How Banks Create Gridlock in Payment Systems to Save Liquidity: The Case of Canada

Abstract: Using detailed data from the introduction of a new high-value payment system (HVPS) in Canada, we show how participants learn to use the new gridlock resolution arrangement to create gridlock and save liquidity. These observed behaviors are consistent with the equilibrium of a “gridlock game” that captures the key incentives participants face in the system. The findings have important implications for the design of HVPSs and shed light on financial institutions' liquidity preference.