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Systemic Risk, Interbank Relations and Liquidity Provision by theCentral Bank

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  • X. Freixas
  • B. Parigi
  • J-C. Rochet

Abstract

We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments systemic repercussions and we examine the justification of the Too-big-to-fail-policy.

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Bibliographic Info

Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 47.

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Length: 39 pages
Date of creation: 2000
Date of revision:
Handle: RePEc:dnb:staffs:47

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Web page: http://www.dnb.nl/en/
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Keywords: systemic risk; contagion; interbank markets;

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References

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  1. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
  2. Peter M. Garber, 1998. "Notes on the Role of TARGET in a Stage III Crisis," NBER Working Papers 6619, National Bureau of Economic Research, Inc.
  3. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  4. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  5. Bhattacharya, Sudipto & Fulghieri, Paolo, 1994. "Uncertain liquidity and interbank contracting," Economics Letters, Elsevier, vol. 44(3), pages 287-294.
  6. de Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic Risk: A Survey," CEPR Discussion Papers 2634, C.E.P.R. Discussion Papers.
  7. Franklin Allen & Douglas Gale, 1999. "Financial Contagion," Levine's Working Paper Archive 2092, David K. Levine.
  8. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
  9. Xavier Freixas & Bruno Parigi, 1998. "Contagion and efficiency in gross and net interbank payment systems," Proceedings 592, Federal Reserve Bank of Chicago.
  10. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, vol. 86(5), pages 1126-38, December.
  11. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  12. Freeman, Scott, 1996. "Clearinghouse banks and banknote over-issue," Journal of Monetary Economics, Elsevier, vol. 38(1), pages 101-115, August.
  13. 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.
  14. Brimmer, Andrew F, 1989. "Distinguished Lecture on Economics in Government: Central Banking and Systemic Risks in Capital Markets," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 3-16, Spring.
  15. Mark J. Flannery, 1996. "Financial crises, payment system problems, and discount window lending," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 804-831.
  16. Jacklin, Charles J & Bhattacharya, Sudipto, 1988. "Distinguishing Panics and Information-Based Bank Runs: Welfare and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 568-92, June.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Correlatedness and interconnectedness risks in bank failures
    by noreply@blogger.com (Gulzar Natarajan) in Urbanomics on 2014-08-03 04:45:00
  2. Financial Interconnectedness and Systemic Risk: The Fed’s FR Y-15
    by Gerald Epstein in Triple Crisis on 2014-07-14 12:00:28
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