Exploring safety and efficiency in payments system design

Published: March 14, 2019

New discussion papers demonstrate alternative modeling approaches for payments research.

Payments Canada released two new discussion papers today on the use of alternative modeling approaches in understanding core policy issues in the design of clearing and settlement systems. The issues explored in the papers include system access, cost efficiency, and counterparty risk and credit extension through the financial cycle.

“While core questions around payments system design may not change much over time, the approaches to answering these questions are constantly evolving, as demonstrated in these papers,” said Neville Arjani, Director of Research at Payments Canada. “An added benefit of the approaches undertaken in the two papers is that they could be similarly applicable in a modernized clearing and settlement environment.”

The first paper, A Computational Model of the Market Microstructure of Bilateral Credit Limits in Payments Systems and other Financial Market Infrastructures, combines machine learning with computational agent-based methods to help to better understand participant behavior in a clearing and settlement system. The paper applies this approach to inform participants’ daily decisions to allocate credit limits to each other in the Large-Value Transfer System (LVTS). The paper highlights the complex considerations and trade-offs that participants face in their daily decision-making, while also noting the incentive-compatible nature of the LVTS design in promoting overall financial system stability.  

The second paper, Procyclicality and Risk-Based Access: Valuing the Embedded Credit Default Swap of Employing Bilateral Credit Limits in Financial Market Infrastructures, models the LVTS risk model as a credit default swap contract. Based on empirical evidence from 2005 to 2016, the paper suggests that loss-sharing arrangements underpinning the LVTS risk model are perhaps most valuable to system participants under periods of significant financial and economic stress, when market liquidity is at a premium. Similar to the first paper, this analysis highlights the incentive-compatible and stability-inducing nature of the LVTS design. Both discussion papers were authored by senior researcher Segun Bewaji.

“Our research team at Payments Canada is committed to delivering timely insights to inform the big questions our organization and industry are facing in this evolving payments landscape,” Neville Arjani said. “This includes leveraging alternative modeling approaches to underpin these insights.”

For further details, please see Our Research.