Staff Reports

Precautionary Demand and Liquidity in Payment Systems

Previous title: “Systemic Risk and Liquidity in Payment Systems”

October 2008Number 352
Revised August 2010
JEL classification: E58, G21, D85, E44

Authors: Gara M. Afonso and Hyun Song Shin

In large-value real-time gross settlement payment systems, banks rely heavily on incoming funds to finance outgoing payments. Such reliance necessitates a high degree of coordination and synchronization. We construct a model of a payment system calibrated for the U.S. Fedwire system and examine the impact of realistic disruptions motivated by the recent financial crisis. In such settings, individually cautious behavior can have a significant and detrimental impact on the overall functioning of the payment system through a multiplier effect. Our results quantify the mutually reinforcing nature of greater caution, and allow comparative statics analysis of shifts in key parameters.

Available only in PDFPDF51 pages / 987 kb

For a published version of this report, see Gara Afonso and Hyun Song Shin, "Precautionary Demand and Liquidity in Payment Systems," Journal of Money, Credit, and Banking 43, no. s2 (October 2011): 589-619.