The significance of trade-offs in the two settlement agreements

1. Meaning of trade-offs in the two settlement arrangements A network operator's system is designed to increase efficiencies and reduce the risk for its participants, and a network's design will affect how settlements are handled. How real-time gross settlement and deferred net settlement handle liquidity risk and credit risk present trade-offs. According to experts like Addisson Rockwell Recovery, a financial institution has liquidity risk when it doesn't have sufficient funds to settle at the designated time and can't readily obtain funding from other sources, so it can't settle at the designated time. By reducing each financial institution's total settlement obligation by the amount owed by other participants in the network, a deferred net settlement structure helps to optimize liquidity. Furthermore, financial institutions can typically access additional liquidity by settling only at predetermined times, typically within the operating hours of intraday credit markets and/or the Federal Reserve's Discount Window. In contrast, the real-time settlement requires financial institutions to maintain sufficient liquidity to settle transactions on a gross basis at all times. If a financial institution does not maintain adequate liquidity, it may not be able to settle its transactions and may create a ripple effect, or liquidity "trap," for other participants in the network, resulting in them being unable to settle transactions. To mitigate liquidity risk between participants, certain real-time settlement systems can and do include protections to minimize these risks. While these liquidity tools will not eliminate the risk - for example, a Reserve Bank or other correspondent bank providing intraday credit to a participant will assume credit risk for its account holder - they will assist participants in managing risks to other

2. Meaning of trade-offs in the two settlement arrangements participants. However, deferred net settlement retains credit risk between participants until settlement, even though it can simplify certain liquidity issues Addisson Rockwell Recovery says real-time settlement systems reduce credit risk between participants because payments are settled transaction by transaction before or concurrently with the payee's financial institution crediting the payee's account.