Payment Economics Network (PEN)

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About the network

Purpose

News

September 2012 - Publication of 1st issue of the Journal of Financial Market Infrastructures

This journal seeks to provide a platform for researchers and practitioners with an interest in payment systems, central counterparties, central securities depositories and trade repositories. It will be published on a quarterly basis and acts as an online forum promoting active discussions on the subject of financial market infrastructures.
April 2012 - The SWIFT Institute was founded
The SWIFT Institute focuses on understanding current practice and future needs in global financial services, looking primarily at transaction banking, and promotes research by offering grants, facilitating access to research data and providing publication opportunities. The SWIFT Institute has issued its first call for proposals and is organising its first conference (in cooperation with the Harvard Kennedy School) in February 2013.

The PEN seeks to link policy practices and research activities in the field of payment systems and post-trading infrastructure. This web page fosters the exchange of information by serving as a point of reference for conference announcements, research papers, data sources and news in the field of payment economics.

The quantity and quality of research on issues relating to payment and settlement systems has increased substantially over the past few years. However, payment economics has not yet gained the recognition or infrastructure that other central bank-related research fields enjoy. As a first step towards filling that gap and as an attempt to further strengthen the link between research and practice, the ECB has joined forces with colleagues at other central banks, as well as academics, and established an informal payment economics network for interested central bankers and academics around the world.

The small team that coordinates the PEN includes representatives of the Reserve Bank of Australia, the Bank of Canada, the Bank of England, the European Central Bank, De Nederlandsche Bank and the Federal Reserve Banks of Chicago and New York.

Main research areas

Payment economics covers a variety of issues relating to large-value and retail payment systems, central clearing counterparties (CCPs) and securities settlement systems in general. Research papers fall into three broad categories:

Large Value Payment Systems

This is the most well-established area of payment economics literature and comprises both theoretical contributions and empirical studies. The latter can be divided into five categories: (i) liquidity; (ii) patterns, timing and participants’ behaviour; (iii) interbank money markets; (iv) topology and network analysis; and (v) simulations of counterfactual scenarios.

Retail payment systems

Research on retail payments includes studies looking at credit cards and mobile and electronic payments. It aims to identify types of consumer behaviour, quantify the impact of technological and regulatory advances in the industry, and propose new ideas and features in the field of retail payments.

Settlement systems

Analysis of post-trading infrastructure represents the newest branch of payment economics. Studies looking at the modelling and simulation of CCP settlement – including analysis of newly proposed regulations and the concept of CCPs as public goods – fall into this category, as do studies of other settlement systems, alternative proposals for new clearing networks and discussions about over-the-counter (OTC) transactions.

Data sources

Data sources have traditionally been the biggest obstacle to research studies in the field of payment economics owing to technical constraints and the problems posed by proprietary databases and confidentiality agreements. However, it has recently become easier for practitioners and academics to access and use transaction-level data.

The SWIFT Institute, which was launched in April 2012, fosters independent research by giving grants and access to research data to academics, industry professionals and central bank experts. The SWIFT Institute regularly publishes calls for proposals and call for papers.

The ECB’s Statistical Data Warehouse (SDW) provides a wide range of data relating to payment and securities settlement systems in the European Union.

Contact

If you would like to join the network, make us aware of new papers, conferences or other relevant developments, or simply suggest improvements, please get in touch with us by email.

Disclaimer

The PEN does not itself express views or adopt positions on issues. Any opinions expressed in documents made available through the PEN (including this web page) are those of the relevant organisations and authors and do not necessarily reflect the views of the member institutions.

Derivatives Clearing, Default Risk, and Insurance: Robert Jones and Christophe Pérignon; The Journal of Risk and Insurance, 2012 , 11 Sep 2012; Abstract
Failure of a clearing house would trigger cascade of damaging disruptions throughout the financial system. Yet little is known about the likelihood of such an event. Using daily data on margins and variation margins for all clearing members of the Chicago Mercantile Exchange, we analyze the clearing house exposure to the risk of default by clearing members. We find that the major source of default risk for a clearing member is proprietary trading rather than trading by customers. Additionally, we show that extreme losses suffered by important clearing firms tend to cluster, which raises systemic risk concerns. To quantify its default risk exposure, we characterize the tail risk of the clearing house using Extreme Value Theory. Finally, we discuss how private insurance could be used to cover the loss from defaults by clearing members.

Competition and Strategic Control of a Central Counterparty: When Lower Risk Increases Profit: Hector Perez Saiz, Bank of Canada, Financial Stability Department, Financial Studies Division, Jean-Sebastien Fontaine, Bank of Canada, Joshua Slive, Bank of Canada; Working paper 1209, Aug 2012; Abstract
Central Counter-Parties (CCPs) impose stringent membership and risk control requirements on its members. These constraints reduce systemic risk (i.e., CCP default risk) but they also increase the market power of its members. We use price competition with horizontal differentiation to model the strategic behaviour of clearing members (dealers) that face a continuum of heterogeneous final clients (hedgers). When dealers control the CCP risk management, they strategically use binding risk constraints to obtain more favourable prices, and increase their rents, at the expense of the hedgers. In other words, risk controls serve as an anticompetitive instrument, allowing dealers to coordinate around an equilibrium with higher prices. In contrast, the social planner favours lax CCP membership requirements combined with risk controls that trade-off costs and risks to the hedgers. CCP default risk is lower than when members control the CCP. As on-going reforms increase the importance of CCPs, our model’s implications for their regulation and governance structure can contribute to building infrastructure that promotes the safety and efficiency of markets.

Clearing, counterparty risk and aggregate risk: Bruno Biais, Florian Heider, Marie Hoerova; IMF Economic Review (2012) 60, pp. 193–222, Mar 2012; Abstract
The paper studies the optimal design of clearing systems. The paper analyzes how counterparty risk should be allocated, whether traders should be fully insured against that risk, and how moral hazard affects the optimal allocation of risk. The main advantage of centralized clearing, as opposed to no or decentralized clearing, is the mutualization of risk. While mutualization fully insures idiosyncratic risk, it cannot provide insurance against aggregate risk. When the latter is significant, it is efficient that protection buyers exert effort to find robust counterparties, whose low default risk makes it possible for the clearing system to withstand aggregate shocks. When this effort is unobservable, incentive compatibility requires that protection buyers retain some exposure to counterparty risk even with centralized clearing

Information insensitive securities: the true benefits of Central Counterparties: Francesca Carapella and David C. Mills, Federal Reserve Board of Governors; Conference in Honor of Warren Weber Federal Reserve Bank of Chicago, 15 Feb 2012; Abstract
This paper combines the idea that securities should be information insensitive in order to be liquid, with the idea that an infrastructure which performs clearing of trades, and offers additional services to the counterparties, facilitates securities to be liquid. In a recent paper, Gorton et al. argue that securities that serve as a transaction medium should be the least information-sensitive, and derive sufficient conditions for such security to be debt. Also, a few recent papers (Acharya and Bisin, Duffie and Zhu and Koeppl and Monnet among others) emphasize the role of a Central Counterparty (CCP) in internalizing externalities that stem from the opacity of over-the-counter (OTC) transactions, therefore achieving the efficient level of trade, and the role of a CCP in providing the participants with insurance and cost effective clearing services. This paper develops a framework very similar to Gorton et al., modified to analyze some of the functions that a CCP performs. It shows that for any type of security, regardless of whether it is debt or equity, clearing transactions through a CCP reduces the extent to which securities are information-sensitive. Two functions of a CCP are key: multilateral netting and the existence of a default fund. By reducing the exposure of each counterparty to one another (or to the CCP), both netting and the default fund reduce the incentives of traders to acquire information about the payoffs of the security they are trading. A role of CCPs that has been identified by policy makers as fostering liquidity and stability of OTC transactions, is to perform margin calls to adjust the available collateral posted for each participant's net position, following the marking to market of securities. In this framework, however, the perception that margin calls foster liquidity is incorrect: traders have even more incentives to acquire information about the securities' payoff so that fewer transactions, which would be welfare improving, are carried out

Central Counterparty Clearing: Incentives, Market Discipline and the Cost of Collateral: Thorsten V. Koeppl, Queen's University; Working Paper, version 3.0, 01 Feb 2012; Abstract
This paper analyzes central counterparty CCP clearing, defined as the diversification of default risk through novation, in the presence of moral hazard that aggravates counterparty risk. Collateral is costly and serves two purposes: it insures against default and provides incentives to avoid moral hazard. When counterparty risk is not directly observable, I show that central clearing can lead to higher collateral requirements for two different reasons. First, a CCP offering diversification of risk cannot selectively forgo incentives for transactions that optimally use collateral only for insurance. Second, requiring more collateral for better incentives can reduce market liquidity and adversely affect market discipline which is a substitute for collateral. Hence, while CCP clearing can lower default through higher collateral requirements, there is a feedback effect through a fall in market liquidity that amplifies collateral costs. As a consequence, CCP clearing is likely to offer net benefits only in markets that are sufficiently liquid and where the potential for endogenous risk taking is not too severe

CDS as Insurance: Leaky Lifeboats in Stormy Seas: Eric Stephens, University of Laberta, James R. Thompson, University of Waterloo; Working Paper, 26 Sep 2011; Abstract
What market features of Credit Defaults Swaps (CDS) exacerbate counterparty risk? To answer this, we formulate a model which elucidates key differences between these and traditional insurance contracts. First, we allow for insurer insolvency with asymmetric information as to its probability. We find that stable insurers become less stable because they are forced to compete on price. When insurer type is known, increased competition among insurers can create instability for the same reason. Second, we allow the insured party to have heterogeneous motivations for purchasing CDS. For example, some may own the underlying asset and purchase CDS for risk management, while others buy these contracts purely for trading purposes. We show that traders will choose to contract with less stable insurers, resulting in higher counterparty risk in this market relative to that of traditional insurance; however, a regulatory policy that removes traders can, perversely, cause market counterparty risk to increase. Finally, we introduce a Central Counterparty (CCP) and show that requiring CDS contracts to be negotiated through CCPs can push stable insurers out of the market, mitigating the benefit of risk pooling.

Inducing Agents To Report Hidden Trades: A Theory Of An Intermediary: Yaron Leitner, Federal Reserve Bank of Philadelphia; Review of Finance (2011) 0: 1–30, 16 Jul 2011; Abstract
When contracts are unobserved (and nonexclusive), agents can promise the same asset to multiple counterparties and subsequently default. I show that a central mechanism can extract all relevant information about contracts that agents enter by inducing them to report one another. The mechanism sets position limits and reveals the names of agents who hit the limits according to (voluntary) reports from their counterparties. This holds even if sending reports is costly and agents can collude. In some cases, an agent’s position limit must be nonbinding in equilibrium. The mechanism has some features of a clearinghouse

Making OTC Derivatives Safe―A Fresh Look: Manmohan Singh, IMF; IMF Working Paper WP/11/66, Mar 2011; Abstract
Recent regulatory efforts, especially in the U.S. and Europe, are aimed at reducing moral hazard so that the next financial crisis is not bailed out by tax payers. This paper looks at the possibility that central counterparties (CCPs) may be too-big-to-fail entities in the making. The present regulatory and reform efforts may not remove the systemic risk from OTC derivatives but rather shift them from banks to CCPs. Under the present regulatory overhaul, the OTC derivative market could become more fragmented. Furthermore, another taxpayer bailout cannot be ruled out. A re-examination of the two key issues of (i) the interoperability of CCPs, and (ii) the cost of moving to CCPs with access to central bank funding, indicates that the proposed changes may not provide the best solution. The paper suggests that a tax on derivative liabilities could make the OTC derivatives market safer, particularly in the transition to a stable clearing infrastructure. It also suggests reconsideration of a “public utility” model for the OTC market infrastructure.

Collateral, Netting and Systemic Risk in the OTC derivatives Market: Manmohan Singh, IMF; IMF Working Paper WP/10/99, Apr 2010; Abstract
To mitigate systemic risk, some regulators have advocated the greater use of centralized counterparties (CCPs) to clear Over-The-Counter (OTC) derivatives trades. Regulators should be cognizant that large banks active in the OTC derivatives market do not hold collateral against all the positions in their trading book and the paper proves an estimate of this under-collateralization. Whatever collateral is held by banks is allowed to be re-hypothecated (or re-used) to others. Since CCPs would require all positions to have collateral against them, off-loading a significant portion of OTC derivatives transactions to central counterparties (CCPs) would require large increases in posted collateral, possibly requiring large banks to raise more capital. These costs suggest that most large banks will be reluctant to offload their positions to CCPs, and the paper proposes an appropriate capital levy on remaining positions to encourage the transition.

