Illiquidity in the Interbank Payment System Following Wide-Scale Disruptions

30 Pages Posted: 13 Mar 2006

See all articles by Morten L. Bech

Morten L. Bech

Bank for International Settlements (BIS) - Committee on Payments and Market Infrastructures

Rod Garratt

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: March 2006

Abstract

We show how the interbank payment system can become illiquid following wide-scale disruptions. Two forces are at play in such disruptions - operational problems and changes in participants' behavior. We model the interbank payment system as an n-player game and utilize the concept of a potential function to describe the process by which one of multiple equilibria emerges after a wide-scale disruption. If the disruption is large enough, hits a key geographic area, or hits a too-big-to-fail participant, then the coordination of payment processing can break down, and central bank intervention might be required to reestablish the socially efficient equilibrium. We also explore how the network topology of the underlying payment flow among banks affects the resiliency of coordination. The paper provides a theoretical framework to analyze the effects of events such as the September 11 attacks.

Keywords: payments, stag hunt, network, topology, moral suasion, too big to fail

JEL Classification: C72, E58

Suggested Citation

Bech, Morten L. and Garratt, Rod, Illiquidity in the Interbank Payment System Following Wide-Scale Disruptions (March 2006). FRB of NY Staff Report No. 239. Available at SSRN: https://ssrn.com/abstract=890345 or http://dx.doi.org/10.2139/ssrn.890345

Morten L. Bech (Contact Author)

Bank for International Settlements (BIS) - Committee on Payments and Market Infrastructures ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland
41612808923 (Phone)

Rod Garratt

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States

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