Economic Policy Review Executive Summary

Economizing on Liquidity with Deferred Settlement Mechanisms

Recapping an article from the December 2004 issue
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of the Economic Policy Review, Volume 10, Number 3
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22 pages / 244 kb

Authors: Kurt Johnson, James J. McAndrews, andKimmoSoramäki

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Index of executive summaries
  • The Federal Reserve’s Fedwire Funds Service is a real-time gross settlement (RTGS) system that transfers the full amount of payment orders between participating commercial banks immediately upon receipt. However, because RTGS systems settle payments as soon as they are received throughout the day, the cost of meeting system liquidity needs is high.

  • Authors Johnson, McAndrews, and Soramäki argue that while banks would want to continue settling time-critical payments through real-time systems, they could process less urgent payments through deferred settlement mechanisms. Such a changeover could help reduce the liquidity needs of RTGS systems.

  • Using historical Fedwire data, the authors simulate three deferred settlement mechanisms that are potential complements to RTGS systems:

    • a one-hour netting system,
    • a six-hour netting system, and
    • a unique mechanism called a receipt-reactive gross settlement (RRGS) system.
  • The study concludes that the RRGS mechanism would benefit users and operators of payments systems by lowering average overdrafts by as much as 14 percent. Moreover, the RRGS mechanism would result in only modest payment delays of forty-three minutes.

  • The authors suggest that the RRGS system may provide good incentives for banks to submit payments earlier in the day, as the release of payments from this queuing system is independent of the timing of a bank’s own RTGS payments. This feature is likely to encourage banks to enter payments sooner and thereby further reduce the number of daylight overdrafts, thus economizing on liquidity.


About the Authors

Kurt Johnson is an economist and JamesJ.McAndrews a vice president at the Federal Reserve Bank of New York; KimmoSoramäki is a payment systems policy expert at the European Central Bank and a research visitor at the Federal Reserve Bank of New York.

Disclaimer

The views expressed in this summary are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York, the Federal Reserve System, or the European Central Bank.