Making Over-the-Counter Derivatives Safer: The Role of Central Counterparties: International Monetary Fund; Global Financial Stability Report (GFSR), Apr 2010; Abstract
In an effort to improve market infrastructure following the crisis, central counterparties (CCPs) are being put forth as the way to make over-the-counter (OTC) derivatives markets safer and sounder, and to help mitigate systemic risk. This chapter provides a primer on this topic and discusses key policy issues. It shows that soundly run and properly regulated CCPs reduce counterparty risk—the risk in a bilateral transaction that one party defaults on its obligations to the other—among OTC derivatives market participants. Importantly, systemic risk—the risk of knock-on failures from one counterparty to another—is also reduced due in part to the ability to net transactions across multiple counterparties. CCPs also have other risk-mitigating features that ensure that payments to others occur when a counterparty defaults. Nevertheless, movement of contracts to a CCP is not a panacea, since it also concentrates the counterparty and operational risk associated with the CCP itself. The chapter makes recommendations for best-practice risk management and sound regulation and oversight to ensure that CCPs will indeed reduce risk. This may mean that existing CCPs will need to upgrade their risk management practices and that regulations will need to be strengthened. A big part of this is making sure that there is coordination among regulators and other overseers on a global basis to ensure that the playing field is level and that it discourages regulatory arbitrage. Contingency plans and appropriate powers should also be globally coordinated to ensure that the financial failure of a CCP does not lead to systemic disruptions in associated markets. To achieve the multilateral netting benefits of a CCP, a critical mass of OTC derivatives needs to move there. However, this will be costly for some active derivative dealers. CCPs require that collateral (called initial margin) be posted for every contract cleared through them, whereas in the OTC context dealers and some other types of participants tend not to currently adhere to this practice. As a result, active OTC derivative dealers, those likely to be members of CCPs, will incur costs in the form of the increase in posted collateral and, if enacted, potentially higher regulatory capital charges against remaining derivatives contracts on their books. Hence, without an explicit mandate to do so there is some uncertainty as to whether dealers will voluntarily move their contracts and whether enough multilateral netting can be achieved. An approach that uses incentives based on capital charges or a levy tied to dealers’ contribution to systemic risk could be used to encourage the transition. The analysis in this chapter shows that CCPs can reduce systemic risks related to counterparty risks that are present in the bilaterally cleared OTC contracts, but that the short-run costs of moving contracts to CCPs are indeed far from trivial. Hence, because the relevant institutions are already challenged to raise funds and capital in the post-crisis period, a gradual phase-in period is warranted.

Does a Central Clearing Counterparty Reduce Counterparty Risk?: Darrell Duffie and Haoxiang Zhu, Graduate School of Business Stanford University; Review of Asset Pricing Studies, Volume 1, Issue 1, pp.74-95, 16 Mar 2010; Abstract
We show whether central clearing of a particular class of derivatives lowers counterparty risk. For plausible cases, adding a central clearing counterparty (CCP) for a class of derivatives such as credit default swaps reduces netting efficiency, leading to an increase in average exposure to counterparty default. Further, clearing different classes of derivatives in separate CCPs always increases counterparty exposures relative to clearing the combined set of derivatives in a single CCP. We provide theory as well as illustrative numerical examples of these results that are calibrated to notional derivatives position data for major banks.

Counterparty Risk, Impact on Collateral Flows, and Role for Central Counterparties: Manmohan Singh and James Aitken, IMF; IMF Working Paper WP/09/173, Aug 2009; Abstract
Counterparty risk in the United States stemming from exposures to OTC derivatives payables (after netting) is now concentrated in five banks―Goldman Sachs, JPMorgan, Bank of America, Morgan Stanley and Citi. This note analyzes how such risks have shifted over the past year. We estimate that the adverse impact of counterparty risk on high-grade collateral flows and global liquidity due to decrease in re-hypothecation, reduced securities lending, and hoarding of cash by major banks is at least $5 trillion. In order to mitigate counterparty risk, there have been regulatory initiatives to establish central counterparties (CCPs). From a policy perspective, counterparty risk remains large at present and recent experience has shown that OTC derivative positions are not supported by sufficient capital, constituting a major risk for participants in this market.

The Economics of Clearing in Derivatives Markets: Netting, Asymmetric Information, and the Sharing of Default Risks Through a Central Counterparty: Craig Pirrong, University of Houston; Working Paper, 11 Jan 2009; Abstract
Credit derivatives have received intense scrutiny -- and criticism -- as a major contributor to the on-going financial crisis. In response, regulators have proposed requiring the formation of a central clearinghouse to share default risk on these contracts. A comparative economic analysis of the costs and benefits of alternative default risk sharing mechanisms casts considerable doubt on the advisability of central clearing of credit derivatives. These products are likely to be subject to severe information asymmetry problems regarding their value, risk, and the creditworthiness of those who trade them, and these information asymmetries are likely to be less severe in bilateral markets than in centrally cleared systems. Moreover, although regulators have argued that clearing would reduce systemic risk, a more complete analysis demonstrates that clearing could actually increase risks to the broader financial system.

Comparing the pre-settlement risk implications of alternative clearing arrangements: John P Jackson and Mark J Manning, Bank of England; Working Paper 321, Apr 2007; Abstract
In recent years, there has been a marked expansion in the range of products cleared through central counterparty clearing houses, accompanied by a trend towards consolidation in the clearing infrastructure. The financial stability implications of these developments are of considerable policy interest. In this paper, we use a simulation approach to analyse, in a systematic way, the potential pre-settlement cost and risk implications of these developments. Our results point towards substantial risk-reduction benefits from multilateral clearing arrangements, arising from multilateral netting and mutualisation. The paper also examines individual incentives to join multilateral clearing arrangements. We suggest that arrangements with restricted direct participation and tiered membership may be a natural response to the uneven distribution of total pre-settlement costs when agents are of heterogeneous credit quality and it is costly to individually tailor margin.

Central counterparty clearing: constructing a framework for evaluation of risks and benefits: Kirsi Ripatti, Financial Markets Department, Bank of Finland; Bank of Finland Discussion Papers, 30 Apr 2004; Abstract
A Central Counterparty (CCP) is an entity that interposes itself between transacting counterparties – a seller vis-à-vis the original buyer and a buyer vis-à-vis the original seller – to guarantee execution of the transaction. Thus, the original transacting parties substitute their contractual relationships with each other with contracts with the CCP. Central Counterparty Clearing has become increasingly popular in Europe, not just in derivatives markets, where, due to the high risk involved, it has been common for decades, but also in equities markets. Within the European Union, the main factor motivating the increased sophistication in clearing arrangements is the on-going process of European economic integration, i.e. the euro’s introduction, the on-going organisation of an internal market for financial services and the corresponding objective of creating a pan-European financial infrastructure for payments and securities clearing and settlement. Central counterparty clearing houses exert a broad influence on the functioning of financial markets. They can increase the efficiency and stability of financial markets to the extent that their smooth functioning results in a more efficient use of collateral, lower operating costs and greater liquidity. As market players actively try to achieve economies of scale and scope with mergers and through harmonising their technical processes, they inevitably have had to focus on one of the most fragmented areas in Europe’s securities market infrastructure – clearing and settlement. Because of the importance of its role, a CCP must have sound risk management. The CCP assumes responsibility in the aggregate and reallocates risk among participants. Moreover, if the CCP fails to perform risk management well, it can increase risk in the markets. While the big market players dominate the current CCP market in Europe, it is not only the big players who can benefit from a functioning CCP. With the right structure, a CCP enables small players to stay in the market and makes it possible for issuers in a regional marketplace to achieve market funding. Indeed, this is the tendency currently seen in the newest EU member states – and one of the main arguments against the single European CCP model. Although, the purpose has been to leave CCP questions to market participants, regulatory, oversight and supervisory issues can drive the actions of market participants. Indeed, authorities must sometimes be actively involved in boosting a CCP project to keep their home markets competitive. This may well be the situation faced by the Nordic/Baltic market in the near future. Thus, this paper attempts to give a neutral evaluation of the risks and benefits related to the functionality of CCPs in integrating markets and construct a framework for possible future risk-benefit analysis in a Finnish/Nordic-Baltic clearing and settlement infrastructure that incorporates a CCP solution. This is an updated version of a Bank of Finland working paper (Financial Markets Department 01/04).

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking: Acharya, New York University and Centre for Economic Policy Research (CEPR) and National Bureau of Economic Research (NBER), Gromb, INSEAD, Boulevard de Constance, Yorulmazer: Federal Reserve Bank of New York; American Economic Journal: Macroeconomics 2012 4(2): 184–217, Apr 2012; Abstract
We study interbank lending and asset sales markets in which banks with surplus liquidity have market power vis-à-vis banks needing liquidity, frictions arise in lending due to moral hazard, and assets are bank-specific. Surplus banks ration lending and instead purchase assets from needy banks, an inefficiency more acute during financial crises. A central bank acting as a lender-of-last-resort can ameliorate this inefficiency provided it is prepared to extend potentially loss-making loans or is better informed than outside markets, as might be the case if it also performs a supervisory role. This rationale for central banking finds support in historical episodes.

Intraday liquidity: risk and regulation: Alan Ball, Edward Denbee, Mark Manning and Anne Wetherilt, Bank of England; Financial Stability Paper 11, Jun 2011; Abstract
Banks require access to liquidity intraday in order to settle obligations in payment and settlement systems. The recent financial crisis has highlighted the need for banks to improve their liquidity risk management, including the management of intraday liquidity risk. The FSA’s new liquidity regime includes intraday liquidity as a key risk driver and requires that banks calibrate their liquid asset buffers considering their need for liquidity intraday, both in normal and stressed circumstances. The Bank fully supports this approach. However, this will increase the cost of intraday liquidity and so could create incentives for banks to change their behaviour as they seek to minimise costs. If this results in payment delays, it risks jeopardising the smooth functioning of payment and settlement systems. There are a number of tools that authorities could use to minimise the chance of adverse behavioural changes. Such tools include the introduction of liquidity saving mechanisms, the strengthening of throughput rules, payment tariffs that vary through the day, setting central bank collateral eligibility criteria for intraday liquidity and regulatory ‘deep dive’ assessments.

Liquidity Provision and Free-Riding in CHAPS: Edward Denbee, Bank of England, Rodney Garratt, University of California, Santa Barbara, Peter Zimmerman, Bank of England; Unpublished Working Paper, 18 Feb 2011; Abstract
Liquidity in the payment system is a public good in the sense that once some banks provide it to make payments, direct or indirect recipients can reuse it, over and over again, to make their own payments. Banks can use their own liquidity to make their payments or wait and use the liquidity from incoming payments. If too many banks attempt to free-ride on the liquidity provision of others the system will not function smoothly. We study liquidity provision and free-riding behaviour in CHAPS, the UK’s wholesale unsecured real-time payment system, to understand the different dimensions of liquidity provision and how it relates to a bank’s size. We also consider how market conditions impact liquidity provision. Our results contribute to the policy debate on how intraday liquidity should be regulated.

Liquidity costs and tiering in large-value payment systems: Mark Adams, Marco Galbiati, Bank of England and Simone Giansante, University of Essex; Working Paper 399, Jul 2010; Abstract
The article studies the forces behind the changes in interbank payment networks across countries. It describes the real-time gross settlement (RTGS) mode where modern large-value payment systems work and which requires large amounts of liquidity. It also states that the use of central bank money by RTGS systems as medium of settlement made central banks to push for the acceptance of RTGS.

Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-Prime Crisis: Viral V. Acharya, Ouarda Merrouche, Bank of England; NYU Working Paper FIN-09-018, 03 Jul 2010; Abstract
We study the liquidity demand of large settlement banks in the UK and its effect on the Sterling Money Markets before and during the sub-prime crisis of 2007-08. Liquidity holdings of large settlement banks experienced on average a 30% increase in the period immediately following 9th August, 2007, the day when money markets froze, igniting the crisis. Following this structural break, settlement bank liquidity had a precautionary nature in that it rose on calendar days with a large amount of payment activity and more so for weaker banks. We establish that the liquidity demand by settlement banks caused overnight interbank rates to rise, an effect virtually absent in the pre-crisis period. This liquidity effect on interbank rates occurred in both unsecured borrowing as well as borrowing secured by UK government bonds. Further, the effect was experienced by all settlement banks, regardless of their credit risk, suggestive of an interest-rate contagion from weaker to stronger banks operating through the interbank markets.

Liquidity-saving mechanisms in collateral-based RTGS payment systems: Marius Jurgilas, Bank of England and Antoine Martin, Federal Reserve of New York; Working Paper 389, Jun 2010; Abstract
This paper studies banks' incentives regarding the timing of payment submissions in a collateral-based RTGS payment system and how these incentives change with the introduction of a liquidity-saving mechanism (LSM). We show that an LSM allows banks to economise on collateral while also providing incentives to submit payments earlier. This is because in our model an LSM allows payments to be matched and offset in real time without any or very minimal funds. Under a collateral-based RTGS payment system, introduction of the LSM always improves welfare. The result contrasts with earlier work, which shows that under a fee-based RTGS system, the introduction of an LSM in some circumstances may reduce welfare.

Liquidity saving in real-time gross settlement systems — an overview: Ben Norman, Bank of England; Financial Stability Paper 7, May 2010; Abstract
During the past two decades, Large Value Payment Systems (LVPSs) in many countries have been redesigned so that the payments they process are settled on a ‘Real-Time Gross Settlement’ (RTGS) basis. Such systems eliminate interbank credit risk in the payment system — which, from the perspective of the Bank of England, is a key feature of the United Kingdom’s LVPS, CHAPS, and one which cannot be compromised by any future design changes. But such RTGS systems can require relatively large amounts of liquidity to be available. So some of the more recent RTGS system designs — for instance, TARGET2 (for euro payments); or Japan’s BOJ-Net — have incorporated sophisticated ‘liquidity saving mechanisms’. These mechanisms have allowed participants in the payment system to save on liquidity needs without reintroducing interbank credit risk. To support discussions among participants in CHAPS on possible liquidity saving mechanisms, this article sets out a conceptual framework for thinking about the drivers of liquidity needs in RTGS systems. It then discusses a number of practical liquidity saving measures, which can meet the good of greater liquidity efficiency without reintroducing credit risk.

Banks’ intraday liquidity management during operational outages: theory and evidence from the UK payment system: Ouarda Merrouche and Jochen Schanz, Bank of England; Journal of Banking & Finance, Volume 34, Issue 2, pp. 314–323 , Feb 2010; Abstract
We investigate how settlement banks in CHAPS, the United Kingdom’s large-value payment system, deal with operational risk. In particular, we are interested in payments behaviour towards a bank that is, for operational reasons, unable to make but able to receive payments. If other banks did not sufficiently monitor their outgoing payments, operational shocks could impact the entire payment system because the affected bank may absorb liquidity from the system. We first build a game-theoretic model in which a bank’s decision to make payments depends both on whether another bank experiences operational problems, and on the time of day at which the outage occurs. We then investigate these reactions empirically using a non-parametric method. Our theory predicts that banks stop paying to a bank which has been unable to make payments early in the day, when they are uncertain about the payment instructions they might have to execute. When this uncertainty has been resolved (later in the day), healthy banks make payments even to a bank experiencing the operational problem. Both predictions are supported by the data. We show that this behaviour effectively contains the disruption caused by the operational outage: payment flows between healthy banks are largely unaffected.

The Role of Interbank Markets in Monetary Policy: A Model with Rationing: Xavier Freixas, Universitat Pompeu Fabra, and Research Fellow at CEPR, Josè Jorge, CEMPRE and Universidade do Porto; Journal of Money, Credit and Banking, Blackwell Publishing, Volume 40(6), pp. 1151-1176, 09, 2008; Abstract
This paper analyses the impact of asymmetric information in the interbank market and establishes its crucial role in the microfoundations of the monetary policy transmission mechanism. We show that interbank market imperfections induce an equilibrium with rationing in the credit market. This has two major implications: first, it reconciles the irresponsiveness of business investment to the user cost of capital with the large impact of monetary policy (magnitude effect) and, second, it shows that banks’ liquidity positions condition their reaction to monetary policy (Kashyap and Stein liquidity effect).

Intraday Liquidity Management: A Tale of Games Banks Play: Morten L. Bech, Federal Reserve Bank of New York; FRBNY Economic Policy Review, Sep 2008; Abstract
The value and volume of interbank payments increased dramatically throughout the 1980s and 1990s as a result of rapid financial innovation and the integration and globalization of financial markets. In the United States, settlement of interbank payments grew from $300 trillion in 1985, or forty-five times GDP, to almost $500 trillion in 1995, or seventy-five times GDP. Historically, interbank payments have been settled via deferred (end-of-day) netting systems. As the volume and value of transactions increased, however, central banks became worried about settlement risks inherent in netting systems. In particular, the banks were concerned about the potential for contagion, or “knock-on,” effects attributable to the unwinding of net positions that would result if a participant failed to meet its end-of-day obligations. Consequently, over the last couple of decades, many countries have chosen to modify the settlement procedures employed by their interbank payments system.

The intraday liquidity management game: Morten Bech, Federal Reserve Bank of New York, Danmarks Nationalbank and Rod Garratt, University of California; Journal of Economic Theory 109 (2003) 198–219, 2003; Abstract
We use a game theoretical framework to analyze the intraday behavior of banks with respect to settlement of interbank claims in a real-time gross settlement setting. The game played by banks depends upon the intraday credit policy of the central bank and it encompasses two well-known game theoretical paradigms: the prisoner’s dilemma and the stag hunt. The former arises in a collateralized credit regime where banks have an incentive to postpone payments when daylight liquidity is costly, an outcome that is socially inefficient. The latter arises in a priced credit regime where the postponement of payments can be socially efficient. Banks are risk neutral, but we show that most of the results are unaffected by risk aversion.

Systemic risk, interbank relations and liquidity provision by the Central Bank: Xavier Freixas, Universitat Pompeu Fabra, Bruno M. Parigi, University of Padua, and Jean-Charles Rochet, Universiteod es Sciences Sociales de Toulouse; Journal of Money, Credit, and Banking, Vol. 32, No. 3 (August 2000, Part 2), Aug 2000; Abstract
We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central bank in preventing payments systemic repercussions and we examine the justification of the too big- to-fail policy.

An analysis of competitive externalities in gross settlement systems: Paolo Angelini, Banca d'Italia; Journal of Banking & Finance 22 (1998), pp. 1-18, 1998; Abstract
Following the on-going debate on risks in interbank payment networks, gross settlement systems are being adopted in several industrialized countries. These systems, which effect real-time transfers of monetary base among bank accounts, add management of intraday liquidity to the duties traditionally performed by central banks, and require new, ad hoc policy instruments. The paper presents a simple model of a real-time gross settlement (RTGS) system, which is used to analyze the reaction of banks and monetary policy variables to this new environment. It is shown that if daylight liquidity is costly, a network externality may induce banks to postpone payment activity, thereby affecting the quality of the information available to counterparts for cash management purposes. The increased noise may in turn induce higher than optimal levels of banks' end-of-day reserve holdings, relative to a social optimum, with adverse effects on expected profits. The rise of a daylight market for funds, predicted by the model, does not solve the mentioned externality problem. Some corrective policy measures are discussed.

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

A comparison of Libor to other measures of bank borrowing costs: Dennis Kuo, UCLA, David Skeie, James Vickery, Federal Reserve Bank of New York; Working Paper, Jun 2012; Abstract
Libor is a survey-based measure of bank borrowing costs that plays a central role in fixed-income markets. There is an active discussion about how well Libor summarized funding conditions during the recent financial crisis. In this paper we match and compare bank Libor survey responses to two novel measures of borrowing rates: 1) bank bids at the Federal Reserve Term Auction Facility and 2) inferences of term borrowing from Fedwire payments data. We find that Libor survey responses broadly track these alternative measures between 2007-09, although Libor lies below them at certain times, particularly at the height of the crisis. Libor quotes are also less diffuse than rates from the matched TAF and Fedwire data. We discuss a range of factors that could account for these differences. We also find that other public data beyond Libor are moderately informative about bank funding costs.

Implicit intraday interest rate in the UK unsecured overnight money market: Marius Jurgilas, Norges Bank and Filip Žikeš, Bank of England; Working Paper No. 447, Mar 2012; Abstract
This paper estimates the intraday value of money implicit in the UK unsecured overnight money market. Using transactions data on overnight loans advanced through the UK large-value payments system (CHAPS) in 2003-09, we find a positive and economically significant intraday interest rate. While the implicit intraday interest rate is quite small pre-crisis, it increases more than tenfold during the financial crisis of 2007-09. The key interpretation is that an increase in the implicit intraday interest rate reflects the increased opportunity cost of pledging collateral intraday and can be used as an indicator to gauge the stress of the payment system. We obtain qualitatively similar estimates of the intraday interest rate using quoted intraday bid and offer rates and confirm that our results are not driven by the intraday variation in the bid-ask spread.

An Empirical Study of Trade Dynamics in the Fed Funds Market: Gara Afonso and Ricardo Lagos, Federal Reserve Bank of New York; Federal Reserve Bank of New York Staff Reports 550, Feb 2012; Abstract
We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.

Is this bank ill? The diagnosis of doctor TARGET2: Ronald Heijmans and Richard Heuver, De Nederlandsche Bank; DNB Working Paper - 316, Aug 2011; Abstract
We develop indicators for signs of liquidity shortages and potential financial problems of banks by studying transaction data of the Dutch part of the European real time gross settlement system and collateral management data. The indicators give information on 1) overall liquidity position, 2) the interbank money market, 3) the timing of payment flows, 4) the collateral’s amount and use and 5) bank run signs. This information can be used both for monitoring the TARGET2 payment system and for individual banks’ supervision. By studying these data before, during and after stressful events in the crisis, banks’ reaction patterns are identified. These patterns are translated into a set of behavioural rules, which can be used in payment systems’ stress scenario analyses, such as e.g. simulations and network topology. In the literature behaviour and reaction patterns in simulations are either ignored or very static. To perform realistic payment system simulations it is crucial to understand how banks react to shocks.

Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis: Gara Afonso, Anna Kovner, Antoinette Schoar, The Federal Reserve Bank of New York and MIT Sloan and NBER; The Journal of Finance, Volume 66, Issue 4 (August), pp. 1109–1139, 19 Jul 2011; Abstract
We examine the importance of liquidity hoarding and counterparty risk in the U.S. overnight interbank market during the financial crisis of 2008. Our findings suggest that counterparty risk plays a larger role than does liquidity hoarding: the day after Lehman Brothers’ bankruptcy, loan terms become more sensitive to borrower characteristics. In particular, poorly performing large banks see an increase in spreads of 25 basis points, but are borrowing 1% less, on average. Worse performing banks do not hoard liquidity. While the interbank market does not freeze entirely, it does not seem to expand to meet latent demand.

Exploring an uncharted market: Evidence on the unsecured Swiss franc money market: Basil Guggenheim, Sébastien Kraenzlin and Silvio Schumacher, Swiss National Bank (SNB); Swiss National Bank Working Papers 2011-5, 15 Dec 2010; Abstract
To date, various central banks have lacked detailed statistical evidence on developments in the unsecured interbank money market. Furfine (1999) introduced the idea of calculating unsecured overnight interbank lending by using data of a RTGS system. Based on data from the Swiss payment system (SIC) we developed an algorithm to identify unsecured interbank loans in Swiss francs. In contrast to Furfine (1999) we also identify longer-term transactions. We thereby gain a deeper insight on the size and structure of the unsecured interbank money market in Swiss francs. This is the first time that SIC data have been used to identify transactions and market rates in the unsecured Swiss franc money market. Overall, the estimates show that after the collapse of Lehman Brothers loss of confidence led to a freezing-up of the market for several months and a decrease in daily turnover.

