What To Do About Bilateral Credit Limits In The LVTS When A Closure Is Anticipated: Risk Versus Liquidity Sharing Among LVTS Participants

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Executive Summary

The authors examine the effect of a trade-off between shared credit risk and liquidity efficiency, among participants in Tranche 2 of the Large Value Transfer System (LVTS T2), on their decisions to leave open, or close, their bilateral credit limits (BCLs) to a participant at risk of imminent closure. The authors' analysis considers a network of three banks, in a settlement system similar to the LVTS T2. Although it is widely believed that closure of one bank is imminent, the exact timing of the closure - during or after the settlement cycle - is uncertain. The other two banks face an "Open or close" choice regarding their BCLs to the problem participant.

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