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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

Suggested Citation

  • Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:282

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    References listed on IDEAS

    1. 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.
    2. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    3. Kahn, Charles M & McAndrews, James & Roberds, William, 2003. " Settlement Risk under Gross and Net Settlement," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 591-608, August.
    4. Freeman, Scott, 1999. "Rediscounting under aggregate risk," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 197-216, February.
    5. Kahn, Charles M & Roberds, William, 1998. "Payment System Settlement and Bank Incentives," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 845-870.
    6. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2005. "Mechanism Design and Payments," 2005 Meeting Papers 11, Society for Economic Dynamics.
    7. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-1138, December.
    8. Allen N. Berger & Diana Hancock & Jeffrey C. Marquardt, 1996. "A framework for analyzing efficiency, risks, costs and innovations in the payments system," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 696-732.
    9. Mills, David Jr., 2006. "Alternative central bank credit policies for liquidity provision in a model of payments," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1593-1611, October.
    10. Kahn, Charles M. & Roberds, William, 2001. "Real-time gross settlement and the costs of immediacy," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 299-319, April.
    11. 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, May.
    12. Martin, Antoine, 2004. "Optimal pricing of intraday liquidity," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 401-424, March.
    13. Lester Benjamin, 2009. "Settlement Systems," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-35, May.
    14. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-151.
    15. 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 1-51, March.
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    Cited by:

    1. George Selgin, 2012. "Mere quibbles: Bagus and Howden’s critique of the theory of free banking," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 25(2), pages 131-148, June.
    2. Philipp Bagus & David Howden, 2012. "Still unanswered quibbles with fractional reserve free banking," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 25(2), pages 159-171, June.
    3. Junfeng Qiu, 2011. "Bank money, aggregate liquidity, and asset prices," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 295-346, November.

    More about this item


    Payment Systems; Banking; Liquidity;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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