No more Tears without Tiers? The Impact of Indirect Settlement on liquidity use in TARGET2

We study the impact of tiered settlement on relative intraday liquidity use (liquidity consumption) for settlement banks in TARGET2. We estimate a panel data model employing transaction-level data from 2010 to 2019 which shows that a higher share of tiered payments from client banks reduces relative liquidity consumption by settlement banks. Metrics on timing, delay, and payment priorities suggest that settlement banks can make use of more leeway in settling tiered payments from client banks compared to their own payments. Payment timing as a proxy for external delay suggests that tiered payments are used to smooth settlement banks' liquidity positions. Results on payment delay within the system show no clear dynamic over time, whereas payment priorities are consistently lower for tiered payments. We conclude that to some degree settlement banks employ tiered arrangements to manage intraday liquidity more effiiently. To a certain extent this hints to "free riding" or higher recycling of liquidity from client banks' payments. However, the results are also consistent with settlement banks' monitoring role or tiered payments potentially exhibiting different characteristics which may be attributable to contractual arrangements.