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Settlement Speed and Financial Stability

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Abstract

This paper investigates how settlement speed affects financial stability in payment networks, taking into account netting benefits, liquidity costs, and counterparty risks. Our analysis reveals that faster settlements have ambiguous effects on systemic risk and social welfare. The optimal settlement speed is determined by the network structure and the trade-off between netting efficiency and liquidity costs on one hand, and the probability of counterparty defaults on the other. Notably, we identify conditions, particularly under liquidity stress, where faster settlement can paradoxically increase systemic risk by amplifying crisis severity, even while reducing crisis probability. Our results have important policy implications, arguing against a one-size-fits-all approach to settlement speed design.

Suggested Citation

  • Agostino Capponi & Jin-Wook Chang, 2025. "Settlement Speed and Financial Stability," Finance and Economics Discussion Series 2025-101, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2025-101
    DOI: 10.17016/FEDS.2025.101
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    References listed on IDEAS

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    1. Hancock, Diana & Wilcox, James A, 1996. "Intraday Management of Bank Reserves: The Effects of Caps and Fees on Daylight Overdrafts," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 870-908, November.
    2. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2008. "A dynamic model of settlement," Journal of Economic Theory, Elsevier, vol. 142(1), pages 233-246, September.
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    Keywords

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    JEL classification:

    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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