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Quantifying the Economic Benefits of Payments Modernization: the Case of the Large-Value Payment System

Author

Listed:
  • Neville Arjani
  • Fuchun Li
  • Zhentong Lu

Abstract

In this paper, we develop a discrete choice framework to quantify the economic benefits of payments modernization in Canada. Focusing on Canada’s large-value transfer system (LVTS), we first estimate participants’ preferences for liquidity cost, payment safety and the network effect by exploiting intraday variations in the relative choice probabilities of the two substitutable sub-systems in the LVTS (i.e., Tranches 1 and 2). Then, with the estimated model, we conduct counterfactual simulations to calculate the changes in participants’ welfare when the LVTS is replaced by a real-time gross settlement system (RTGS), like Lynx (as an important part of the payments modernization initiative). The results show that, first, compared to the old system, Lynx has higher liquidity costs but is more secure, while the former is considered a more important factor by system participants. Second, when over 90% of current LVTS payments migrate to Lynx, there is an overall welfare gain; however, it maybe difficult to achieve such a high migration ratio in the new market equilibrium. Third, accounting for equilibrium adjustment, about a 75% service level improvement is needed to generate overall net economic benefits to participants. Among other things, adopting a liquidity savings mechanism and reducing risks in the new system could help achieve this improvement. Finally, the welfare changes are quite heterogeneous, especially between large and small participants.

Suggested Citation

  • Neville Arjani & Fuchun Li & Zhentong Lu, 2021. "Quantifying the Economic Benefits of Payments Modernization: the Case of the Large-Value Payment System," Staff Working Papers 21-64, Bank of Canada.
    • Handle: RePEc:bca:bocawp:21-64
    DOI: 10.34989/swp-2021-64
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    References listed on IDEAS

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    3. Anneke Kosse & Zhentong Lu & Gabriel Xerri, 2020. "An Economic Perspective on Payments Migration," Staff Working Papers 20-24, Bank of Canada.
    4. Kim McPhail & Anastasia Vakos, 2003. "Excess Collateral in the LVTS: How Much is Too Much?," Staff Working Papers 03-36, Bank of Canada.
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    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • G1 - Financial Economics - - General Financial Markets
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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