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Deposit insurance and money market freezes

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  • 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

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

References

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Citations

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Cited by:
  1. Beatriz de Blas & James Costain, 2012. "Smoothing shocks and balancing budgets in a currency union^M," 2012 Meeting Papers 975, Society for Economic Dynamics.
  2. Ben R. Craig & Goetz von Peter, 2009. "Interbank tiering and money center banks," Working Paper 0912, Federal Reserve Bank of Cleveland.
  3. Heider, Florian & Hoerova, Marie & Holthausen, Cornelia, 2009. "Liquidity hoarding and interbank market spreads: the role of counterparty risk," Working Paper Series 1126, European Central Bank.
  4. Szafarz, Ariane & Oosterlinck, Kim & Mignon, Valérie & Drut, Bastien & Brière, Marie, 2011. "Is the Market Portfolio Efficient? A New Test to Revisit the Roll (1977) versus Levy and Roll (2010) Controversy," Economics Papers from University Paris Dauphine 123456789/9297, Paris Dauphine University.
  5. Merwan Engineer & Paul Schure & Mark Gillis, 2012. "A Positive Analysis of Deposit Insurance Provision: Regulatory Competition Among European Union Countries," Working Paper Series 29_12, The Rimini Centre for Economic Analysis.
  6. Diana Bonfim & Moshe Kim, 2012. "Liquidity risk in banking: is there herding?," Working Papers w201218, Banco de Portugal, Economics and Research Department.
  7. Stefano Puddu & Andreas Waelchli, 2011. "Too TAF Towards the Risk," IRENE Working Papers 11-01, IRENE Institute of Economic Research.
  8. Marie Briere & 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.
  9. Pierluigi Bologna, 2011. "Is there a Role for Funding in Explaining Recent U.S. Banks' Failures?," IMF Working Papers 11/180, International Monetary Fund.
  10. 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).
  11. Vinogradov, Dmitri, 2012. "Destructive effects of constructive ambiguity in risky times," Journal of International Money and Finance, Elsevier, vol. 31(6), pages 1459-1481.

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