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Credit Market Competition and Liquidity Crises

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  • Elena Carletti
  • Agnese Leonello

Abstract

We develop a model where banks invest in reserves and loans, and face aggregate liquidity shocks. Banks with liquidity shortage sell loans on the interbank market. Two equilibria emerge. In the no default equilibrium, all banks hold enough reserves and remain solvent. In the mixed equilibrium, some banks default with positive probability. The former exists when credit market competition is intense. The latter emerges when banks exercise market power. Thus, competition is beneficial to financial stability. The structure of liquidity shocks affects the severity and the occurrence of crises, as well as the amount of credit available in the economy.

Suggested Citation

  • Elena Carletti & Agnese Leonello, 2014. "Credit Market Competition and Liquidity Crises," CESifo Working Paper Series 4647, CESifo.
  • Handle: RePEc:ces:ceswps:_4647
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    References listed on IDEAS

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    Cited by:

    1. Mr. Sami Ben Naceur & Raja Almarzoqi & Alessandro Scopelliti, 2015. "How Does Bank Competition Affect Solvency, Liquidity and Credit Risk? Evidence from the MENA Countries," IMF Working Papers 2015/210, International Monetary Fund.
    2. Matsuoka, Tarishi, 2018. "Banks and liquidity crises in emerging market economies," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 43-62.
    3. Michiel Bijlsma & Andrei Dubovik & Gijsbert Zwart, 2012. "Inside Liquidity in Competitive Markets," CPB Discussion Paper 209, CPB Netherlands Bureau for Economic Policy Analysis.
    4. Ronald Fischer & Nicolás Inostroza & Felipe J. Ramírez, 2015. "Banking Competition and Economic Stability," Documentos de Trabajo 320, Centro de Economía Aplicada, Universidad de Chile.
    5. Fabio Castiglionesi, 2014. "Discussion of Hakenes and Schnabel," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(s1), pages 289-293, February.
    6. Ronald Fischer & Nicolás Inostroza & Felipe J. Ramírez, 2013. "Banking Competition and Economic Stability," Documentos de Trabajo 296, Centro de Economía Aplicada, Universidad de Chile.

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    More about this item

    Keywords

    interbank market; default; price volatility;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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