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Credit in a Tiered Payments System

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  • Alexandra Lai
  • Nikil Chande
  • Sean O'Conner

Abstract

Payments systems are typically characterized by some degree of tiering, with upstream firms (clearing agents) providing settlement accounts to downstream institutions that wish to clear and settle payments indirectly in these systems (indirect clearers). Clearing agents provide their indirect clearers with an essential input (clearing and settlement services), while also competing directly with them in the retail market for payment services. The authors construct a model of a clearing agent with an indirect clearer to examine the clearing agent.s incentives to lever off its upstream position to gain a competitive advantage in the retail payment services market. The model demonstrates that a clearing agent can attain this competitive advantage by raising the indirect clearer.s costs, but that the incentive to raise these costs is mitigated by credit risk to the clearing agent from the provision of uncollateralized overdrafts to its indirect clearer. The results suggest that tiered payments systems, which require clearing agents to provide overdraft facilities to their indirect clearers, may result in a more competitive retail payment services market.

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Bibliographic Info

Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 126.

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Date of creation: Jan 2007
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Handle: RePEc:dnb:dnbwpp:126

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  1. Economides, Nicholas & Salop, Steven C, 1992. "Competition and Integration among Complements, and Network Market Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 105-23, March.
  2. Charles M. Kahn & William Roberds, 1997. "Payment system settlement and bank incentives," Proceedings 537, Federal Reserve Bank of Chicago.
  3. Alvaro Bustos & Alexander Galetovic, 2003. "Vertical Integration and Sabotage in Regulated Industries," Documentos de Trabajo 164, Centro de Economía Aplicada, Universidad de Chile.
  4. Jens Tapking & Jing Yang, 2004. "Horizontal and vertical integration in securities trading and settlement," Bank of England working papers 245, Bank of England.
  5. Holthausen, Cornelia & Tapking, Jens, 2007. "Raising rival's costs in the securities settlement industry," Journal of Financial Intermediation, Elsevier, vol. 16(1), pages 91-116, January.
  6. Economides, Nicholas, 1998. "The incentive for non-price discrimination by an input monopolist," International Journal of Industrial Organization, Elsevier, vol. 16(3), pages 271-284, May.
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Cited by:
  1. Jonathan Chiu & Alexandra Lai, 2007. "Modelling Payments Systems: A Review of the Literature," Working Papers 07-28, Bank of Canada.
  2. James Chapman & Jonathan Chiu & Miguel Molico, 2008. "A Model of Tiered Settlement Networks," Working Papers 08-12, Bank of Canada.

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