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Relationships in the Interbank Market

Author

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  • Jonathan Chiu
  • Cyril Monnet

Abstract

The market for central bank reserves is mainly over-the-counter and exhibits a core-periphery network structure. This paper develops a model of relationship lending in the unsecured interbank market. In equilibrium, a tiered lending network arises endogenously as banks choose to build relationships to insure against liquidity shocks and to economize on the cost to trade in the interbank market. Relationships matter for banks’ bidding strategies at the central bank auction and introduce a relationship premium that can significantly distort the observed overnight rate. For example, it can explain some anomalies in the level of interest rates—namely, that banks sometimes trade above (below) the central bank’s lending (deposit) rate. The model also helps to explain how monetary policy affects the network structure of the interbank market and its functioning, and how the market responds dynamically to an exit from the floor system. We also use the model to discuss the potential effects of bilateral exposure limits on relationship lending.

Suggested Citation

  • Jonathan Chiu & Cyril Monnet, 2016. "Relationships in the Interbank Market," Staff Working Papers 16-33, Bank of Canada.
  • Handle: RePEc:bca:bocawp:16-33
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    References listed on IDEAS

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    Cited by:

    1. Jonathan Chiu & Jens Eisenschmidt & Cyril Monnet, . "Relationships in the Interbank Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    2. Jonathan Chiu & Jens Eisenschmidt & Cyril Monnet, . "Relationships in the Interbank Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    3. Sylvia Xiao & Randall Wright & Guillaume Rocheteau, 2017. "Open Market Operations," 2017 Meeting Papers 345, Society for Economic Dynamics.

    More about this item

    Keywords

    Interest rates; Monetary policy implementation; Transmission of monetary policy;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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