Offshore Settlement, Collateral, and Interest Rates

Recent developments in private payments arrangements, particularly at the wholesale level, challenge central banks’ longstanding monopoly on the provision of the ultimate means of settlement for financial transactions. This paper examines competition between public payments arrangements and private intermediaries, and the effect on central banks’ role in monetary policy. Central to the issue is the role of collateral both as a requirement for participation in central bank sponsored payments arrangements and as the backing for private intermediary arrangements. The presence of private systems serves as a check on the ability of a monetary authority to tighten monetary policy. The previous century may turn out to have been the high-water mark of public payment systems. The developments of central banking in the twentieth century may have made it seem inevitable that government fiat money form the base and centerpiece of a modern economy’s methods of payment Actually the underlying institutions arose relatively recently; many innovations over the last three decades have made central bank based payment systems seem an aberration.1 The significance of some recent payments innovations could be debated: While the rise of credit cards has been an important change in payment for retail economic activity, it might still be argued that it makes no “fundamental” difference to the system, because, at the end of the month, every transaction translates one-for-one into a payment (or almost every transaction–default does occur), and that payment passes through an account in some commercial bank somewhere. And since commercial banks “ultimately” depend on central bank reserves and “ultimately” settle with one another through central bank payments systems, central banks are still at the core of the arrangement–with only a money multiplier as a minor caveat. 1For an introduction, see Kahn and Roberds (2008); for an extensive history of institutions see Manning et al (2008).