In their report, Settlement Liquidity and Monetary Policy Implementation – Lessons from the Financial Crisis, BIS economist Morten Bech and New York Fed economists Antoine Martin and James McAndrews observe how smoothly the U.S. dollar clearing and settling system performed during and after the financial crisis. One reason for this, the authors write, was the increase in settlement liquidity stemming from the Fed's emergency policy measures to restore economic and financial stability. In particular, Fed actions to increase reserves in the banking system quickened settlement time, which benefited both Wall Street and Main Street. The authors focused on settlement liquidity specifically in the Federal Reserve's Fedwire® Funds Service, the major large-value payment system in the United States.
Key findings include:
Clearing and settlement have become more efficient since fall 2008
The clearing and settlement process is the effective beginning and end of a securities or loan transaction between banks. Banks have flexibility in choosing the time at which payments are settled, as long as settlement occurs on a particular day. Up until a few weeks after the Lehman Brothers' bankruptcy, banks would wait until the afternoon or late in the day to send payments. This could be problematic, as payment delay increases uncertainty and operational risk in the system.
Fed policy changes improved settlement liquidity in the Fedwire® Funds Service
Over time, the Federal Reserve has looked for ways to bring forward settlement times and reduce the credit risk to which it is exposed. While the Fed's monetary policy actions during the crisis were not aimed at improving the functioning of the payment system, they did a lot to achieve these goals. The authors show payment delays decreasing as reserves increased. Similarly, payment delays decreased in tandem with the opportunity cost of holding onto those reserves until later in the day.
The Fed bought $1.725 trillion of Treasury, agency debt and agency mortgage-backed securities from 2008 to 2011. With so many extra reserves in the banking system, the demand for daylight credit provided by the Federal Reserve dropped. The Fed now extends less credit to the banking system, which means reduced risk to taxpayers.
The study can be read in full in the New York Fed's Economic Policy Review.