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How do different models of foreign exchange settlement influence the risks and benefits of global liquidity management?

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  • Schanz, Jochen

    ()
    (Bank of England)

Abstract

Large, international banking groups have sought to centralise their cross-currency liquidity management: liquidity shortages in one currency are financed using liquidity surpluses in another currency. The nature of risks to financial stability emerging from global liquidity management depends on how these foreign exchange transactions settle. I analyse these risks in a game of asymmetric information. The main result is that the transition from local to global liquidity management, and better co-ordination in settlement of foreign exchange transactions, have two effects. On the one hand, the likelihood rises that payments are delayed beyond their due date. On the other hand, solvency shocks are less likely to be passed on to other banks. The main assumption is that lending between subsidiaries of the same banking group takes place under symmetric information, while external interbank market loans are extended under asymmetric information. More co-ordinated settlement increases the exposure of the intragroup lender relative to the interbank lender and leads to more informed lending.

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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 374.

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Length: 58 pages
Date of creation: 24 Aug 2009
Date of revision:
Handle: RePEc:boe:boeewp:0374

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Keywords: Liquidity risk; foreign exchange settlement;

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  1. Tapking, Jens, 2003. "Multiple equilibrium overnight rates in a dynamic interbank market game," Discussion Paper Series 1: Economic Studies 2003,04, Deutsche Bundesbank, Research Centre.
  2. Gary Gorton & Lixin Huang, 2002. "Liquidity, Efficiency and Bank Bailouts," Center for Financial Institutions Working Papers 02-33, Wharton School Center for Financial Institutions, University of Pennsylvania.
  3. Mallick, Indrajit, 2004. "Inefficiency of bilateral bargaining in interbank markets," International Review of Economics & Finance, Elsevier, vol. 13(1), pages 43-55.
  4. David R. Skeie, 2004. "Money and Modern Bank Runs," 2004 Meeting Papers 785, Society for Economic Dynamics.
  5. Fujiki, Hiroshi, 2006. "Institutions of Foreign Exchange Settlement in a Two-Country Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 697-719, April.
  6. Christian Ewerhart & Nuno Cassola & Steen Ejerskov & Natacha Valla, . "Liquidity, Information, and the Overnight Rate," IEW - Working Papers 186, Institute for Empirical Research in Economics - University of Zurich.
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Cited by:
  1. Foote, Elizabeth, 2014. "Information asymmetries and spillover risk in settlement systems," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 179-190.

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