The Timing and Funding of CHAPS Sterling Payments

he use of real-time gross settlement (RTGS) systems for the settlement of large-value payments offers considerable advantages, the principal one being the elimination of the credit risk that can arise between participants in deferred net settlement systems. However, in comparison with deferred net settlement systems, RTGS systems require relatively large amounts of liquidity to support payment activity. This liquidity can be sourced from the settlement agent (usually a central bank in the case of large-value payments systems)—in the form of intraday overdrafts—or from incoming payments from other participants. Obtaining intraday liquidity from a central bank is typically costly. In order to minimise this cost and to take advantage of incoming payments as a funding source, participants may choose to delay outgoing payments. However, payment delay may itself prove costly. Participants face a trade-off, therefore, between the cost of borrowing from the central bank and the expected cost of delaying payments. McAndrews and Rajan (2000) explore this trade-off in a study of payment behaviour in Fedwire. They describe how the use of incoming funds to offset outgoing payments allows participants to avoid incurring costly overdrafts from the central bank and hence reduces the liquidity cost of making payments. Such offsetting can be achieved to a greater extent during activity peaks, so banks are induced to coordinate their payments around, and thereby to reinforce, these peaks.