Monitoring the unsecured interbank money market using TARGET2 data: Ronald Heijmans, Richard Heuver and Daniëlle Walraven, De Nederlandsche Bank; Working Paper 276, Oct 2010; Abstract
We investigate the euro unsecured interbank money market during the current financial crisis. To identify the loans traded in this market and settled in TARGET2, we extend the algorithm developed by Furfine (1999) and adapt it to the European interbank loan market with maturity up to one year. This paper solves the problem of systematic errors which occur when you only look at overnight loans (as the Furfine algorithm does). These errors especially occur in times of (very) low interest rates. The algorithm allows us to track the actual interest rates rather than quoted interest rates on liquidity trading by participants of the Dutch part of the euro large value payment system (TARGET2-NL). The algorithm enables us to constitute the Dutch part of the EONIA, making it possible to compare the interest rates developments in the Dutch market to the European average ones. Based on the new algorithm, we develop a policy tool to monitor the interbank money market, both at macro level (whole market) and individual ban level (Money Market Monitoring Dashboard).

Interbank overnight interest rates – gains from systemic importance: Q. Farooq Akram and Casper Christophersen, Norges Bank; Working papers Norges Bank 2010|11, 23 Jul 2010; Abstract
We study overnight interbank interest rates paid by banks in Norway over the period 2006-2009. We observe large variations in interest rates across banks and over time. During the financial crisis, the interest rates are found to be substantially below indicative quotes of interest rates provided by major banks. Our econometric model attributes the interest rate variation partly to differences in banks' characteristics including relative size and connectedness, implying favorable terms for banks of systemic importance. Moreover, interest rates are found to depend not only on overall liquidity in the interbank market, but possibly on its distribution among banks as well, suggesting exploitation of market power by banks with surplus liquidity. There is also evidence of stronger effects on interest rates of systemic importance, credit ratings and liquidity demand and supply since the start of the current financial crisis.

The impact of reserves averaging on banks liquidity: Claire Halsally, John Jacksonz, Ouarda Merrouchex, Bank of England; Working Paper, 30 Apr 2008; Abstract
Using data on the timing of trading in the sterling overnight unsecured interbank market during the period January 2003-February 2008 we test the impact on banks’ liquidity management of recent reforms to the Bank of England’s sterling money market operations. We find that the introduction of reserves averaging in May 2006 is associated with trading shifting later in the day, as was the widening of the target ranges on reserve accounts in October 2007. We also show that the magnitude of this timing shift is greatest in the early days of a maintenance period. Our results support the hypothesis that the introduction of reserves averaging enhanced banks’ ability to manage their daily liquidity requirements, by enabling them to trade in the interbank market with better information about their liquidity needs.

Uncollateralized Overnight Loans Settled in LVTS: Scott Hendry and Nadja Kamhi, Bank of Canada; Working Paper 2007-11, Feb 2007; Abstract
Loan-level data on the uncollateralized overnight loan market is generated using payment data from Canada’s Large Value Transfer System (LVTS) and a modified version of the methodology proposed in Furfine (1999). There were on average just under 100 loans extended in this market each day from March 2004 to March 2006 for a total daily value of about $5 billion. This makes the market slightly larger than the brokered repo market but only about one-tenth of the estimate for the direct trade repo market. The implied uncollateralized overnight rate was found to be remarkably stable relative to other measures of the overnight rate. Loan rates are found to vary with market conditions, the size of the loan, and the type (big vs. small) of the borrower and lender.

The relationship between the overnight interbank unsecured loan market and the CHAPS Sterling system: Stephen Millard and Marco Polenghi, Bank of England; Bank of England Quarterly Bulletin, Spring 2004, Volume: 44 Issue: 1, pp.42-47, 2004; Abstract
This article uses data on CHAPS Sterling transactions to describe the segment of the unsecured overnight loan market that settles within CHAPS. It assesses the size, timing and importance of these transactions for the underlying payments infrastructure. Advances and repayments of overnight loans are estimated to have accounted for around 20% of CHAPS Sterling activity by value over our sample period; four CHAPS Sterling members send and receive virtually all payments corresponding to these loans; and, finally, the value of CHAPS Sterling payments associated with this market rises towards the end of the CHAPS day.

Overnight Interbank Loan Markets: Selva Demiralp, Brian Preslopsky, and William Whitesell, Staff of the Board of Governors of the Federal Reserve System; FEDS Working Paper 2004-29, May 2004; Abstract
This paper investigates transactions and interest rates on brokered and direct trades in federal funds, Eurodollar transactions, and repurchase agreements, all of which are used by banks in overnight funding. We expand on earlier work on calendar-day effects in these markets, investigating also volumes of funding in recent years. Our data include daily trades in federal funds reported by major brokers and also records of uncollateralized transactions over the wire transfer system operated by the Federal Reserve. We find that the share of the overnight interbank loan market represented by brokered fed funds has decreased and is now only about one-third of the total. We also show evidence of close but incomplete arbitrage among the major segments of the overnight interbank market, though the specific calendar day patterns of spreads and volatilities have evolved relative to the literature using earlier sample periods.

Lending Relationships in the Interbank Market: Joao F. Cocco, Francisco J. Gomes, London Business School, Nuno C. Martins, Universidade Nova de Lisboa and Banco de Portugal; J. Finan. Intermediation 18 (2009), 24–48, Aug 2003; Abstract
We use a unique dataset to show that relationships are an important determinant of banks’ ability to access interbank market liquidity. More precisely, we find that: (i) banks with a larger reserve imbalance are more likely to borrow funds from banks with whom they have a relationship, and to pay a lower interest rate than otherwise; (ii) smaller banks and banks with more nonperforming loans tend to have limited access to international markets, and rely more on relationships; (iii) relationships are established between banks with less correlated liquidity shocks. These results suggest that relationships allow banks to insure liquidity risk in the presence of market frictions such as transaction and information costs. Our analysis explicitly controls for the endogeneity of bank relationships.

Are Banks Risk Averse? Intraday Timing of Operations in the Interbank Market: Paolo Angelini, Bank of Italy; Journal of Money, Credit and Banking, Vol. 32, No. 1, pp. 54-73, Feb 2000; Abstract
The paper presents a simple theory of intraday behavior in the interbank market. The timing of borrowing and lending operations depends on the information available on two key variables: the end-of-day balance from the clearing system the algebraic sum of incoming (+) and outgoing (-) daily payments and the short term interest rate. When the former is the relevant source of uncertainty, risk-averse banks should tend to operate close to the end of the business day, when the balance becomes observable. Conversely, when the interbank rate is relatively more volatile, operations should be shifted to the early morning, when the balance is not observable but the rate is. The theory is found to be consistent with banks' behavior in the Italian interbank market.

The Microstructure of the Federal Funds Market: CRAIG H. FURFINE; Financial Markets, Institutions & Instruments, Volume 8 (5), Nov 1999; Abstract
Unique transaction-level data for nearly every federal funds transaction made during the first quarter of 1998 forms the foundation for this in-depth exploration of the federal funds market. Unlike previous studies that have relied on aggregate and typically infrequent measures of federal funds market participation, the transaction-level data exploited here allows a closer look at the microstructure of the market. The paper explores the relationship between bank size and participation in the funds market and discovers that even the largest banks are frequently net sellers of funds. A time-of-day pattern is uncovered, as is significant market concentration. Preliminary exploration into trading patterns, or networks, is conducted, and the existence of relationship lending in the interbank market is investigated.

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

The microstructure of the money market before and after the financial crisis: a network perspective: Silvia Gabrieli, Tor Vergata University; CEIS Tor Vergata, Volume 9, Issue 1, 181, 19 Jan 2011; Abstract
This paper provides an in depth microstructure analysis of the euro money market by taking an explicit network perspective. Banks are the nodes of the networks; unsecured overnight loans are the links connecting the nodes. Daily interbank networks verify the same stylised facts documented for many real complex systems: they are highly sparse, far from being complete, exhibit the “small world” property and a power-law distribution of degree (the number of counterparties each bank establishes credit relationships with). On the other hand, the tendency of banks to “cluster”, i.e. to form groups where ties are relatively denser, is much lower than in other real networks. The time patterns of some network statistics provide interesting insights into the evolution of the potential for financial contagion; different developments across different groups of banks after the onset of the crisis offer insights into banks’ behaviour. Individual centrality measures provide a variety of concepts by which banks are central in the interbank market. The various concepts indicate unambiguously that the largest players (by deposits traded) are also the most central in the system before the onset of the crisis; however, medium, small, and very small banks’ centralities increase progressively after August 2007, as these banks increase their “influence” as liquidity providers. The rich set of measures described in this paper represents a key input for future research.

The sterling unsecured loan market during 2006–08: insights from network theory: Anne Wetherilt, Peter Zimmerman, Bank of England and Kimmo Soramäki, Helsinki University of Technology; Working Paper 398, Jul 2010; Abstract
We model the unsecured overnight market in the United Kingdom as a network of relationships and examine how the structure has changed over the recent period of crisis. Using established network techniques, we find strong evidence of the existence of a core of highly connected banks alongside a periphery. We find that membership of this core expanded during the crisis and suggest that this is due to a few intermediate banks becoming more connected. The widened reserve target bands may have also had an effect, by partially alleviating the need to manage reserve accounts close to a target and therefore allowing banks to exercise more discretion in forming relationships. However, there is an asymmetry between borrowers and lenders in the overnight market, with borrowers more reliant on the most established of the core banks during the crisis.

Network and eigenvalue analysis of financial transaction networks: F. Kyriakopoulos, Medical University of Vienna, S. Thurner, C. Puhr, Santa Fe Institute, and S.W. Schmitz, Oesterreichische Nationalbank; Eur. Phys. J. B 71, pp. 523–531, 21 Jul 2009; Abstract
We study a dataset containing all financial transactions between the accounts of practically all major financial players within Austria over one year. We empirically analyze transaction networks of money (in and out) flows and report the characteristic network parameters. We observe a significant dependence of network topology on the time scales of observation, and remarkably low correlation between node degrees and transaction volume. We further use transaction time series of the financial agents to compute covariance matrices and their eigenvalue spectra. Eigenvectors corresponding to eigenvalues deviating from the Marcenko-Pastur law are analyzed in detail. The potential for practical use as an automated detection mechanism for abnormal behavior of financial players is discussed. The opinion expressed in this paper is that of the authors and does not necessarily reflect the opinion of the OeNB or the ESCB.

The Topology of the Federal Funds Market: Morten L. Bech and Enghin Atalay, Federal Reserve Bank of New York; Staff Report, November 2008, 354, 12 May 2009; Abstract
We explore the network topology of the federal funds market. This market is important for distributing liquidity throughout the financial system and for the implementation of monetary policy. The recent turmoil in global financial markets underscores its importance. We find that the network is sparse, exhibits the small-world phenomenon, and is disassortative. Centrality measures are useful predictors of the interest rate of a loan.

A Model of Tiered Settlement Networks: James Chapman, Jonathan Chiu, and Miguel Molico, Bank of Canada; Working Paper 2008-12, Jun 2008; Abstract
This paper develops a model of settlement system to study the endogenous structure of settlement networks, and the welfare consequences of clearing agent failure. The equilibrium degree of tiering is endogenously determined by the cost structure and the information structure. The degree of tiering is decreasing in the fixed cost of operating the second-tier network and the availability of public credit history. Furthermore, the welfare effects of clearing agent failure can be decomposed into operational inefficiency and the loss of private information.

A network analysis of the Italian overnight money market: Giulia Iori, City University, Giulia De Masi, University of L'Aquila, Ovidiu Vasile Precup, King’s College London, Giampaolo Gabbi, SDA Bocconi School of Management, University of Siena, Guido Caldarelli, University of La Sapienza; Journal of Economic Dynamics & Control 32 (2008), pp. 259–278, 21 Mar 2007; Abstract
The objective of this paper is to analyse the network topology of the Italian segment of the European overnight money market through methods of statistical mechanics applied to complex networks. We investigate differences in the activities of banks of different sizes and the evolution of their connectivity structure over the maintenance period. The main purpose of the analysis is to establish the potential implications of the current institutional arrangements on the stability of the banking system and to assess the efficiency of the interbank market in terms of absence of speculative and preferential trading relationships.

