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Rev Fin 1998; 11:845-870
© 1998 the Society for Financial Studies

Article

Payment system settlement and bank incentives

CM Kahn1 and W Roberds2,z
1 University of Illinois, USA
2 Federal Reserve Bank of Atlanta, 104 Marietta Street, N.W., Atlanta, GA 30303-2713, USA
z Corresponding author
e-mail: william.roberds@atl.frb.org

Abstract

In this article, we consider the relative merits of net versus gross settlement of interbank payments. Net settlement economizes on the costs of holding non-interest-bearing reserves, but increases moral hazard problems. The 'put option' value of default under net settlement can also distort banks' investment incentives. Absent these distortions, net settlement dominates gross, although the optimal net settlement scheme may involve a positive probability of default.


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