlement: This involves facilitating commercial
      banks’ obligations arising from their payment system activities by using
      their centralised settlement and clearing accounts domiciled at Central

2.4.6 As an Overseer of Payment Systems: The Central Bank has formal
      authority relating to the supervision of payment system. This is in keeping

      with Central Bank Responsibility No. 3 of the BIS Core Principles for
      Systemically Important Payment Systems.

      The oversight approach has been facilitated through a combination of co-
      operation and consultation with the banking industry. The reform and
      modernization process has been facilitated by the National Payment
      System Operations Committee, a joint committee of the Central Bank and
      the Kenya Bankers Association. The NPS Division forms the secretariat.

2.4.7 On a regional front, there is an East African Payment System
      Harmonisation Committee comprising of the respective technical teams
      drawn from the three NPS units of the three Central Banks.


      The following groups, committees and associations are involved in
      National Payment Systems.

2.5.1 Kenya Bankers Association: An association of banks that safeguards
      and raises matters of common interest with regulators and government. It
      works through various sub-committees.

2.5.2 The Clearing House: Owned by Kenya Bankers Association, its
      membership is limited to licensed banks including CBK who meet KBA
      prescribed terms and conditions. It is managed by CBK on behalf of KBA.
      Its main role is to facilitate settlement of clearing instruments such as,
      cheques, EFTs, Direct debits and credits.

2.5.3 National Payments Systems Operations Committee: This is the
      steering and decision making body on National Payment Systems in
      Kenya with membership from KBA and CBK officials.

2.5.4 NPS Technical Committee: This comprises experts drawn from KBA
      Member banks and CBK. It is responsible for the overall strategy
      formulation and framework design pertaining to payment systems in

2.5.5 Kenya Swift User Group: This is a committee of SWIFT users in Kenya.


2.6.1 Cash Payments: the most common form of payment because it is readily

2.6.1 Non Cash Payments:      Cheques

          Cheques are the major non-cash payment instruments in Kenya
          accounting for over 90% of all non-cash payment. The bulk of cheques
          issued in Kenya bear the MICR code line.

          These cheques are cleared in T+3 days in most parts of the country and
          (T+1) day for high value (i.e. Shs.10m and above). Cheques from remote
          centres are cleared on (T+10).      Payment Cards

          These have taken a significant leap within Kenya’s non cash payment
          instruments segment. They include different cards: credit, debit and pre-
          paid, with credit cards being the most common.      Electronic Funds Transfers through the Clearing House      Electronic Funds Transfer: Credit

          EFTs is used for transferring value through the Clearing House among
          banks and on behalf of their customers. On conclusion of days settlement
          value is given on a same day basis. Finality and irrevocability is
          guaranteed.      Electronic Funds Transfer: Direct Debits

          These are pre-authorised by the paying customer who gives permission
          for his bank to debit his account upon receipt of instructions initiated by the
          receiving customer e.g. insurance or mortgage companies.      EFTs through SWIFT

          Majority of the banks are members of the Society for Worldwide Interbank
          Financial Telecommunications (SWIFT). It is a requirement by CBK that

      any interbank transfer must be through SWIFT. The banks are connected
      to SWIFT either directly or through a bureau.


      The clearing and settlement arrangement is divided into two sessions and
      there are no limits to the value of credit or debit items that pass through
      the Clearing House.

2.7.1 Cheque Clearing Process:

      Presently, all commercial banks have settlement accounts at the Central
      Bank and credit extended to them for settlement purposes has to be
      covered by collateral. There are no intraday arrangements or intraday
      controls on net debit balances. In the Clearing House, banks are exposed
      to clearing and settlement risk and the “unwinding” of all instruments of a
      defaulting bank is the ultimate solution in the event of failure to settle.
      However, the Central Bank in conjunction with the industry is planning to
      come up with management and containment of these risks.

2.7.2 Credit and Liquidity risks

      The cheque clearing system is exposed to both credit and liquidity risk. A
      “Failure to Settle Mechanism” to mitigate these risks is currently lacking.
      The situation is aggravated by the lack of an automatic settlement
      overdraft facility from the Central Bank.

      In terms of liquidity risk the participating banks are exposed due to lack of
      mechanism to facilitate final settlement by member banks.


      Major categories of financial instruments commonly traded in Kenya
      include, Equity Securities, Corporate Debt Securities, Treasury Bonds and

2.8.1 Government Securities

      Government Securities include Treasury Bills that are short term (1-12
      months) and Treasury Bonds, which are medium Term (1-10 years).
      Investors are required to open a Central Depository System (CDS)
      Account with the CBK. The CDS is a paperless book entry account used
      as evidence of investment instead of paper certificates. On redemption,

      the CDS account holder, is paid by an electronic credit (EFT/SWIFT) to
      his/her commercial bank account.

2.8.2 Equity Securities: Capital Markets Authority (CMA) and Nairobi Stock
      Exchange (NSE)
      Capital Markets Authority (CMA) is the regulator of capital markets in
      Kenya. CDS accounts are opened for listed companies in the Nairobi
      Stock Exchange. Trading is currently manual and there are plans to
      automate it.

      The conceptual design for RTGS is being finalized for implementation in
2.9.1 Risks Associated with Payment Systems

      Risk in payment systems refers to the possibility/threat/danger of
      payments being incomplete. The impact can be measured in terms of
      damaging value or level of confidence in payment systems.

      Basic sources of risks include: Failure of one of the parties to perform,
      time lag between trade and settlement, lack of co-ordination between
      delivery and payment; linked transactions triggering a chain reaction and
      risky settlement medium.

      To ensure smooth and reliable modernization of the Payment Systems, it
      is important to understand the inherent spectrum of risks given the
      increasing number of payments streams in this market. It is important to
      identify, measure, contain and manage these risks. It is worthwhile to note
      that the major payment system risks are: Credit, Custodian, Foreign
      Exchange, Settlement, Legal, Liquidity, Operational, Systemic and
      reputation risk.

2.9.2 The culture of a cash society: Cash is risky and expensive and the
      publics’ propensity to hold cash has not diminished. This is evidenced by
      a high percentage of cash holdings as a proportion of the money supply.
      People distrust cheque payments due to lack of legal meaningful penalties
      against cheques not honoured due to lack of funds.

2.9.3 Use of cheques by Financial Institutions to effect high-value
      payments: Cheques are the second most popular payment instrument in
      Kenya but with the advent of EFTs, now in place, and the proposed

      introduction of RTGS System, it is expected that the use of cheques to
      effect high value payment will diminish.

2.9.4 Service providers of electronic payment media: Existence of
      credit/debit card service providers yet no mechanism for sharing elaborate
      information exchange infrastructure.
2.9.5 Inadequate regulatory framework to support modern payment
      systems: Enactment of draft bills to support modern payment systems is
      yet to be done.
2.9.6 Limited knowledge and expertise in National Payment Systems, within the
      Financial Sector.
2.9.7 Inadequate and unreliable Infrastructure programmes.
2.9.8 Lack of a co-ordinated public awareness among the payment system

                      3      STRATEGIC FRAMEWORK


      The primary goal of the NPS is:

      To facilitate the efficient and effective flow of value within the

      This goal gives due cognisance to the fact that NPS has today become a
      core component of not only a broader financial system but also the
      economy at large. It is also presently viewed as the infrastructure that
      provides the economy with highways for processing the payments
      resulting from various economic activities within the Kenyan economy.


      • The objectives of the NPS are:

      • To provide effective mechanisms for the exchange of value between
        transacting parties.

      • To ensure finality and irrevocability of both payment and settlement.

      • To facilitate the management, reduction and containment of systemic
        and other payment-related risks.

3.3   VISION

      It is envisaged that by the end of year 2008, Kenya will have put in place a
      modern payment system that is effective, efficient and secure. It will be
      characterised by the following features:

      • Risks related to Payment Systems will be well understood and
        managed by all stakeholders.

      • The Payment System shall be self-regulated.

      • Settlement of all domestic inter-bank exchanges on the value date of
        the settlement instruction.

       • Open for all parties, both domestic and foreign who wish to provide
         payment services.

       • Easily accessible to both urban and rural consumers to effect both
         domestic and international transactions.

       • Efficiency and lack of duplications as shared payment infrastructure
         will be encouraged.

       • Basic NPS features well understood by all including the rural populace.

       • The Payment System will support electronic trading in both the
         securities and foreign exchange markets.

       • The Payment System will be compliant with international standards,
         practices and compatible with other international payment systems.


       The success of the NPS Vision will be measured against the achievement
       of the following:

3.4.1 NPS Awareness: All the stakeholders know the NPS basic objectives and

3.4.2 NPS Risk Management: All participants have a clear understanding of
      the risks they run in the NPS and their liability. All payment streams
      contain appropriate risk-control and containment measures.

3.4.3. NPS Management: Clearly defined structures, roles, responsibilities and
       relationships among the established bodies and stakeholders.

3.4.4. Irrevocability of Settled Transactions: All interbank settlement
       instructions processed through the Central Bank System are final and

3.4.5. All Eligible: The system is open to all eligible participants subject to laid
       down criteria.

3.4.6. NPS Accessibility: Payment services are accessible to all irrespective of
       whether they are in the metropolis, remote rural areas, banked or un-

3.4.7. Facilitation of Monetary-policy Execution: The NPS mechanism
       enhances the ability of the Central Bank to execute monetary policy. The
       NPS provides banks with the necessary information to manage their
       demand for Central Bank money and to react immediately to new market
       conditions or to unexpected shortages or surpluses.

