An analysis of competitive externalities in gross settlement systems

Following the ongoing 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. (C) 1998 Elsevier Science B.V. All rights reserved.