https://macropaperwarehouse.com/authors/zhentong-lu/Zhentong LuHugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/how-banks-create-gridlock-in-payment-systems-to-save-liquidity-the-case-of-canada/https://macropaperwarehouse.com/papers/how-banks-create-gridlock-in-payment-systems-to-save-liquidity-the-case-of-canada/<p>This paper uses detailed transaction-level data from Canada&rsquo;s new high-value payment system (HVPS) to show how participants save liquidity by strategically exploiting the gridlock resolution arrangement built into the system. Observed behaviors are found to be consistent with the equilibrium of a &ldquo;gridlock game&rdquo; that captures the key incentives participants face: by withholding outgoing payments to induce gridlock events, participants trigger the system&rsquo;s bilateral netting algorithm, which settles stuck payment queues at lower liquidity cost than bilateral sequential settlement would require. The findings have implications for the design of high-value payment systems and shed light on financial institutions&rsquo; liquidity preference in payment system environments.</p>