A Comparison of Alternative Interbank Settlement Systems

Abstract

This paper presents a model to analyse alternative interbank settlement systems. Intraday credit exposures in netting systems generate systemic risk (the failure by one bank to settle at the end of the day may cause a chain of bank failures). To prevent this, mutual loss-sharing is implemented. Following Merton (1977), we develop a methodology to measure the cost of loss-sharing. Alternatively, banks can move to gross settlement. Since each payment is immediately settled, systemic risk is eliminated. But banks need collateral or reserves before making payments. Facing costly collateral holdings, banks will economise on them, which may generate delays. The trade-off between the cost of collateral and delay is incorporated in our model. Finally, we estimate the total cost of net and gross settlement. It is found that the extra cost of gross settlement exceeds the reduction in systemic risk.

JEL Classification: E58, G21, G28