DEPFID Working Paper 1 / 2010 - Abstract
Emergence of networks in large value payment systems (LVPSs)
Marco Galbiati* and Simone Giansante**
This paper develops and simulates a model of emergence of networks in an interbank, RTGS payment system. A number of banks, faced with random streams of payment orders, choose whether to link directly to the payment system, or to use a correspondent bank. Settling payments directly via the system imposes liquidity costs, which depend on the maximum liquidity overdraft incurred during the day. On the other hand, using a correspondent entails paying a flat fee, charged by the correspondent to recoup liquidity costs and to extract a profit. We specify a protocol whereby banks sequentially choose whether to link directly to the system or to become clients of other banks, thus generating a client-correspondent network. We calibrate our model on real data on the UK payment system, and we compare the networks it produces with i) the true client-correspondent network, ii) the outcomes of two ‘dummy' benchmark models. The model is found to outperform the benchmarks. Its predicted networks reproduce some key features of the real UK network.
Keywords: RTGS, network formation, tiering, correspondent bank, Nash bargaining.
JEL Classification: C7, G2.
* Economist, Payment and Infrastructure Division, Bank of England
** DEPFID, University of Siena and Department of Economics, University of Essex