Bank Credit and Money Creation on Payment Networks: A Structural Analysis of Externalities and Key Players

Fisher College of Business Working Paper No. 2021-03-022

Charles A. Dice Working Paper No. 2021-22

87 Pages Posted: 1 Jan 2022 Last revised: 19 Jan 2022

See all articles by Ye Li

Ye Li

Ohio State University (OSU)

Yi Li

Board of Governors of the Federal Reserve System

Huijun Sun

Columbia Business School

Date Written: December 31, 2021

Abstract

This paper documents a strong connection between payment system and credit supply. The dual role of deposits as financing instruments for banks and means of payment for bank customers implies spillover effects of bank lending. After a bank finances loans with new deposits, the deposit holders' payments cause reserves and deposits to flow from the lending bank to the payees' banks. The change in liquidity conditions for both banks and their customers gives rise to two opposing forces that generate respectively strategic complementarity and strategic substitution in banks' lending decisions. We model bank lending through a linear-quadratic game on a random graph of payment flows and structurally estimate the spillover effects using Fedwire data to quantify the probability distribution of payment-flow network. Payment network externalities reduce the average level of aggregate credit supply by 9% while amplify the volatility by 20%. We identify a small subset of banks that have a disproportionately large influence on credit supply due to their special positions in the payment-flow network.

Keywords: Credit supply, inside money, payment, network, externalities, systemic risk

JEL Classification: E42, E43, E44, E51, E52, G21, G28

Suggested Citation

Li, Ye and Li, Yi and Sun, Huijun, Bank Credit and Money Creation on Payment Networks: A Structural Analysis of Externalities and Key Players (December 31, 2021). Fisher College of Business Working Paper No. 2021-03-022, Charles A. Dice Working Paper No. 2021-22, Available at SSRN: https://ssrn.com/abstract=3998037 or http://dx.doi.org/10.2139/ssrn.3998037

Ye Li (Contact Author)

Ohio State University (OSU) ( email )

Blankenship Hall-2010
901 Woody Hayes Drive
Columbus, OH OH 43210
United States

Yi Li

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-721-4576 (Phone)

HOME PAGE: http://sites.google.com/view/yili/

Huijun Sun

Columbia Business School ( email )

NY
United States

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