Risk and Concentration in Payment and Securities Settlement Systems

Large value payment and securities settlement systems are important components of an economy's nancial system. Many such systems are operated by central banks and are liquidity intensive. Central banks often provide inexpensive liquidity to facilitate settlement. This leads to a number of policy questions about the provision of such liquidity. To answer these questions, central banks need to understand what factors in uence the timing of settlement. This paper o ers a model to better understand intraday patterns of settlement and identi es three factors that in uence the timing of settlement: the cost of intraday liquidity, a participant's exposure to settlement risk, and system design. Incorporating all three factors enables our model to explain a number of stylized facts concerning behavior within the Federal Reserve's Fedwire fund and securities systems around a major policy change. In particular, the model captures the di erent responses of the two systems in both the pattern of settlement and the use of intraday liquidity. The results map out how policy interacts with participants' incentives to in uence the use of intraday liquidity and the resultant credit exposure of a central bank. The model, therefore, can inform decision-making at central banks.