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How do different models of foreign exchange settlement influence the risks and benefits of global liquidity management?

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  • Jochen Schanz

    (Bank of England)

Abstract

Large, international banking groups have sought to centralise their cross-currency liquidity management: liquidity shortages in one currency are financed using liquidity surpluses in another currency. The nature of risks to financial stability emerging from global liquidity management depends on how these foreign exchange transactions settle. I analyse these risks in a game of asymmetric information. The main result is that the transition from local to global liquidity management, and better co-ordination in settlement of foreign exchange transactions, have two effects. On the one hand, the likelihood rises that payments are delayed beyond their due date. On the other hand, solvency shocks are less likely to be passed on to other banks. The main assumption is that lending between subsidiaries of the same banking group takes place under symmetric information, while external interbank market loans are extended under asymmetric information. More co-ordinated settlement increases the exposure of the intragroup lender relative to the interbank lender and leads to more informed lending.

Suggested Citation

  • Jochen Schanz, 2009. "How do different models of foreign exchange settlement influence the risks and benefits of global liquidity management?," Bank of England working papers 374, Bank of England.
    • Handle: RePEc:boe:boeewp:0374
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    References listed on IDEAS

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    5. David S. Scharfstein & Jeremy C. Stein, 2000. "The Dark Side of Internal Capital Markets: Divisional Rent‐Seeking and Inefficient Investment," Journal of Finance, American Finance Association, vol. 55(6), pages 2537-2564, December.
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    7. Mark J Manning & Matthew Willison, 2006. "Modelling the cross-border use of collateral in payment systems," Bank of England working papers 286, Bank of England.
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    Cited by:

    1. Foote, Elizabeth, 2014. "Information asymmetries and spillover risk in settlement systems," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 179-190.
    2. Vollmer, Uwe & Wiese, Harald, 2014. "Explaining breakdowns in interbank lending: A bilateral bargaining model," Finance Research Letters, Elsevier, vol. 11(3), pages 247-253.

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    More about this item

    Keywords

    Liquidity risk; foreign exchange settlement;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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