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Interbank Market Freezes and Creditor Runs

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  • Xuewen Liu

Abstract

We model the interplay between trade in the interbank market and creditor runs on financial institutions. We show that the feedback between them can amplify a small shock into "interbank market freezing" with "liquidity evaporating." Credit crunches of the interbank market drive up the interbank rate. For an individual institution, a higher interbank rate — meaning a higher funding cost — results in more severe coordination problems among creditors in debt rollover decisions. Creditors thus behave more conservatively and run more often. Facing an increased chance of creditor runs, institutions demand more and supply less liquidity, tightening the interbank market. Received September 29, 2014; accepted March 7, 2016 by Editor Itay Goldstein.

Suggested Citation

  • Xuewen Liu, 2016. "Interbank Market Freezes and Creditor Runs," The Review of Financial Studies, Society for Financial Studies, vol. 29(7), pages 1860-1910.
    • Handle: RePEc:oup:rfinst:v:29:y:2016:i:7:p:1860-1910.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhw017
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    Cited by:

    1. Kristian Blickle & Markus Brunnermeier & Stephan Luck, 2020. "Micro-evidence from a System-wide Financial Meltdown: The German Crisis of 1931," Working Papers 275, Princeton University, Department of Economics, Center for Economic Policy Studies..
    2. Kristian Blickle & Markus K. Brunnermeier & Stephan Luck, 2022. "Who Can Tell Which Banks Will Fail?," NBER Working Papers 29753, National Bureau of Economic Research, Inc.
    3. Ahnert, Toni & Anand, Kartik & König, Philipp Johann, 2022. "Real interest rates, bank borrowing, and fragility," Working Paper Series 2755, European Central Bank.
    4. Angeletos, G.-M. & Lian, C., 2016. "Incomplete Information in Macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1065-1240, Elsevier.
    5. Ahnert, Toni & Martinez-Miera, David, 2021. "Bank Runs, Bank Competition and Opacity," VfS Annual Conference 2021 (Virtual Conference): Climate Economics 242348, Verein für Socialpolitik / German Economic Association.
    6. Morrison, Alan D & Wang, Tianxi, 2021. "Bank liquidity, bank lending, and "bad bank" policies," Economics Discussion Papers 29501, University of Essex, Department of Economics.
    7. Axelle Arquié, 2023. "Fire Sales and Bank Runs in the Presence of a Saving Allocation by Depositors," Working Papers 2023-09, CEPII research center.
    8. Qi Chen & Itay Goldstein & Zeqiong Huang & Rahul Vashishtha, 2020. "Liquidity Transformation and Fragility in the US Banking Sector," NBER Working Papers 27815, National Bureau of Economic Research, Inc.
    9. Cai, Zhifeng & Dong, Feng, 2023. "Public disclosure and private information acquisition: A global game approach," Journal of Economic Theory, Elsevier, vol. 210(C).
    10. T. R. Hurd, 2018. "Bank Panics And Fire Sales, Insolvency And Illiquidity," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(06), pages 1-30, September.
    11. Xuewen Liu, 2018. "Diversification and Systemic Bank Runs," 2018 Meeting Papers 739, Society for Economic Dynamics.
    12. Zhao Li & Kebin Ma, 2022. "Contagious Bank Runs and Committed Liquidity Support," Management Science, INFORMS, vol. 68(12), pages 9152-9174, December.
    13. T. R. Hurd, 2017. "Bank Panics and Fire Sales, Insolvency and Illiquidity," Papers 1711.05289, arXiv.org.
    14. Louis RAFFESTIN, 2021. "Uncertainty as a vector of financial contagion: how does it work, and how much does it matter?," LEO Working Papers / DR LEO 2881, Orleans Economics Laboratory / Laboratoire d'Economie d'Orleans (LEO), University of Orleans.
    15. Xuewen Liu, 2023. "A Model of Systemic Bank Runs," Journal of Finance, American Finance Association, vol. 78(2), pages 731-793, April.

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