Understanding congestion and cascades in exchange systems
Modern economies depend on efficient and reliable financial markets. Critical to the smooth functioning of these markets are a set of trading, payment, clearing and settlement infrastructures. Financial infrastructures are formed by a large number of technological and institutional components that interact within complex networks. Congestion in a payment system is both a cause and a consequence of reduced transfer capacity
We conducted a series of analyses with the goal of understanding how congestion arising from this stress is influenced by two control parameters: the global liquidity level and the conductance of a global liquidity market. More specifically, our objectives included identification of the basic parameters that control the quality of operation of payment systems, characterization of the problems that can arise when performance degrades, identification of the effects of coupling among payment systems and how different policies influence their performance.
Loki Transact allows us to evaluate liquidity and credit risks in the context of interdependent interbank payment systems interlinked through foreign exchange transactions. Further interdependence is created by a Payment versus Payment (PvP) constraint that links the two legs of the foreign exchange transactions. Using this model, the team identified conditions under which payment settlement in the two systems becomes correlated and showed that large credit exposures can be generated as the result of liquidity pressures in one of the two systems. PvP can eliminate this credit risk but creates a new interdependence by making settlement of payments in both systems dependent on the level of liquidity available in the other system.
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