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A Model of Interbank Settlement

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  • Benjamin Lester

    ()
    (Department of Economics University of Pennsylvania)

Abstract

A settlement system is a set of rules and procedures that govern when and how funds are transferred between banks. Perhaps the most crucial feature of a settlement system is the frequency with which settlement occurs. On the one hand, a higher frequency of settlement limits the risk of default should a bank be rendered insolvent. On the other hand, a lower frequency of settlement is less costly for banks to operate. We construct a model of the banking sector in which this trade-off between cost and risk arises endogenously. We then complete the economy with a trading sector that has a micro-founded role for credit as a media of exchange. The result is a general equilibrium model that allows for welfare and policy analysis. We parameterize the economy and study the optimal intra-day borrowing policy that the operator of a settlement system should impose on member banks. We also determine conditions under which one settlement system is more appropriate than another

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 282.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:282

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Related research

Keywords: Payment Systems; Banking; Liquidity;

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References

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  1. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
  2. Jean-Charles Rochet & Jean Tirole, 1996. "Controlling risk in payment systems," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 832-869.
  3. Kahn, Charles M. & Roberds, William, 2001. "Real-time gross settlement and the costs of immediacy," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 299-319, April.
  4. Ted Temzelides & Cyril Monnet & Thor Koeppl, 2007. "Mechanism design and Payments," 2007 Meeting Papers 23, Society for Economic Dynamics.
  5. David C. Mills, Jr., 2005. "Alternative central bank credit policies for liquidity provision in a model of payments," Finance and Economics Discussion Series 2005-55, Board of Governors of the Federal Reserve System (U.S.).
  6. Lester Benjamin, 2009. "Settlement Systems," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-35, May.
  7. Michael J. Fleming & Kenneth D. Garbade, 2002. "When the back office moved to the front burner: settlement fails in the treasury market after 9/11," Economic Policy Review, Federal Reserve Bank of New York, issue Nov, pages 35-57.
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Cited by:
  1. Stephen P Millard & Matthew Willison, 2004. "The welfare benefits of stable and efficient payment systems," Money Macro and Finance (MMF) Research Group Conference 2004 36, Money Macro and Finance Research Group.
  2. Junfeng Qiu, 2011. "Bank money, aggregate liquidity, and asset prices," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 295-346, November.
  3. Jonathan Chiu & Alexandra Lai, 2007. "Modelling Payments Systems: A Review of the Literature," Working Papers 07-28, Bank of Canada.

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