Optimal Dynamic Clearing for Interbank Payments

51 Pages Posted: 8 Feb 2023 Last revised: 16 Feb 2024

See all articles by Shuzhen Chen

Shuzhen Chen

Central South University - School of Business

Opher Baron

University of Toronto - Rotman School of Management

Ningyuan Chen

University of Toronto - Rotman School of Management

Date Written: February 7, 2023

Abstract

We investigate the optimal clearing policy for a financial payment system composed of a number of member banks and a central bank in a dynamic setting, when new payment obligations or debts between member banks are generated over time. The central bank clears the debts among members in the system in order to minimize the costs, including the set-up cost of each clearing, the variable cost of clearing the net debts and the liquidity cost of uncleared debts. We formulate the problem using dynamic programming via state space reduction that provides a tractable framework to analyze and compute the optimal policy. We characterize the structure of the optimal policy and show that it is optimal for the central bank either to clear all the debts in the system or not to clear at all in each period under mild conditions. This structure leads to efficient computation of the optimal clearing policy. We further characterize the optimal clearing frequency based upon the deterministic approximation for the debt process. We conduct a comprehensive case study based on the data acquired from our industry partner, Payments Canada, to demonstrate the performance of the policy and its feasibility in industrial-size problems.

Keywords: dynamic programming, inventory management, interbank payments, clearing policy

Suggested Citation

Chen, Shuzhen and Baron, Opher and Chen, Ningyuan, Optimal Dynamic Clearing for Interbank Payments (February 7, 2023). Available at SSRN: https://ssrn.com/abstract=4345393 or http://dx.doi.org/10.2139/ssrn.4345393

Shuzhen Chen

Central South University - School of Business ( email )

Opher Baron

University of Toronto - Rotman School of Management ( email )

Ningyuan Chen (Contact Author)

University of Toronto - Rotman School of Management ( email )

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