Liquidity-saving Mechanism Research Articles

From LVTS to Lynx: Quantitative assessment of payment system transition in Canada

Modernising Canada’s wholesale payments system from the legacy large-value transfer system (LVTS) to Lynx brings two key changes: (1) the settlement model shifts from a hybrid system that combined components of both real-time gross settlement (RTGS) and deferred net settlement to an RTGS system; and (2) the policy regarding queue usage changes from discouraging it to encouraging the adoption of the new liquidity-saving mechanism. This paper quantitatively assesses the effects of these changes on the behaviour of participants in the payments system. The analysis reveals that most system-level payments in Lynx are settled in a single stream via the liquidity-saving mechanism, thus facilitating liquidity pooling and leading to higher efficiency than with LVTS, where payments were distributed in two streams. Moreover, due to Lynx’s liquidity-saving mechanism, many payments arrive earlier than those settled in LVTS, providing more opportunities for liquidity saving at the cost of slightly increased payment delay. At the participant level, meanwhile, the analysis suggests that liquidity efficiency is improved for various participants, with most experiencing slightly longer payment delays in Lynx than in LVTS.

Quantifying the economic benefits of payments modernization: the case of Canada’s large-value payment system

In this paper, we develop a discrete-choice framework to quantify the economic benefits of Canada’s large-value payment system modernization (ie, the replacement of Canada’s large-value transfer system (LVTS) with Lynx, the new large-value payments system in Canada). We first estimate participants’ preferences for liquidity cost, payment safety and the network effect by exploiting intraday variations in the relative choice probabilities of the two substitutable subsystems (tranches 1 and 2) in the LVTS. Then, with the estimated model, we calculate the changes in participants’ welfare when the LVTS is replaced by Lynx. First, compared with the LVTS, Lynx has higher liquidity costs but is more secure. Second, when over 90% of current LVTS payments migrate to Lynx, there is an overall welfare gain. Third, accounting for equilibrium adjustment after the replacement of the LVTS with Lynx, about a 75% improvement in service quality level is needed to generate overall net economic benefits to participants. Among other things, adopting a liquidity-saving mechanism and reducing risks in the new large-value payments system could help achieve this improvement. Finally, the welfare changes are fairly heterogeneous across participants, especially between large and small participants.

How much liquidity would a liquidity-saving mechanism save if a liquidity-saving mechanism could save liquidity? A simulation approach for Canada’s large-value payment system

Canada’s Large Value Transfer System (LVTS) is in the process of being replaced by a real-time gross settlement (RTGS) system. A pure RTGS system typically requires participants to hold substantial amounts of intraday liquidity in order to settle their payment obligations. Implementing one or more liquidity-saving mechanisms (LSMs) can reduce the amount of liquidity that participants need to hold. This paper investigates how much liquidity requirements can be reduced with the implementation of different LSMs in the Financial Network Analytics simulation engine using LVTS transaction data from 2018. These LSMs include (1) bilateral offsetting, (2) FIFO–bypass, (3) multilateral offsetting and (4) a combination of all LSMs. We simulate two different scenarios at varying levels of the upper bound of liquidity. In the first scenario, all payments from Tranche 1, which are considered time critical, are settled in a pure RTGS payment stream, while less time-critical Tranche 2 payments are settled in a payment stream with LSMs. In the second scenario, we settle all payments (Tranches 1 and 2) in the LSM stream. Our results show that when there is ample liquidity available in the system, there is minimal benefit from LSMs, as payments are settled without much delay: the effectiveness of LSMs increases as the amount of intraday liquidity decreases. A combination of LSMs shows a reduction in liquidity requirements that is larger than any one individual LSM.