Liquidity, Risk Concentration and Network Structure in the Austrian Real Time Interbank Settlement System: Stefan W. Schimitz and Claus Puhr; Banking & Finance WPS, European Finance WPS and Banking & Insurance (Forthcoming) WPS at SSRN, 29 Dec 2006; Abstract
The objective of this paper is to present a statistical analysis of liquidity, risk concentrations, and network structure in ARTIS. The main results of the analysis were: despite sufficient aggregate liquidity, individual accounts were occasionally illiquid and payment delays occurred frequently. The disaggregated analysis of liquidity usage revealed that liquidity usage was highly heterogeneous across participants. These results demonstrate that conclusions drawn from aggregate liquidity data do not necessarily apply to the individual participant level. In general, the value and the number of payments received and submitted were quite concentrated among the top three banks and the top transfer account in the ARTIS system during the sample period. This conclusion is supported by the analysis of the network topology. AN analysis of operational risk in the system should focus on operational problems at the institutions with high payment concentration risk and high liquidity concentration risk to test for high impact scenarios

Trading strategies in the Italian interbank market: Giulia Iori, City University, Roberto Reno, University of Siena, Giulia De Masi, University of L'Aquila, Guido Caldarelli, University of La Sapienza; Physica A 376 (2007) 467–479, 13 Nov 2006; Abstract
Using a data set which includes all transactions among banks in the Italian money market, we study their trading strategies and the dependence among them. We use the Fourier method to compute the variance–covariance matrix of trading strategies. Our results indicate that well defined patterns arise. Two main communities of banks, which can be coarsely identified as small and large banks, emerge.

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

Estimating the intraday liquidity risk of financial institutions: a Monte Carlo simulation approach: Carlos Leon, Banco de la República; Journal of Financial Market Infrastructures, Volume 1, Number 1 (Fall), pp. 75-107, 27 Sep 2012; Abstract
The recent financial crisis has shown that liquidity risk is far more important and intricate than regulators had previously acknowledged. The shift from bank-based to market-based financial systems and from deferred net settlement systems to liquidity-demanding real-time gross settlement of payments explains some of the shortcomings of traditional liquidity risk management. Although liquidity regulations do exist, they are still in an early stage of development and discussion. Moreover, not all connotations of liquidity are being equally addressed. Unlike market and funding liquidity, intraday liquidity has been absent from financial regulation, and has appeared only recently, after the crisis. This paper addresses the measurement of large-value payment system intraday liquidity risk. Based on the generation of bivariate Poisson random numbers for simulating the minute-by-minute arrival of received and executed payments, each financial institution's intraday payments' time-varying volume and degree of synchrony (i.e., timing) is modelled. Modelling the uncertainty of intraday payments allows us to oversee participants' intraday behavior, to assess their ability to fulfil intraday payments at a certain confidence level, to identify participants that are non-resilient to changes in payment timing mismatches, and to estimate intraday liquidity buffers. These results are useful for financial authorities and institutions given the increased importance of liquidity risk as a source of systemic risk, and the recent regulatory amendments.

The impact of Payment System Design on Tiering Incentives: Robert Arculus, Jennifer Hancock and Greg Moran, Reserve Bank of Australia; Research Discussion Paper 2012-06, Jun 2012; Abstract
Tiering occurs when an institution does not participate directly in the central payment system but instead settles its payments through an agent. A high level of tiering can be a significant issue for payment system regulators because of the increased credit and concentration risk. This paper explores the impact of payment system design on institutions' incentives to tier using simulation analysis. Some evidence is found to support the hypothesis that the liquidity-saving mechanisms in Australia's real-time gross settlement (RTGS) system – the Reserve Bank Information and Transfer System (RITS) – reduce the liquidity cost of direct participation. This may have contributed to the low level of tiering in RITS relative to RTGS systems in other countries. We find no clear relationship between system design and the size of the substantial two-way exposures tiering creates between clients and their settlement banks. Our data suggest that more tiering would result in only small increases to the level of concentration in RITS.

Payment System Design and Participant Operational Disruptions: Ashwin Clarke and Jennifer Hancock, Reserve Bank of Australia; Research Discussion Paper 2012-05, May 2012; Abstract
Real-time gross settlement (RTGS) systems often incorporate features designed to economise on liquidity. Such ‘hybrid features’ have the potential to mitigate the systemic impact of operational disruptions of participants. This paper simulates operational disruptions of participants, using data from Australia's RTGS system – the Reserve Bank Information and Transfer System (RITS) – to analyse the effect of these hybrid features on the systemic impact of such disruptions. The results suggest that the bilateral-offset algorithm and sub-limit feature in RITS generally mitigate the impact of a participant's operational disruption, even if there is less liquidity committed to the RTGS system. The hybrid features of the Australian RTGS system also mean that the size of the participant with the operational disruption has less effect on the systemic impact of that disruption than otherwise. While a central queue, in and of itself, would tend to mitigate the impact of a participant's operational disruption, methodological issues make it difficult to draw any conclusions regarding this hybrid feature in this paper.

An agent-based model of payment systems: Marco Galbiati, Bank of England, Kimmo Soramaki, Aalto University School of Science and Technology; Journal of Economic Dynamics & Control 35, pp. 859–875, 2011; Abstract
We layout and simulate a multi-agent, multi-period model of an RTGS payment system. At the beginning of the day, banks choose how much costly liquidity to allocate to the settlement process. Then, they use it to execute an exogenous, random stream of payment orders. If a bank’s liquidity stock is depleted, payments are queued until new liquidity arrives from other banks, imposing costs on the delaying bank. We study the equilibrium level of liquidity posted in the system, performing some comparative statics and obtaining insights on the efficiency of alternative system configurations.

Designing large value payment systems: An agent-based approach: Sheri Markose, University of Essex, Amadeo Alentorn, OMAM and Centre for Computational Finance and Economic Agents (CCFEA), Stephen Millard, Bank of England, and Jing Yang, Bank of International Settlements; Discussion Paper Series 700, Nov 2011; Abstract
The purpose of this paper is to show how agent-based simulations of payment systems can be used to aid central bankers and payment system operators in thinking about the appropriate design of payment settlement systems to minimise risk and increase their efficiency. Banks, which we model as the ‘agents’, are capable of a degree of autonomy with which to respond to payment system rules and adopt a strategy that determines how much collateral to post with the central bank at the start of the day (equivalently how much liquidity to borrow intraday from the central bank) and when to send payment orders to the central processor. An interbank payment system with costly liquidity requires banks to solve an intraday cash management problem, minimising their liquidity and delay costs subject to their beliefs about what the other banks are doing. We use the Erev and Roth (1998) reinforcement learning algorithm for banks to endogenously determine how much liquidity to post in the interbank liquidity management game.

Operational problems in banks – Effects on the settlement of payments in Norges Bank: Tor Oddvar Berge, and Casper Christophersen, Norges Bank; Norges Bank penger og kreditt 3/2011 (årg. 39), pp. 30–41, Mar 2011; Abstract
We analyse the robustness of the settlement process in the Norges Bank settlement system (NBO) to operational problems in one of its participating banks. The analysis is based on a large number of simulations using actual payments data. We find that of the 21 banks directly participating in NBO, only four are of systemic importance in the sense that their inability to send payments would have a significant effect on the other banks in the system. Moreover, the level of such systemic risk varies substantially, depending on the liquidity available to individual banks and on overall activity in the system. On most days, the systemic effects would be limited due to benign liquidity conditions in the system. Furthermore, we find that the systemic effects can be significantly reduced if banks react quickly by postponing their outgoing payments to the stricken bank.

Simulation analyses and stress testing of payment networks: Harry Leinonen, Bank of Finland; Proceedings from the Bank of Finland Payment and Settlement System Seminars 2007–2008, Scientific monographs E:42-2009, 2009; Abstract
This publication consists of ten separate studies on payment and settlement systems employing simulation techniques. Most of these were carried out using the payment and settlement system simulator BoF-PSS2 provided by the Bank of Finland. The preliminary versions were presented at the annual simulator seminars arranged by the Bank in 2007 and 2008. The main focus of the analyses is on continuity arrangements, operational stability, liquidity requirements, liquidity economising, gridlock resolution, transaction queuing arrangements, network features and network topologies. The studies examine systems in several countries and cover different kinds of payment systems and regimes.

Exploring agent-based methods for the analysis of payment systems: A crisis model for StarLogo TNG: Luca Arciero, Claudia Biancotti, Leandro D'Aurizio and Claudio Impenna, Banca d'Italia; Working Paper 686, Aug 2008; Abstract
This paper presents an exploratory agent-based model of a real time gross settlement (RTGS) payment system. Banks are represented as agents who exchange payment requests, which are settled according to a set of simple rules. The model features the main elements of a real-life system, including a central bank acting as liquidity provider, and a simplified money market. A simulation exercise using synthetic data of BI-REL (the Italian RTGS) predicts the macroscopic impact of a disruptive event on the flow of interbank payments. The main advantage of agent - based modelling is that we can dynamically see what happens to the major variables involved. In our reduced-scale system, three hypothetical distinct phases emerge after the disruptive event: 1) a liquidity sink effect is generated and the participants’ liquidity expectations turn out to be excessive; 2) an illusory thickening of the money market follows, along with increased payment delays; and, finally 3) defaulted obligations dramatically rise. The banks cannot staunch the losses accruing on defaults, even after they become fully aware of the critical event, and a scenario emerges in which it might be necessary for the central bank to step in as liquidity provider. The methodology presented differs from traditional payment systems simulations featuring deterministic streams of payments dealt with in a centralized manner with static behavior on the part of banks. The paper is within a recent stream of empirical research that attempts to model RTGS with agent – based techniques.

Simulation studies of liquidity needs, risks and efficiency in payment networks: Harry Leinonen, Bank of Finland; Proceedings from the Bank of Finland Payment and Settlement System Seminars 2005–2006, 2007; Abstract
This publication consists of nine separate studies on payment and settlement systems conducted using simulation techniques. Most have been carried out using the payment and settlement system simulator BoF-PSS2 provided by the Bank of Finland. The preliminary versions were presented at the annual simulator seminars arranged by the Bank in 2005 and 2006. The main focus of the analyses is on liquidity requirements, settlement speed, gridlock situations, gridlock resolution methods, liquidity economising, systemic risk and the impact of shocks on system performance as well as network analysis and modelling of payment systems. The studies look at systems in several countries and cover both RTGS and netting systems as well as securities settlement systems.

Systemic Risk in Alternative Payment System Designs: Peter Galos and Kimmo Soramäki, European Central Bank; ECB Working Paper Series 508, Jul 2005; Abstract
This paper is part of the research conducted under a Special Study Group analysing various issues relevant for the design of TARGET2. TARGET2 is the second generation of the Eurosystem’s Trans-European Automated Real-time Gross settlement Express Transfer system, which is planned to go live in 2007. (See http://www.ecb.int/paym/target/target2 html/index.en.html for further details on the TARGET2 project). The Special Study Group operated between spring 2003 and summer 2004. It was chaired by Philipp Hartmann, assisted by Thorsten Koeppl (both ECB). The Group was further composed of experts from the ECB (Dirk Bullmann, Peter Galos, Cornelia Holthausen, Dieter Reichwein and Kimmo Soramäki), researchers from national central banks (Paolo Angelini, Banca d’Italia, Morten Bech, Federal Reserve Bank of New York, Wilko Bolt, de Nederlandsche Bank, Harry Leinonen, Suomen Pankki, and Henri Pagès, Banque de France) and academic consultants (David Humphrey, Florida State University, Charles Kahn, University of Illinois at Urbana Champaign, and Jean-Charles Rochet, Université de Toulouse). Following the completion of the Group’s work, the ECB Working Paper Series is issuing a selection of the papers it produced.

Liquidity, risks and speed in payment and settlement systems – a simulation approach: Harry Leinonen, Bank of Finland; Bank of Finland Studies E:31-2005, May 2005; Abstract
This publication consists of eleven separate studies on payment and settlement systems conducted using simulation techniques. Most have been carried out using the payment and settlement system simulators BoF-PSS1 or BoF-PSS2 provided by the Bank of Finland and presented at the simulator seminars arranged by the Bank. The main focus in the analyses is on liquidity requirements, settlement speed, gridlock situations, gridlock resolving methods, liquidity economising, systemic risk, and the impact of shocks on system performance. The studies look at systems in several countries and cover both RTGS and netting systems as well as securities settlement systems.

