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Illiquidity in the Interbank Payment System Following Wide‐Scale Disruptions

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  • MORTEN L. BECH
  • RODNEY J. GARRATT

Abstract

We show how the interbank payment system can become illiquid following wide-scale disruptions. Two forces are at play in such disruptions-operational problems and changes in participants' behavior. We model the interbank payment system as an n-player game and utilize the concept of a potential function to describe the process by which one of multiple equilibria emerges after a wide-scale disruption. If the disruption is large enough, hits a key geographic area, or hits a "too-big-to-fail" participant, then the coordination of payment processing can break down, and central bank intervention might be required to reestablish the socially efficient equilibrium. We also explore how the network topology of the underlying payment flow among banks affects the resiliency of coordination. The paper provides a theoretical framework to analyze the effects of events such as the September 11 attacks.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2012.00515.x
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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): 5 (08)
Pages: 903-929

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i:5:p:903-929

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Aumann, Robert J, 1987. "Correlated Equilibrium as an Expression of Bayesian Rationality," Econometrica, Econometric Society, vol. 55(1), pages 1-18, January.
  2. Aumann, Robert J., 1974. "Subjectivity and correlation in randomized strategies," Journal of Mathematical Economics, Elsevier, vol. 1(1), pages 67-96, March.
  3. Bech, Morten L. & Garratt, Rod, 2003. "The intraday liquidity management game," Journal of Economic Theory, Elsevier, vol. 109(2), pages 198-219, April.
  4. James J. McAndrews & Simon M. Potter, 2002. "Liquidity effects of the events of September 11, 2001," Economic Policy Review, Federal Reserve Bank of New York, issue Nov, pages 59-79.
  5. Kahn, Charles M & McAndrews, James & Roberds, William, 2003. " Settlement Risk under Gross and Net Settlement," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 591-608, August.
  6. Stacy Panigay Coleman, 2002. "The evolution of the Federal Reserve's intraday credit policies," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Feb, pages 67-84.
  7. Rausser, Gordon C. & Simon, Leo K. & Zhao, Jinhua, 2000. "Environmental Remedies: An Incomplete Information Aggregation Game," Berkeley Olin Program in Law & Economics, Working Paper Series qt9z00731z, Berkeley Olin Program in Law & Economics.
  8. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. James McAndrews & Samira Rajan, 2000. "The timing and funding of Fedwire funds transfers," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 17-32.
  10. Monderer, Dov & Shapley, Lloyd S., 1996. "Potential Games," Games and Economic Behavior, Elsevier, vol. 14(1), pages 124-143, May.
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Citations

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Cited by:
  1. Galbiati, Marco & Soramäki, Kimmo, 2011. "An agent-based model of payment systems," Journal of Economic Dynamics and Control, Elsevier, vol. 35(6), pages 859-875, June.
  2. Morten Bech & James T. E. Chapman & Rod Garratt, 2008. "Which Bank is the "Central" Bank? An Application of Markov Theory to the Canadian Large Value Transfer System," Working Papers 08-42, Bank of Canada.
  3. Marc Pröpper & Iman van Lelyveld & Ronald Heijmans, 2008. "Towards a Network Description of Interbank Payment Flows," DNB Working Papers 177, Netherlands Central Bank, Research Department.
  4. Upper, Christian, 2011. "Simulation methods to assess the danger of contagion in interbank markets," Journal of Financial Stability, Elsevier, vol. 7(3), pages 111-125, August.
  5. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2007. "A dynamic model of the payment system," Working Papers 07-22, Federal Reserve Bank of Philadelphia.
  6. Morten L. Bech & Antoine Martin & James McAndrews, 2012. "Settlement liquidity and monetary policy implementation—lessons from the financial crisis," Economic Policy Review, Federal Reserve Bank of New York, issue Mar, pages 3-20.
  7. Ronald Heijmans & Richard Heuver, 2011. "Is this bank ill? The diagnosis of doctor TARGET2," DNB Working Papers 316, Netherlands Central Bank, Research Department.
  8. Klaus Abbink & Ronald Bosman & Ronald Heijmans & Frans van Winden, 2010. "Disruptions in large value payment systems: An experimental approach," Working Paper series, University of East Anglia, Centre for Behavioural and Experimental Social Science (CBESS) 10-11, School of Economics, University of East Anglia, Norwich, UK..
  9. Clara Machado & Carlos León & Miguel Sarmiento & Freddy Cepeda, 2011. "Riesgo Sistémico Y Estabilidad Del Sistema De Pagos De Alto Valor En Colombia: Análisis Bajo Topología De Redes Y Simulación De Pagos," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
  10. Bech, Morten L. & Chapman, James T.E. & Garratt, Rodney J., 2010. "Which bank is the "central" bank?," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 352-363, April.

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