Working Paper

Settlement Speed and Financial Stability

Abstract: This paper investigates how settlement speed affects financial stability in payment networks, taking into account netting benefits, liquidity costs, and counterparty risks. Our analysis reveals that faster settlements have ambiguous effects on systemic risk and social welfare. The optimal settlement speed is determined by the network structure and the trade-off between netting efficiency and liquidity costs on one hand, and the probability of counterparty defaults on the other. Notably, we identify conditions, particularly under liquidity stress, where faster settlement can paradoxically increase systemic risk by amplifying crisis severity, even while reducing crisis probability. Our results have important policy implications, arguing against a one-size-fits-all approach to settlement speed design.

JEL Classification: D49; D53; G01; G21; G33;

https://doi.org/10.17016/FEDS.2025.101

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2025-11-20

Number: 2025-101