This project will focus on how to design an effective system for inter-bank payments. Such payments are a basic feature of a modern financial system. Checks, ATM transactions, and direct deposits and debits from individual accounts all involve transfering funds from one bank to a second bank.
The PI will use recent developments in microeconomic theory to answer a number of research questions. First, he will consider the structure of an efficient payment system. One possibility is that all banks have direct access to the system. Another possibility is that smaller banks would each have a relationship with a specific larger "correspondent" bank; these larger banks would then make interbank payments for their smaller partners.
The second research question is how to determine the maximum amount that a bank can borrow on a short term basis. These "caps" might be set at a fixed level, or they might vary from bank to bank and be based on a specific bank's history of transactions. Setting these caps determines important features of the payment system, since the cap defines the maximum net amount of interbank transfers -- a bank cannot pay more than its "cap" amount unless it has funds coming in from other banks.
The third research question is how to best use the available information to structure an efficient payment system. If banks have incomplete information about other banks, then setting up local payment systems might be an excellent idea; banks in the same geographic area may have better information about each other than they would have about a bank in a different part of the country.
The strength and flexibility of interbank payment systems is an important part of how the global economy responds to unanticipated events. This includes both financial crises, natural disasters, and terrorist events. Therefore, central banks throughout the world have been increasingly interested in understanding how to design effective interbank transfer systems. This research is aimed directly at this need.