3.4.8. Sound and Supportive Legal Frameworks: Appropriate legislative and
       regulatory framework recognising agreements between parties are in
       place and respected by all and are enforceable. There is a mechanism for
       speeding up dispute resolutions of any kind in the system.

3.4.9. Confidentiality and Security: The NPS mechanism ensures privacy of
       all transactions. Confidentiality required in a competitive environment
       cannot be compromised in any way by the mechanisms transmitting
       information on payments through the NPS.

3.4.10. Robustness: The NPS is reliable and provides adequate protection to the
        financial system in crisis situations.

3.4.11. NPS Integration and International Compatibility: The NPS complies
         with international standards and practices that facilitate international
         transfers and ensures compatibility with payment systems and
         instruments developed internationally.

3.4.12. National Standards: The NPS standards exist on a national level and/or
         within a holistic context to enable:

       • The smooth introduction and operation of payment instruments and the
         functioning of the system overall; and
       • The effective technological integration of systems.

3.4.13. Fraudulent Incidences:     Effective fraud-prevention and detection
        measures are in place. Fraud occurrences in all payment streams are
        effectively minimised.

3.4.14. Variety of Payment Instruments: A sufficient variety of instruments are
        available to enable the selection of the most appropriate instrument for a
        particular situation, from a convenience, cost and risk perspective.


       Fundamental principles guide the development, deployment and
       management of the NPS. Once agreed on, they should be non-negotiable
       and form the basis on which future disputes will be resolved.

      Fundamental principles are also aimed at dispelling any ambiguities about
      the roles, responsibilities, ownership and participation of different
      stakeholders in the NPS. The principles dispel any confusion about
      different payment system processes and should be fair to existing and
      future NPS stakeholders.

      The following are the principles guiding the development, deployment and
      management of the NPS:

3.5.1 Clearing and settlement of payments is the exclusive domain of
      The banks are the gateway to the payments clearing and interbank
      settlement facilities. Only banks and recognised institutions can act as
      principals in Central Bank settlement.

3.5.2 The provision of NPS services is not exclusive to commercial banks
      The provision of NPS services will not be limited to only banks. The
      provision of payment services by non-bank institutions and other service
      providers shall be recognized in the NPS and be subject to elaborate code
      of conduct and best practices.

3.5.3 The Evolution of the NPS Infrastructure is a Co-operative
      The payment service infrastructure is critical to the smooth operations of
      the economy. The Central Bank, Commercial Banks and the Payment
      Service Providers will co-operate in the design, implementation and
      management of infrastructure components. The infrastructure that will
      facilitate NPS will be accessible to all eligible participants.

3.5.4 Payment Related Risks and Exposure are visible
      Since NPS does not control risks, all payment-related risks should be
      identified and assessed so as to provide information to participants to
      manage their exposures.

3.5.5 NPS Participants are liable to the risks introduced into the NPS
      NPS participants are responsible for managing the risks that they
      introduce into the system.

      Participants in either bilateral or multilateral netting arrangements carry the
      risk of potential default of one or more of the participants concerned and
      will be involved in designing the suitable risk reduction measures.

3.5.6 A balance is maintained between risk reduction and cost:
      A justification will be required in terms of the cost of risk reduction
      measures vis-à-vis the potential system risks being addressed.

3.5.7 Central Bank’s response to problems in the NPS will be in the
      interest of the system not individual participants.

       The Central Bank will act to provide liquidity to a participant experiencing a
       temporary liquidity problem subject to its meeting borrowing terms and

       The Central Banks’ response in a systemic crisis is geared towards
       meeting national interest, for the sake of the stability of the financial
       system as a whole.

3.5.8 All banks are eligible to have a settlement account at the Central
      The Central Bank is the settlement agent to the banks and each bank will
      be responsible for its own inter-bank indebtness and can settle over its
      own account and hence all banks’ settlement accounts must be domiciled
      in the Central Bank.

3.5.9 All banks are entitled to clear payments under their own name
      In order to ensure that all exposures are visible, a bank, providing
      payment services to its customers will preferably participate in the inter-
      bank clearing process under its own name.

3.5.10 Settlement is subject to the availability of funds
       All inter-bank settlements require pre-funding. Any arrangements to obtain
       accommodation from the Central Bank to pre-fund the settlement account
       shall apply equally to all banking institutions.

3.5.11 The payer has responsibility to initiate the transfer of funds to an
       For a credit push instruction the responsibility lies with the payer to initiate
       payment by issuing a payment instruction to his bank. The bank then
       issues a payment instruction to the payee’s bank in favour of the payee.

3.5.12 Finality of payment follows settlement finality

       Settlement of inter-bank indebtness is achieved once entries have been
       passed over the settlement accounts of the banks held at the Central Bank
       or cash has been exchanged. Irrevocable finality of payment follows
       settlement finality and is achieved only in Central Bank money.

3.5.13 Surveillance is necessary to ensure safety and soundness of the
       NPS oversight framework

      The Central Bank through its oversight responsibility will focus on the
      overall soundness and effectiveness of the NPS. All risk reduction
      measures applied in the interbank payment clearing and settlement will be
      agreed with the Central Bank as an overseer of NPS before being
      introduced. All payment – related interbank exposures will be available to
      the Central Bank in its overseer capacity.


      The following are the main strategies for aligning the current payment
      system with the envisaged NPS visions.

3.6.1 Systemic Risk Reduction

      Strategy 1: Introduction of an on-line Settlement System to enable
      banks to effect Interbank funds transfer electronically on a real time

      A major shortcoming in the current Kenyan payment system is the lack of
      a real time interbank exchange. In the envisaged Framework and Strategy
      the proposed settlement system will provide facilities for banks to settle
      their obligations on a real time basis, or in a delayed settlement
      arrangement, providing guaranteed settlement. This then calls for the
      Introduction of Real Time Gross Settlement System (RTGS) for high value
      and time critical payments.

      Strategy 2: Implementation of risk-reduction measures in bilateral
      and multi-lateral netting schemes

      The main advantage of netting inter-bank settlement obligation is that it
      limits the actual values that are exchanged between two banks (bilateral)
      schemes and multiple banks (multilateral). BIS-CPSS core principles for
      systemically important Payment Systems in particular Core Principle 5
      (CP-V) will be adhered to as risk-reduction measures in all netting
      schemes. The cheque clearing system is on a multi-lateral netting basis in
      line with the Lamfalussy Standards on Netting.

Cheque Truncation

In order to reduce clearing days from T+ 3 to at most T+ 2, it is planned to
introduce cheque truncation in the country. A prerequisite for this is the
enactment of an enabling legal framework.

Strategy 3: Introduction of same day settlement

Currently, all our settlement streams are not on a same day basis. Hence
all the settlement protocols will have to be adapted to achieve true same
day settlement for and across all payment streams.

Strategy 4: Collateral Requirements and Related Management

Availability of liquidity for settlement purposes will require a dynamic
collateral management system especially intra-day liquidity management
techniques. Currently there is a functional Central Depository Systems
(CDS) for Government debt instruments and line arrangement for Lender
of last resort facility by the Central Bank.

In view of the measures taken to reduce payment-system-related risks, the
prudential requirements (that is, capital and reserves, cash reserves, liquid
assets) also need to be reassessed, to ascertain whether such cash
reserves or liquid assets could be considered, in part as collateral for
settlement purposes.

Strategy 5: Payment System Oversight

For continuous surveillance and assessment of the payment system
efficiency and effectiveness, a comprehensive checklist to be used in
payment system oversight, shall be developed.

Specific legislation on NPS and amendments to the Central Bank of Kenya
Act will be enacted to give CBK formal statutory authority relating to the
oversight of payment systems. This will involve public policy activities
principally intended to promote the safety and efficiency of payment
systems and in particular to reduce systemic risk embedded in the
systemically important payment systems.

The Systemically Important Payment Systems (S.I.P.S.) will be designated
and continuously reviewed and evaluated to ensure their design and
operations meet and continue to meet, at the very minimum, international
best practices, standards and protocols.

3.6.2 Legal and Regulatory Framework

     Adequate laws and regulations must be put in place to regulate and
     support payment systems. Currently, the laws are inadequate and in some
     cases non-existent. Hence there will be comprehensive review of existing
     laws relating to the payment systems and amendments formulated, where

     Strategy 6: Review the statutory powers of the Central Bank
     regarding payments systems

     Shortcomings in the current statutory powers of the Central Bank, in its
     role in the NPS, will be identified and amended in the Central Bank of
     Kenya Act.

     Strategy 7: Adaptation of the Legal Framework to ensure legal
     enforceability of payment service agreements and legal certainty in
     respect of industry practices

     The relevant Acts of Parliament will be identified for possible amendments.
     In the absence of this a new legal framework, in the form of a specific
     “Payment System Act” will have to be introduced. This will ensure that
     payment practices are legally sound, taking into account regional and
     international practices and payment requirements.

