Liquidity Considerations in Large-Value Payments Systems

1
Liquidity Considerations in Large-Value Payments
Systems

• James McAndrews
• Federal Reserve Bank of New York
• May 29, 2007
• For presentation at Exploring Frontiers in
  Payments Systems Development

2
Liquidity

• A liquid asset can be sold
• rapidly,
• with little loss of value,
• anytime within market hours.
• Characteristic of a liquid market ready and
  willing buyers and sellers at all times.

3
Large-Value Payment Systems

• What does liquidity mean in LVPS?
• Low-cost access to settlement asset (ability to
  transform other assets into settlement asset with
  little loss of value)
• Counterparties ready and willing to make payments
  in timely way.
• If LVPS system is liquid, payments flow smoothly
  (rapidly anytime within market hours).

4
Net systems and Gross systems

• In Netting systems, the need for settlement asset
  is economized.
• Counterparty promises reinforced by pledge of
  collateral.
• In RTGS systems, greater need for settlement
  asset.
• Central banks often provide access to daylight
  balances against collateral.
• U.S. limits extension of uncollateralized
  daylight overdrafts, and banks pay fee for use.

5
Liquidity in LVPS Systems

• The aim is to achieve
• a willingness to submit payments in a timely way,
  
• to settle all credit within system at end of day,
  
• Avoids any spillovers into overnight balances and
  interference with monetary policy objectives
• to avoid large counterparty exposures.

6
Liquidity in LVPS Systems

• Designs for liquidity provision vary, but often
  include
• Netting systems Counterparty limits, collateral
  backing
• RTGS systems Participant credit limits,
  collateral backing

7
Liquidity in RTGS

• BIS Report on Real-Time Gross Settlement (1997)
• Sources of funds are
• balances maintained on account with the central
  bank,
• incoming transfers from other banks,
• credit extensions from the central bank and
• borrowing from other banks through the money
  markets.

8
RTGS Diffusion

• Many countries have adopted RTGS during last two
  decades.
• Low-cost assurance of end-of-day settlement and
  freedom from counterparty credit risk.

9
RTGS Diffusion

10
RTGS Diffusion

• Many countries have adopted RTGS during last two
  decades.
• Low-cost assurance of end-of-day settlement and
  freedom from counterparty credit risk.
• But some situations may cause gridlock an
  unwillingness of participants to submit
  payments.

11
Experience of September 11, 2001 in Fedwire
Payments settlement slowed significantly for a
few days, partially because of bottlenecks as
some banks could not send out payments. Federal
Reserve injected large amounts of balances.
12

Mixing RTGS and netting features
Liquidity-Savings Mechanisms

BIS Report New Developments in LVPS (2005)
Lower bound
Upper bound
DNS
Delay
Pure RTGS
Liquidity available/required
13
Advantages and Disadvantages LSMs

• Former DNS systems New CHIPS and PNS
• Now achieve intraday finality and may be
• safer than DNS systems but probably more
  costly
• Former traditional RTGS system RTGSplus
• Now provides continuous offsetting and may be
• as safe as RTGS and probably less costly in
  terms of liquidity

14
Advantages and Disadvantages LSMs

• High development costs
• Less transparency
• Is liquidity really a problem?
• There is not necessarily a single optimal design
  for LVPS.

15
Liquidity Considerations

• There are a range of methods to create a liquid
  LVPS.
• A liquid payment system is one that is
• allows low-risk access to the settlement asset at
  low cost, and
• adequately controls counterparty risk exposures.