Payment Technology and Financial Stability

Abstract

This paper investigates how the evolution of interbank payments towards central bank settlement, and thus central bank money as a settlement asset, has affected the dynamics of bank crises.We take the cluster of bank defaults in the United States in 2023 as a starting example and show how, alongside fractional reserves and fast digital communication, centralized settlement in central bank money played a critical role in triggering swift bank failures.We argue that technical centralization has amplified banks' fragility in the development of confidence crises, making bank runs easier and expanding the role of central banks to a point where conflict of interest becomes nearly inevitable.While previous literature has emphasized the effects of fast news spread and online banking, the role of settlement technology in recent bank runs has been largely overlooked.Thus we describe the stability consequences of different settlement architectures in detail, and also discuss potential improvements to the current architecture, particularly decentralized approaches built on distributed ledgers, to mitigate financial instability and reduce the negative effects of centralization without reverting to inefficient legacy systems.