Intraday Liquidity Management: A Tale of Games Banks Play

Abstract

Over last few decades, most central banks, concerned about settlement risks inherent in payment netting systems, have implemented real-time gross settlement (RTGS) systems. Although RTGS systems can significantly reduce settlement risk, they require greater liquidity to smooth nonsynchronized payment flows. Thus, central banks typically provide intraday credit to member banks, either as collateralized credit or priced credit. Because intraday credit is costly for banks, how intraday liquidity is managed has become a competitive parameter in commercial banking and a policy concern of central banks. This article uses a game-theoretical framework to analyze intraday liquidity management behavior of banks in an RTGS setting. The games played by banks depend on intraday credit policy of central bank and encompass two well-known paradigms in game theory: the prisoner's dilemma and the stag hunt. The former strategy arises in a collateralized credit regime, where banks have an incentive to delay payments if intraday credit is expensive, an outcome that is socially inefficient. The latter strategy occurs in a priced credit regime, where postponement of payments can be socially efficient under certain circumstances. The author also discusses how several extensions of framework affect results, such as settlement risk, incomplete information, heterogeneity, and repeated play.