Payment Instruments and Collateral in the Interbank Payment System

This paper analyzes the distinction between payment instruments and collateral in the interbank payment system. Given the interbank market is an over-the-counter market, decentralized settlement of bank transfers is inefficient if bank loans are illiquid. In this case, a collat- eralized interbank settlement contract improves efficiency through a liquidity-saving effect. The large value payment system operated by the central bank can be regarded as an implicit implementation of such a contract. This result explains why banks swap Treasury secu- rities for bank reserves despite that both are liquid assets. This paper also discusses if a private clearing house can implement the contract.