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Settlement liquidity and monetary policy implementation—lessons from the financial crisis

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  • Morten L. Bech
  • Antoine Martin
  • James J. McAndrews

Abstract

The U.S. dollar clearing and settlement system received little attention during the recent financial crisis, mainly because it performed reliably, processing record volumes and values of trades made in stressed financial markets. This article shows how Federal Reserve policy measures aimed at providing liquidity and stability to the financial system during and after the crisis had a major impact on settlement liquidity and thus on the efficiency of clearing and settlement system activity. The measures led to a substantial decrease in daylight overdrafts extended by the Federal Reserve and a quickening of settlement relative to the precrisis period. The decrease in daylight overdrafts reduced credit risk for the Federal Reserve and the earlier time at which payments settled suggests important efficiency gains as well as diminished operational risks. Interestingly, both improvements were the focus of the revisions to the Federal Reserve’s Payment System Risk policy, adopted in late 2008 and implemented in March 2011. To a large extent, the desired outcome had been achieved ahead of the policy change. The authors explain that as the amount of reserves available to the banking system and the opportunity cost of holding such reserves are at the center of any framework for implementing monetary policy, the recent experience offers important lessons for policy going forward.

Suggested Citation

  • Morten L. Bech & Antoine Martin & James J. McAndrews, 2012. "Settlement liquidity and monetary policy implementation—lessons from the financial crisis," Economic Policy Review, Federal Reserve Bank of New York, issue Mar, pages 3-20.
  • Handle: RePEc:fip:fednep:y:2012:i:mar:p:3-20:n:v.18no.1
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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, vol. 55(3), pages 554-567, April.
    2. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.
    3. James J. McAndrews & Simon M. Potter, 2002. "Liquidity effects of the events of September 11, 2001," Economic Policy Review, Federal Reserve Bank of New York, issue Nov, pages 59-79.
    4. 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.
    5. Martin, Antoine, 2004. "Optimal pricing of intraday liquidity," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 401-424, March.
    6. Mills Jr., David C. & Nesmith, Travis D., 2008. "Risk and concentration in payment and securities settlement systems," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 542-553, April.
    7. Bech, Morten L. & Klee, Elizabeth, 2011. "The mechanics of a graceful exit: Interest on reserves and segmentation in the federal funds market," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 415-431.
    8. Christopher Becher & Marco Galbiati & Merxe Tudela, 2008. "The timing and funding of CHAPS sterling payments," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 113-133.
    9. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
    10. Morten L. Bech & Rodney J. Garratt, 2012. "Illiquidity in the Interbank Payment System Following Wide‐Scale Disruptions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(5), pages 903-929, August.
    11. David Bowman & Etienne Gagnon & Michael P. Leahy, 2010. "Interest on excess reserves as a monetary policy instrument: the experience of foreign central banks," International Finance Discussion Papers 996, Board of Governors of the Federal Reserve System (U.S.).
    12. Enghin Atalay & Antoine Martin & James J. McAndrews, 2010. "Quantifying the benefits of a liquidity-saving mechanism," Staff Reports 447, Federal Reserve Bank of New York.
    13. Morten L. Bech & Christine Preisig & Kimmo Soramäki, 2008. "Global trends in large-value payments," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 59-81.
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    Citations

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    Cited by:

    1. Ron Berndsen & Ronald Heijmans, 2017. "Risk indicators for financial market infrastructure: from high frequency transaction data to a traffic light signal," DNB Working Papers 557, Netherlands Central Bank, Research Department.
    2. repec:eee:jmacro:v:54:y:2017:i:pb:p:208-216 is not listed on IDEAS
    3. McAndrews, James J. & Kroeger, Alexander, 2016. "The payment system benefits of high reserve balances," Staff Reports 779, Federal Reserve Bank of New York.
    4. Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2012. "Funding, Collateral and Hedging: uncovering the mechanics and the subtleties of funding valuation adjustments," Papers 1210.3811, arXiv.org, revised Dec 2012.
    5. Marco Macchiavelli & Thomas Keating, 2017. "Interest on Reserves and Arbitrage in Post-Crisis Money Markets," Finance and Economics Discussion Series 2017-124, Board of Governors of the Federal Reserve System (U.S.).
    6. Peter Heemeijer & Ronald Heijmans, 2015. "Central bank intervention in large value payment systems: An experimental approach," DNB Working Papers 466, Netherlands Central Bank, Research Department.

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