Payments and Settlements Systems

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Antoine Martin and James McAndrews

An Economic Analysis of Liquidity-Saving Mechanisms
• Liquidity-saving mechanisms (LSMs) are
queuing arrangements for payments that operate alongside traditional real-time gross settlement (RTGS) systems.

1. Introduction

L

• LSMs allow banks to condition the release of
queued payments on the receipt of offsetting or partially offsetting payments; as a result, banks are less inclined to delay the sending of payments.

• An analysis of LSMs finds that these
mechanisms typically perform better than pure RTGS systems when it comes to settling payments early.

• RTGS systems can sometimes be preferable
to LSMs, such as when many banks that send payments early in RTGS choose to queue their payments when an LSM is available.

arge-value payments systems, used by banks to settle financial and commercial transactions, play a key role in the financial system. The importance of these payments systems can be illustrated by the large amounts they settle. Every year in the United States, the systems process value equal to approximately 100 times GDP. Innovations in the design of large-value payments systems have led to many improvements in their operations. For example, over the last twenty years, many countries have adopted real-time gross settlement (RTGS) systems for their large-value payments. In an RTGS system, each payment is settled individually, on a gross basis, at the time the payment is sent. RTGS systems offer many advantages—for instance, they limit the risk exposure of payments system participants and allow for rapid final settlement of payments during the day. However, RTGS systems require large amounts of central bank balances to function smoothly. More recent innovations have occurred in the design and implementation of various liquidity-saving mechanisms (LSMs) that are used in conjunction with RTGS systems.1 An LSM gives participants in the payments system an additional option not offered by RTGS alone: A payment can be put into a queue and then released from the queue if some prespecified event occurs. Such mechanisms can reduce the amount of central bank balances necessary to operate the system smoothly as well as quicken the settlement of payments. The authors thank Enghin Atalay for excellent research assistance. The views expressed are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.

Antoine Martin is a research officer and James McAndrews a senior vice president at the Federal Reserve Bank of New York.

FRBNY Economic Policy Review / September 2008

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As we describe in detail below, an LSM allows banks to send payments conditional on the receipt of payments, and it can accommodate some netting of payments. Over the past decade, researchers have been able to simulate the performance of various LSMs. In most of these simulations, the researcher makes assumptions about the behavior of the parties in the system and measures various consequences of the assumed behavior. This approach has great potential to yield useful answers to a number of questions. This article outlines a different approach to the study of LSMs in a payments system. It examines a theoretical model of the behavior of parties, which for simplicity we refer to as banks. Each bank has particular motivations and constraints; as a result, its behavior can be determined as an equilibrium

Every year in the United States, [largevalue payments] systems process value equal to approximately 100 times GDP. outcome in response to the incentives it faces. The theoretical approach has the advantage of allowing banks’ reactions to alternative payments system designs to be determined within a theoretical model, rather than be assumed by the researcher. This approach also allows outcomes to be compared consistently across a number of designs. Innovations in LSMs are numerous and, in some cases, quite...
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