Research Discussion Papers, Bank of Finland
No 16/1999:
Optimizing Liquidity Usage and Settlement Speed in Payment Systems
Harry Leinonen ()
and Kimmo Soramäki ()
Abstract: The operating speed of a payment system depends on the
stage of technology of the system's communication and information
processing environment. Frequent intraday processing cycles and real-time
processing have introduced new means of speeding up the processing and
settlement of payments. In a real-time environment banks face new
challenges in liquidity management. They need to plan for intraday as well
as interday fluctuations in liquidity. By employing various types of hybrid
settlement structures, banks may be able to even out intraday fluctuations
in liquidity demand. The aim of this study is to develop a framework for
analysing fluctuations in liquidity demand and assessing the efficiency of
different settlement systems in terms of speed and liquidity needs. In this
study we quantify the relationship between liquidity usage and settlement
delay in net settlement systems, real-time gross settlement systems and
hybrid systems, as well as the combined costs of liquidity and delay in
these systems. We analyse ways of reducing costs via optimization features
such as netting of queues, offsetting of payments and splitting of
payments. We employ a payment system simulator developed at the Bank of
Finland, which enables us to evaluate the impact of changes in system
parameters and thus to compare the effects of alternative settlement
schemes with given payment flows. The data used covers 100 days of actual
payments processed in the Finnish BoF-RTGS system. Our major findings
relate to risk reduction via real-time settlement, effects of optimization
routines in hybrid systems, and the effects of liquidity costs on banks'
choice of settlement speed. A system where settlement takes place
continuously in real-time and with queuing features is more efficient from
the perspective of liquidity and risks than a net settlement system with
batch processing. Real-time processing enables a reduction in payment delay
and risks without necessarily increasing liquidity needs. Participants will
operate under immediate payment/settlement if liquidity costs are low
enough relative to delay costs and if the liquidity arrangements are
sufficiently flexible. The central bank can therefore support risk
reduction and payment speed objectives by providing low cost intraday
liquidity as well as more flexible ways for participants to add or withdraw
liquidity from the system. Optimizing and gridlock solving features were
found to be effective at very low levels of liquidity. The efficiency of
the different optimization methods for settlement systems are affected by
the actual flow of payments processed. Gains from netting schemes with
multiple daily netting cycles were found to be somewhat more limited.
Keywords: payment systems; clearing/settlement; liquidity; efficiency; gridlock; (follow links to similar papers)
39 pages, November 12, 1999
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