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Liquidity-saving mechanisms and bank behaviour

Author

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  • Galbiati, Marco

    () (Bank of England)

  • Soramaki, Kimmo

    () (Helsinki University of Technology)

Abstract

This paper investigates the effect of liquidity-saving mechanisms (LSMs) in interbank payment systems. We model a stylised two-stream payment system where banks choose (a) how much liquidity to post and (b) which payments to route into each of two ‘streams’: the RTGS stream, and an LSM stream. Looking at equilibrium choices we find that, when liquidity is expensive, the two-stream system is more efficient than the vanilla RTGS system without an LSM. This is because the LSM achieves better co-ordination of payments, without introducing settlement risk. However, the two-stream system still only achieves a second-best in terms of efficiency: in many cases, a central planner could further decrease system-wide costs by imposing higher liquidity holdings, and without using the LSM at all. Hence, the appeal of the LSM resides in its ability to ease (but not completely solve) strategic inefficiencies stemming from externalities and free-riding. Second, ‘bad’ equilibria too are theoretically possible in the two-stream system. In these equilibria banks post large amounts of liquidity and at the same time overuse the LSM. The existence of such equilibria suggests that some co-ordination device may be needed to reap the full benefits of an LSM. In all cases, these results are valid for this particular model of an RTGS payment system and the particular LSM.

Suggested Citation

  • Galbiati, Marco & Soramaki, Kimmo, 2010. "Liquidity-saving mechanisms and bank behaviour," Bank of England working papers 400, Bank of England.
    • Handle: RePEc:boe:boeewp:0400
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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2010/liquidity-saving-mechanisms-and-bank-behaviour.pdf
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    References listed on IDEAS

    as
    1. Beyeler, Walter E. & Glass, Robert J. & Bech, Morten L. & Soramäki, Kimmo, 2007. "Congestion and cascades in payment systems," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 384(2), pages 693-718.
    2. Kurt Johnson & James J. McAndrews & Kimmo Soramaki, 2004. "Economizing on liquidity with deferred settlement mechanisms," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 51-72.
    3. 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. Marius Jurgilas & Antoine Martin, 2013. "Liquidity-saving mechanisms in collateral-based RTGS payment systems," Annals of Finance, Springer, vol. 9(1), pages 29-60, February.
    2. Ball, Alan & Denbee, Edward & Manning, Mark & Wetherilt, Anne, 2011. "Financial Stability Paper No 11: Intraday Liquidity - Risk and Regulation," Bank of England Financial Stability Papers 11, Bank of England.
    3. Norman, Ben, 2010. "Financial Stability Paper No 7: Liquidity Saving in Real-Time Gross Settlement Systems - an Overview," Bank of England Financial Stability Papers 7, Bank of England.
    4. Jonnathan Cáceres Santos and René Aldazosa Inchauste, 2013. "Analizando el riesgo sistémico en Bolivia: una aplicación de modelos de topología de redes y simulación al funcionamiento del Sistema de Pagos de Alto Valor," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 17(2(2012)-1), pages 45-80, January.
    5. Constanza Martínez & Freddy Cepeda, 2016. "Free-riding on Liquidity in the Colombian LVPS," Borradores de Economia 977, Banco de la Republica de Colombia.
    6. Ashwin Clarke & Jennifer Hancock, 2012. "Payment System Design and Participant Operational Disruptions," RBA Research Discussion Papers rdp2012-05, Reserve Bank of Australia.

    More about this item

    Keywords

    Payment system; RTGS; liquidity-saving mechanism;

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General

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