The Effect of Instant Payments on the Banking System: Liquidity Transformation and Risk-Taking

Abstract

Instant payment systems have received considerable attention because of their integration with the banking system and their shared functionalities with CBDCs. We show that instant payments may have the unintended consequences of increasing the banking sector's demand for liquidity and risk-taking incentives. Using administrative banking data and transactionlevel payment data from Brazils Pix, one of the most widely adopted instant payment systems, we find that banks increased their liquid asset holdings and lent out more subprime and defaulting loans after the adoption of instant payments. We establish the causal relationship by constructing a novel instrument based on passive payment timeouts. These findings arise because the convenience of instant payments to consumers comes at the expense of banks ability to delay and net payment flows. The inability to delay payments increases banks demand for holding liquid assets over transforming illiquid ones. Banks' increased holding of liquid and safe assets in turn exacerbates their risk-taking incentives in choosing illiquid assets. Our findings bear important financial stability implications in light of the global surge in adopting instant payment systems, e.g., FedNow in the US.

Keywords: Payments, banking, financial stability, liquidity, FedNow