Quantifying the Economic Benefits of Payments Modernization: the Case of the Large-Value Payment System

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Canada is undertaking a major initiative to modernize its payments ecosystem. The modernized ecosystem is expected to bring significant benefits to Canadian financial markets and the overall economy. But much work remains, including a detailed quantitative assessment based on an economic model. Moreover, given that payment system modernization involves substantial costs and may generate new types of risks, measuring its economic benefits is crucial.

In this paper, we develop an empirical framework to quantify the economic benefits of modernizing the payment system in Canada. Focusing on Canada's large-value transfer system (LVTS), we first estimate participants' preferences for liquidity cost and payment safety by exploiting intra-day variations in the transaction data from the LVTS. Using counterfactual simulations, we then use the estimated preferences to calculate changes in participants' welfare when the LVTS is replaced by Lynx—a vital step in the payment system modernization initiative.

We find that liquidity costs and safety are higher in Lynx than in the LVTS, and system participants consider liquidity costs to be the more important factor. We also find an overall welfare gain when more than 90 percent of current LVTS payments migrate to a real-time gross settlement system such as Lynx. However, it may be hard to achieve such a high migration ratio in the new market equilibrium. With the equilibrium market share of Lynx, a service level improvement of about 75 percent is needed to generate overall net economic benefits for participants. Among other things, adopting a liquidity-saving mechanism and reducing risks in the new system can help achieve this improvement. We also find that welfare changes are quite heterogeneous across participants, especially between those that are large versus those that are small.