     The legal foundation pertaining to finality of payment needs to be affirmed.
     This includes legal clarity on the role of a statutory manager, receiver and
     the legal powers of any subsequently appointed liquidator in the event of
     insolvency of a system participant.

3.6.3 Interface Between the Trading System and the NPS and payment

     Strategy 8: Review of Financial Market Practices from an NPS

     NPS will influence and encourage the financial markets practitioners to
     embrace modern payments system developments in the market domain to
     contain systemic risks caused by contagion, as risks arising from market
     practices can be introduced in the NPS. Hence the NPS should create an
     environment that will be acceptable for both the market players and the
     NPS participants.

      Strategy 9: Encouragement of Electronic Trading and Payment
      Mechanisms in the Trading Systems

      The Trading System developers will be encouraged to introduce delivery-
      versus-payment (DvP) and payment versus payment (PvP) principles
      accompanying payment, clearing and settlement with supporting
      mechanisms e.g. EDI (Electronic Data Interchange), E-Commerce and the
      regime of information flow accompanying an electronic payment.

      Strategy 10: Introduction of mechanism to relay information
      associated with a payment to the beneficiary

       NPS will facilitate the flow of information accompanying an electronic
      payment where applicable. A mechanism to support business applications
      of EDI, especially in electronic commerce will also be accommodated in
      the design of NPS.

      Strategy 11: Review of cross Border/Foreign Currency Market
      Practices from an NPS perspective

      Cross border and foreign currency market practices will be reviewed with
      a view to incorporating them into the NPS.

3.6.4 Payment practices

      Strategy 12: Introduction of a regulatory framework for a payment
      service provider

      Legally enforceable rules and regulations as well as a code of conduct
      applicable to all participants will be formulated published, implemented
      and enforced in order to ensure sound payment services.

      Strategy 13: Creation of public awareness

      The Kenyan public will have to be made aware of the features and risks
      involved in accepting and using payment instruments. The awareness
      campaigns will take many forms, e.g. organising payments system
      sensitisation seminars and workshops, placing advertisements in the mass
      media, as well as working closely with the banks and utility companies in
      Kenya to promote the understanding of available payment instruments.

3.6.5 Management of the NPS

     Strategy 14: Establishment of a Kenya NPS forum

     The Central Bank will establish a forum in which stakeholders will be

     Strategy 15: Establishment of NPS standards

      A function will be established to oversee the development of national
     standards and to ensure that Kenyan standards are in harmony with
     international standards, where applicable.



      In order to achieve the stated vision and objectives of the NPS Project, the
      business requirements and processes at a conceptual level will have to be
      defined and guiding principles built into the proposed systems so as to
      ensure that the resulting systems are consistent with the NPS vision,
      objectives and expectations of the NPS Project.

      In this chapter a description of business processes at a conceptual level is
      made with the aim of defining a high level design, which embodies the
      fundamental principles and issues detailed in Chapter Three entitled
      “Strategic Framework”. The emphasis is therefore on a design framework,
      within which every component can be identified, viewed within the context
      and appropriately addressed. This design or model will serve as a
      common basis for further analysis and numerous independent projects.


      Conceptualising and determining the nature and scope of the NPS model
      for Kenya to adopt, will be a Herculean task as there are various factors to
      be considered ranging from costs to the present and projected state of the
      country’s needs.

      The different phases of the envisaged business processes encompassing
      both the market and payment systems are to be studied in detail. The
      Business processes are as follows:

      •       Payment
      •       Clearing
      •       Settlement
      •       Risk Monitoring

            4.3           THE PAYMENT PROCESS

            Below is the Payment Process in a diagram showing its linkage with the financial
            markets and the real sector activities.

                                               THE PAYMENT PROCESS

                                               REAL ECONOMY AND FINANCIAL MARKETS
                                                 Purchase and sale of goods and services

                                                             BANKING SYSTEM
                                                        Provision of payment services

                                                           INTERBANK FUND-
                                                          Clearing and settlement

            Payment               Payment                                                  Payment      Payment

            Instruction           Initiation       Clearing             Settlement          Finality   Confirmation


                          Payment process includes:

                          • Deal agreement, resulting in a payment instruction.
                          • Payment initiation: through credit transfer or debit collection channel.
                          • Clearing: through the clearing house to generate a settlement
                          • Settlement: Interbank settlement once forwarded to Central Bank is
                          • Payment finality: This follows settlement payment finality
                          • Deal completion, resulting from a payment confirmation
                          • Synchronisation of delivery and payment


      The nature of the clearing process will be determined by the nature of the
      settlement required, e.g.:

      • Payment of a low-risk and/or a low-value nature will be cleared in bulk
        through the Clearing House on a multi-lateral basis.
      • Payment instructions requiring immediate payment finality will be
        cleared bilaterally as individual payment instructions.


      Final settlement in Central Bank money will be achieved only through
      entries across the accounts of the banks held at the Central Bank. The
      settlement system will provide a range of alternative settlement options,

      • Immediate settlement, that is, settled in real time, on a gross basis-
        principle through a Real Time Gross Settlement (RTGS) system; and
      • Delayed settlement, that is, for settlement instructions due but placed
        on hold and accumulated for queuing settlement. These settlement
        instructions will be processed conditionally, that is, settlement at, inter
        alia, a specific time and when funds are available. The Clearing House
        resultant multilateral net values will be settled as a batch through the
        RTGS system.

      • The settlement system encompasses the following:
        − A settlement instruction.
        − A settlement –instruction registration process.
        − A real-time line, a number of netting bands, and a process to
           manage them. Real time line will provide for immediate final
           settlement. A settlement instruction will be processed only if funds
           are available in the particular account. In this line there will be no
           build-up of unprocessed settlement instructions. The netting bands
           will provide for delayed settlement, that is, settlement instructions
           that are already due for settlement, but are delayed and
           accumulated in a net to achieve off-setting with other settlement
           instructions to minimise liquidity requirements.

         − A scheduled list.
         − Collateral and a dynamic collateral-management process.
         − A set of settlement accounts and an account management process.

         − A settlement process to effect final settlement, both in trading and
           at the end of the day, and;
         − Various confirmations.


      Deal agreements initiated in the trading system are a source of payment
      risk. Risks build up in the trading system and can spill over to payment
      system. Monitoring should start as early as possible in the trading cycle.
      Risk monitoring of the NPS should therefore harmonise with risk
      monitoring of the broader financial system.

      Risk monitoring for the NPS focuses primarily on the payment risks and
      exposures of banks. The NPS should therefore provide integrated
      information, to compile a holistic payment-risk profile of a bank. Every
      bank should be able to access all information pertaining to it, to build a
      dynamic risk profile comprising, inter alia, the following:

      • The bilateral and multilateral exposure limits for delayed settlement.
      • The settlement instructions in the real-time line and scheduled list in
        the settlement system.
      • The balance on its settlement account.
      • The status regarding the utilisation of securities it has provided as
        collateral, and;
      • The status of all other relevant accounts.

      As the overseer of the NPS, the Central Bank will have access to the
      same information mentioned, above in the paragraph on Risk Monitoring,
      for every bank. This information will be utilised to provide a risk profile to
      the NPS in total.

      To support the Central Bank’s oversight role, the Central Bank will have
      access to the RTGS centralised accounting system and monitor the
      positions of all participants on a real-time basis.

                 5      NPS STAKEHOLDERS AND ROLES


      The NPS modernisation and reforms, once accomplished will have
      implications for a wide range of stakeholders requiring a redefinition of
      roles, responsibilities and management structures. In this chapter, the
      stakeholders in the NPS are identified, designated functionalities and roles
      articulated accordingly.


      Stakeholders are those that have an interest in the NPS. The definition
      includes those that need to be informed and consulted and those that own,
      provide, manage or use components of the system, or take ultimate
      responsibility thereof.

      •   Central Bank of Kenya
      •   The Banking Industry
      •   Payment-system infrastructure providers
      •   Payment-service providers
      •   End-users
      •   Regulatory bodies
      •   Government
      •   Regional monetary authorities and regional arrangements
      •   International monetary authorities
      •   International financial community

5.2.1 Roles and Responsibilities of the Stakeholders

      To manage and operate the NPS, it is necessary to define the role and
      specific responsibilities of all the key NPS players clearly. It will also be
      necessary to identify and, if necessary, create structures to provide for the
      requirements of the NPS.

5.2.2 Role of the CBK in the NPS

      The CBK fulfils a number of roles that, to a greater or lesser extent, are
      related to the above-mentioned function, including:

      a.)      Monetary policy-maker
      b.)      Banker of banks and government
      c.)      Settlement institution
      d.)      Issuer of currency –legal tender
      e.)      Overseer of the NPS.

      Within the context of NPS, Central Bank is responsible for the following
      among other roles:

            (a) Ensuring that the interests of all stakeholders are served by the
            (b) Guiding the evolution of the NPS, focusing primarily on the overall
                soundness and effectiveness of the NPS.
            (c) Ensuring that a sound legal framework exists.
            (d) The clearing and settlement services on a net-multilateral
                arrangement at the Nairobi Clearing House.
            (e) Overseeing the application of NPS risk-management measures.
            (f) Ensuring the smooth functioning and conclusion of the settlement
            (g) Ensuring that infrastructure relating to settlement process is in

5.2.3 Role of Commercial Banks in the NPS

      For the purposes of the NPS, a commercial bank is understood to be an
      institution registered as a bank or as a branch of a foreign institution under
      the Banking Act.

