Finance and Economics Discussion Series (FEDS)
December 2007
Risk and Concentration in Payment and Securities Settlement Systems
David C. Mills, Jr. and Travis D. Nesmith
Abstract:
Large value payment and securities settlement systems are important components of an economy's financial system. Many such systems are operated by central banks and are liquidity intensive. Central banks often provide inexpensive liquidity to facilitate settlement. This leads to a number of policy questions about the provision of such liquidity. To answer these questions, central banks need to understand what factors influence the timing of settlement. This paper offers a model to better understand intraday patterns of settlement and identifies three factors that influence the timing of settlement: the cost of intraday liquidity, a participant's exposure to settlement risk, and system design. Incorporating all three factors enables our model to explain a number of stylized facts concerning behavior within the Federal Reserve's Fedwire fund and securities systems around a major policy change. In particular, the model captures the different responses of the two systems in both the pattern of settlement and the use of intraday liquidity. The results map out how policy interacts with participants' incentives to influence the use of intraday liquidity and the resultant credit exposure of a central bank. The model, therefore, can inform decision-making at central banks.
Full Paper (Screen Reader Version)Keywords: Interbank payments, securities settlement, strategic games, bank behavior
PDF: Full Paper
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