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Interbank market friction-induced holdings of precautionary liquidity: implications for bank loan supply and monetary policy implementation

Author

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  • Monika Bucher

    (Deutsche Bundesbank)

  • Achim Hauck

    (Nottingham Trent University)

  • Ulrike Neyer

    (Heinrich Heine University Düsseldorf)

Abstract

We analyze the impact of overnight interbank market frictions on bank loan supply when banks face idiosyncratic liquidity risk and discuss resulting implications for monetary policy implementation. Sufficiently pronounced interbank market frictions imply that banks hold positive or negative precautionary liquidity. Holding positive (negative) precautionary liquidity means that banks hold more (less) liquidity than they expect to need. As holding precautionary liquidity is costly, interbank market frictions negatively influence bank loan supply. However, by means of its standing facilities, the central bank not only offers an alternative to using the interbank market but also determines the costs of friction-induced holdings of positive or negative precautionary liquidity. Therefore, the facilities allow the central bank to influence banks’ expected liquidity costs, and thereby their loan supply, so that interbank market frictions need not be an impediment to monetary policy transmission.

Suggested Citation

  • Monika Bucher & Achim Hauck & Ulrike Neyer, 2020. "Interbank market friction-induced holdings of precautionary liquidity: implications for bank loan supply and monetary policy implementation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(1), pages 165-222, July.
    • Handle: RePEc:spr:joecth:v:70:y:2020:i:1:d:10.1007_s00199-019-01207-6
    DOI: 10.1007/s00199-019-01207-6
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    More about this item

    Keywords

    Interbank market; Monetary policy; Precautionary liquidity; Monetary policy implementation; Interest corridor; Loan supply;
    All these keywords.

    JEL classification:

    • 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
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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