Analysing the impact of operational incidents in large-value payment systems: A simulation approach: Paul Bedford, Stephen Millard, and Jing Yang, Bank of England; Bank of England Working Paper ISSN 1368-5562, 2004; Abstract
In recent years, central banks have focused considerable attention on improving the operational resilience of large-value payment systems (LVPS). These systems play a vital role in supporting financial market activity, often standing at the centre of a complex web of infrastructural arrangements for discharging payment obligations and clearing/settling securities trades. Their reliable operation is thus crucial to the continued stability of the financial system and, more generally, to establishing an environment that allows economic agents to exploit valuable opportunities for exchange of goods or assets. It is recognised, however, that the possibility for operational incidents to impair the ability of an LVPS to settle payments cannot be eliminated entirely; an element of residual operational risk will always remain. In this paper, we propose a simulation-based approach to examining the consequences of different types of operational incident affecting an LVPS. Our method exhibits many similarities with the type of stress-testing exercises often used to evaluate the robustness of the banking system to financial shocks. In particular, we outline a three procedure: the first stage involves identification of a set of worst-case scenarios; the second, assessing the impact of operational incidents; the third step uncovers the empirical distribution of impacts of operational risk for various liquidity levels. By way of illustration, we present results obtained from applying the proposed methodology to data extracted from CHAPS Sterling (the UK’s main large-value payments system). We are able to conclude that the likelihood of an operational failure causing a significant disruption to CHAPS Sterling payments activity is low. This finding reflects the availability of a range of robust contingency arrangements and the abundance of available liquidity in the system.

Liquidity, gridlocks and bank failures in large value payment systems: Morten Linnemann Bech Economist, Danmarks Nationalbank and Kimmo Soramäki, European Central Bank; E-money and Payment Systems Review, 29 Jan 2002; Abstract
During the last few decades, most industrialised countries have introduced real-time gross settlement (RTGS) systems for the settlement of large, time critical interbank payments. In RTGS systems, payments are settled continuously and individually in real time during the day and payments are only made if the funds on the settlement account are sufficient. Settlement in RTGS systems carries no credit risk and thus a low level of systemic risks. The reduction in these risks is however traded against increased liquidity requirements and thereby increased liquidity risk. The liquidity risks can be significant because of the pivotal role of these systems in the economy, and due to the high value transferred in these systems. Mobilising the required liquidity imposes costs on the banks and, all other things being equal, the banks have an incentive to economise on liquidity and may prefer to wait for incoming payments before sending their own payments2. This can lead to delays and gridlocks, i.e. situations where several payments each await the settlement of others. This article describes the phenomenon of gridlock in relation to RTGS systems, and analyses a resolution mechanism that has been implemented in the new Danish RTGS system, Kronos3. In order to quantify the effects of the gridlock resolution mechanism under various levels of liquidity, results of a number of simulations using real payment data are presented. Recent events (those of September 11) have highlighted financial and operational failures by one or more of the banks as potential causes for disruptions to the functioning of the payment system. In order to quantify these risks and analyse the effects of potential remedies in an RTGS setting, results from simulations modelling the bankruptcy of a bank or an operational problem barring it from connecting to the system, are presented as well.

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

The Statistics and Timing of TARGET2 Interbank Payments: Marco Massarenti, Silvio Petriconi, Johannes Lindner, European Central Bank; Journal of Financial Market Infrastructure 1(2), pp. 1-22, 19 Dec 2012; Abstract
This paper provides a descriptive analysis of daily patterns of settlement of payments in the European TARGET2 settlement system using a unique transaction-level data set. For the first time, we provide insights into the intraday pattern of interbank payments (i.e. a subset of all TARGET2 transactions), and identify intraday periods of highest activity. Next, we focus on the time dimension, looking in particular at settlement delay and its evolution over time, showing the effect of emergency monetary policy measures on payments timing. Finally, our analysis hints at a link between trading activity on financial markets and interbank payments, showing the potential of large value payment data to read out patterns and participants' behavior in financial markets.

Bank behaviour and risks in CHAPS following the collapse of Lehman Brothers: vangelos Benos, Rodney Garratt and Peter Zimmerman, Bank of England; Working Paper 451, 19 Apr 2012; Abstract
We use payments data for the period 2006-09 to study the impact of the global financial crisis on payment patterns in CHAPS, the United Kingdom’s large-value wholesale payments system. CHAPS functioned smoothly throughout the crisis and all CHAPS settlement banks continued to meet their payment obligations. However, the data show that in the two months following the Lehman Brothers failure, banks did, on average, make payments at a slower pace than before the failure. Our analysis suggests this was partly explained by concerns about counterparty default risk as well as system-wide risk. The ratio of payments made to liquidity used was 30% lower in the period from 15 September 2008 to 30 September 2009 than in the period preceding the default of Lehman Brothers. This was due initially to payment delay, but later was due to banks making more payments with their own liquidity, probably because quantitative easing increased the amount of reserves in the system. To assess the economic significance of the observed delays in the value of payments settled, we develop risk indicators, based on Markov models, to quantify the theoretical liquidity impact of delays during an operational outage. We find that payment delays in the months following the failure of Lehman Brothers led to a statistically significant but economically modest increase in these risk measures.

Intraday two-part tariff in payment systems: Tamahiro Ota, Bank of England; Working Paper 428, May 2011; Abstract
This paper studies the optimal intraday pricing in payment systems and its impact on banks’ payment behaviour and intraday liquidity management. A model is developed to compare the performance of two different mechanisms to reduce payment delay: a throughput guideline and a tariff that varies over time, and concludes that a linear time-varying tariff achieves a better outcome unless the payment system experiences a system-wide liquidity shock. We show that settlement delay can be socially efficient, contrary to general understanding of the literature, when it reduces the aggregate cost of liquidity. The theoretical model suggests that the tariff eliminates the inefficient settlement delay that does not contribute to lowering the cost, while leaving the socially efficient delay.

Changes in the Timing Distribution of Fedwire Funds Transfers: Olivier Armantier, Jeffrey Arnold, and James McAndrews, Federal Reserve Bank of New York; FRBNY Economic Policy Review, Sep 2008; Abstract
The Federal Reserve’s Fedwire funds transfer service is the biggest large-value payments system in the United States in terms of participants, value, volume, and use by other settlement systems. Although Fedwire funds activity has long been concentrated in the late afternoon, recently there has been a noticeable shift to later in the day. The value of funds activity after 17:00 has increased from 20 percent in 1998 to more than 30 percent in 2005. There is a complex set of trade-offs between risks and costs in large-value payments systems (Bank for International Settlements 2005). Theory suggests that the concentration of late-afternoon Fedwire activity is the result of coordination among banks to reduce liquidity costs, delay costs, and credit risks. As these costs and risks change over time, we would expect the timing of payment activity to be affected. In this article, we seek to quantify how the changing environment in which Fedwire operates has affected the timing of payment value transferred within the stem.

Global Trends in Large-Value Payments: Morten L. Bech, Christine Preisig, Federal Reserve Bank of New York, and Kimmo Soramäki, European Central Bank; FRBNY Economic Policy Review, Sep 2008; Abstract
Globalization and technological innovation are two of the most pervasive forces affecting the financial system and its infrastructure. Perhaps nowhere are these trends more apparent than in the internationalization and automation of payments. The evolving landscape is most obvious in retail payments. The use of paper checks is in rapid decline or has been eliminated in most of the industrialized world. Credit and debit cards can be used in the most surprising places. Internet banking with money transfer capabilities is common, and several providers are competing to service consumers’ payments over the Internet and mobile devices. In wholesale, or interbank, payments, the effect of globalization and technological innovation is probably less obvious to the casual observer—but it has been equally impressive. Given the importance of payments and settlement systems to the smooth operation as well as resiliency of the financial system, stakeholders need to understand and assess the potential consequences of this evolution. This article offers an in-depth look at the current environment for large-value payments systems (LVPSs). We describe ten trends common to LVPSs around the world and identify the key drivers of these developments and the most important policy issues facing central banks (see box). Furthermore, we provide empirical support for each of the trends by using numerous publicly available sources, including Bank for International Settlements (BIS) statistics on payments and settlement systems in selected countries (the “Red Book”).

The Timing and Funding of CHAPS Sterling Payments: Christopher Becher, Marco Galbiati, and Merxe Tudela, Bank of England; FRBNY Economic Policy Review, Sep 2008; Abstract
he use of real-time gross settlement (RTGS) systems for the settlement of large-value payments offers considerable advantages, the principal one being the elimination of the credit risk that can arise between participants in deferred net settlement systems. However, in comparison with deferred net settlement systems, RTGS systems require relatively large amounts of liquidity to support payment activity. This liquidity can be sourced from the settlement agent (usually a central bank in the case of large-value payments systems)—in the form of intraday overdrafts—or from incoming payments from other participants. Obtaining intraday liquidity from a central bank is typically costly. In order to minimise this cost and to take advantage of incoming payments as a funding source, participants may choose to delay outgoing payments. However, payment delay may itself prove costly. Participants face a trade-off, therefore, between the cost of borrowing from the central bank and the expected cost of delaying payments. McAndrews and Rajan (2000) explore this trade-off in a study of payment behaviour in Fedwire. They describe how the use of incoming funds to offset outgoing payments allows participants to avoid incurring costly overdrafts from the central bank and hence reduces the liquidity cost of making payments. Such offsetting can be achieved to a greater extent during activity peaks, so banks are induced to coordinate their payments around, and thereby to reinforce, these peaks. This article investigates the factors influencing the timing and funding of payments in the CHAPS Sterling system, drawing where appropriate on comparisons with payment activity in Fedwire. In the next section, we discuss theoretical approaches to the study of payment behaviour and their application to CHAPS Sterling.

Operational Risk and Contagion in the Austrian Large-Value Payment System ARTIS: Stefan W. Schmitz, Claus Puhr, Hannes Moshammer, Martin Hausmann, Ulrike Elsenhuber; Financial Stability Report 11, 2007; Abstract
The objective of this paper is to quantify, by use of simulations, the degree to which an operational incident occurring at one of the ARTIS2 participants affects the ability of the other participants to settle transactions.

Modelling the cross-border use of collateral in payment systems: Mark J Manning and Matthew Willison, Bank of England; Working Paper 286, Jan 2006; Abstract
Banks often rely on collateralised intraday liquidity from the central bank in order to be able to effect payments in a real- time gross settlement (RTGS) payment system. If a bank is holding insufficient eligible collateral in a particular country, and therefore cannot obtain credit from the local central bank, it may have to delay payments. This constitutes a liquidity risk to the system. Furthermore, a bank operating in multiple systems may face a mismatch between the location of its collateral holdings and liquidity needs. In this paper, we examine the extent to which the liquidity risk arising from such a mismatch may be mitigated by allowing cross-border use of collateral. We develop a two-country, two-bank model in which risk- neutral banks minimise expected costs with respect to their collateral choice in each country. In our baseline model, in which each bank faces a liquidity need in only one country, we find that liquidity risk is indeed reduced by cross-border use of collateral. This result holds despite the fact that banks may find it optimal to economise on their total holdings of collateral. However, when we extend the model to allow for the possibility that a bank faces liquidity needs in both countries simultaneously, the total quantum of collateral held is important. Indeed, when a bank finds it optimal to reduce its total holdings, there may be an increase in liquidity risk in at least one country when simultaneous liquidity demands are realised.

Liquidity Effects of the Events of September 11, 2001: James J. McAndrews and Simon M. Potter, Federal Reserve Bank of New York; FRBNY Economic Policy Review, Nov 2002; Abstract
In the wake of the terrorist attacks of September 11, 2001, the Federal Reserve supplied funds to the banking system in unprecedented amounts. The destructive force of the attacks themselves caused severe disruptions to the U.S. banking system, particularly in banks’ abilities to send payments. In this article, we provide new evidence of the importance of the coordination mechanism that banks use in their normal payments activity to provide liquidity. We do so by first outlining the sources of funding for banks’ payments activity, thus highlighting the role of expected incoming payments from other banks. Next, we examine the disruptions in the payments and communications mechanisms on September 11 and the disorder that resulted from those disruptions. We then directly estimate banks’ payments reactions to the receipt of payments from other banks and how their reactions changed in the days following the attacks. Finally, we discuss possible alternative ways to avoid such large disruptions to the payments mechanism, as well as ways to settle payments and the potential of these ways to reduce liquidity demands in the event of a significant disruption to the payments mechanism.

