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Efficiency and Bargaining Power in the Interbank Loan Market

  • Jason Allen
  • James Chapman
  • Federico Echenique
  • Matthew Shum

Using detailed loan transactions-level data we examine the efficiency of an overnight interbank lending market, and the bargaining power of its participants. Our analysis relies on the equilibrium concept of the core, which imposes a set of no-arbitrage conditions on trades in the market. For Canada we show that while the market is fairly efficient, some degree of inefficiency persists throughout our sample. The level of inefficiency matches distinct phases of both the Bank of Canada’s operations as well as phases of the 2007- 2008 financial crisis, where more liquidity intervention implies more inefficiency. We find that bargaining power tilted sharply towards borrowers as the financial crisis progressed, and towards riskier borrowers. This supports a nuanced version of the Too- Big-To-Fail story, whereby participants continued to lend to riskier banks at favorable rates, not because of explicit support to the riskier banks provided by governmental authorities, but rather due to the collective self-interest of these banks.

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Paper provided by Bank of Canada in its series Working Papers with number 12-29.

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Length: 44 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:bca:bocawp:12-29
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  1. Viral V. Acharya & Ouarda Merrouche, 2010. "Precautionary Hoarding of Liquidity and Inter-Bank Markets: Evidence from the Sub-prime Crisis," NBER Working Papers 16395, National Bureau of Economic Research, Inc.
  2. Scott Hendry & Nadja Kamhi, 2009. "Uncollateralized overnight lending in Canada," Applied Financial Economics, Taylor & Francis Journals, vol. 19(11), pages 869-880.
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  9. Becker, Gary S., 1985. "Public policies, pressure groups, and dead weight costs," Journal of Public Economics, Elsevier, vol. 28(3), pages 329-347, December.
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  12. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  14. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2006. "Valuation in Over-the-Counter Markets," NBER Working Papers 12020, National Bureau of Economic Research, Inc.
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