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A minimal model of money creation under regulatory constraints

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  • Victor Le Coz
  • Michael Benzaquen
  • Damien Challet

Abstract

We propose a minimal model of the secured interbank network able to shed light on recent money markets puzzles. We find that excess liquidity emerges due to the interactions between the reserves and liquidity ratio constraints; the appearance of evergreen repurchase agreements and collateral re-use emerges as a simple answer to banks' counterparty risk and liquidity ratio regulation. In line with prevailing theories, re-use increases with collateral scarcity. In our agent-based model, banks create money endogenously to meet the funding requests of economic agents. The latter generate payment shocks to the banking system by reallocating their deposits. Banks absorbs these shocks thanks to repurchase agreements, while respecting reserves, liquidity, and leverage constraints. The resulting network is denser and more robust to stress scenarios than an unsecured one; in addition, the stable bank trading relationships network exhibits a core-periphery structure. Finally, we show how this model can be used as a tool for stress testing and monetary policy design.

Suggested Citation

  • Victor Le Coz & Michael Benzaquen & Damien Challet, 2024. "A minimal model of money creation under regulatory constraints," Papers 2410.18145, arXiv.org.
    • Handle: RePEc:arx:papers:2410.18145
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    References listed on IDEAS

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    1. Samira BOURAHLA & Émilie FIALON & Alexandre GARCIA & Aurélien VIOLON, 2018. "Does the leverage ratio have an adverse impact on client clearing? [Les services de compensation centrale pour compte de tiers pénalisés par le ratio de levier ?]," Bulletin de la Banque de France, Banque de France, issue 218.
    2. Matteo Accornero, 2020. "Repo Markets, Collateral Re-use and Systemic Fragility. A Literature Review," Working Papers 7/20, Sapienza University of Rome, DISS.
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    4. Johannes Brumm & Michael Grill & Felix Kubler & Karl Schmedders, 2023. "Re-use of collateral: Leverage, volatility, and welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 19-46, January.
    5. Hałaj, Grzegorz, 2018. "Agent-based model of system-wide implications of funding risk," Working Paper Series 2121, European Central Bank.
    6. Victor Le Coz & Nolwenn Allaire & Michael Benzaquen & Damien Challet, 2024. "Stylized facts in money markets: an empirical analysis of the eurozone data," Papers 2410.16021, arXiv.org.
    7. Dawid, Herbert & Gemkow, Simon & Harting, Philipp & Hoog, Sander van der & Neugart, Michael, 2018. "Agent-based macroeconomic modeling and policy analyses: The Eurace@Unibi Model," Publications of Darmstadt Technical University, Institute for Business Studies (BWL) 110863, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).
    8. Belinda Cheung & Mark Manning & Angus Moore, 2014. "The Effective Supply of Collateral in Australia," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 53-66, September.
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