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In the 1980s, central banks around the world joined the Federal Reserve and began implementing real-time gross settlement (RTGS) systems to reduce the risks associated with the growing volume of daily payments among commercial banks.
RTGS systems can reduce settlement risk significantly; however, they require more liquidity to smooth nonsynchronized payment flows. Central banks therefore typically provide intraday credit to commercial banks, either as collateralized credit or priced credit.
Because intraday credit is costly—either implicitly as the opportunity cost of collateral or explicitly as fees—banks look to minimize their use of liquidity by timing the release of payments.
The management of intraday liquidity positions thus has become an increasingly important competitive component of commercial bank operations as well as a policy concern of central banks.
Bech uses a game-theoretical framework to analyze the effect of central bank credit policies on the intraday liquidity management behavior of commercial banks in an RTGS environment.
He observes that the actions taken by commercial banks depend on the intraday credit policy and encompass two well-known paradigms in game theory: “the prisoner’s dilemma” and “the stag hunt”—two useful tools for understanding the fundamental trade-offs faced by RTGS participants.
The prisoner’s dilemma arises in a collateralized credit regime, where commercial banks have an incentive to delay payments if intraday credit is expensive. The stag hunt occurs in a priced credit regime, where the banks seek to coordinate the timing of their payments to avoid overdraft fees.
The author also discusses how several extensions of the framework affect his results, such as settlement risk, incomplete information, heterogeneity, and repeated play.
About the Author
Morten L. Bech is a senior economist at the Federal Reserve Bank of New York.
The views expressed in this summary are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.