A settlement system is a set of rules and procedures that govern when and
how funds are transferred between banks. Perhaps the most crucial feature
of a settlement system is the frequency with which settlement occurs. On
the one hand, a higher frequency of settlement limits the risk of default
should a bank be rendered insolvent. On the other hand, a lower frequency
of settlement is less costly for banks to operate. We construct a model
of the banking sector in which this trade-off between cost and risk arises
endogenously. We then complete the economy with a trading sector that
has a micro-founded role for credit as a media of exchange. The result is a
general equilibrium model that allows for welfare and policy analysis. We
parameterize the economy and study the optimal intra-day borrowing policy
that the operator of a settlement system should impose on member banks.
We also determine conditions under which one settlement system is more
appropriate than another
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