      Banks are the gateway to the NPS clearing and settlement facilities and
      only commercial banks are eligible to:

      (a) Have a settlement account at Central Bank
      (b) Participate in interbank clearing and settlement: and
      (c) Act as both principal and/or intermediary in payment transactions.
      (d) Deal in the forex market.

      A commercial bank can fulfil one or more of the following roles:

      (a) As a settlement bank, settling its own interbank payment obligations
          and effecting real-time payments.
      (b) As a clearing bank, clearing payment instruments by joining the
          Payment Clearing House (PCH).
      (c) As an end-user, issuing payment instructions on its own behalf and as
          the beneficiary of payments made by other banks.

      Within the context of the NPS, commercial banks are responsible for the

      (a) Managing the risks that they introduce into the NPS and ensuring that
          their institutions have a clear understanding of these risks and their
          liability in terms thereof
      (b) Ensuring that they have sufficient liquidity for their interbank settlement
      (c) Ensuring that their interbank payment obligations can be settled in
          Central Bank money, either across their settlement account held at
          Central Bank of Kenya or in cash.
      (d) Ensuring that the payment-processing cycle is completed in
          accordance with customer’s requirements and the risks associated
          with the payment instruction in terms of interbank agreements and
      (e) Making their customers aware of the features of, and the risks involved
          in, accepting and using payment instruments and educating them in
          the alternatives available.

5.2.4 Role of a Payment Clearing House (PCH) in the NPS

      A PCH is defined as any central location or processing mechanism whose
      role is to facilitate exchange of payment instructions or other financial
      obligations. It may also be a physical entity such as the Nairobi automated
      cheque-clearing house, a manual clearing process in remote centres or an
      electronic switch. These processes will be subject to similar controls, rules
      and regulations.

5.2.5 Role of the Proposed Kenyan National Payment System Council

      A national body to be called National Payment System Council will be
      constituted. The Council will be the supreme policy body to direct and
      oversee the development of a sound, stable, market-oriented NPS. Its role
      will be to determine the national payment systems policy while ensuring
      that the interest of all participants and key stakeholders are served by the
      NPS. The body will also debate issues relating to payment systems
      practices and developments. The Governor of the Central Bank will chair
      the Council.

      Its composition will include KBA, Telkom, financial market regulators and
      other major service providers.

5.2.6 Role of NPS Steering Committee

      The present NPS Operations Committee will be transformed into NPS
      Steering Committee whose responsibility will be to develop the overall
      strategy and framework for NPS modernisation and reform process, define
      ownership and operational responsibilities.

      The Committee will have powers to co-opt other sub-committees and form
      relevant and specific Task Forces for various NPS projects. The
      Committee will also act as the Secretariat for the NPS Council and will be
      manned by technocrats drawn from major designated stakeholders, e.g.,
      other financial market regulators.

5.2.7 Role of NPS Division

      The NPS Division within the Central Bank will act as the Secretariat to the
      NPS Steering Committee and will be chief co-ordinator of the NPS Project
      on a day-to-day basis. The Division will comprise of a multi-disciplinary
      team of professionals and will be responsible for the Central Bank’s
      oversight role as articulated in the CBK Act, Section 4A, (D).

      The Division will also be responsible for carrying out research and
      development of payment products and services.

      The Division will endeavour to:

      • Facilitate the development of payment systems in Kenya so as to
        provide for the needs of the economy.
      • Provide for a secure and efficient payment, clearing and settlement
      • Monitor and identify risks that could undermine the soundness of the
        payment system.
      • Reduce and contain systemic risks inherent in the payment system.
      • Involve and disseminate information to stakeholders in NPS
        developments affecting payment system – education/public
      • Ensure that the domestic payment system keeps abreast with
        international developments and best practices.
      • Facilitate the development of regional strategies for payment systems.
      • Develop and continuously review the necessary legal and regulatory
        framework to regulate and support payment systems.
      • Research and continuously review payment systems and practices
        with the aim of introducing and implementing strategies to enhance
        existing payment systems

5.2.8 Role of a Securities Depository in the NPS

      A securities depository, although not part of the payment clearing and
      settlement domain of the NPS, fulfils the role of custodian for
      immobilised/dematerialised securities. In efforts to synchronise delivery
      with payment, it will be the responsibility of the depository to:

      a)    reserve the securities on request of a securities clearing house
            prior to confirming a payment instruction;
      b)    change the ownership of securities once confirmation of payment
            has been received; and,
      c)    Enable the pledging of immobilised and/or dematerialised

                   6        IMPLEMENTATION STRATEGY


      The opening up of the economy has resulted in notable developments in
      the number of participants and the range of payment instruments. The
      level of competition has increased significantly and the payment systems
      currently include the use of ATMs, debit and credit cards, execution of
      payments through EFTs at the Point of Sale (EFT-POS) and Web-based
      Internet banking practices.

      Furthermore, developments are anticipated to continue in these areas,
      and not least in terms of the operational structure and automation of the
      clearing and settlement systems. It should also be noted that the CBK has
      a direct interest in ensuring that the development of the payment system
      proceeds in a co-ordinated manner and that potential credit and settlement
      risks are sufficiently controlled.

      On the part of the banks, the evolution of the payment system in a co-
      ordinated manner will entail greater co-operation and this will enhance
      operational efficiency and cost savings as unnecessary duplications are
      avoided and economies of scale realized.


      In an endeavour to resolve the current shortcomings and envisage the
      ideal NPS for Kenya, the vision of the NPS architecture was set for 2008.
      The vision defines the end state, which is the situation that should prevail
      in 2008. This does not imply, however that all the NPS project proposals
      will be implemented by 2008. It should be noted that our vision date is
      linked to the East African Community’s NPS reform agenda as a result of
      the region’s harmonization efforts being carried by the East African
      Payments Harmonization Committee (EAPSHC) as mandated by the
      Monetary Affairs Committee (MAC) of the 3 Central Bank Governors.


      The Kenyan NPS reform process follows the strategic approach. This is
      firstly because there are certain issues that need immediate attention due
      to their impact on payment systems efficiency and effectiveness and

      secondly because this is the globally accepted best practice for NPS
      reform process and is also internationally recommended by BIS
      Committee on Payment and Settlement Systems (CPSS).

      The NPS implementation began with the modernization of the payment
      and settlement arrangement initiated with the Automation of The Nairobi
      Clearing House.


      The strategic approach adopted by the NPS Operation Committee calls for
      a systematic implementation of the development program in a phased and
      evolutionary manner.


      Development and Implementation of the NPS will be based on
      consultation with and consensus amongst the relevant stakeholders. This
      will be a co-operative endeavor, characterized by joint ventures with
      various stakeholders, requiring multi-disciplined and skilled people from
      many different business areas and organizations.

      Effective co-ordination of inter-organizational system developments will be
      a critical success factor in the development of the NPS Project. To this
      end, structures will have to be created to ensure that all parties, not banks
      only, are kept fully informed of and involved in the development and
      implementation plan. The Central Bank, as a neutral agent and the
      overseer of the NPS, will co-ordinate the implementation process.


      In an effort to establish a sound and robust NPS by 2008, the provisional
      implementation plan is articulated in Appendix II. The sole responsibility of
      managing the Implementation Plan during the interim period lies with the
      operations NPS Committee presently chaired by the Deputy Governor with
      the various sub-committees and Task Forces as and when constituted.

                                  APPENDIX I
                                 Country Profile


1.0   Geography: Kenya, bisected by the Equator line and strategically located
      in the eastern coast of the African continent, has an area covering 569,259
      square kilometres - about the same size as France and roughly twice the
      size of the United Kingdom. The dominant physical feature is the Great
      Rift Valley, which bisects the country from north to south.

      The country shares common borders with Somalia, Ethiopia, Sudan,
      Uganda and Tanzania.

2.0   Climate: With the Equator running through the middle and the country’s
      altitude ranging from the sea level to 5,199 meters, Kenya enjoys a varied
      climate ranging from tropical to temperate and has two rainy seasons first
      being the long rains in April – May and then the short rains in October-

3.0   Population: Kenya’s population is approximately 30 million, which is both
      multi-racial and multi-ethnic, with a rich diversity of cultural roots. Nairobi,
      the capital of Kenya, has an approximate population of 3 million. Other
      cities are Mombasa and Kisumu, the former being Kenya’s main port on
      the Indian Ocean, and the latter a major port on Lake Victoria. Other
      mainland urban centres are Nakuru, Eldoret and Thika.

4.0   Language: Kiswahili is Kenya’s national language and English is the
      official language. Various local languages and dialects are also spoken.

5.0   Political Situation: Kenya has been a republic in the Commonwealth
      since independence in 1963. Executive authority is vested in the
      President with two five-year term limits, who is directly elected. The
      legislative authority is vested in the National Assembly. Presidential,
      Parliamentary and Civic elections are held every 5 years. Mayoral
      elections are held by elected civic leaders once every two years.

