Among the default risks, systemic risk is of the biggest concern over the safety and effi-ciency of the payment and settlement system. When homogeneous financial institutions are linked with each other through the credit chain, a gridlock takes place as equilibrium in the payment and settlement system. A heterogeneous participant in the system could, however, have incentive to fulfill the obligation when otherwise homogenous participants strategically default. That is, fulfillment of obligation turns out to be a Nash equilibrium strategy for the heterogeneous participant whose level of investment return differs from those of remaining participants. The larger the benefit is, the stronger incentive a finan-cial institution has to keep the system working properly. The current paper sheds new light on the effect of heterogeneous financial institutions on the robustness of payment and settlement system under the general equilibrium setup.

This paper investigates a collateral pool settlement (CPS) payment system – a system that provides intra-day liquidity against a collateral pool. First, we show that participants of CPS do not have incentives to delay payments once they have committed to participate. This is in striking contrast to a Real Time Gross Settlement (RTGS) system where banks have strong incentives to free-ride on liquidity provided by incoming payments. Second, we establish conditions under which banks prefer to participate in a collateral pool instead of settling payments in RTGS. Third, we show that a late payment equilibrium may arise in RTGS in the presence of a possible intra-day failure of a participant if the cost of intra-day liquidity is sufficiently high.

earlier versions. The motivation for this work stems from my time as a visiting researcher at Norges Bank. Parts of the research have been done during visits to CentER at Tilburg University,

for helpful comments. The views expressed in this paper are those of the authors and do not necessarily reflect those

Clearinghouses support financial trades by keeping records of transactions and by providing liquidity through short-term credit that is periodically cleared by participants. We study efficient clearing arrangements for formal exchanges, where traders must clear with a clear-inghouse, and for over-the-counter (OTC) markets, where trades can be cleared bilaterally. When clearing is costly, we show that it can be efficient to subsidize the clearing process for OTC transactions by charging a higher price for the clearing of transactions in exchanges. This necessitates a clearinghouse that operates across both markets. As a clearinghouse offers credit, intertemporal incentives are needed in order to ensure settlement. An increase in the costs of liquidity provision worsens the incentives to settle. Hence, when liquidity

Bank of Canada working papers are theoretical or empirical works-in-progress on subjects in economics and finance. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada.