Liquidity costs and tiering in large-value payment systems
AbstractThis paper develops and simulates a model of the emergence of networks in an interbank, RTGS payment system. A number of banks, faced with random streams of payment orders, choose whether to link directly to the payment system, or to use a correspondent bank. Settling payments directly on the system imposes liquidity costs which depend on the maximum liquidity overdraft incurred during the day. On the other hand, using a correspondent entails paying a flat fee, charged by the correspondent to recoup liquidity costs and to extract a profit. We specify a protocol whereby one bank in each period can revisit its choice whether to link directly to the system, or to become clients of other banks, thus generating a dynamic client-correspondent network. We simulate this protocol, observing the emergence of different network structures. The liquidity pricing regime chosen by a central bank is found to affect the tiering process and the network structures it produces. A calibration exercise on data from the UK CHAPS system suggests that the model is able to generate realistic predictions, ie a network topology similar to that observed in reality, driven solely by the underlying pattern of payments and the structure of liquidity costs.
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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 399.
Length: 22 pages
Date of creation: 29 Jul 2010
Date of revision:
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Tiering; liquidity cost; large-value payment system; RTGS; network formation;
Find related papers by JEL classification:
- C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
- G20 - Financial Economics - - Financial Institutions and Services - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-08-06 (All new papers)
- NEP-BAN-2010-08-06 (Banking)
- NEP-NET-2010-08-06 (Network Economics)
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