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Settlement Systems

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  • Lester Benjamin

    () (University of Western Ontario)

Abstract

We construct a general equilibrium model in which credit is used as a medium of exchange, and banks participate in a settlement system to finalize their customers' transactions. We study the optimal settlement system design, and find that a trade-off arises endogenously within the model. A higher frequency of settlement and more costly intra-day borrowing policies limit the banks' accumulation of liabilities and promote conservative reserve management, hence limiting the risk of default should a bank fail for any reason. However, such policies also imply higher banking costs, less interest paid on deposits, and less capital allocated by banks to productive investments. After characterizing equilibrium and welfare, we parameterize the economy and analyze how the optimal settlement system policies depend on several features of the economy, including the risk of bank failure, the fragility of the settlement system, the volume of trade by banks' customers, and the rate of return on investments available to banks.

Suggested Citation

  • Lester Benjamin, 2009. "Settlement Systems," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-35, May.
  • Handle: RePEc:bpj:bejmac:v:9:y:2009:i:1:n:17
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    References listed on IDEAS

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    1. Martin, Antoine & McAndrews, James, 2008. "Liquidity-saving mechanisms," Journal of Monetary Economics, Elsevier, pages 554-567.
    2. Martin, Antoine & McAndrews, James, 2010. "A study of competing designs for a liquidity-saving mechanism," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1818-1826, August.
    3. Mills, David Jr., 2006. "Alternative central bank credit policies for liquidity provision in a model of payments," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1593-1611, October.
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    5. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-1138, December.
    6. Enghin Atalay & Antoine Martin & James J. McAndrews, 2008. "The welfare effects of a liquidity-saving mechanism," Staff Reports 331, Federal Reserve Bank of New York.
    7. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
    8. Kahn, Charles M & McAndrews, James & Roberds, William, 2003. " Settlement Risk under Gross and Net Settlement," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 591-608, August.
    9. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
    10. Greenspan, Alan, 1996. "Remarks on Evolving Payment System Issues," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 689-695, November.
    11. Morten L. Bech & Bart Hobijn, 2007. "Technology Diffusion within Central Banking: The Case of Real-Time Gross Settlement," International Journal of Central Banking, International Journal of Central Banking, vol. 3(3), pages 147-181, September.
    12. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
    13. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-151.
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    Cited by:

    1. Martin, Antoine & McAndrews, James, 2010. "A study of competing designs for a liquidity-saving mechanism," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1818-1826, August.
    2. Williamson, Stephen & Wright, Randall, 2010. "New Monetarist Economics: Models," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 2, pages 25-96 Elsevier.
    3. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.

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