Monetary plumbing is an informal name for the infrastructure through which money moves between banks, investors, companies and governments: payment and settlement systems, correspondent banking links, short-term funding markets such as repo, and the chains of collateral that secure them. Like a building's pipes, it is noticed only when something blocks or bursts.
The metaphor is widely used by central bankers and market analysts. It was popularised in market commentary after the 2008 crisis by Zoltan Pozsar, a former New York Fed economist, and by economist Perry Mehrling, whose "money view" treats the financial system as a web of payment promises that must be settled every day. Monetary plumbing differs from monetary policy: policy sets the price of money, while the plumbing determines whether money actually arrives where it is due.
Monetary plumbing in plain terms
Think of the water supply in a large city. The reservoir decides how much water is available, but water reaches each tap only through mains, valves and meters. If a main bursts in one district, homes there go dry even though the reservoir is full, and neighbours start hoarding buckets, which makes the shortage worse.
The financial system works the same way. The central bank fills the reservoir with money, and banks, clearing houses and lenders carry it through a network of pipes to the people who need it. Most days the flow is smooth and dull. When one pipe clogs, for example when lenders refuse to accept certain securities as security for loans, payments back up and firms that look perfectly healthy can run out of cash within hours, and the central bank has to open emergency taps to restore the flow.
Main components
- Settlement systems. Central bank real-time gross settlement systems, such as Fedwire in the United States, move central bank money between banks with immediate finality.
- Correspondent banking. A correspondent bank holds accounts for other banks so that they can make payments in currencies and countries where they have no direct access.
- Funding markets. In the repo market, cash is lent overnight or for short terms against securities, setting benchmarks such as SOFR.
- Collateral and margin. Securities pledged in repo and derivatives are valued daily, and a haircut protects the lender against price falls.
- Clearing and FX settlement. A central counterparty stands between buyers and sellers of securities and derivatives, while CLS settles both sides of many foreign exchange trades at the same time.
How money flows through the pipes
A typical cross-border payment shows the plumbing at work. A company instructs its bank, which sends a message to a correspondent; the correspondent debits and credits accounts on its books, and the final transfer between banks settles in a central bank system before its cut-off time. Banks often need intraday credit from the central bank to keep payments moving before incoming funds arrive, and a settlement bank may settle on behalf of smaller institutions that lack direct access.
Behind the payments sit funding flows. Dealers finance their securities holdings in repo, money market funds lend them cash, and the same Treasury bond may be pledged several times along a chain of trades. Each link depends on the next one paying on time.
When the plumbing fails
Several episodes show what happens when a pipe blocks:
- September 2008. After the Reserve Primary Fund "broke the buck" on 16 September, investors pulled cash from money market funds, and unsecured funding for banks dried up worldwide.
- September 2019. On 17 September, SOFR jumped to 5.25% from 2.43% the day before, and some overnight repo trades printed near 10%. The New York Fed began offering up to $75 billion a day in repo operations to calm the market.
- March 2020. A rush for cash at the start of the COVID-19 pandemic disrupted even the US Treasury market, and the Federal Reserve expanded swap lines to address a global shortage of dollar liquidity.
- September 2022. A sharp rise in UK gilt yields triggered collateral calls on liability-driven investment strategies used by pension funds, and the Bank of England began temporary gilt purchases on 28 September.
In each case, a problem of plumbing turned into a liquidity crisis: institutions that owned plenty of assets could not convert them into cash quickly enough.
Oversight and reform
Since 2012, the Principles for Financial Market Infrastructures issued by the Committee on Payments and Market Infrastructures and IOSCO have set international standards for payment systems, central counterparties and securities settlement systems. In the United States, the Financial Stability Oversight Council can designate systemically important financial market utilities for enhanced supervision by the Federal Reserve and other agencies.
Central banks have also added permanent backstops. The Federal Reserve made its Standing Repo Facility and the FIMA repo facility for foreign official institutions permanent in July 2021, so that dealers and central banks can turn Treasury securities into cash when private repo markets seize up. Debates continue over how far such backstops encourage risk-taking and whether reforms to Treasury market clearing will make the pipes more resilient.