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Payment system settlement and bank incentives

  • Charles M. Kahn
  • William Roberds

In this paper we consider the relative merits of net versus gross settlement of interbank payments. Net settlement economizes on the costs of holding non-interest-bearing reserves but increases moral hazard problems. The "put option" value of default under net settlement can also distort banks' investment incentives. ; Absent these distortions, net settlement dominates gross, although the optimal net settlement scheme may involve a positive probability of default. Net settlement becomes more attractive relative to gross settlement if bank assets have to be liquidated at less than book value.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper No. with number 96-10.

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Date of creation: 1996
Date of revision:
Publication status: Published in Review of Financial Studies, Winter 1998
Handle: RePEc:fip:fedawp:96-10
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  1. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-62, November.
  2. Scott Freeman, 1993. "Clearinghouse banks and banknote over-issue," Research Paper 9326, Federal Reserve Bank of Dallas.
  3. Giuseppe Bertola & Ricardo J. Caballero, 1991. "Irreversibility and Aggregate Investment," NBER Working Papers 3865, National Bureau of Economic Research, Inc.
  4. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  5. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  6. Robert Eisenbeis, 1987. "Eroding market imperfections: implications for financial intermediaries, the payments system, and regulatory reform," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 19-62.
  7. Edward J. Green, 1999. "Money and debt in the structure of payments," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 13-29.
  8. Charles M. Kahn & William Roberds, 1998. "On the role of bank coalitions in the provision of liquidity," Proceedings 590, Federal Reserve Bank of Chicago.
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