What Drives the Turnover Ratio?

Abstract

Settling transactions in a payment system imposes opportunity costs of holding liquidity on the participating banks. A measure of these costs is the turnover ratio, defined as the value of payments a bank makes per unit of overnight central bank balances. We assume that a bank can increase its turnover ratio (and thus decrease the opportunity cost of liquidity) by an active cash management. Despite the fact that all banks have access to the same cash management technology, we observe that the turnover ratios vary widely not only through time but also across banks. We argue that these differences can be attributed to two sources: increasing re-turns in cash management and reserve requirements. We show that the optimal behavior of a bank depends in a non-trivial way on the whole joint distribution of transaction volume, interest rates, and reserve requirements. These distributions vary substantially among banks because of the different lines of business they pur-sue. We test the model with data from the Swiss Interbank Clearing system (SIC) and find significant empirical support for it. Using our estimate of the cost function of cash management, we are also able to quantify the costs of reserve requirements imposed on banks.

Keywords: Payment systems, reserve requirements, bank behavior

JEL Classification: G21, G28