How Much Liquidity Would a Liquidity-saving Mechanism Save if a Liquidity-saving Mechanism could Save Liquidity? A Simulation Approach for Canada’s Large-value Payment System

Canada’s Large Value Transfer System (LVTS) is in the process of being replaced by a real-time gross settlement (RTGS) system. A pure RTGS system typically requires participants to hold substantial amounts of intraday liquidity in order to settle their payment obligations. Implementing one or more liquidity-saving mechanisms (LSMs) can reduce the amount of liquidity that participants need to hold. This paper investigates how much liquidity requirements can be reduced with the implementation of different LSMs in the Financial Network Analytics simulation engine using LVTS transaction data from 2018. These LSMs include (1) bilateral offsetting, (2) FIFO–bypass, (3) multilateral offsetting and (4) a combination of all LSMs. We simulate two different scenarios at varying levels of the upper bound of liquidity. In the first scenario, all payments from Tranche 1, which are considered time critical, are settled in a pure RTGS payment stream, while less time-critical Tranche 2 payments are settled in a payment stream with LSMs. In the second scenario, we settle all payments (Tranches 1 and 2) in the LSM stream. Our results show that when there is ample liquidity available in the system, there is minimal benefit from LSMs, as payments are settled without much delay: the effectiveness of LSMs increases as the amount of intraday liquidity decreases. A combination of LSMs shows a reduction in liquidity requirements that is larger than any one individual LSM.

Liquidity Saving Mechanisms in Payment Systems and Settlement Liquidity

Payment systems are one of the key Financial Market Infrastructures (FMIs) and have showed remarkable progress over the past two decades. The first half of this paper focuses on the evolutionary process of payment systems, starting with the Deferred Net Settlement (DNS) system and progressing to the Real-Time Gross Settlement (RTGS) system. Subsequently, much more sophisticated payment systems have been put in place, which include the “Hybrid System,” and the “RTGS system with Liquidity Saving Mechanism (LSM).” In the latter half of this paper, experience from the “Next-Generation Real-Time Gross Settlement” (RTGS-XG) project of BOJ-NET is discussed. BOJ-NET is the large-value payment system operated by Bank of Japan (BOJ). BOJ-NET, a pure RTGS system, added an LSM in 2008 and became an RTGS system with LSM. The impact of the LSM's introduction is analyzed, which includes the participants' settlement liquidity, the liquidity-saving effect, the average settlement time, the average waiting time in the queue, the turnover ratio, and the volume of idle liquidity. These analyses would be useful for any nations considering the introduction of the same kind of enhanced payment system.

Liquidity Saving Mechanism Under Interconnected Payment Network

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.

Information asymmetries and spillover risk in settlement systems

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.

Auto-collateralization as a liquidity-saving mechanism

Auto-collateralization as a liquidity-saving mechanism

Liquidity-Saving Mechanisms in Collateral-Based RTGS Payment Systems

This paper studies banks’ incentives regarding the timing of payment submissions in a collateral-based RTGS payment system and how these incentives change with the introduction of a liquidity-saving mechanism (LSM). We show that an LSM allows banks to economise on collateral while also providing incentives to submit payments earlier. This is because in our model an LSM allows payments to be matched and offset in real time without any or very minimal funds. Under a collateral-based RTGS payment system, introduction of the LSM always improves welfare. The result contrasts with earlier work, which shows that under a fee-based RTGS system, the introduction of an LSM in some circumstances may reduce welfare.

Liquidity-saving mechanisms in collateral-based RTGS payment systems

This paper studies banks’ incentives regarding the timing of payment submissions in a collateral-based RTGS payment system and how these incentives change with the introduction of a liquidity-saving mechanism (LSM). We show that an LSM allows banks to economise on collateral while also providing incentives to submit payments earlier. This is because in our model an LSM allows payments to be matched and offset in real time without any or very minimal funds. Under a collateral-based RTGS payment system, introduction of the LSM always improves welfare. The result contrasts with earlier work, which shows that under a fee-based RTGS system, the introduction of an LSM in some circumstances may reduce welfare.

Liquidity-Saving Mechanisms in Collateral-Based RTGS Payment Systems

This paper studies banks’ incentives regarding the timing of payment submissions in a collateral-based RTGS payment system and how these incentives change with the introduction of a liquidity-saving mechanism (LSM). We show that an LSM allows banks to economise on collateral while also providing incentives to submit payments earlier. This is because in our model an LSM allows payments to be matched and offset in real time without any or very minimal funds. Under a collateral-based RTGS payment system, introduction of the LSM always improves welfare. The result contrasts with earlier work, which shows that under a fee-based RTGS system, the introduction of an LSM in some circumstances may reduce welfare.

