Recipient of SWIFT Institute Grant

Lead Project Investigator: GUO Zhiling
Associate Professor of Information Systems
School of Information Systems, SMU

Co- Project Investigators:

• Robert KAUFFMAN, Professor of Information Systems
• Mei LIN, Assistant Professor of Information Systems
• Dan MA, Assistant Professor of Information Systems

Project Title

Near Real-Time Retail Payment and Settlement Systems Mechanism Design

Duration

July 2014 – March 2015

Amount awarded

EUR $15,000

Overview

Rapid expansion of e-commerce, along with rising domestic and cross-border payments, has fuelled the demand among financial institutions for cost-effective means to achieve real-time settlement of mobile and online payments.

Online retail payments rely extensively on interbank netting systems, in which payments are accumulated for end-of-day settlement. Known as the Deferred Net Settlement (DNS) mechanism, this offers an efficient way to reduce the liquidity needs of a payment system. However, given the exponential increase in retail payment flows over the recent years, large dollar volumes for settlement are accumulating swiftly, while inherent operational risks in netting systems are increasing.

In comparison to the DNS, the Real-time Gross Settlement (RTGS) mechanism has the potential to reduce operational risks by processing payments individually to achieve immediate full settlement. Nevertheless, it incurs high operational costs and creates intraday liquidity needs to mitigate asynchronous payment flows. The significant cost of borrowing intraday credit from a central bank makes RTGS a less attractive option.

By combining various functions of RTGS and DNS, a hybrid payment management system presents a promising solution to support near real-time retail payment and settlement. Such systems have less delay than DNS systems, and much lower liquidity needs than RTGS systems. They also achieve efficiency gains and cost savings through consolidating payment streams into a central payment management platform.

However, successful development and implementation of the hybrid system require a deep understanding of economic incentives and the business value that arise from the adoption of a multi-faceted technology platform like a centralised payment management system.

The proposed project aims to provide a hybrid payment management framework that aligns economic incentives of individual banks to create a system-wide optimal payment and settlement solution. It attempts to address key mechanism design issues from several perspectives, including retail and financial services in the economy, information in the payment process, technology as a solution for digital intermediation, and economics as a theoretical lens through which to view and resolve some of the issues. An analytical modelling framework will be created, and a series of market experiments, as well as an empirical evaluation of the mechanisms will be conducted.

In bringing about benefits such as less delay in total payment, enhanced liquidity by pooling payments from participating banks, and optimising settlement at a low cost, the proposed research will impact infrastructure design, bank incentives and coordination, and regulations that drive market adoption for near real-time retail payment and settlement innovations.