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

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  • Viral V. Acharya
  • Denis Gromb
  • Tanju Yorulmazer

Abstract

We study interbank lending and asset sales markets in which banks with surplus liquidity have market power vis-�-vis banks needing liquidity, frictions arise in lending due to moral hazard, and assets are bank-specific. Surplus banks ration lending and instead purchase assets from needy banks, an inefficiency more acute during financial crises. A central bank acting as a lender-of-last-resort can ameliorate this inefficiency provided it is prepared to extend potentially loss-making loans or is better informed than outside markets, as might be the case if it also performs a supervisory role. This rationale for central banking finds support in historical episodes. (JEL E58, G01, G21, G28, L13, N21)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 4 (2012)
Issue (Month): 2 (April)
Pages: 184-217

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Handle: RePEc:aea:aejmac:v:4:y:2012:i:2:p:184-217

Note: DOI: 10.1257/mac.4.2.184
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