Measuring the impact of a failing participant in payment systems

Large banks and critical financial market infrastructures (FMIs) that are not able to fulfill their payment obligations, for example following a bankruptcy or cyber-attack, can be a source of financial instability and contagion in the financial system. This paper develops a composite risk indicator to evaluate the criticality of participants in a large value payment system network, combining liquidity risk (i.e. size of incoming and outgoing payments) and systemic impact or interconnections between network participants in one approach. It is applied, as a proof of concept, to the TARGET2 payment system that links banks and FMIs in a tight network of interdependencies. We find that the most critical participants in TARGET2 are other payment systems (large value and retail) because of the underlying gross size of their payment flows. Some banks may be critical, but this is mainly due to their interconnectedness with other TARGET2 participants. Central counterparties and central securities depositories are less critical to the payment system. Our findings can be used by (1) financial stability experts to evaluate the impact of a failing critical participant in the financial system, and (2) central banks in their role as payment system operator and overseer. Besides, it feeds into policy discussions on payment system access, oversight, and crisis management.