Liquidity Saving Mechanism in an Interconnected Payment Network

This paper studies the intraday payment behavior of banks under the real time gross settlement(RTGS) system. Our game structure is based on Bech and Garratt (2003), with additional stages for recycling reserve. This gives us a variant of the hawk–dove structure, which enables efficient reserve recycling in an equilibrium. Based on this structure, we analyze the welfare effects of introducing a liquidity saving mechanism(LSM) to the RTGS system. We focus on situations where the LSM works only locally, that is, it serves to offset only a part of the whole obligation. Such partial offsetting effectively works to separate a connected payments network into mutually disconnected subnetworks. It is apparent that disconnection of the network itself will prevent efficient recycling throughout the network. We further find that there possibly exists a strategic indirect effect which will prevent efficient recycling even within each subnetwork. We show that introducing an LSM possibly has an overall negative welfare effect. Specifically, we devise a theoretical class of core-periphery structures for underlying payment networks, and examine situations where the LSM could offset obligations only among the core banks. We show that the density of the network could have a nonlinear impact in the effects of the LSM in the sense that the negative effect is more likely for middle ranged dense networks. Our analysis suggests a policy mix wherein the utilization of the LSM should be examined in combination with other policies promoting efficient liquidity recycling, namely controlling the fee for the reserve or the ordering of banks regarding their