Thursday, December 18, 2008

On Central Banks Muscling the Clearing System

For you bank clearing wonks out there, Jeffrey Rogers Hummel sends along this footnote to his recent comments re: the Fed paying interest on reserves.

Only after my recent comment on "Paradoxes of Paying Interest on Reserves," did I become aware of an important, relatedarticle by George Selgin. Entitled "Wholesale Payments: Questioning the Market-Failure Hypothesis" and appearing in the International Review of Law and Economics, 24 (2004): 333-350, it tellingly critiques the worldwide effort of central banks, culminating in the 1990s, to replace deferred net settlement clearing systems with real-time gross settlement (RTGS) systems. Pressure was applied even to private clearing systems, such as CHIPS, using spurious market-failure arguments.

The Selgin abstract:
The 1990s witnessed a major worldwide change in the management of “wholesale” payments. Insisting that traditional Deferred Net Settlement (DNS) payment systems involve serious externalities, monetary authorities legally restricted such systems and compelled or encouraged their replacement by Real-Time Gross Settlement (RTGS) systems. The present paper argues that market failure arguments used to justify these reforms reflect a fundamental misunderstanding of the manner in which traditional DNS systems generate and assign intraday credit risk. A proper understanding of the nature and role of intraday credits in deferred net settlement supplies no market-failure rationale for government interference with traditional payments systems, suggesting that recent reforms are at most justified on second-best grounds only.

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