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Optimizing Liquidity Usage and Settlement Speed in Payment Systems

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Author Info

  • Leinonen, Harry

    ()
    (Bank of Finland)

  • Soramäki, Kimmo

    ()

Abstract

The operating speed of a payment system depends on the stage of technology of the system's communication and information processing environment. Frequent intraday processing cycles and real-time processing have introduced new means of speeding up the processing and settlement of payments. In a real-time environment banks face new challenges in liquidity management. They need to plan for intraday as well as interday fluctuations in liquidity. By employing various types of hybrid settlement structures, banks may be able to even out intraday fluctuations in liquidity demand. The aim of this study is to develop a framework for analysing fluctuations in liquidity demand and assessing the efficiency of different settlement systems in terms of speed and liquidity needs. In this study we quantify the relationship between liquidity usage and settlement delay in net settlement systems, real-time gross settlement systems and hybrid systems, as well as the combined costs of liquidity and delay in these systems. We analyse ways of reducing costs via optimization features such as netting of queues, offsetting of payments and splitting of payments. We employ a payment system simulator developed at the Bank of Finland, which enables us to evaluate the impact of changes in system parameters and thus to compare the effects of alternative settlement schemes with given payment flows. The data used covers 100 days of actual payments processed in the Finnish BoF-RTGS system. Our major findings relate to risk reduction via real-time settlement, effects of optimization routines in hybrid systems, and the effects of liquidity costs on banks' choice of settlement speed. A system where settlement takes place continuously in real-time and with queuing features is more efficient from the perspective of liquidity and risks than a net settlement system with batch processing. Real-time processing enables a reduction in payment delay and risks without necessarily increasing liquidity needs. Participants will operate under immediate payment/settlement if liquidity costs are low enough relative to delay costs and if the liquidity arrangements are sufficiently flexible. The central bank can therefore support risk reduction and payment speed objectives by providing low cost intraday liquidity as well as more flexible ways for participants to add or withdraw liquidity from the system. Optimizing and gridlock solving features were found to be effective at very low levels of liquidity. The efficiency of the different optimization methods for settlement systems are affected by the actual flow of payments processed. Gains from netting schemes with multiple daily netting cycles were found to be somewhat more limited.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/9916.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 16/1999.

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Length: 39 pages
Date of creation: 12 Nov 1999
Date of revision:
Handle: RePEc:hhs:bofrdp:1999_016

Contact details of provider:
Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: payment systems; clearing/settlement; liquidity; efficiency; gridlock;

References

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  1. Dirk Schoenmaker & Peter M. Garber & D. F. I. Folkerts-Landau, 1996. "The Reform of Wholesale Payment Systems and its Impact on Financial Markets," IMF Working Papers 96/37, International Monetary Fund.
  2. Charles M. Kahn & William Roberds, . "Payment System Settlement and Bank Incentives," Center for Financial Institutions Working Papers 97-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
  3. Angelini, P. & Maresca, G. & Russo, D., 1996. "Systemic risk in the netting system," Journal of Banking & Finance, Elsevier, vol. 20(5), pages 853-868, June.
  4. Craig Furfine & Jeff Stehm, 1997. "Analyzing alternative intraday credit policies in real-time gross settlement systems," Finance and Economics Discussion Series 1997-40, Board of Governors of the Federal Reserve System (U.S.).
  5. Kuussaari, Harri, 1996. "Systemic Risk in the Finnish Payment System: an Empirical Investigation," Research Discussion Papers 3/1996, Bank of Finland.
  6. Freixas, Xavier & Parigi, Bruno, 1998. "Contagion and Efficiency in Gross and Net Interbank Payment Systems," Journal of Financial Intermediation, Elsevier, vol. 7(1), pages 3-31, January.
  7. Guntzer, Michael M. & Jungnickel, Dieter & Leclerc, Matthias, 1998. "Efficient algorithms for the clearing of interbank payments," European Journal of Operational Research, Elsevier, vol. 106(1), pages 212-219, April.
  8. James J. McAndews & George Wasilyew, 1995. "Simulations of failure in a payment system," Working Papers 95-19, Federal Reserve Bank of Philadelphia.
  9. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
  10. Christian Vital & David L. Mengle, 1988. "SIC: Switzerland's new electronic interbank payment system," Economic Review, Federal Reserve Bank of Richmond, issue Nov, pages 12-27.
  11. Humphrey, David B, 1996. "Comment on Intraday Bank Reserve Management: The Effects of Caps and Fees on Daylight Overdrafts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 909-13, November.
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Citations

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Cited by:
  1. Tanai Khiaonarong, 2004. "Payment systems efficiency, policy approaches, and the role of the central bank," Finance 0405004, EconWPA.
  2. Hellqvist , Matti & Laine, Tatu, 2012. "Diagnostics for the financial markets – computational studies of payment system: Simulator Seminar Proceedings 2009–2011," Scientific Monographs E:45/2012, Bank of Finland.
  3. Leinonen, Harry & Soramäki, Kimmo, 2003. "Simulating interbank payment and securities settlement mechanisms with the BoF-PSS2 simulator," Research Discussion Papers 23/2003, Bank of Finland.
  4. Iori, G. & Deissenberg, C., 2008. "An Analysis of Settlement Risk Contagion in Alternative Securities Settlement Architecture," Working Papers 08/03, Department of Economics, City University London.
  5. Devriese, Johan & Mitchell, Janet, 2006. "Liquidity risk in securities settlement," Journal of Banking & Finance, Elsevier, vol. 30(6), pages 1807-1834, June.
  6. Matthew Willison, 2005. "Real-Time Gross Settlement and hybrid payment systems: a comparison," Bank of England working papers 252, Bank of England.
  7. Khiaonarong, Tanai, 2003. "Payment systems efficiency, policy approaches, and the role of the central bank," Research Discussion Papers 1/2003, Bank of Finland.
  8. Kurt Johnson & James J. McAndrews & Kimmo Soramaki, 2004. "Economizing on liquidity with deferred settlement mechanisms," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 51-72.

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