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Substitution between net and gross settlement systems: A concern for financial stability?

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  • Craig, Ben
  • Fecht, Falko

Abstract

While net settlement systems make more efficient use of liquidity than gross settlement systems, they are known to generate systemic risk. What does that tendency imply for the stability of the payments [or financial] system when the two settlement systems coexist? Do liquidity shortages induce banks to settle more transactions in net settlement system, thereby increasing systemic risk? Or do banks require their counterparties to send payments through gross settlement system when default risks are high, increasing the need for liquidity and the money market rate but reducing overall systemic risk? This paper studies the factors that drive the relative importance of net and gross settlement systems over the short run, using daily data on transaction volumes from the large-volume payment systems of all euro area countries that have had both a net and a gross settlement system at the same time. Applying a large portfolio of different econometric techniques, we find that it is actually the transactions volumes in gross settlement systems that affect the daily price of liquidity and the credit risk spread in money markets. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2011,16.

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Date of creation: 2011
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Handle: RePEc:zbw:bubdp1:201116

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Keywords: Payment System; financial stability; interbank market; financial contagion;

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  1. Kahn, Charles M. & Roberds, William, 2001. "Real-time gross settlement and the costs of immediacy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(2), pages 299-319, April.
  2. Charles M. Kahn & James McAndrews & William Roberds, 1999. "Settlement risk under gross and net settlement," Staff Reports, Federal Reserve Bank of New York 86, Federal Reserve Bank of New York.
  3. Holthausen, Cornelia & Rochet, Jean-Charles, 2005. "Incorporating a "public good factor" into the pricing of large-value payment systems," Working Paper Series, European Central Bank 0507, European Central Bank.
  4. Charles M. Kahn & William Roberds, . "Payment System Settlement and Bank Incentives," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 97-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. Holthausen, Cornelia & Rochet, Jean-Charles, 2003. "Efficient Pricing of Large Value Interbank Payment Systems," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 185, Institut d'Économie Industrielle (IDEI), Toulouse.
  6. Lacker, Jeffrey M., 1997. "Clearing, settlement and monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 40(2), pages 347-381, October.
  7. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, Elsevier, vol. 22(1), pages 1-18, January.
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