The Timing and Funding of Fedwire Funds Transfers: James McAndrews and Samira Rajan, Federal Reserve Bank of New York; FRBNY Economic Policy Review, Jul 2000; Abstract
In this article, we measure banks’ alternative funding sources for Fedwire funds transfers throughout the day, using a data set that includes all banks’ Fedwire funds transfers and Federal Reserve System deposits. This approach allows us to gauge the importance of incoming payments as a source of funding. We find that incoming payments used by banks to offset outgoing payments that are entered within the same minute account for 25 percent of the value of these transfers during normal activity periods and as much as 40 percent during peak periods. This level of payment coordination is impressive. However, economic analyses suggest that activity coordination by subjects in similar environments typically falls short of the level that would allow the subjects to benefit fully from such coordination. Accordingly, with many thousands of banks participating in Fedwire, there is reason to believe that the banks would prefer even greater coordination of payment activity. Furthermore, greater synchronization of payments would lead to a decrease in daylight overdrafts extended by the central bank. With these considerations in mind, we also examine a policy that might allow banks to coordinate their payment activity even more effectively: the creation of activity periods that would serve as “focal times” for entering payments.

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

(In)efficient investment in financial market infrastructure: the role of governance structures: Thorsten V. Koeppl, Queen’s University; Journal of Financial Market Infrastructures, Volume 1, Number 1 (Fall), pp. 55–73, 27 Sep 2012; Abstract
This paper establishes a link between investment in financial market infrastructure and its governance structure as either a user-oriented or a for-profit organization. The infrastructure is used to ensure that capital can be allocated through financial trades. It is shown that only a user-oriented infrastructure that allocates costs appropriately across different user groups can achieve efficiency. If costs cannot be allocated appropriately, underinvestment occurs even if the infrastructure is user-oriented. Hence, user-orientation is a necessary, but not a sufficient, condition for efficiency. On the contrary, an infrastructure that operates for profit and that is free to set its access fees will always lead to overinvestment. Moreover, requiring free access to the infrastructure does not necessarily lead to efficiency, and overinvestment can still occur. These results should caution policy-makers and regulators in two ways. First, efficiency does not necessarily result from regulating access to a for-profit infrastructure. Second, one cannot interpret measures such as trading volume as accurate indicators of efficiency in financial market infrastructures.

Auto-collateralization as a liquidity saving mechanism: Soren Korsgaard, Danmarks Nationalbank; Journal of Financial Market Infrastructures, Volume 1, Number 1, (Fall), pp. 3–27, 27 Sep 2012; Abstract
This paper examines the effects of introducing an auto-collateralization scheme in a simulated securities settlement system. Using artificially generated data, it shows that auto-collateralization can substantially lower liquidity needs without delaying settlement. By allowing for a more efficient usage of collateral, it also reduces intraday credit exposures. The paper further demonstrates how these efficiency improvements in usage of liquidity depend on the structure of the settlement cycle. The benefits of auto-collateralization are particularly large when system participants' incoming and outgoing payments are negatively correlated over time. Finally, the impact of participant defaults is assessed, and it is shown that auto-collateralization protects against liquidity risk in certain stress scenarios.

Is collateral becoming scarce? Evidence for the euro area: Anouk Levels and Jeannette Capel, De Nederlandsche Bank; Journal of Financial Market Infrastructures, Volume 1, Number 1 (Fall), pp. 29–53, 27 Sep 2012; Abstract
The global financial crisis has driven several trends in wholesale financial markets that have led to a higher demand for high-quality collateral. More transactions are now secured instead of unsecured on the money market, and, in over-the-counter derivatives markets, central counterparty clearing for standardized contracts becomes mandatory, raising collateral needs for market participants. Moreover, the Basel III liquidity standards will probably increase banks' need for high-quality liquid assets. It is not clear in advance whether the supply of collateral will grow and at what rate. On the one hand, many euro area governments now need to finance high budget deficits. While this is not a favorable development, it does imply that more debt instruments will become available as potential collateral. On the other hand, there are concerns about the creditworthiness of several euro area sovereigns, which limits the debt's collateral value. Due to these developments, some market participants expect that collateral will soon become scarce, which could impair the smooth functioning of financial markets. This paper quantifies the trends in demand for and supply of collateral, and concludes that collateral is likely to become more scarce, but not scarce in absolute terms. We also discuss the expected economic effects and policy implications of this conclusion.

CCPs
LVPS/Liquidity
LVPS/Money Market
LVPS/Network Analysis
LVPS/Simulations
LVPS/Statistics and Timing
Other
Retail

Retail payments and economic growth: Iftekhar Hasan, Fordham University and Bank of Finland, Tania De Renzis, Central Bank of Malta, Heiko Schmiedel, European Central Bank; Discussion Paper 12.2012, 2012; Abstract
This paper examines the fundamental relationship between retail payments and overall economic growth. Using data from across 27 European markets over the period 1995–2009, the results confirm that migration to efficient electronic retail payments stimulates overall economic growth, consumption and trade. Among different payment instruments, this relationship is strongest for card payments, followed by credit transfers and direct debits. Cheque payments are found to have a relatively low macroeconomic impact. Retail payment transaction technology itself is also associated positively to real economic aggregates. We also show that initiatives to integrate and harmonise retail payment markets foster trade and consumption and thereby have a beneficial effect for whole economy. Additionally, the findings reveal that the impact of retail payments on economic growth is more pronounced in euro area countries. Our findings are robust to different regression specifications. The study supports the adoption of policies promoting a swift migration to efficient and harmonised electronic payment instruments.

The social and private costs of retail payment instruments: a European perspective: Heiko Schmiedel, Gergana Kostova, Wiebe Ruttenmberg, European Central Bank; ECB Occasional Paper 137, Sep 2012; Abstract
The European Central Bank (ECB) carried out a study of the social and private costs of different payment instruments with the participation of 13 national central banks in the European System of Central Banks (ESCB). It shows that the costs to society of providing retail payment services are substantial. On average, they amount to almost 1% of GDP for the sample of participating EU countries. Half of the social costs are incurred by banks and infrastructures, while the other half of all costs are incurred by retailers. The social costs of cash payments represent nearly half of the total social costs, while cash payments have on average the lowest costs per transaction, followed closely by debit card payments. However, in some countries, cash does not always yield the lowest unit costs. Despite countries’ own market characteristics, the European market for retail payments can be grouped into five distinct payment clusters with respect to the social costs of payment instruments, market development, and payment behaviour. The results from the present study may trigger a constructive debate about which policy measures and payment instruments are suitable for improving social welfare and realising potential cost savings along the transaction value chain.

ATM Fees, Pricing and Consumer Behavior: An Analysis of ATM Network Reform in Australia: Clare Noone, Reserve Bank of Australia; Research Discussion Paper 2012-03, Mar 2012; Abstract
Automated teller machine (ATM) networks are a key component of payments systems. A number of competing theoretical models have been developed to examine fees associated with ATM transactions. A common feature of these models is that they imply that the elimination of interchange fees will cause a one-for-one increase in direct fees and a one-for-one fall in foreign fees, leaving the price of foreign ATM transactions unchanged in the short run. This prediction is not entirely consistent with recent experience in Australia. Following reform of the Australian ATM network in March 2009 that eliminated interchange fees, the total price of foreign ATM transactions was unchanged but the adjustment in foreign and direct fees was almost twice as large as the eliminated interchange fee. This paper addresses this discrepancy by developing a model of ATM fees that can explain this feature of the Australian experience and also explicitly models various ATM usage costs often ignored in the literature. However, this approach to modelling ATM fees, and the approach taken in the existing literature, cannot explain a striking feature of the Australian experience – the shift in consumer behaviour away from foreign ATM use – and two potential explanations for the observed behaviour are proposed.

Consumer credit and payment cards: Wilko Bolt, De Nederlandsche Bank, Elizabeth Foote, London School of Economics, and Heiko Schmiedel, European Central Bank; Working Paper Series 1387, Oct 2011; Abstract
We consider debit and credit card networks. Our contribution is to introduce the role of consumer credit into these payment networks, and to assess the way this affects competition and equilibrium fees. We analyze a situation in which overdrafts are associated with current accounts and debit cards, and larger credit lines with ‘grace’ periods are associated with credit cards. If we just introduce credit cards, we find their merchant fees depend not only on the networks’ cost of funds and the probability of default, but also on the interest rates of overdrafts. Whilst debit card merchant fees do not depend on funding costs or default risk in a debit-card only world, this changes when they start to compete with credit cards. First, debit merchant acceptance increases with the default probability, even though merchant fees increase. Second, an increase in funding costs causes a surprising increase in debit merchant fees. Effectively, the bank offering the debit card benefits from consumers maintaining a positive current account balance, when they use their credit instead of their debit card. As a result, this complementarity may lead to relatively high debit card merchant fees as the bank discourages debit card acceptance at the margin.

Interchange fees in card payments: Ann Börestam and Heiko Schmiedel, European Central Bank; ECB Occasional Paper Series No 131, Oct 2011; Abstract
The present paper explores issues surrounding multilateral interchange fees (MIFs) in payment card markets from various angles. The Eurosystem’s public stance on interchange fees is neutral. However, the Eurosystem takes a keen interest in facilitating a constructive dialogue among the stakeholders involved in this debate. Transparency and clarity with respect to the real costs and benefits of different payment instruments are indispensable for a modern and harmonised European retail payments market. Interchange fees (if any) should be set at a reasonable level so as to promote overall economic efficiency in compliance with competition rules.

Adopting, Using, and Discarding Paper and Electronic Payment Instruments: Variation by Age and Race: Ronald J. Mann, Federal Reserve Bank of Boston; Public Policy Discussion Paper 11-2, May 2011; Abstract
This paper uses data from the 2008 Survey of Consumer Payment Choice to discuss the adoption, use, and discarding of various common payment instruments. Using a nationally representative sample of individual-level data, it presents evidence in unparalleled detail about how consumers use different payment instruments. Most interestingly, it displays robust evidence of significant age- and race-related differences in payments choices. Among other things, it suggests that the range of payment instruments adopted and regularly used by blacks is narrower than that chosen by whites, presumably because of relatively limited access to financial institutions. With regard to age, it documents pervasive (and complex) age-related patterns at every step of the decisions to adopt, use, and discard payment instruments.

The 2010 Federal Reserve Payments Study Noncash Payment Trends in the United States: 2006 – 2009: Geoffrey R. Gerdes et al., Federal Reserve; 2010 Federal Reserve Payments Study, 05 Apr 2011; Abstract
The 2010 Federal Reserve Payments Study is the fourth of a series of triennial studies conducted by the Federal Reserve System to comprehensively estimate and study aggregate trends in noncash payments in the United States. This study estimates the total number and value of payments that were made in 2009 by check, debit card, credit card, automated clearinghouse (ACH), and prepaid card from accounts domiciled in the United States. The study also estimates the number and value of ATM withdrawals

The Benefits to Government of Connecting Low-Income Households to an E-Payment System: An Analysis in India: Rajiv Lochan, Ignacio Mas (pictured), Dan Radcliffe, Supriyo Sinha and Naveen Tahilyani, Lydian Journal; Lydian Payments Journal, Dec 2010; Abstract
Governments around the world have within their hands a powerful catalyst to promote financial inclusion – their own payment interaction with low-income households. Indeed, government is frequently the largest micro-payer and bill payer in the country. Delivering government payments electronically will not only connect low-income households to an electronic grid, but the government itself will derive sizeable benefits from automating these flows. A recent study by McKinsey, which was commissioned by the Bill & Melinda Gates Foundation, explores the inefficiencies in India’s government payment systems and estimates the monetary and non-monetary benefits of making all of India’s government payment flows electronic. The study finds that automating these payments could save the Indian government US $22.4 billion per year, equal to nearly 8 percent of the total payment flows between the government and its citizens. To put these benefits into perspective, these savings could alternatively reduce India’s fiscal deficit by 20 percent, boost India’s welfare spending by 25 percent or fund the entire cost of India’s Food Security Act (estimated at $12 billion annually) for nearly two years. Connecting all Indian households to an e-payment system will also generate large but less measurable benefits by increasing take of social welfare programs, making it easier to monitor suspicious transaction flows and boosting tax collection.

