Nonmonotonic trade-offs of tiering in a large-value payment system

Carlos A. Arango-Arango and Freddy Cepeda

Abstract

Even though international authorities encourage open and wide access to large-value payment systems, the optimal level of access, or tiering, is still an open problem. For real-time gross settlement systems, it may be limited by the trade-off between the potentially higher liquidity needs of a larger pool of direct participants settling in real time and the lower counterparty credit risks resulting from a smaller number of second-tier participants entering uncovered bilateral credit positions with correspondent banks. The literature has evaluated this trade-off through simulations, finding monotonically increasing liquidity savings and increasing credit risk exposures as the level of tiering in the system rises. In contrast, we find that, in the Colombian real-time gross settlement systems, liquidity savings increase but then decrease with higher tiering, showing a humped shape. Our results provide insights into the effects of tiering when participants are too big or too connected to tier.