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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. 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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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 97-32.

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Handle: RePEc:wop:pennin:97-32
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  1. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  2. 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.
  3. Scott Freeman, 1993. "Clearinghouse banks and banknote over-issue," Research Paper 9326, Federal Reserve Bank of Dallas.
  4. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  5. Edward J. Green, 1996. "Money and Debt in the Structure of Payments," Macroeconomics 9609002, EconWPA, revised 09 Sep 1996.
  6. Charles M. Kahn & William Roberds, 1998. "On the role of bank coalitions in the provision of liquidity," Proceedings 590, Federal Reserve Bank of Chicago.
  7. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-51.
  8. Robert 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.
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