How Much Liquidity Would a Liquidity-saving Mechanism Save if a Liquidity-saving Mechanism could Save Liquidity? A Simulation Approach for Canada’s Large-value Payment System

Abstract

Canada’s Large Value Transfer System (LVTS) is in the process of being replaced by a real-time gross settlement (RTGS) system. A pure RTGS system typically requires participants to hold large amounts of intraday liquidity in order to settle their payment obligations. Implementing one or more liquidity-saving mechanisms (LSMs) can reduce the amount of liquidity participants need to hold. This paper investigates how much liquidity requirements can be reduced with the implementation of different LSMs in the Financial Network Analytics simulation engine using LVTS transaction data from 2018. These LSMs include: 1) Bilateral offsetting, 2) FIFO-Bypass, 3) Multilateral offsetting, and 4) a combination of all LSMs. We simulate two different scenarios. In the first scenario, all payments from Tranche 1, which are considered time-critical, are settled in a pure RTGS payment stream, while less time-critical Tranche 2 payments are settled in a payment stream with LSMs. In the second scenario, we settle all payments (Tranches 1 and 2) in the LSM stream. Our results show that when there is ample liquidity available in the system, there is minimal benefit from LSMs as payments are settled without much delay—the effectiveness of LSMs increases as the amount of intraday liquidity decreases. A combination of LSMs shows a reduction in liquidity requirements that is larger than any one individual LSM.

Keywords: Liquidity Saving Mechanism, Simulation, LVTS, RTGS, Financial Market Infrastructure, Intraday Liquidity, Collateral

JEL Classification: E42, E50, E58, E59, G21