Following the ongoing debate on risks in payment systems, gross settlement systems are increasingly considered as an alternative to netting. In these systems risk reduction is achieved through real time settlement of each transaction during the day via an exchange of monetary base, without a preliminary netting phase. The paper presents a simple dynamic model of a gross system, and shows that if banks are charged for the use of daylight credit by the central bank, an intraday market for funds is bound to arise. Within this context it is found that a network externality may cause banks to excessively reduce their reserve holdings and demand for interbank loans, relative to a social optimum. As a consequence, payments processing is relatively slow; this tends to worsen the quality of the information available to banks for cash management purposes, thereby reducing expected profits. In addition, risk levels are relatively high. The rise of the intraday market for funds, predicted by the model, does not by itself solve the problem. Some corrective policy measures are discussed.
This essay is a revised version of the third chapter of Ph.D. dissertation at Brown University.
