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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 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. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
  2. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Robert A. 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.
  4. Edward J. Green, 1996. "Money and Debt in the Structure of Payments," Macroeconomics 9609002, EconWPA, revised 09 Sep 1996.
  5. Scott Freeman, 1993. "Clearinghouse banks and banknote over-issue," Research Paper 9326, Federal Reserve Bank of Dallas.
  6. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  7. Charles M. Kahn & William Roberds, 1998. "On the role of bank coalitions in the provision of liquidity," Proceedings 590, Federal Reserve Bank of Chicago.
  8. Guiseppe Bertola & Ricardo J. Caballero, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Oxford University Press, vol. 61(2), pages 223-246.
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