- In the 1980s, central banks around the world joined the Federal Reserve and began implementing real-time gross settlement (RTGS) systems to reduce the risks associated with the growing volume of daily payments among commercial banks.
- RTGS systems can reduce settlement risk significantly; however, they require more liquidity to smooth nonsynchronized payment flows. Central banks therefore typically provide intraday credit to commercial banks, either as collateralized credit or priced credit.
- Because intraday credit is costly—either implicitly as the opportunity cost of collateral or explicitly as fees—banks look to minimize their use of liquidity by timing the release of payments.
- The management of intraday liquidity positions thus has become an increasingly important competitive component of commercial bank operations as well as a policy concern of central banks.
- Bech uses a game-theoretical framework to analyze the effect of central bank credit policies on the intraday liquidity management behavior of commercial banks in an RTGS environment.
- He observes that the actions taken by commercial banks depend on the intraday credit policy and encompass two well-known paradigms in game theory: “the prisoner’s dilemma” and “the stag hunt”—two useful tools for understanding the fundamental trade-offs faced by RTGS participants.
- The prisoner’s dilemma arises in a collateralized credit regime, where commercial banks have an incentive to delay payments if intraday credit is expensive. The stag hunt occurs in a priced credit regime, where the banks seek to coordinate the timing of their payments to avoid overdraft fees.
- The author also discusses how several extensions of the framework affect his results, such as settlement risk, incomplete information, heterogeneity, and repeated play.