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Payment System Settlement and Bank Incentives

Charles M. Kahn1; William Roberds2

1 University of Illinois System · 2 Federal Reserve

Review of Financial Studies 1998

In this article, we consider the relative merits of net versus gross settlement of interbank payments. Net settlement economizes on the costs of holding non-interest-bearing reserves, but increases moral hazard problems. The "put option" value of default under net settlement can also distort banks' investment incentives. Absent these distortions, net settlement dominates gross, although the optimal net settlement scheme may involve a positive probability of default.

DOI
10.1093/rfs/11.4.845
Volume
11 (4)
Pages
845-870
Language
en
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