Connectivity, Netting, and Systemic Risk of Payment Systems

The stability of payment system is of vital importance to the credit market as well as the economic development. Most researches focus on the effect of system connectivity on systemic risk and demonstrate that connectivity provides both risk-spread channel and risk-sharing mechanism. But the management of systemic risk is quite different in real-time gross settlement system and net settlement system. We provide an integrated analysis of the effect of connectivity and netting on systemic risk in payment systems by considering more detailed network structures of pure creditors and pure debtors. We show that the effect of netting is partly due to the change of network connectivity, which severs the contagion channel of shocks. Moreover, netting can lower the actual magnitude of the shock from the beginning by reducing source bank's debt.