Liquidity Saving Mechanism Under Interconnected Payment Network

Abstract

This paper studies the intraday payment behavior of banks under the real time gross settlement (RTGS) system. Our game structure is based on Bech and Garratt (2003), with additional stages for recycling reserve. This gives us a variant of the hawk-dove structure, which enables efficient reserve recycling in an equilibrium. Based on this structure, we analyze the welfare effects of introducing a liquidity saving mechanism(LSM) to the RTGS system. We focus on situations where the LSM works only locally, that is, it serves to offset only a part of the whole obligation. Such partial offsetting effectively works to separate a connected payments network into mutually disconnected subnetworks. It is apparent that disconnection of the network itself will prevent efficient recycling throughout the network. We further find that there possibly exists a strategic indirect effect which prevents efficient recycling even within each subnetwork. Specifically, we devise a theoretical class of core-periphery structures for underlying payment networks, and show that the density of the network could have a nonlinear impact on the effects of the LSM. Our analysis suggests a policy mix wherein the utilization of the LSM should be examined in combination with other policies promoting efficient liquidity recycling.