THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 464

432

PA R T V

Central Banking and the Conduct of Monetary Policy

THE FRAM EWO RK FO R THE IM PL EM E NTATI O N
OF M O NE TARY P OL I CY
The tools used by the Bank of Canada to implement monetary policy are closely
linked to the institutional arrangements regarding the clearing and settlement systems
in the Canadian economy. Understanding the tools of monetary policy therefore
requires that we know the key features of the framework for the implementation of
monetary policy. As you will see, this framework has been designed to encourage
deposit-taking financial institutions to deal directly with the market, rather than with
the Bank of Canada.1

The Large
Value Transfer
System (LVTS)

The core of the Canadian payments system is the Large Value Transfer System
(LVTS), introduced by the Canadian Payments Association on February 4, 1999. The
LVTS is an electronic, real-time net settlement network, designed to provide immediate finality and settlement to time-critical transactions. In addition to the Bank of
Canada there are fourteen LVTS participants.2 A financial institution can participate directly in the LVTS if it is a member of the Canadian Payments Association,
uses the SWIFT telecommunications network, maintains a settlement account at
the Bank of Canada, and has agreements regarding borrowing from the Bank of
Canada and pledging eligible collateral. All other members of the Canadian
Payments Association that are not direct participants in the LVTS (110 members)
are able to arrange LVTS payments through the LVTS participants.
The LVTS has been put in place in order to eliminate systemic risk the risk to
the entire payments system due to the inability of one financial institution to fulfill its

payment obligations in a timely fashion. In fact, each LVTS payment is subject to realtime risk-control tests to confirm that sufficient collateral is available, and is final and
irrevocable in real time. In particular, LVTS participants can make a payment only
if they have, in real time (right now), either positive settlement balances in their
accounts with the Bank of Canada, or posted collateral (such as Government of
Canada treasury bills and bonds), or explicit lines of credit with other participants.
As a result, the system will settle at the end of each day even in the face of risk
and liquidity problems.
Of course, it is not just Canada that is concerned about systemic risk. Real-time
settlement systems were implemented by Sweden in 1986, Germany and Switzerland
in 1987, Japan in 1988, Italy in 1989, Belgium and the United Kingdom in 1996, and
France, Hong Kong, and the Netherlands in 1997. Moreover, the central banks of the
G-10 countries, through the Bank for International Settlements, have developed minimum standards for the operation of the global payment network for large-value
funds transfers.
In Canada s LVTS, participants know in real time their large-value, wholesale
transactions (over $50 000). Although these transactions account for less than 1% of
the total number of transactions, they account for about 94% of the value of transac1

For more details, see Donna Howard, A Primer on the Implementation of Monetary Policy in the
LVTS Environment, Bank of Canada Review (Autumn, 1998): 57 66; Kevin Clinton, Implementation
of Monetary Policy in a Regime with Zero Reserve Requirements, Bank of Canada Working Paper 97 8;
and The Framework for the Implementation of Monetary Policy in the Large Value Transfer System
Environment, Bank of Canada Release, March 31, 1999.

2

These are the Big Six (Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce,
National Bank of Canada, Royal Bank of Canada, and the Toronto Dominion Bank), Alberta Treasury
Branches, Bank of America National Association, BNP Paribas, Caisse centrale Desjardins du Qu bec,
Credit Union Central of Canada, HSBC Bank Canada, Laurentian Bank of Canada, and State Street Bank
and Trust Company.