Journal of Financial Market Infrastructures

Payment coordination and liquidity efficiency in wholesale payments systems

Francisco Rivadeneyra and Nellie Zhang

  • We identify which of two Lynx settlement mechanisms the Bank of Canada should use for sending its payments.
  • The results show that Lynx achieves significantly higher efficiency, due to liquidity pooling, if all payments are settled in the mechanism allowing offsetting.
  • When only this liquidity-saving mechanism is used, the minimum amount of collateral required to settle all payments by their critical timelines would be approximately $10 billion, or about half the collateral allocated in LVTS (pre–COVID-19), with an associated 10-minute weighted average delay.
  • When the two settlement mechanisms are used in tandem, payment coordination falls, and a higher level of liquidity is required while introducing longer settlement delays.

A new wholesale payments system launched in Canada in 2021. This real-time gross settlement system, called Lynx, has two types of settlement mechanisms, one allowing offsetting and the other not. This paper studies the decision problem of the Bank of Canada: which of the two settlement mechanisms it should use to send its payments. Using extensive simulation, we show that, mainly due to the benefits of liquidity pooling, Lynx would achieve its highest liquidity efficiency (even better than that of the current Large Value Transfer System (LVTS)) if all payments (urgent and nonurgent) from all participants were sent to the mechanism allowing offsetting. The minimum amount of liquidity required to settle all payments by critical intraday deadlines is approximately C$10 billion, around half the amount of collateral that LVTS participants allocated pre-Covid-19. Since time-critical payments sent to the offsetting mechanism could experience a delay, the high level of liquidity efficiency is accompanied by an increase in the number of participants’ operational interventions (to pledge more collateral or to alter payment priorities) to ensure that those time-critical payments are never delayed. When coordination does not occur, liquidity efficiency can be far lower than in the LVTS. The results highlight that the Bank of Canada helping with coordination is more important than the specific choice of mechanism.

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