6.0   International Relations: Kenya is a member of the East African
      Community, Common Market of Eastern and Southern Africa (COMESA),

      the Commonwealth, the United Nations, the African Union (AU), and an
      associate of the EEC as a signatory to the Lome Convention.

7.0   The Economy: Kenya runs a mixed economy and has the potential to be
      dominant in the region and an engine for regional growth.

      Agriculture, the main sector of the economy, being the largest source of
      employment and foreign exchange earnings, contributes a quarter of total
      GDP, while manufacturing, the second most important sector and the
      strongest in East Africa, contributes about 13%.

      The other important sector is the trade, restaurants and hotels contributing
      about 12%, with tourism being second in foreign exchange earnings after

8.0   Infrastructure: Kenya has a well-developed infrastructure in the sub-
      region, with an extensive road network, three international airports, a
      national carrier – Kenya Airways, the port of Mombasa, which is an
      excellent natural harbour that is the gateway to the sub-region and a
      railway line connecting Mombasa and Kampala via Nairobi. The
      Government is implementing a number of measures with the assistance of
      development partners, among them the World Bank, to rehabilitate the

      Two major players in power and telecommunications sectors are
      undergoing restructuring, while plans are underway to streamline
      operations in the port of Mombasa to allow private sector participation in
      the provision of services.

9.0   The General Business Climate: Kenya has enjoyed a stable government
      since independence, forty years ago. Kenya has made a strong political
      commitment to promoting private-sector investment, both local and foreign
      to sustain economic growth. Over the past eight years the Government
      has introduced liberal market-oriented policies and reforms to improve the
      investment environment. Exchange controls have been removed, prices
      de-controlled, import licensing abolished, interest rate regimes de-
      controlled and divestiture from non-strategic public sector bodies,
      privatisation and parastatal reform programmes instituted.

10.0 Trade and Investment: A number of incentives to promote foreign
     investment are being implemented. The introduction of tax holidays under
     the Export Processing Zones and elimination of restrictions on the
     repatriation of profits was aimed at promoting foreign investment. The

      capital account was freed to allow investment in the Nairobi Stock
      Exchange, which however is limited to 40% of the value of floated shares.
      Traditionally, larger share of foreign capital inflows originate from the
      European Union countries, however South Africa and some Asian
      economies are gaining importance. Some of the foreign direct investments
      are in form of invested profits by multinational companies.

      As far as trade is concerned, Kenya’s major trading partners are African
      countries, which account for 47% of its exports and 9% of imports,
      followed by European Union countries which account for 30% of exports
      and 33% of imports. Other trading partners are the Far East and Middle
      East Countries, which account for 13% of exports and 23% of imports.

11.0 Kenya’s Other Potentials: Since independence, Kenya has enjoyed
     political stability that has enabled it to emerge as one of the strongest
     economies in the region. The varied agro-ecological zones and the
     unique tourist attraction sites also provide a great potential for the


                                   Activity and Description
  Year                                                                                Responsibility
         (i)        Develop and Document NPS Vision and Strategy
2002/    (i)        Develop Guidelines on Credit Reference Bureaus                   KBA
2003     (ii)       Implementation of an Operational Credit Reference Bureaus        KBA
         (iii)      Implementation Electronic Exchange of data with the Clearing KBA/KBA
         (iv)       Exchange of information/returns electronically                   CBK/KBA
         (v)        Promote Sharing of ATM’s Kenswitch Project and implement KBA
                    Kenswitch Settlement Mechanism
         (vi)       Encourage use of EFT’s for transfers of Funds                    CBK/KBA
         (vii)      Promote SWIFT for Domestic Payments                              CBK/KBA
         (viii)     Promote SWIFT for Regional Payments                              CBK
         (ix)       Encourage Connection of Non-swift Banks to SWIFT                 CBK
         (x)        Work out Modalities for introduce direct debit instrument        KBA
2003/    (i)        Finalise RTGS Concept and Design Memorandum for discussion
2004                                                                                 CBK
                    and way forward
         (ii)       Transform the NPS operations committee into NPS steering         CBK/KBA
         (iii)      Implement Local Foreign Currency Clearing Arrangements           KBA/CBK
         (iv)       Implement Central Depository System (CDS) for Nairobi Stock      KBA/CBK/NSE
2004/    (i)        Realisation of high value interbank exchange (RTGS)              CBK
         (ii)       Institute the NPS Council                                        CBK
2006/    (i)       Establish a link between ACH and other cross border small value   CBK
         (ii)      Linkage of the 3 E. African RTGS Systems                          CBK

         (iii)     Implement Cheque Truncation/Imaging                               KBA/CBK



Public Policy Objectives: Safety and Efficiency in Systematically Important
Payment Systems

Core Principles for Systemically Important Payment Systems

I.       The system should have a well-founded legal basis under all relevant

II.      The system’s rules and procedures should enable participants to have a
         clear understanding of the system’s impact on each of the financial risks
         they incur.

III.     The system should have clearly defined procedures for the management
         of credit risks and liquidity risks, which specify the respective
         responsibilities of the system operator and the participants and which
         provide appropriate incentives to manage and contain those risks.

IV*      The system should provide prompt final settlement on the day of value,
         preferably during the day and at a minimum at the end of the day.

V*       A system in which multilateral netting takes place should, as a minimum,
         be capable of ensuring the timely completion of daily settlements in the
         event of an inability to settle by the participant with the largest single
         settlement obligation.

VI.      Assets used for settlement should preferably be a claim on the Central
         Bank; where other assets are used, they should carry little or no credit risk
         and little or no liquidity risk.

VII.     The system should ensure a high degree of security and operational
         reliability and should have contingency arrangements for timely completion
         of daily processing.

VIII.    The system should provide a means of making payments, which is
         practical for its users and efficient for the economy.

IX.   The system should have objective and publicly disclosed criteria for
      participation, which permit fair and open access.
X.    The system’s governance arrangements should be effective, accountable
      and transparent.

      *      Systems should seek to exceed the minima included in these two
             Core Principles.

Responsibilities of the Central Bank in applying the Core Principles

A.    The Central Bank should define clearly its payment system objectives and
      should disclose publicly its role and major policies with respect to
      Systemically Important Payment Systems.

B.    The Central Bank should ensure that the systems it operates comply with
      the Core Principles.

C.    The Central Bank should oversee compliance with the Core Principles by
      systems it does not operate and it should have the ability to carry out this

D.    The Central Bank, in promoting payment systems safety and efficiency
      through the Core Principles, should cooperate with other Central Banks
      and with any other relevant domestic or foreign authorities.

BIS Committee on Payment and Settlement Systems Core Principles -
January 2001



Refers to any extension of credit, or any purchase of assets by the Central Bank
in the performance of its various Central Bank functions. In its narrowest term
refers to Central Bank’s refinancing at the discount window.

Auditable Payment Schemes

Are payment schemes that facilitate payment, exchange of instructions and
exchange of value through the existing banking and NPS infrastructure, and for
which e-money product transaction data are maintained as value is expended
and can be traced throughout the processing cycle to its finality. (See Non-
auditable payment schemes.

Automated Clearing House (ACH): see Clearing House

Automated Teller Machines (ATM)

Electro-mechanical device that permits authorised users, typically using machine-
readable plastic cards, to withdraw cash from their accounts and/or access other
services, such as balance enquiries, transfer of funds or acceptance of deposits.
ATMs may be operated either on-line with real-time access to an authorisation
database or off-line. See also cash dispensers.

Appointed Member

A member of an Electronic Clearing House (ECH) who has been appointed as an
agent of a non participating member of the ECH.

Bank Draft

Is the term that generally refers to a draft drawn by a bank on itself. The payer
purchases the draft from his bank and sends to the payee, who presents it to his
bank for payment. The payee’s bank presents it to the payer’s bank for


Is the transmission or processing of a group of payment orders and/or securities
transfer instructions as a set at discrete time intervals.

Bilateral Clearing Arrangement

Is an agreement between two banks to clear instructions between them.

Bilateral Netting

Is an arrangement between two parties to net their bilateral obligations. The
obligations covered by the arrangement may arise from financial contracts,
transfers or both.

Bilateral Net Settlement System

Is a settlement system in which participants’ bilateral net settlement positions are
settled between every bilateral combination of participants.

Bill of Exchange

Is a written order from one party (the drawer) to another (the drawee) to pay a
specified sum on demand or on a specified date to the drawer or to a third party
specified by the drawer. Widely used to finance trade and, when discounted with
a financial institution, to obtain credit.

Book-entry System

Is an accounting system that permits the transfer of claims (e.g. securities)
without the physical movement of paper documents or certificates.

Bulk Transfer System

Is an inter-bank funds system which handles large volume of payments or
relatively low value in such forms as cheques, credit transfers, direct debits, ATM
transactions and EFTs at the point of sale. See also retail transfer system.


For risk management purposes, the quantitative limits placed on the positions
(debit or credit positions, which may be either net or gross) that participants in a
funds or securities transfer system can incur during a business day. Caps may
be set by participants on credit extended bilaterally to other participants in a
system, e.g. bilateral credit limits, or by the system operator or by the body
governing the transfer system on the aggregate net debit a participant may incur
on the system, e.g. sender net debit limits. Sender net debit limits may be either
collateralised or uncollateralised.


