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Abstract

A lesson of the recent financial crisis is that the interbank market is crucial for banks facing uncertainty regarding their liquidity needs. This article studies the efficiency of the interbank market in allocating funds. We show that the central bank should lower the interbank rate when confronted with a crisis that causes a disparity in the liquidity held among banks. This suggests that the traditional tenet prescribing the separation between prudential regulation and monetary policy should be abandoned. We also show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhr018
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Bibliographic Info

Article provided by Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 24 (2011)
Issue (Month): 8 ()
Pages: 2656-2692

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Handle: RePEc:oup:rfinst:v:24:y:2011:i:8:p:2656-2692

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Find related papers by JEL classification:

• G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
• E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
• E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
• E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

References

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1. Ioannidou, Vasso P., 2005. "Does monetary policy affect the central bank's role in bank supervision?," Journal of Financial Intermediation, Elsevier, vol. 14(1), pages 58-85, January.
   
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   • Xavier Freixas & Antoine Martin & David Skeie, 2011. "Bank Liquidity, Interbank Markets, and Monetary Policy," Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2656-2692.
   • Xavier Freixas & Antoine Martin & David Skeie, 2010. "Bank Liquidity, Interbank Markets and Monetary Policy," Working Papers 429, Barcelona Graduate School of Economics.
   • Freixas, X. & Martin, A. & Skeie, D., 2010. "Bank Liquidity, Interbank Markets, and Monetary Policy," Discussion Paper 2010-35S, Tilburg University, Center for Economic Research.
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5. Viral Acharya & Tanju Yorulmazer, 2007. "Cash-in-the-market pricing and optimal resolution of bank failures," Bank of England working papers 328, Bank of England.
   
   • Viral V. Acharya & Tanju Yorulmazer, 2008. "Cash-in-the-Market Pricing and Optimal Resolution of Bank Failures," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2705-2742, November.
6. Goodhart, Charles & Schoenmaker, Dirk, 1995. "Should the Functions of Monetary Policy and Banking Supervision Be Separated?," Oxford Economic Papers, Oxford University Press, vol. 47(4), pages 539-60, October.
7. Xavier Freixas & José Jorge, 2007. "The role of interbank markets in monetary policy: A model with rationing," Economics Working Papers 1027, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2008.
   
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8. Gary Gorton & Lixin Huang, 2002. "Bank Panics and the Endogeneity of Central Banking," Center for Financial Institutions Working Papers 02-29, Wharton School Center for Financial Institutions, University of Pennsylvania.
   
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   • Gary Gorton & Lixin Huang, 2002. "Bank Panics and the Endogeneity of Central Banking," NBER Working Papers 9102, National Bureau of Economic Research, Inc.
9. David R. Skeie, 2008. "Banking with nominal deposits and inside money," Staff Reports 242, Federal Reserve Bank of New York.
   
   • Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.
10. Adam Ashcraft & James Mcandrews & David Skeie, 2011. "Precautionary Reserves and the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 311-348, October.
    
    • Adam Ashcraft & James McAndrews & David Skeie, 2009. "Precautionary reserves and the interbank market," Staff Reports 370, Federal Reserve Bank of New York.
11. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
    
    • Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
12. Xavier Freixas & Cornelia Holthausen, 2001. "Interbank market integration under asymmetric information," Economics Working Papers 579, Department of Economics and Business, Universitat Pompeu Fabra.
    
    • Xavier Freixas, 2005. "Interbank Market Integration under Asymmetric Information," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 459-490.
    • Freixas, X. & Holthausen, C., 2001. "Interbank Market Integration under Asymmetric Information," Papers 74, Quebec a Montreal - Recherche en gestion.
    • Cornelia Holthausen & Xavier Freixas, 2001. "Interbank market integration under asymmetric information," Working Paper Series 074, European Central Bank.
13. Carmine Di Noia & Giorgio Di Giorgio, 1999. "Should banking supervision and monetary policy tasks be given to different agencies?," Economics Working Papers 411, Department of Economics and Business, Universitat Pompeu Fabra.
    
    • Di Noia, Carmine & Di Giorgio, Giorgio, 1999. "Should Banking Supervision and Monetary Policy Tasks Be Given to Different Agencies?," International Finance, Wiley Blackwell, vol. 2(3), pages 361-78, November.
    • Carmine Di Noia & Giorgio Di Giorgio, 1999. "Should Banking Supervision and Monetary Policy Tasks Be Given to Different Agencies," Center for Financial Institutions Working Papers 00-11, Wharton School Center for Financial Institutions, University of Pennsylvania.
14. Antoine Martin, 2009. "Reconciling Bagehot and the Fed's Response to September 11," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 397-415, 03.
15. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
16. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.

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1. Bank Liquidity, Interbank Markets and Monetary Policy
   by Christian Zimmermann in NEP-DGE blog on 2010-04-07 19:34:48

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