Quantifying the Benefits of a Liquidity-Saving Mechanism

This paper attempts to quantify the benefits associated with operating a liquidity-saving mechanism (LSM) in Fedwire, the large-value payment system of the Federal Reserve. Calibrating the model of Martin and McAndrews (2008), we find that potential gains are large compared to the likely cost of implementing an LSM, on the order of hundreds of thousands of dollars per day.

A study of competing designs for a liquidity-saving mechanism

We study two designs for a liquidity-saving mechanism (LSM), a queuing arrangement used with an interbank settlement system. With a balance-reactive LSM, banks can set a balance threshold below which payments are not released from the queue, an action not possible with a receipt-reactive LSM. Payments that are costly to delay are settled earlier with a receipt reactive LSM. Payments that are not costly to delay may be queued with a balance reactive LSM but are always delayed with a receipt reactive LSM. We show that either system can provide higher welfare.

A Study of Competing Designs for a Liquidity-Saving Mechanism

We study two designs for a liquidity-saving mechanism (LSM), a queuing arrangement used with an interbank settlement system. We consider an environment where banks are subjected to liquidity shocks. Banks must make the decision to send, queue, or delay their payments after observing a noisy signal of the shock. With a balance-reactive LSM, banks can set a balance threshold below which payments are not released from the queue. Banks can choose their threshold such that the release of a payment from the queue is conditional on the liquidity shock. With a receipt-reactive LSM, a payment is released from the queue if an offsetting payment is received, regardless of the liquidity shock. We find that these two designs have opposite effects on different types of payments. Payments that are costly to delay will be settled at least as early, or earlier, with a receipt-reactive LSM. Payments that are not costly to delay will always be delayed with a receipt-reactive LSM, while some of them will be queued and settled early with a balance-reactive LSM. We also show that parameter values will determine which system provides higher welfare.

The Welfare Effects of a Liquidity-Saving Mechanism

This paper considers the welfare effects of introducing a liquidity-saving mechanism (LSM) in a real-time gross settlement (RTGS) payment system. We study the planner’s problem to get a better understanding of the economic role of an LSM and find that an LSM can achieve the planner’s allocation for some parameter values. The planner’s allocation cannot be achieved without an LSM, as long as some payments can be delayed without cost. In equilibrium with an LSM, we show that there can be either too few or too many payments settled early compared with the planner’s allocation, depending on the parameter values.

An Economic Analysis of Liquidity-Saving Mechanisms

A recent innovation in large-value payments systems has been the design and implementation of liquidity-saving mechanisms (LSMs), tools used in conjunction with real-time gross settlement (RTGS) systems. LSMs give system participants, such as banks, an option not offered by RTGS alone: they can queue their outgoing payments. Queued payments are released if some prespecified event occurs. LSMs can reduce the amount of central bank balances necessary to operate a payments system as well as quicken settlement. This article analyzes the performance of RTGS systems with and without the addition of an LSM. The authors find that, in terms of settling payments early, these mechanisms typically outperform pure RTGS systems. However, there are times when RTGS systems can 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. The authors also show that the design of a liquidity-saving mechanism has important implications for the welfare of system participants, even in the absence of payment netting. In particular, the parameters specified determine whether the addition of an LSM increases or decreases welfare.

Liquidity-saving mechanisms

This paper studies the incentives of participants in a real-time gross settlement system with and without the addition of a liquidity-saving mechanism (LSM). Participants in the model face a liquidity shock and different costs for delaying payments. They trade off the cost of delaying a payment against the cost of borrowing liquidity from the central bank. The main contribution of the paper is to show that the design of an LSM has important implications for welfare. In particular, parameters determine whether the addition of an LSM increases or decreases welfare.

Liquidity-Saving Mechanisms

We study the incentives of participants in a real-time gross settlement system with and without the addition of a liquidity-saving mechanism (queue). Participants in our model face a liquidity shock and different costs for delaying payments. They trade off the cost of delaying a payment against the cost of borrowing liquidity from the central bank. The heterogeneity of participants in our model gives rise to a rich set of strategic interactions. The main contribution of our paper is to show that the design of a liquidity-saving mechanism has important implications for welfare, even in the absence of netting. In particular, we find that parameters will determine whether the addition of a liquidity-saving mechanism increases or decreases welfare.