See cash card, chip card, credit card, debit card, debit card, delayed debit card,
prepaid card, retailer’s card, travel and entertainment card. Pre-paid card (or
payment card) is a card “loaded” with a given value paid for in advance. (See
smart card).

Cash Card

Is a card for use only in ATMs or cash dispensers (often, other cards also have a
cash function that permits the holder to withdraw cash).

Cash Dispenser

Is an electro-mechanical device that permits consumers, typically using machine-
readable plastic cards, to withdraw banknotes (currency) and, in some cases,
coins. See also Automated Teller Machine (ATM).


Is a written order from one party (the drawer) to another (the drawee, normally a
bank) requiring the drawee to pay a specified sum on demand to the drawer or to
a third party specified by the drawer.

Central Bank Credit (liquidity) Facility

A standard credit facility that can be drawn upon by certain designated account
holders (e.g. banks), at the Central Bank. In some cases, the facility can be used
automatically at the initiative of the account holder, while in other cases the
Central Bank may retain some degree of discretion. The loans typically take the
form either of advances or overdrafts on an account holder’s current account
which may be secured by a pledge of securities (also known as Lombard loans or
of traditional rediscounting of bills).

Central Securities Depository (CSD) System

Is a securities trading system for holding securities in a book entry form and
enables securities transactions to be processed and transferred in a
dematerialised and immobilized manner. The system may incorporate
safekeeping comparison, clearing and settlement functions.

Central Bank Money

Consists of notes and coins in circulation outside the Central Bank, and all
deposits with the Central Bank by other banks. (Sometimes known as MO or the
banking system ‘cash base’).


Is the process of transmitting, reconciling and confirming payment orders or
security transfer instructions prior to settlement. Clearing may include netting of
instructions and the establishment of final positions for settlement.

Clearing Bank

A Clearing Bank is a bank represented at the Clearing House.

Clearing House

Is a central location or central processing mechanism through which financial
institutions agree to exchange payment instructions or other financial obligations.
The institutions settle for items exchanged at a designated time based on rules
and procedures of the Clearing House. Automated Clearing House (ACH): is an
electronic clearing system in which payment orders (cheques) are exchanged
among clearing house participants, primarily via magnetic media or
communication networks, and handled by a data-processing centre.

Clearing Centre

The operational centre of a Clearing Bank or group of banks which prepares and
accepts transactions from the Clearing House. A Clearing Centre will have as
many settlements as the number of banks it is acting for i.e. sponsored banks.

Local Clearing

Is the clearing of instruments originating from and destined to banks or their
branches located within the municipality of the same clearing centre.

Clearing Days

This refers to the days during which the process of transmitting, reconciling and in
some cases confirming payment in order of security transfer instructions prior to
settlement possibly including netting of instructual establishment of final position
for settlement. The clearing days are counted from the day of lodging the cheque
at the bank which is referred as ‘T’ and this is added to the number of days that
the cheque would be processed in the clearing house i.e. T+ No. of days.

Clearing System

Is a set of procedures whereby financial institutions present and exchange data
and/or documents relating to funds or securities transfers to other financial
institutions at a single location (Clearing House). The procedures often also
include a mechanism for the calculation of participants’ bilateral and/or
multilateral net positions with a view to facilitating the settlement of their
obligations on a net or gross basis.

Clearing Cycle

The timetable for processing Inter-bank payments. References to days in the
Clearing Cycle DO NOT take account of delays, however caused.

Chip Card

Also known as an IC (integrated circuit) card or smart card; is a card containing
one or more computer chips or integrated circuits for identification, data storage
or special-purpose processing used to validate personal identification numbers
(PINs), authorise purchases, verify account balances and store personal records.
In some cases, the memory in the card is updated every time the card is used,
e.g. an account balance is updated.

Code Line

This refers to the MICR code-line at the bottom of the cheques and as specified
in the Cheque/Voucher Design document. The code-line is the single most
important feature towards the automation of the clearing process.

Code-line Clearing

Is the automation of cheque clearing by adopting electronic exchange of MICR
(see magnetic ink character recognition) code-lines in computer files on diskette
or on-line. The MICR code-line at the bottom of the cheque form comprises the
details of the branch and account number, where the cheque has been drawn,
the cheque number and the amount of the cheque.


Is the security provided to the Central Bank in conjunction with an agreement to
borrow funds to relieve a shortage of liquidity.

Collateral Depository

Is a register of all securities lodged with the Central Bank for securing settlement.
Dynamic Collateralisation is a system in which automatic lending to a net deficit
clearing participant is fully covered automatically by collaterals drawn from a
reserve of liquid collaterals usually securities.

Corrupt Data File

Electronic file that contains data which is either wholly or partly unreadable, or
incomplete or contains meaningless characters that cannot be processed
including odd cents.

Collecting Bank or Branch

The bank or branch first receiving payment instructions from a customer.

Collecting Clearing Centre

The Clearing Centre receiving payment instructions from collecting branches and

Correspondent banking

Is an arrangement under which one bank (correspondent) holds deposits owned
by other banks (respondents) and provides payment and other services to those
respondent banks. Such arrangements may also be known as agency
relationships in some domestic contexts. In international banking, balances held

for a foreign respondent bank may be used to settle foreign exchange
transactions. Reciprocal correspondent banking relationships may involve the use
of so-called nostro and vostro account to settle foreign transactions.


The opposite party to a financial transaction.

Credit Card

Is a card indicating that the holder has been granted a line of credit. It enables
him to make purchases and/or draw cash up to a pre-arranged ceiling; the credit
granted can be settled in full by the end of a specified period or can be settled in
part, with the balance taken as extended credit. Interest is charged on the
amount of any extended credit and the holder is sometimes charged an annual

Credit Push Instruction

This implies the paying bank initiates the settlement transaction on its behalf or
on behalf of its customer and assumes responsibility for obtaining finality of
settlement. If the payer’s funds do not suffice, the payment does not go further
than the paying bank. This method of payment provides a “pre-fated or pre-
authorised” payment transaction.

Credit Risk/Exposure

Is a risk that a counterpart will not settle an obligation for full value either when
due or at any time thereafter. It includes principal risk, or cost risk. The
counterpart may be insolvent.

Credit Transfer

Is a payment order or possibly a sequence of payment orders made for the
purpose of placing funds at the disposal of the beneficiary. Both the payment
instructions and the funds described therein move from the bank of the
payer/originator to the bank of the beneficiary, possible via several other banks
as intermediaries and/or more than one credit transfer system.

Credit Transfer System (Giro System)

Is a system through which payment instructions and the funds described therein
may be transmitted for the purpose of effecting credit based payments.

Cross Border Transaction

Is a transaction in which at least one of the counter parties is located outside the
home country.

Cross Currency Settlement Risk

Also known as Harsttat Risk is the risk that a transaction with a correspondent
bank may not materialize due to instantaneous of transactions caused by time
zones differences and currency differences.

Customer Network

Is where buyers and sellers interact for the purpose of buying goods and
services. This is known as a Customer Payment Service Provider (CPSP).

Daylight Credit (or daylight overdraft, daylight exposure, intra-day credit)

Credit extended for a period of less than one business day.

Debit caps: see caps

Debit Card

Card enabling the holder to have his purchases directly charged to funds on his
account at a deposit-taking institution (may sometimes be combined with another
function, e.g. that of a cash card or cheque guarantee card).

Debit Transfer System (or debit collection system)

Is a funds transfer system in which debit collection orders made or authorised by
the payer move from the bank of the payee to the bank of the payer and result in
a charge (debit) to the account of the payer; for example, cheque-based systems
are typical debit transfer systems.

Deferred Net Settlement (DNS) Systems

Are settlement systems in which payment instructions are batched and off-setting
positions calculated between participating banks before settlement is undertaken.

Final settlement occurs at one or more discrete, pre-specified settlement times
during the processing day. If such settlement takes place only once, normally at
the end of the processing day, the system is called End-of-Day settlement

Delivery Versus Payment (DVP)

Is a mechanism in an exchange-for-value settlement system that ensures that the
final transfer of one asset occurs if and only if the final transfer of the other asset
occurs. DVP is mainly used in reference to securities trading where the transfer
of securities ownership is tied to the transfer of respective funds.

Debit Pull instrument

Is like a cheque or credit card whose processing involves presenting the cheque
or the details of the credit card to the collecting bank. Clearing is usually done in
bulk at the clearing house. Payment is only final if the buyer has sufficient funds
to cover payment and the cheque is not fraudulent. This means a debit-pull
instrument is only fated at the end of the process. The seller’s bank collects the
money on his/her behalf, and the transaction date is determined by the seller, but
the payment finality is still determined by the buyer, e.g. debit order.

Discrepancy File

The file returned to the Collecting Centre identifying the cheques identified in the
Electronic Journal but not received.


Is the elimination of physical certificates or documents of title which represent
ownership of securities so that securities exist only as accounting records.

Direct Debit

A pre-authorised debit on the payer’s bank account initiated by the payee.


Occurs when one party borrows from another instead of from a bank.
Disintermediation is also said to occur when two or more parties discharge their
financial obligations to each other wholly or partially being made for only the net
amount owing. Barter can be regarded as disintermediation.

