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The economics of payment finality

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  • Charles M. Kahn
  • William Roberds

Abstract

Payment finality is critical to decentralized exchange. By specifying how the transfer of one type of claim extinguishes another, the rules governing finality minimize opportunities for default along credit chains and allocate other risks. ; The authors provide a basic analysis of finality and its role in facilitating exchange. They first present a simple, historically based model of transferable debt and finality. The discussion demonstrates the desirability of transferable debt and why rules governing payment finality are needed to sort out who will bear the losses in the event of default. Over time, the introduction of such rules helped establish the concept of negotiability, which greatly increased the efficiency of trade. ; A second model shows how a more modern payment system works. The large volume and scope of payments in modern systems have resulted in disparate sets of finality rules. For example, the finality of check payments is generally tentative, and the risks are often concentrated on a single party. Credit and debit card payments are generally more final, and the liability for potential losses tends to be shared among participants. Choosing the degree of finality for a given situation involves a trade-off between the benefits of finality and the costs of an erroneous or fraudulent transfer. The introduction of new technologies for payments may improve these trade-offs, but finality will remain the essential service provided.

Suggested Citation

  • Charles M. Kahn & William Roberds, 2002. "The economics of payment finality," Economic Review, Federal Reserve Bank of Atlanta, issue Q2, pages 1-12.
  • Handle: RePEc:fip:fedaer:y:2002:i:q2:p:1-12:n:v.87no.2
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    References listed on IDEAS

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    1. David Humphrey & Lawrence Pulley & Jukka Vesala, 2000. "The Check's in the Mail: Why the United States Lags in the Adoption of Cost-Saving Electronic Payments," Journal of Financial Services Research, Springer;Western Finance Association, vol. 17(1), pages 17-39, February.
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    Cited by:

    1. Stephen F. Quinn & William Roberds, 2012. "The Bank of Amsterdam through the lens of monetary competition," FRB Atlanta Working Paper 2012-14, Federal Reserve Bank of Atlanta.
    2. Thorsten Koeppl & Cyril Monnet & Theodosios Temzelides, 2007. "A dynamic model of the payment system," Working Papers 07-22, Federal Reserve Bank of Philadelphia.
    3. Stephen Millard, 2007. "The foundations of money, payments and central banking: A review essay," Money Macro and Finance (MMF) Research Group Conference 2006 106, Money Macro and Finance Research Group.
    4. Richard J. Sullivan, 2012. "The Federal Reserve’s reduced role in retail payments: implications for efficiency and risk," Economic Review, Federal Reserve Bank of Kansas City, issue Q III.
    5. Thor Koeppl & Cyril Monnet & Ted Temzelides, 2007. "Payments and Mechanism Design," Working Papers 1124, Queen's University, Department of Economics.

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    Keywords

    Payment systems ; Credit cards ; Checks;

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