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Deposit insurance and money market freezes

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Author Info

  • Bruche, Max
  • Suarez, Javier

Abstract

In the presence of deposit insurance, a rise in counterparty risk may cause a freeze in interbank money markets. We show this in a general equilibrium model with regionally segmented bank-based retail financial markets, in which money markets facilitate the reallocation of funds across banks from different regions. Counterparty risk creates an asymmetry between banks in savings-rich regions, which remain marginally financed by the abundant regional insured deposits, and in savings-poor regions, which have to pay large spreads in money markets. This asymmetry distorts the aggregate allocation of credit and, in the presence of demand externalities, can cause large output losses.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 57 (2010)
Issue (Month): 1 (January)
Pages: 45-61

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Handle: RePEc:eee:moneco:v:57:y:2010:i:1:p:45-61

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Web page: http://www.elsevier.com/locate/inca/505566

Related research

Keywords: Deposit insurance Money markets Bank solvency Financial market freezes;

References

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Citations

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Cited by:
  1. Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk," Discussion Paper 2009-40 S, Tilburg University, Center for Economic Research.
  2. Pierluigi Bologna, 2011. "Is There a Role for Funding in Explaining Recent U.S. Banks' Failures?," IMF Working Papers 11/180, International Monetary Fund.
  3. Ben R. Craig & Goetz von Peter, 2010. "Interbank tiering and money center banks," Working Paper 1014, Federal Reserve Bank of Cleveland.
  4. Ben R. Craig & Goetz von Peter, 2009. "Interbank tiering and money center banks," Working Paper 0912, Federal Reserve Bank of Cleveland.
  5. Diana Bonfim & Moshe Kim, 2012. "Liquidity risk in banking: is there herding?," Working Papers w201218, Banco de Portugal, Economics and Research Department.
  6. Craig, Ben R. & von Peter, Goetz, 2010. "Interbank tiering and money center banks," Discussion Paper Series 2: Banking and Financial Studies 2010,12, Deutsche Bundesbank, Research Centre.
  7. James Costain & Beatriz de Blas, 2012. "Smoothing shocks and balancing budgets in a currency union," Banco de España Working Papers 1207, Banco de España.
  8. Ben Craig & Goetz von Peter, 2010. "Interbank tiering and money center banks," BIS Working Papers 322, Bank for International Settlements.
  9. Marie Brière & Bastien Drut & Valérie Mignon & Kim Oosterlinck & Ariane Szafarz, 2012. "Is the Market Portfolio Efficient? A New Test of Mean-Variance Efficiency when All Assets Are Risky," Working Papers CEB 12-003, ULB -- Universite Libre de Bruxelles.
  10. Stefano Puddu & Andreas Waelchli, 2011. "Too TAF Towards the Risk," IRENE Working Papers 11-01, IRENE Institute of Economic Research.
  11. Costain, James & de Blas, Beatriz, 2012. "The role of fiscal delegation in a monetary union: a survey of the political economy issues," Working Papers in Economic Theory 2012/11, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).

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