Credit in a Tiered Payments System

Alexandra Lai (laia@bankofcanada.ca), Nikil Chande and Sean O'Connor

Staff Working Papers from Bank of Canada

Abstract: Payments systems are typically characterized by some degree of tiering, with upstream firms (clearing agents) providing settlement accounts to downstream institutions that wish to clear and settle payments indirectly in these systems (indirect clearers). Clearing agents provide their indirect clearers with an essential input (clearing and settlement services), while also competing directly with them in the retail market for payment services. The authors construct a model of a clearing agent with an indirect clearer to examine the clearing agent's incentives to lever off its upstream position to gain a competitive advantage in the retail payment services market. The model demonstrates that a clearing agent can attain this competitive advantage by raising the indirect clearer's costs, but that the incentive to raise these costs is mitigated by credit risk to the clearing agent from the provision of uncollateralized overdrafts to its indirect clearer. The results suggest that tiered payments systems, which require clearing agents to provide overdraft facilities to their indirect clearers, may result in a more competitive retail payment services market.

Keywords: Financial institutions; Financial services; Market structure and pricing; Payment clearing and settlement systems (search for similar items in EconPapers)
JEL-codes: G21 L12 L13 L22 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2006
New Economics Papers: this item is included in nep-cba, nep-com, nep-fin and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:06-36

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