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A Model of Interbank Settlement

  • Benjamin Lester

    ()

    (Department of Economics University of Pennsylvania)

A settlement system is a set of rules and procedures that govern when and how funds are transferred between banks. Perhaps the most crucial feature of a settlement system is the frequency with which settlement occurs. On the one hand, a higher frequency of settlement limits the risk of default should a bank be rendered insolvent. On the other hand, a lower frequency of settlement is less costly for banks to operate. We construct a model of the banking sector in which this trade-off between cost and risk arises endogenously. We then complete the economy with a trading sector that has a micro-founded role for credit as a media of exchange. The result is a general equilibrium model that allows for welfare and policy analysis. We parameterize the economy and study the optimal intra-day borrowing policy that the operator of a settlement system should impose on member banks. We also determine conditions under which one settlement system is more appropriate than another

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File URL: http://www.econ.upenn.edu/~lester/Lester_Settlement.pdf
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File URL: http://repec.org/sed2006/up.29560.1139600666.pdf
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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 282.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:282
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  2. Charles M. Kahn & William Roberds, 1999. "Real-time gross settlement and the costs of immediacy," FRB Atlanta Working Paper 98-21, Federal Reserve Bank of Atlanta.
  3. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2005. "Mechanism Design and Payments," 2005 Meeting Papers 11, Society for Economic Dynamics.
  4. Charles M. Kahn & James J. McAndrews & William Roberds, 1999. "Settlement risk under gross and net settlement," Staff Reports 86, Federal Reserve Bank of New York.
  5. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
  6. Charles M. Kahn & William Roberds, 1996. "Payment system settlement and bank incentives," FRB Atlanta Working Paper 96-10, Federal Reserve Bank of Atlanta.
  7. Berger, Allen N & Hancock, Diana & Marquardt, Jeffrey C, 1996. "A Framework for Analyzing Efficiency, Risks, Costs, and Innovations in the Payments System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 696-732, November.
  8. Martin, Antoine, 2004. "Optimal pricing of intraday liquidity," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 401-424, March.
  9. David C. Mills, 2005. "Alternative central bank credit policies for liquidity provision in a model of payments," Finance and Economics Discussion Series 2005-55, Board of Governors of the Federal Reserve System (U.S.).
  10. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  11. Philippe Aghion, Patrick Bolton & Steven Fries, 1999. "Optimal Design of Bank Bailouts: The Case of Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(1), pages 51-, March.
  12. Jean-Charles Rochet & Jean Tirole, 1996. "Controlling risk in payment systems," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 832-869.
  13. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  14. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
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