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Intraday liquidity management: a tale of games banks play

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  • Morten L. Bech

Abstract

Over the last few decades, most central banks, concerned about settlement risks inherent in payment netting systems, have implemented real-time gross settlement (RTGS) systems. Although RTGS systems can significantly reduce settlement risk, they require greater liquidity to smooth nonsynchronized payment flows. Thus, central banks typically provide intraday credit to member banks, either as collateralized credit or priced credit. Because intraday credit is costly for banks, how intraday liquidity is managed has become a competitive parameter in commercial banking and a policy concern of central banks. This article uses a game-theoretical framework to analyze the intraday liquidity management behavior of banks in an RTGS setting. The games played by banks depend on the intraday credit policy of the central bank and encompass two well-known paradigms in game theory: "the prisoner's dilemma" and "the stag hunt." The former strategy arises in a collateralized credit regime, where banks have an incentive to delay payments if intraday credit is expensive, an outcome that is socially inefficient. The latter strategy occurs in a priced credit regime, where postponement of payments can be socially efficient under certain circumstances. The author also discusses how several extensions of the framework affect the results, such as settlement risk, incomplete information, heterogeneity, and repeated play.

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Bibliographic Info

Article provided by Federal Reserve Bank of New York in its journal Economic Policy Review.

Volume (Year): (2008)
Issue (Month): Sep ()
Pages: 7-23

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Handle: RePEc:fip:fednep:y:2008:i:sep:p:7-23:n:v.14no.2

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Keywords: Payment systems ; Banks and banking; Central ; Bank liquidity ; Game theory ; Credit;

References

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  1. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  2. AUMANN, Robert J., . "Subjectivity and correlation in randomized strategies," CORE Discussion Papers RP -167, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. Greenspan, Alan, 1996. "Remarks on Evolving Payment System Issues," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 689-95, November.
  4. Morten L. Bech & Bart Hobijn, 2007. "Technology Diffusion within Central Banking: The Case of Real-Time Gross Settlement," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 147-181, September.
  5. Joseph Farrell & Matthew Rabin, 1996. "Cheap Talk," Journal of Economic Perspectives, American Economic Association, vol. 10(3), pages 103-118, Summer.
  6. Antoine Martin, 2002. "Optimal pricing of intra-day liquidity," Research Working Paper RWP 02-02, Federal Reserve Bank of Kansas City.
  7. Furfine, Craig H & Stehm, Jeff, 1998. "Analyzing Alternative Intraday Credit Policies in Real-Time Gross Settlement Systems," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 832-48, November.
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Cited by:
  1. Olivier Armantier & Jeffrey Arnold & James McAndrews, 2008. "Changes in the timing distribution of Fedwire funds transfers," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-112.
  2. Carlos Léon, 2012. "Estimating financial institutions´ intraday liquidity risk: a Monte Carlo simulation approach," BORRADORES DE ECONOMIA 009441, BANCO DE LA REPÚBLICA.
  3. Davey, Nick & Gray, Daniel, 2014. "How has the Liquidity Saving Mechanism reduced banks’ intraday liquidity costs in CHAPS?," Bank of England Quarterly Bulletin, Bank of England, vol. 54(2), pages 180-189.
  4. Hellqvist , Matti & Laine, Tatu, 2012. "Diagnostics for the financial markets – computational studies of payment system: Simulator Seminar Proceedings 2009–2011," Scientific Monographs E:45/2012, Bank of Finland.

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