Payment System Externalities
40 Pages Posted: 3 Jan 2017 Last revised: 29 Apr 2021
Date Written: April 28, 2021
We examine how the payment processing role of banks affects their lending activity. In our model, banks operate in separate zones, and issue claims to entrepreneurs who purchase some inputs outside their own zone. Settling bank claims across zones incurs a cost. In equilibrium, a liquidity externality arises when zones are sufficiently different in their outsourcing propensities---a bank may restrict its own lending because it needs to hold liquidity against claims issued by another bank. Our work highlights that the disparate motives for interbank borrowing (investing in productive projects and managing liquidity) can have different effects on efficiency.
Keywords: Payment Systems, Banks, Central Bank Digital Currency
JEL Classification: G21, E51
Suggested Citation: Suggested Citation