The safety of cash and debit cards: a study on the perception and behavior of Dutch customers: Anneke Kosse, De Nederlanddsche Bank; DNB Working Paper 245, Apr 2010; Abstract
This paper investigates the impact of consumers’ safety perception on debit card and cash usage. A conceptual framework of safety perception and payment behaviour is introduced and tested with 2008 consumer survey data. The results demonstrate that consumers’ payment preferences for cash and debit cards are strongly affected by how consumers assess the likelihood and seriousness of safety incidents related to cash, debit cards and ATM withdrawals. Risk aversion, personal characteristics and personal experiences all play a significant role. This study underlines the importance of effective safety measures, which minimise the risks inherent in the payment system, and of clear communication towards consumers, so that they may continue to pay efficiently and safely in all circumstances.

The Impact of Electronic Payments on Economic Growth: Mark Zandi, Virendra Singh; Moody's Analytics, Mar 2010; Abstract
In the half-century since their introduction, payment cards—credit and debit—have changed how, when and where consumers pay for goods and services. Moody’s Economy.com measured the effects of this shift from paper to electronic forms of payment and found that credit and debit cards stimulate economic growth. The study calculates that, for the 51 countries in the sample—which collectively account for 93% of the world’s gross domestic product—electronic card usage added $1.1 trillion in real dollars to private consumption and GDP from 2003 to 2008. Put another way, real global GDP grew an extra 0.2% a year on average beyond what it would have without card usage. If not for card usage, global GDP would have grown by an average of only 3% a year, instead of actual growth of 3.2%.

Return to retail banking and payments: Iftekhar Hasan, The Lally School of Management and Technology of Rensselaer Polytechnic Institute and Bank of Finland, Heiko Schmiedel, European Central Bank, and Liang Song, Rensselaer Polytechnic Institute and Bank of Finland; Working Paper Series 1135, Dec 2009; Abstract
The European banking industry joined forces to achieve a fully integrated market for retail payment services in the euro area: the Single Euro Payments Area (SEPA). Against this background, the present paper examines the fundamental relationship between retail payment business and overall bank performance. Using data from across 27 European markets over the period 2000-07, we analyse whether the provisions of retail payment services are reflected in improved bank performance, using accounting ratios and efficiency measures. The results confirm that the performance of banks in countries with more developed retail payment service markets is better. This relationship is stronger in countries with a relatively high adoption of retail payment transaction technologies. Retail payment transaction technology itself can also improve bank performance, and evidence shows that heterogeneity in retail payment instruments is associated with enhanced bank performance. Similarly, a higher usage of electronic retail payment instruments seems to stimulate banking business. We also show that retail payment services have a more significant impact on savings and cooperative bank performance although they have a positive influence on the performance of commercial banks. Additionally, findings reveal that impact of retail services on bank performance is dominated by fee income. Finally, an effective payment service market is found to be associated with higher bank stability. Our findings are robust to different regression specifications. The results may also be informative for the industry when reconsidering its business models in the light of current financial market developments.

SEPA, efficiency, and payment card competition: Wilko Bolt, De Nederlandsche, and Heiko Schmiedel, European Central Bank; ECB Working Paper Series 1140, Dec 2009; Abstract
This paper analyzes the welfare implications of creating a Single Euro Payments Area. We study the effects of increased network compatibility and payment scale economies on consumer and merchant card fees and its impact on card usage. In particular, we model competition among debit cards and between debit and credit cards. We show that competitive pressures dampen merchant fees and increase total card acceptance. The paper argues that there is room for multilateral interchange fee arrangements to achieve optimal consumer and merchant fees, taking safety, income uncertainty, default risk, merchant's pricing power, and the avoided cost of cash at the retailers side into account. Consumers and merchants are likely to benefit the most from the creation of SEPA when sufficient payment card competition alleviates potential monopolistic tendencies.

Competing Technologies for Payments: ATMs, POS Terminals and the Demand for Currency: Santiago Carbó-Valverde, University of Granada and Federal Reserve Bank of Chicago, Francisco Rodríguez-Fernández, University of Granada; Working Paper - Fundacion BBVA, Oct 2009; Abstract
Payment cards are considered as the main drivers of the shift from paper-based towards electronic-based payment instruments, which is commonly viewed as a significant socioeconomic and welfare improvement. This shift, however, is following a slow path in many developed countries which may be, at least partially, due to the over-time overlapping of the objectives of banks in deploying automated teller machines (ATMs) and point of sale (POS) devices. In this working paper, we employ a unique database to explore these issues. The results of various empirical tests suggest that the intensity of adoption and diffusion of ATM and POS transactions is mostly driven by rival precedence, network effects and market power, while demand factors do not seem to be significant. Additionally, the growth of ATMs is found to negatively affect POS adoption. We provide estimates of the effects of these technologies on the demand for currency, showing that POS devices and higher debit and credit POS transactions may significantly reduce the demand for currency.

Financial institutions and Market across Countries and over Time - Data Analysis: Thorsten Beck and Asli Demirguc-Kunt; Policy Research working paper WPS 4943, May 2009; Abstract
This paper introduces the updated and expanded version of the Financial Development and Structure Database and presents recent trends in structure and development of financial institutions and markets across countries. The authors add indicators on banking structure and financial globalization. They find a deepening of both financial markets and institutions, a trend concentrated in high-income countries and more pronounced for markets than for banks. Similarly, the recent increase in cross-border lending and debt issues has been concentrated in high-income countries, while low and lower-middle income countries have experienced an increase in remittance flows. Low net interest margins, rising profitability and declining stability in high-income countries’ banking sectors characterize the recent financial sector boom in high income countries leading up to the global financial crisis of 2007

Measuring Payment System Development: Massimo Cirasino and Jose Antonio Garcia, The World Bank; Working Paper, 2008; Abstract
The payments system is the infrastructure (comprised of institutions, instruments, rules, procedures, standards, and technical means) established to enable the transfer of monetary value between parties discharging mutual obligations. Its technical efficiency determines the efficiency with which transaction money is used in the economy, and the risks associated with its use. An efficient payments system reduces the cost of exchanging goods and services, and is indispensable to the functioning of the interbank, money, and capital markets. A weak payments system may severely drag on the stability and developmental capacity of an economy; its failures can result in inefficient use of financial resources, inequitable risk sharing among agents, actual losses for participants, and loss of confidence in the financial system and in the very use of money.

Financial Dependence and Industry Growth in Europe: Better Banks and Higher Productivity: Robert Inklaar and Michael Koetter, University of Groningen; Research Memorandum GD-100, Apr 2008; Abstract
Financial development stimulates growth, in particular in industries dependent on external finance. In this paper we show that more efficient banks are particularly important in stimulating both output and productivity growth, while traditional volume measures of finance are much less important for productivity growth. For this we exploit firm-level information to measure the dependence of industries on external finance and the efficiency of intermediaries. Our results are in line with Schumpeter’s (1912) contention that bankers provide resources to the most deserving entrepreneurs. Within the EU-25, growth gains are concentrated in the new member states.

Transaction Pricing and the Adoption of Electronic Payments: A Cross-Country Comparison: Wilko Bolt, David Humphrey, and Roland Uittenbogaarda, De Nederlandsche Bank, Florida State University; International Journal of Central Banking, (2008), Volume 4, Issue 1, pp. 89-123, Mar 2008; Abstract
After safety, the efficiency of a nation's payment system is a primary concern of central banks. Since electronic payments are typically cheaper than paper-based or cash payments, pricing these transactions should speed up the shift to electronics. But by how much? Norway explicitly priced point-of-sale and bill-payment transactions and rapidly shifted to electronic payments, while the Netherlands experienced a similar shift without pricing. Controlling for terminal availability and differences between countries, direct pricing accelerated the shift to electronics by about 20 percent. The quid pro quo was the elimination of bank-float revenues.

Payment instrument choice: The case of prepaid cards: Sujit Chakravorti and Victor Lubasi, Federal Reserve of Chicago; Economic Perspectives 2Q, 2006; Abstract
Technological advances continue to allow more and more individuals and businesses to shift toward the electronic delivery of information instead of the exchange of paper-based documents. Examples of this migration include the use of e-mail instead of traditional mail service, the delivery of real-time news via the Internet instead of a physical newspaper, and the payment of bills using online transfers instead of mailing checks. While electronic delivery is faster, often less costly, and often more reliable and secure, the older paper-based systems have not disappeared. Some users of the older technology prefer it to the newer technology, given the incentives they face today. In this article, we will explore the replacement of paper-based payment instruments by prepaid payment cards—an electronic alternative.

Conferences

Upcoming

3-4 April 2014: "Economics of Payments VII" Call for papers
Organisers: Federal Reserve Bank of Boston
29-30 August 2013: "11th Simulator Seminar - Quantitative analysis of the payments and securities settlement systems" Call for papers
Organisers: Bank of Finland, Helsinki
28 Feb - 1 Mar 2013: "Financial Inclusion Research Conference 2013" Call for papers
Organisers: The SWIFT Institute, The Ash Center for Democratic Governance and Innovation and The Mossavar-Rahmani Center for Business and Government (Harvard Kennedy School)
10-12 July 2013: 19th International Conference on Computing in Economics and Finance (CEF 2013) including an invited session titled "Payment methods, payment systems and interbank money market from a network perspective"
Organisers: The Society for Computational Economics and Simon Fraser University - Canada
11-12 September 2013: September 2013, four years after Pittsburgh: What has OTC derivatives reform achieved so far?
Organisers: ECB, Banque de France and Bank of England
21-22 October 2013: "Retail payments at a crossroads: economics, strategies, and future policies" Call for papers
Organisers: Banque de France and ECB – Paris

Past

9 October 2012: " Payment system monitoring indicators"
Organisers: Bank for International Settlements (BIS)
19-20 April 2012: "Financial Infrastructures Research Conference 2012" programme , call for papers
Organisers: De Nederlandsche Bank (DNB) and Tilburg University
24-25 May 2012: " Economics of Payments VI (call for papers) "
Organisers: The Bank of Canada
21-22 June 2010: "Payment Markets: Theory, Evidence and Policy"
Organisers: The University of Granada and the Federal Reserve Bank of Chicago
1-2 April 2010: "The Economics of Payments IV" (announcement)
Organisers: Federal Reserve Bank of New York and Federal Reserve Bank of Atlanta
2 October 2009: "Payment Systems in a Changing Financial Environment (call for papers)"
Organisers: Purdue University and Federal Reserve Bank of New York.
24-25 September 2009: "Recent Developments in Consumer Credit and Payments "
Organisers: Federal Reserve Bank of Philadelphia - Philadelphia.
25-26 May 2009: "Retail Payments: Integration and Innovation"
Organisers: European Central Bank and De Nederlandsche Bank - Frankfurt am Main.
14-15 May 2009: "Payments Pricing: Who Bears the Cost?"
Organisers: Federal Reserve Bank of Chicago - Chicago.
11-12 December 2008: "Risk Transfer: Challenges for Financial Institutions and Markets"
Organisers: CFS, CEPR and Deutsche Bundesbank - Frankfurt am Main.
19-20 November 2008: "Payment Economics: Theory and Policy"
Organisers: Organiser: Bank of Canada - Ottawa.
14-15 November 2008: "Norges Bank Research Conference on Payments Systems"
Organiser: Norges Bank - Oslo.
Special conference on retail payment systems.
9-10 June 2008: "Liquidity in Interdependent Transfer Systems"
Organisers: Banque de France and European Central Bank - Paris.
21-22 April 2008: "The Safety and Efficiency of Post-Trading Arrangements in Europe"
Organisers: European Central Bank and European Commission - Frankfurt am Main.
12-13 November 2007: "Payments and Monetary and Financial Stability"
Organisers: Bank of England and European Central Bank - Frankfurt am Main.

Payment Economics Network (PEN)

About the network

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Main research areas

Large Value Payment Systems

Retail payment systems

Settlement systems

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Publications

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