Information asymmetries and spillover risk in settlement systems

Abstract

I show how information asymmetries between agents in different settlement systems can increase the risk that a problem in one may spill over to another. I focus on the strategic behavior of participants who operate in multiple systems as they choose how best to manage their liquidity across the systems. In the event of an operational shock in one system, these participants may continue to make payments in order to avoid delay costs, thereby risking a liquidity sink, if they believe they can recycle liquidity from the other, unaffected system. They are more likely to risk a liquidity sink if they believe banks in the unaffected system will continue making payments early, unaware of the operational problem. I show that a liquidity-saving mechanism (LSM) in one system may reduce the probability of spillover into the other; in this sense, I identify a positive externality from the introduction of an LSM.