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On the efficiency of cash settlement

  • Charles M. Kahn
  • William Roberds

This paper investigates the question of why banks almost always settle payments in cash as opposed to debt. Our model suggests that adverse selection with respect to the quality of bank assets may be the primary motivation underlying this practice. Banks with higher-quality assets prefer not to exchange debt with other banks if their debt is indistinguishable from that of banks with lower-quality assets. Banks with higher-quality assets prefer to sell off assets to informed outside agents in return for cash, which can then be used in settlement. Willingness to settle in cash serves as a signal of the quality of a bank's assets; hence, in equilibrium all banks settle in cash. If information flows are disrupted so that no outsiders are informed, then the signaling value of cash settlement is lost. The last result is consistent with the use of debt-based settlement schemes during the National Banking Era (1864-1914).

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 95-11.

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Date of creation: 1995
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Handle: RePEc:fip:fedawp:95-11
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  1. S. Rao Aiyagari, 1989. "Gresham's Law in a Lemons Market for Assets," Canadian Journal of Economics, Canadian Economics Association, vol. 22(3), pages 686-97, August.
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  3. Charles W. Calomiris & Gary Gorton, 1991. "The Origins of Banking Panics: Models, Facts, and Bank Regulation," NBER Chapters, in: Financial Markets and Financial Crises, pages 109-174 National Bureau of Economic Research, Inc.
  4. Timberlake, Richard H., 1993. "Monetary Policy in the United States," University of Chicago Press Economics Books, University of Chicago Press, edition 1, number 9780226803845.
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  6. Williamson, S. & Wright, R., 1991. "Barter and Monetary Exchange Under Private Information," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9107, University of Western Ontario, The Centre for the Study of International Economic Relations.
  7. Frederic S. Mishkin, 1991. "Asymmetric Information and Financial Crises: A Historical Perspective," NBER Chapters, in: Financial Markets and Financial Crises, pages 69-108 National Bureau of Economic Research, Inc.
  8. Gorton, Gary, 1985. "Clearinghouses and the Origin of Central Banking in the United States," The Journal of Economic History, Cambridge University Press, vol. 45(02), pages 277-283, June.
  9. Hugh Cohen & William Roberds, 1993. "Towards the systematic measurement of systemic risk," Working Paper 93-14, Federal Reserve Bank of Atlanta.
  10. Williamson, Stephen D., 1992. "Laissez-faire banking and circulating media of exchange," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 134-167, June.
  11. Timberlake, Richard H, Jr, 1984. "The Central Banking Role of Clearinghouse Associations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(1), pages 1-15, February.
  12. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  13. Selgin, G., 1993. "In Defence of Bank Suspension," Papers 367, Georgia - College of Business Administration, Department of Economics.
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  15. Donaldson, R. Glen, 1992. "Costly liquidation, interbank trade, bank runs and panics," Journal of Financial Intermediation, Elsevier, vol. 2(1), pages 59-82, March.
  16. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
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