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Liquidity-saving mechanisms and bank behaviour

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  • Galbiati, Marco

    ()
    (Bank of England)

  • Soramaki, Kimmo

    ()
    (Helsinki University of Technology)

Abstract

This paper investigates the effect of liquidity-saving mechanisms (LSMs) in interbank payment systems. We model a stylised two-stream payment system where banks choose (a) how much liquidity to post and (b) which payments to route into each of two ‘streams’: the RTGS stream, and an LSM stream. Looking at equilibrium choices we find that, when liquidity is expensive, the two-stream system is more efficient than the vanilla RTGS system without an LSM. This is because the LSM achieves better co-ordination of payments, without introducing settlement risk. However, the two-stream system still only achieves a second-best in terms of efficiency: in many cases, a central planner could further decrease system-wide costs by imposing higher liquidity holdings, and without using the LSM at all. Hence, the appeal of the LSM resides in its ability to ease (but not completely solve) strategic inefficiencies stemming from externalities and free-riding. Second, ‘bad’ equilibria too are theoretically possible in the two-stream system. In these equilibria banks post large amounts of liquidity and at the same time overuse the LSM. The existence of such equilibria suggests that some co-ordination device may be needed to reap the full benefits of an LSM. In all cases, these results are valid for this particular model of an RTGS payment system and the particular LSM.

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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 400.

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Length: 28 pages
Date of creation: 29 Jul 2010
Date of revision:
Handle: RePEc:boe:boeewp:0400

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Keywords: Payment system; RTGS; liquidity-saving mechanism;

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References

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  1. Morten L. Bech & Christine Preisig & Kimmo Soramäki, 2008. "Global trends in large-value payments," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Sep, pages 59-81.
  2. Beyeler, Walter E. & Glass, Robert J. & Bech, Morten L. & Soramäki, Kimmo, 2007. "Congestion and cascades in payment systems," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 384(2), pages 693-718.
  3. Kurt Johnson & James J. McAndrews & Kimmo Soramaki, 2004. "Economizing on liquidity with deferred settlement mechanisms," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Dec, pages 51-72.
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Cited by:
  1. Marius Jurgilas & Antoine Martin, 2010. "Liquidity-saving mechanisms in collateral-based RTGS payment systems," Staff Reports, Federal Reserve Bank of New York 438, Federal Reserve Bank of New York.
  2. Ashwin Clarke & Jennifer Hancock, 2012. "Payment System Design and Participant Operational Disruptions," RBA Research Discussion Papers, Reserve Bank of Australia rdp2012-05, Reserve Bank of Australia.

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