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Payment system settlement and bank incentives

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  • Charles M. Kahn
  • William Roberds

Abstract

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. Journal of Economic Literature Classification Numbers G21, G28. This paper was presented at the Financial Institutions Center's conference on Performance of Financial Institutions, May 8-10, 1997.
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  • Charles M. Kahn & William Roberds, 1997. "Payment system settlement and bank incentives," Proceedings 537, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhpr:537
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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