Part 4: The Payments System and the Market for Interbank Funds

he two papers in a session on systemic issues in the federal funds market examined the interbank payments system and the market for borrowing funds used to settle interbank payments. Both analyses were based on data on payments made through the Federal Reserve’s Fedwire system. Fedwire—the nation’s primary interbank payments system—is a real-time gross settlement system through which payments are settled individually and with finality. More than 9,500 participants use Fedwire to send and receive time-critical and/or large-value payments on behalf of corporate, financial, and individual clients as well as to settle positions with other participants stemming from payments in other systems, securities settlement, and interbank loans. In the first half of 2006, an average of 525,000 Fedwire payments were made each day, with the daily value of funds transferred averaging $2.1 trillion. Complementing the Fedwire payments system is the U.S. federal funds market, where banks borrow funds to settle the payments they make over Fedwire. Fed funds are the bank reserves on deposit at the Federal Reserve used to settle payments between banks. The fed funds market plays a critical role in allocating liquidity in the financial system as well as in supporting banks ’ ability to finalize the settlement of interbank payment obligations. The first paper, by Adam Ashcraft of the Federal Reserve Bank of New York and Darrell Duffie of Stanford University, explored whether trading frictions in the fed funds market affect the reallocation of excess reserves to banks requiring funds to complete their payments. Ashcraft and Duffie found that fed funds trading is driven partially by individual banks’ precautionary targeting of balances, and that this targeting contributes to systemic stability. The banks ’ trading of funds mitigates the risk of overconcentration of reserves in some banks, and contributes to the liquidity of the fed funds market and keeps price volatility relatively low. The second paper