Drawee or (Payee) bank/branch

The bank or branch of the bank of the customer whose cheque or instruction is
being processed. In the case of Electronic Funds Transfers to credit an account
at another bank, the Drawee Bank/Branch is the bank branch to be credited.

Drawee Clearing Centre

The Clearing Centre processing a cheque or instruction on behalf of the Drawee

Drawer’s Bank
A bank or branch of the person who issues the cheque to pay the amount
mentioned herein (also referred as the paying bank or branch).

Electronic Clearing House (ECH): See Clearing House
Electronic Data Interchange (EDI)

Is the electronic exchange between commercial entities, in a standard format, of
data relating to a number of message categories, such as orders, invoices,
customs documents, remittance advices and payments. EDI messages are sent
through public data transmission networks or banking system channels. Any
movement of funds initiated by EDI is reflected in payment instructions flowing
through the banking system. EDIFACT a United Nations body, has established
standards for electronic data interchange.

Electronic money

Refers to electronically stored monetary value on a device that functions as a pre-
paid bearer instrument, which can be widely used for making payments to parties
other than the issuer, with or without involving bank accounts in the transactions.

Electronic commerce

Interactions relating to the purchase of goods or services, conducted over public
networks that requires the use of intelligent networked devices.

Electronic Funds Transfer File

A file containing details of customer credits and/or debits destined for banks and
branches not served by the collecting Clearing Centre.

Electronic Journal

A file containing details of the cheques and vouchers passed to the Clearing
House by the collecting Clearing Centre.


Endorsement means the printing or writing of information on the rear of the
cheque or voucher for various reasons, by the holder or issuer e.g. the cheque or
voucher in the course of transferring or processing the cheque or voucher.

Final settlement

Refers settlement, which is irrevocable and unconditional.

Final Transfer

Is an irrevocable and unconditional transfer that effects a discharge of the
obligation to make the transfer. The terms “Delivery” and “Payment” are each
defined to include a final transfer.

Finality of Payment

Takes place when a customer has been given advice of payment finality after
settlement has taken place. Final payment is irreversible, irrevocable and
unconditional payment.


The aggregate value of a payment instruments submitted for clearing and
settlement through a payment system but not cleared. The float magnitude is a
factor of volume of transaction per period (usually a day) value per transaction
and the payment cycle or payment lag.

Giro System

See credit transfer system.


A situation that can arise in a funds or securities transfer system in which failure
of some transfer instructions to be executed (because the necessary funds or

securities balances are unavailable) prevents a substantial number of other
institutions from other participants from being executed.

Gross Settlement System

Is a transfer system in which the settlement of funds or securities transfers occurs
individually on an order-by-order basis according to the rules and procedures of
the system, i.e. without netting debits against credits. See Real Time Gross

High Value Items

High value items means instruments that are equivalent to or above a defined

Home Banking

Banking services a retail customer of a financial institution can access using a
telephone, television set, terminal or personal computer as a telecommunication
link to the institution’s computer centre.

IC Card: see Chip Card.


Placement of certified securities and financial instruments in a central securities
depository to facilitate book-entry transfers.

Image Processing

Computer based technology that allows end users to electronically capture, store,
process and retrieve images that may include numeric data, text, handwriting,
graphics, documents and photographs – it heavily uses optical scanning and
optical desk technologies

Interbank Funds Transfer System (IFTS)

Is a funds transfer system in which most (or all) direct participants are financial
institutions, mainly banks.

Irrevocable and Unconditional Transfer

Transfer that irrevocable by the person transferring and is unconditional.

Large-value Funds Transfer System

Inter-bank Funds Transfer System through which large-value and high-priority
(Critical Credit) funds transfers are made between participants in the system for
their own account or on behalf of their customers provided that the sending bank
has sufficient covering balances or credit. As a rule no minimum value is set for
the payments they carry, the average size of payments through such systems is
relatively large. Large-value funds transfer systems are sometimes called
wholesale funds transfer systems.

Time Critical or Time Sensitive Payments are funds, which need immediate
settlement. (See Time Critical and Time Sensitive).

Legal Risk

The risk that a loss in a payment transaction may be incurred because of
inadequate non-coverage of a certain element in a payment process or
arrangement. It also includes differences in two legal systems covering the same
payment arrangement in the case of payment counterparts operating in different

Lender of Last Resort

Where a deposit taking institution experiencing a need for cash balances that
cannot readily be satisfied in any other way, are allowed to obtain cash balances
from the Central Bank.

Liquidity Risk

The risk that a counterpart will not settle an obligation for full value when due, but
may be able to settle the required obligations at some other time. Risks include
replacement cost risk and adjustment cost risk. The counterpart in this case is
still solvent.

Loss Sharing Arrangement

Payment System Risks mitigating measures agreed upon by members of a
Clearing House or a transfer system, which involve a bailout mechanism, or
allocation of any loss arising when one or more participants fail to fulfil their
obligation. They include “Defaulter Pays Mechanisms” which involve the use of
the defaulter’s collateral to settle the deficit position, and the “Survivors” Pay
Arrangement, which means the surviving members assume the loss based on
agreed formula.

Market Risk

Is the risk that a loss in a payment transaction may occur because of fluctuations
in interest rates and foreign exchange rates. Market risks are linked to securities
trading and trading in futures.

Magnetic Ink Character Recognition (MICR)

Is a technique, using special MICR machine-readable characters, by which
documents (i.e. cheques, credit transfers, direct debits) are read by machines for
electronic processing. See optical character recognition (OCR).


Means a licensed bank which participates in a Clearing House.

Missing (Electronic Journal) Record

An entry in the Electronic Journal for which a corresponding cheque has not been

Money Order

Is an instrument used to remit money to the named payee, often used by persons
who do not have a chequing account relationship with a financial institution, to
pay bills or to transfer money to another person or to a company. There are three
parties to a money order: the remitter (payer), the payee and the drawee.
Drawees are usually financial institutions or post offices. Payees can either cash
their money orders or present them to their bank for collection.

Multilateral Clearing

Is an arrangement between more than two parties to clear instructions between

Multilateral Netting

An arrangement among three or more parties to net their obligations. The
obligations covered by the arrangement may arise from, financial contracts,
payment transfers or both. The multilateral netting of payment obligations
normally takes place in context of a multilateral net settlements system. See
bilateral netting, multilateral net clearing, and multilateral net settlement system.

National Payment System (NPS)

Is defined as a defined group of institutions using a set of instruments and agreed
procedures used to effect payments transactions in the process of ensuring the
circulation of money within a specified geographical area; usually a country.

NPS Stakeholders

Comprise of the Central Bank, the government, commercial banks, financial
institutions, payment system providers, laws, rules and regulations governing the
payment system, technological and physical infrastructure and users.

Net Credit or Debit Position

A participant’s net credit or net debit position in a netting system is the sum of the
value of all the transfers it has received up to a particular point in time less the
value of all transfers it has sent. If the difference is positive, the participant is in a
net credit position; if the difference is negative, the participant is in a net debit
position. The net credit or net debit position at settlement time is called the net
settlement position. These net positions may be calculated on bilateral or
multilateral basis.

Net Settlement

The settlement of a number of obligations or transfers between or among
counterparties on a net basis. See netting.

Net Settlement system

A system to effect net settlement.


Is a process in which gross, or trade by trade obligations between two or more
participants are settled by a single transfer of the net amount of funds. See also
bilateral and multilateral netting, position netting.

Non-auditable Products

Are those in respect of which no record of payment transactions is maintained
(i.e. as value is expended).


The term may refer to the transmission of transfer instructions by users, through
such means as voice, written or tele-faxed instructions that must subsequently be
input into a transfer processing system. The term may also refer to the storage of
data by the transfer processing system on media such as magnetic tape or disk
such that the user may not have direct and immediate access to the data.


In the context of payment and settlement systems, the term may refer to the
transmission of transfer instructions by users, through such electronic means as
computer-to-computer interfaces or electronic terminals, that are entered into a
transfer processing system by automated means. The term may also refer to the
storage of data by the transfer processing system on a computer database such
that the user has direct access to the data (frequently real-time) through
input/output devices such as terminals.

Operational Risk

Is a risk that settlement finality may not be achieved due to mal-functioning of a
system, mishandling, manipulations etc. Operational risks include systems risks,
security risks, technology risk and intellectual risk.

Optical Character Recognition (OCR)

The machine identification of printed characters through the use devices sensitive
to light.

Overnight Money

A loan with a maturity of one business day.

Paperless Credit Transfers

Credit transfers that do not involve the exchange of paper documents between
banks. Other credit transfers are called paper-based.

Participant/ Member

A party who participates in a transfer system. This generic term refers to an
institution which is identified by a transfer system (e.g. by a bank identification
number) and is allowed to send payment orders directly to the system or which is

directly bound by the rules governing the transfer system.               See direct
participant/member, indirect participant/member.

Paying Bank/Branch

See Drawer’s bank branch.


The payer’s transfer of a monetary claim on a party acceptable to the payee.
Typically, claims taken the form of banknotes or deposits balances held at a
financial institution or at a central bank.

Payment Instrument

Is a device or system or physical unit used to initiate instructions for the transfer
of value from a payer to a payee in settlement of an obligation. The more
common forms of payment instruments are cash, non-cash debit payments,
cheques, bankers’ drafts, banker’s payments cards, Mail Transfers and
Telegraphic Transfers.

