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A dynamic network model of the unsecured interbank lending market

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  • Brauning, Falk
  • Francisco Blasques
  • Iman Van Lelyveld

Abstract

The unsecured interbank lending market plays a crucial role in financing business activity, a fact underscored by the market's disruption following the Lehman Brothers failure in September 2008. This event, a defining moment in the global financial crisis, fostered greater uncertainty about counterparty risk, an adverse shock that severely curtailed credit supply, hampered monetary policy, and negatively impacted the real economy. To counteract the consequences of the crisis, central banks became the primary intermediaries for a large portion of the money market. However, a single main counterparty reduces the incentives for peer monitoring and the market discipline obtained from private information about counterparty credit risk. To assess the benefits gained from having a decentralized market, this paper builds and estimates a dynamic network model of interbank lending using transaction-level data. The analysis focuses on assessing the roles that credit-risk uncertainty and private information, gathered through peer monitoring and repeated interactions, play in shaping the network of bilateral lending relationships, interest rates, loan volumes, and the liquidity allocation among banks. The paper also analyzes how changes in the central bank's interest rate corridor affect the interbank market structure.

Suggested Citation

  • Brauning, Falk & Francisco Blasques & Iman Van Lelyveld, 2016. "A dynamic network model of the unsecured interbank lending market," Working Papers 16-3, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:16-3
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    More about this item

    Keywords

    interbank liquidity; financial networks; credit-risk uncertainty; peer monitoring; monetary policy; trading relationships; indirect parameter estimation;

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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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