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Settlement Systems

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  • Lester Benjamin

    (University of Western Ontario)

Abstract

We construct a general equilibrium model in which credit is used as a medium of exchange, and banks participate in a settlement system to finalize their customers' transactions. We study the optimal settlement system design, and find that a trade-off arises endogenously within the model. A higher frequency of settlement and more costly intra-day borrowing policies limit the banks' accumulation of liabilities and promote conservative reserve management, hence limiting the risk of default should a bank fail for any reason. However, such policies also imply higher banking costs, less interest paid on deposits, and less capital allocated by banks to productive investments. After characterizing equilibrium and welfare, we parameterize the economy and analyze how the optimal settlement system policies depend on several features of the economy, including the risk of bank failure, the fragility of the settlement system, the volume of trade by banks' customers, and the rate of return on investments available to banks.

Suggested Citation

  • Lester Benjamin, 2009. "Settlement Systems," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-35, May.
    • Handle: RePEc:bpj:bejmac:v:9:y:2009:i:1:n:17
    DOI: 10.2202/1935-1690.1695
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    References listed on IDEAS

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    1. Martin, Antoine & McAndrews, James, 2010. "A study of competing designs for a liquidity-saving mechanism," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1818-1826, August.
    2. Williamson, Stephen & Wright, Randall, 2010. "New Monetarist Economics: Models," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 2, pages 25-96, Elsevier.
    3. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.

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