Payment Lag

Is the time-lag between the initiation of the payment order and its final settlement.

Payment Instruction (Payment Order)

An order or message requesting the transfer of funds, in the form of a monetary
claim on a party, to the order of the payee. The order may relate either to a credit
transfer or to a debit transfer.

Payment Network

Is where actual payment takes place. Customer Payment Service Providers
(CPSPs) enter payment networks when they receive or make payment on behalf
of the customers.

Payment System

A payment system consists of a set of instruments, banking procedures and
typically, interbank funds transfer systems that ensure the circulation of money.
Payment system covers the whole process of initiating a payment transaction,
processing the transaction throughout to its settlement finality known as payment
system cycle/chain.

Payment Versus Payment (PVP)

This is a mechanism that ensures that the final transfer of one value is conditional
to the final transfer of the correspondent value. PVP is used in foreign exchange
or cross currency transactions.

Payment System

Consists of a set of instruments, banking procedures and typically interbank
funds transfer systems that ensure the circulation of money.

PIN (Personal Identification Number)

A numeric code that the cardholder may need to quote for verification of identity.
in electronic transactions. It is seen as the equivalent of a signature.

Point of Sale (POS)

This term refers to the use of payment cards at a retail location (point of sale).
The payment information is captured either by paper vouchers or by electronic
terminals, which, in some cases, are designed also to transmit the information.
Where this is so, the arrangement may be referred to as “Electronic Funds
Transfer at the Point of Sale” (EFTPOS).

Principal Risk

The credit risk that a party will lose the full value involved in a transaction. In the
settlement process, this term is typically associated with exchange for value
transactions when there is a lag between the final settlement of the various legs
of a transaction (i.e. the absence of delivery versus payment).

Processing Endorsements

The printing of the Clearing Centre system generated variable information on the
rear of a voucher.

Provision Transfer

A conditional transfer in which one or more parties retain the right by law or
agreement to rescind the transfer.


A risk management arrangement whereby transfer orders are held pending by the
originator/deliverer or by the system until sufficient cover is available in the
originator’s/deliverer’s clearing account or under the limits set against the payer;
in some cases, cover may include unused credit lines or available collateral. See
also caps.

Real-time Gross Settlement (RTGS)

Is a gross settlement system in which processing and settlement take place in
real time (continuously). Real Time Settlement Systems are systems where
final settlement occurs on a continuously on real time transaction-by-transaction
basis during the processing day.

Real-time Processing or Settlement

The transmission, processing or settlement of a fund’s or securities transfers
instruction on an individual basis at the time it is initiated.

Reason for Return Code

A code to indicate the reason for returning a payment as Unpaid or Unapplied.

Receiver Finality

Analytical rather than operational or legal term used to describe the point at which
an unconditional obligation arises on the part of the receiving participant in a
transfer system to make final funds available to its beneficiary customer on the
value date. See Final Settlement.

Real Time Line

Where a settlement instruction settled immediately is sent by debiting the paying
bank and crediting the beneficiary’s bank by the value of the settlement

Replacement Cost Risk (or Market Risk, Price Risk)

The risk that a counterparty to an outstanding transaction for completion at a
future date will fail to perform on the settlement date. This failure may leave the
solvent party with an unhedged or open market position or deny the solvent party
unrealized gains on the position. The resulting exposure is the cost of replacing,
at current market prices, the original transaction. See also credit risk.

Retailer’s Card

A card issued by non-banking institutions, to be used in specified stores. The
holder of the card has usually been granted a line of credit.

Retail Transfer System

Inter bank funds transfer system which handles a large volume of payments of
relatively low value in such forms as cheques, credit transfers, direct debits, ATM
transactions and EFT at the point of sale.

Sender Finality

Is an analytical rather than operational or legal term used to describe the point at
which an unconditional obligation arises on the part of the initiating participant in
a funds transfer system to make final payment to the receiving participant on the
value date. See final settlement. It indicates that once a payment instruction by
the sender is sent, it cannot be altered or reversed by the sender.


Is an act that discharges obligations in respect of funds or securities transfers
between two or more parties.

Inter-bank settlement is accomplished by posting entries across the accounts of
the banks held at the central bank resulting in finality and irrevocability.

Settlement Agent

An institution that manages the settlement process, e.g. the determination of
settlement positions, monitoring the exchange of payments and so on for the
transfer systems or other arrangements that require settlement. See Final
Settlement, Settlement, Settlement Institution(s), Multilateral Net Settlement

Settlement Certificates

Means a certificate issued by the Clearing House to indicate the settlement
position (balance) of each bank at a particular clearing session.

Settlement File

A file of totals (volume and value) being passed from a collecting bank.

Settlement Position File

A file of totals (volume and value) received by a bank form collecting banks.

Settlement Finality

Settlement that is irrevocable and unconditional. In this regard receiver finality
refers to a point at which an unconditional obligation arises on the part of the
receiving participant.

Settlement Network

Is the network that link banks and the settlement agent when inter-bank
settlement takes place. The central bank is the settlement agent to the banks just
as a bank is a payment agent to CPSPs and customers. Clearing houses do not
settle on their behalf. They provide service to allow bank’s to clear, net and settle
their inter-bank obligations.

Settlement Risk

General term used to designate the risk that settlement in a transfer system will
not take place as expected. This risk may comprise both credit and liquidity risk.

Settlement System

Is a system in which settlement takes place. Settlement systems are basically of
two types, namely designated-time (deferred) net settlement, and real-time (or
continuous) gross settlement. The distinction lies basically on the methods in
which settlement takes place and the timing/frequency of settlement.

Settlement Lag

The time lag between the initiation of a payment instruction and its discharge by
the final exchange of a financial asset for payment. It is sometimes referred to as
a payment lag.

Situational Risk

Also known as circumstantial risk is the risk that settlement may not be achieved
due to factors outside payment and settlement systems such as natural disasters,
political uprising war etc. Situational risk includes country risks.

Smart Card (having an embedded computer chip)

Has the capability of performing stored value applications, in addition to other
functions such as debit and credit payment capabilities.

Sponsored Bank

This is a bank whose clearances are forwarded to the Clearing House on its
behalf by a clearing bank. Receipt of inward clearing is also through the
sponsoring clearing bank. However, the settlement figures with Settlement Agent
will be for the individual sponsored bank to facilitate liquidity position
management by Settlement Agent. The sponsoring bank will take no
responsibility for the settlement position of the sponsored bank.

Standing Order

An instruction from a customer to his bank to make a regular payment of a fixed
amount to a named creditor.

SWIFT (Society for World-wide Interbank Financial Telecommunication)

A cooperative organization that operates a network for the exchange of payment
and other financial messages between financial institutions throughout the world.
The organization is owned by banks.

Systemic Risk

The risk that the failure of one participant in a transfer system or in financial
markets to meet its required obligation will cause other participants or financial
institutions to be unable to meet their obligations.

Time Critical Payments

Are payments whose settlement at due date trigger other financial transactions.
Non-settlement of Time Critical Payments leads to a non-fulfillment of the
secondary transactions.

Time Sensitive Payments

Are payments whose non-settlement at the due date draws immediate legal and
other implications including penalties and other obligations.

Trading System

Is where a deal is entered between the buyer and seller of goods and services, or
trading of securities.

Transaction Code

These are codes that indicate the nature of a transaction. These are also helpful
in obtaining specific statistics for any code.


Operationally, the sending (or movement) of funds or securities or of a right
relating to funds or securities from one party to another party by (1) conveyance
of physical instruments/money; (2) accounting entries on the books of a financial
intermediary; or (3) accounting entries processed through a funds and/or
securities transfer system. The act of transfer affects the legal rights of the
transfer or transferee and possibly third parties in relation to the money balance,
security or other financial instrument being transferred.

Transfer System

Is a generic term covering interbank funds transfer systems and exchange-for-
value systems.

Unwinding (or Settlement Unwind)

A procedure followed in certain clearing and settlement systems in which
transfers of securities or funds are settled on a net basis, at the end of the
processing cycle, with all transfers provisional until all participants have
discharged their settlement obligations. If a participant fails to settle, some or all
of the provisional transfers involving that participant are deleted from the system
and the settlement obligations from the remaining transfers are then recalculated.
Such a procedure has the effect of transferring liquidity pressures and possibly
losses from the failure to settle to other participants, and may, in the extreme,
result in significant and unpredictable systemic risks.


A procedure in which the physical movement of paper based payment
instruments is curtailed or eliminated, and is replaced in whole or in part by their
electronic data contents for processing and transmission.

Value Date

Means the date when the cheque proceeds are credited on the payee’s account.

Voucher Type Code

These are codes that indicate the nature of a transaction. These are also helpful
in obtaining specific statistics for any code.

Wholesale Funds Transfer System

See large-value funds transfer system.

Wrongly delivered cheque.

A cheque delivered accidentally to the wrong Clearing Centre.

The glossary gives an explanation of terms used in the payments context on the basis of best
consensus between the central banks involved (G-10 and EC). It does not attempt to provide
precise legal definitions. It is recognized that it may not always be possible to find an exact
equivanlent for each term in other languages.