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How a liquidity saving mechanism affects bank behavior in interconnected payment networks

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  • Hitoshi Hayakawa

    (Hokkaido University)

Abstract

A surge in banks’ liquidity needs increases settlement costs that could burden the functioning of the real economy through its impact on banks’ lending behavior. A liquidity saving mechanism (LSM) can help reduce banks’ liquidity needs, but it could also affect banks’ strategic behavior. To understand how an LSM affects banks’ behavior in a real-time gross settlement system, this study models settlements in a day as a timing game in which banks decide when to make payments, thereby trading off the cost of delaying payments against the cost of borrowing liquidity. An LSM provides a partial offsetting service, whose direct effect is to decrease the cost of liquidity associated with payments that are offset. The study’s stylized analyses reveal that an LSM indirectly affects banks’ strategic behavior in a network context. Without an LSM, a positive strategic spillover effect can arise through the network of payments, which an LSM can dismiss by cutting off the underlying payment network. To demonstrate its welfare impact along with the network structures, this study theoretically analyzes a class of core-periphery networks. The density of the network is shown to have implications on the welfare consequence of adding an LSM. From a policy perspective, the implications on a policy mix between an LSM and the fee setting for intraday lending are discussed.

Suggested Citation

  • Hitoshi Hayakawa, 2025. "How a liquidity saving mechanism affects bank behavior in interconnected payment networks," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 20(1), pages 41-71, January.
  • Handle: RePEc:spr:jeicoo:v:20:y:2025:i:1:d:10.1007_s11403-024-00408-0
    DOI: 10.1007/s11403-024-00408-0
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    References listed on IDEAS

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    1. Soramäki, Kimmo & Bech, Morten L. & Arnold, Jeffrey & Glass, Robert J. & Beyeler, Walter E., 2007. "The topology of interbank payment flows," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 379(1), pages 317-333.
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    3. Galbiati, Marco & Soramaki, Kimmo, 2010. "Liquidity-saving mechanisms and bank behaviour," Bank of England working papers 400, Bank of England.
    4. Mills Jr., David C. & Nesmith, Travis D., 2008. "Risk and concentration in payment and securities settlement systems," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 542-553, April.
    5. Hitoshi Hayakawa, 2020. "Liquidity in Financial Networks," Computational Economics, Springer;Society for Computational Economics, vol. 55(1), pages 253-301, January.
    6. Martin, Antoine & McAndrews, James, 2008. "Liquidity-saving mechanisms," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 554-567, April.
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    More about this item

    Keywords

    Game on network; Spillover; Core-periphery network; Payment system; Real-time gross settlement system;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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