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Modelling the cross-border use of collateral in payment systems

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  • Mark J Manning
  • Matthew Willison
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    Abstract

    Banks often rely on collateralised intraday liquidity from the central bank in order to be able to effect payments in a real-time gross settlement (RTGS) payment system. If a bank is holding insufficient eligible collateral in a particular country, and therefore cannot obtain credit from the local central bank, it may have to delay payments. This constitutes a liquidity risk to the system. Furthermore, a bank operating in multiple systems may face a mismatch between the location of its collateral holdings and liquidity needs. In this paper, we examine the extent to which the liquidity risk arising from such a mismatch may be mitigated by allowing cross-border use of collateral. We develop a two-country, two-bank model in which risk-neutral banks minimise expected costs with respect to their collateral choice in each country. In our baseline model, in which each bank faces a liquidity need in only one country, we find that liquidity risk is indeed reduced by cross-border use of collateral. This result holds despite the fact that banks may find it optimal to economise on their total holdings of collateral. However, when we extend the model to allow for the possibility that a bank faces liquidity needs in both countries simultaneously, the total quantum of collateral held is important. Indeed, when a bank finds it optimal to reduce its total holdings, there may be an increase in liquidity risk in at least one country when simultaneous liquidity demands are realised.

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    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2006/WP286.pdf
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    Paper provided by Bank of England in its series Bank of England working papers with number 286.

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    Date of creation: Jan 2006
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    Handle: RePEc:boe:boeewp:286

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    1. Baltensperger, Ernst, 1974. "The Precautionary Demand for Reserves," American Economic Review, American Economic Association, vol. 64(1), pages 205-10, March.
    2. Kobayakawa, Shuji, 1997. "The Comparative Analysis of Settlement Systems," CEPR Discussion Papers 1667, C.E.P.R. Discussion Papers.
    3. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," Working Paper 98-21, Federal Reserve Bank of Atlanta.
    4. Heller, Daniel & Lengwiler, Yvan, 2003. "Payment obligations, reserve requirements, and the demand for central bank balances," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 419-432, March.
    5. Bech, Morten L. & Garratt, Rod, 2001. "The Intraday Liquidity Management Game," University of California at Santa Barbara, Economics Working Paper Series qt0m6035wg, Department of Economics, UC Santa Barbara.
    6. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
    7. Chakravorti, Sujit, 2000. "Analysis of systemic risk in multilateral net settlement systems," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(1), pages 9-30, January.
    8. 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. Cronin, David, 2011. "Large-Value Payment System Design and Risk Management," Quarterly Bulletin Articles, Central Bank of Ireland, pages 78-88, January.
    2. John P Jackson & Mark J Manning, 2007. "Comparing the pre-settlement risk implications of alternative clearing arrangements," Bank of England working papers 321, Bank of England.
    3. 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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