Skip navigation
Title: 

Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking

Authors: Acharya, Viral
Gromb, Denis
Yorulmazer, Tanju
Issue Date: 21-Jan-2010
Series/Report no.: FIN-09-031
Abstract: We study liquidity transfers between banks through the interbank borrowing and asset sale markets when(i)surplus banks providing liquidity have market power, ii)there are frictions in the lending market due to moral hazard, and(iii)assets are bank-specific. We show that when the outside options of needy banks are weak, surplus banks may strategically under-provide lending, thereby inducing inefficient sales of bank-specific assets. A central bank can ameliorate this inefficiency by standing ready to lend to needy banks, provided it has greater information about banks(e.g.,through supervision) compared to outside markets, or is prepared to extend potentially loss-making loans. The public provision of liquidity to banks, in fact its mere credibility, can thus improve the private allocation of liquidity among banks. This rationale for central banking funds support in historical episodes preceding the modern era of central banking and has implications for recent debates on the supervisory and lender-of-last-resort roles of central banks.
URI: http://hdl.handle.net/2451/29539
Appears in Collections:Finance Working Papers

Files in This Item:
File Description SizeFormat 
wpa09031.PDF323.69 kBAdobe PDFView/Open


Items in FDA are protected by copyright, with all rights reserved, unless otherwise indicated.