Precautionary Demand and Liquidity in Payment Systems

Abstract: In large-value real-time gross settlement payment systems, banks rely heavily on incoming funds to finance outgoing payments. Such reliance necessitates a high degree of coordination and synchronization. We construct a model of a payment system calibrated for the U.S. Fedwire system and examine the impact of realistic disruptions motivated by the recent financial crisis. In such settings, individually cautious behavior can have a significant and detrimental impact on the overall functioning of the payment system through a multiplier effect. Our results quantify the mutually reinforcing nature of greater caution, and allow comparative statics analysis of shifts in key parameters.

Keywords: high-value payment systems; precautionary demand; systemic risk; financial networks;

JEL Classification: E44; E58; G21; D85;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2010-08-01

Number: 352

Pages: 51 pages

Note: Previous title: “Systemic Risk and Liquidity in Payment Systems” For a published version of this report, see Gara Afonso and Hyun Song Shin, "Precautionary Demand and Liquidity in Payment Systems," Journal of Money, Credit, and Banking 43, no. s2 (October 2011): 589-619.