IDEAS home Printed from https://ideas.repec.org/p/tiu/tiucen/06dc8c5e-b918-4028-8330-9ed737236d73.html
   My bibliography  Save this paper

Bank Liquidity, Interbank Markets, and Monetary Policy

Author

Listed:
  • Freixas, X.
  • Martin, A.
  • Skeie, D.

Abstract

A major lesson of the recent financial crisis is that the interbank lending market is crucial for banks facing large uncertainty regarding their liquidity needs. This paper studies the efficiency of the interbank lending market in allocating funds. We consider two different types of liquidity shocks leading to different implications for optimal policy by the central bank. We show that, when confronted with a distributional liquidity-shock crisis that causes a large disparity in the liquidity held among banks, the central bank should lower the interbank rate. This view implies that the traditional tenet prescribing the separation between prudential regulation and monetary policy should be abandoned. In addition, we show that, during an aggregate liquidity crisis, central banks should manage the aggregate volume of liquidity. Two different instruments, interest rates and liquidity injection, are therefore required to cope with the two different types of liquidity shocks. Finally, we show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Freixas, X. & Martin, A. & Skeie, D., 2010. "Bank Liquidity, Interbank Markets, and Monetary Policy," Discussion Paper 2010-35S, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:06dc8c5e-b918-4028-8330-9ed737236d73
    as

    Download full text from publisher

    File URL: https://pure.uvt.nl/ws/portalfiles/portal/1212610/2010-08S.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Ioannidou, Vasso P., 2005. "Does monetary policy affect the central bank's role in bank supervision?," Journal of Financial Intermediation, Elsevier, vol. 14(1), pages 58-85, January.
    2. Freixas, X. & Martin, A. & Skeie, D., 2010. "Bank Liquidity, Interbank Markets, and Monetary Policy," Other publications TiSEM d716ff9a-e8da-448f-86a1-8, Tilburg University, School of Economics and Management.
    3. Antoine Martin, 2006. "Liquidity provision vs. deposit insurance: preventing bank panics without moral hazard," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(1), pages 197-211, May.
    4. Viral V. Acharya & Tanju Yorulmazer, 2008. "Cash-in-the-Market Pricing and Optimal Resolution of Bank Failures," The Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2705-2742, November.
    5. Marvin Goodfriend & Robert G. King, 1988. "Financial deregulation, monetary policy, and central banking," Economic Review, Federal Reserve Bank of Richmond, vol. 74(May), pages 3-22.
    6. Xavier Freixas & Antoine Martin & David Skeie, 2011. "Bank Liquidity, Interbank Markets, and Monetary Policy," The Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2656-2692.
    7. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    8. Xavier Freixas, 2005. "Interbank Market Integration under Asymmetric Information," The Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 459-490.
    9. Xavier Freixas & Jos… Jorge, 2008. "The Role of Interbank Markets in Monetary Policy: A Model with Rationing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(6), pages 1151-1176, September.
    10. Adam Ashcraft & James Mcandrews & David Skeie, 2011. "Precautionary Reserves and the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(s2), pages 311-348, October.
    11. Goodhart, Charles & Schoenmaker, Dirk, 1995. "Should the Functions of Monetary Policy and Banking Supervision Be Separated?," Oxford Economic Papers, Oxford University Press, vol. 47(4), pages 539-560, October.
    12. repec:bla:intfin:v:2:y:1999:i:3:p:361-78 is not listed on IDEAS
    13. Antoine Martin, 2009. "Reconciling Bagehot and the Fed's Response to September 11," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2‐3), pages 397-415, March.
    14. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.
    15. Carmine Di Noia & Giorgio Di Giorgio, 1999. "Should Banking Supervision and Monetary Policy Tasks be Given to Different Agencies?," International Finance, Wiley Blackwell, vol. 2(3), pages 361-378, November.
    16. Whitesell, William, 2006. "Interest rate corridors and reserves," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1177-1195, September.
    17. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, vol. 8(May), pages 77-84.
    18. Gorton, Gary & Huang, Lixin, 2006. "Bank panics and the endogeneity of central banking," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1613-1629, October.
    19. Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.
    20. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Xavier Freixas, 2009. "Monetary policy in a systemic crisis," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 25(4), pages 630-653, Winter.
    2. Acharya, Viral V. & Skeie, David, 2011. "A model of liquidity hoarding and term premia in inter-bank markets," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 436-447.
    3. Martin, Antoine & Skeie, David & von Thadden, Ernst-Ludwig, 2014. "The fragility of short-term secured funding markets," Journal of Economic Theory, Elsevier, vol. 149(C), pages 15-42.
    4. Makoto (M.) Watanabe & Tarishi Matsuoka, 2019. "Banking Panics and the Lender of Last Resort in a Monetary Economy," Tinbergen Institute Discussion Papers 19-002/V, Tinbergen Institute.
    5. Vincent Bignon & Marc Flandreau & Stefano Ugolini, 2012. "Bagehot for beginners: the making of lender‐of‐last‐resort operations in the mid‐nineteenth century," Economic History Review, Economic History Society, vol. 65(2), pages 580-608, May.
    6. Xavier Freixas, 2009. "Post crisis challenges to bank regulation," Economics Working Papers 1201, Department of Economics and Business, Universitat Pompeu Fabra.
    7. Agur, Itai, 2014. "Bank risk within and across equilibria," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 322-333.
    8. Jin Cao & Gerhard Illing, 2022. "Money in the Equilibrium of Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(1), pages 119-144, February.
    9. Allen, Franklin & Carletti, Elena & Gale, Douglas, 2014. "Money, financial stability and efficiency," Journal of Economic Theory, Elsevier, vol. 149(C), pages 100-127.
    10. Heider, F. & Hoerova, M. & Holthausen, C., 2009. "Liquidity Hoarding and Interbank Market Spreads : The Role of Counterparty Risk," Discussion Paper 2009-40 S, Tilburg University, Center for Economic Research.
    11. Michal Kowalik, 2014. "To sell or to borrow: a theory of bank liquidity management," Research Working Paper RWP 14-18, Federal Reserve Bank of Kansas City.
    12. Diana Bonfim & Moshe Kim, 2012. "Liquidity risk in banking: is there herding?," Working Papers w201218, Banco de Portugal, Economics and Research Department.
    13. Florian Heider & Marie Hoerova, 2009. "Interbank Lending, Credit-Risk Premia, and Collateral," International Journal of Central Banking, International Journal of Central Banking, vol. 5(4), pages 5-43, December.
    14. Willmott, Bryony, 2014. "Excess reserves, interbank markets and domestic money market intervention," MPRA Paper 57046, University Library of Munich, Germany.
    15. Bucher, Monika & Dietrich, Diemo & Tvede, Mich, 2018. "Coordination failures, bank runs and asset prices," Discussion Papers 39/2018, Deutsche Bundesbank.
    16. Heider, Florian & Hoerova, Marie & Holthausen, Cornelia, 2015. "Liquidity hoarding and interbank market rates: The role of counterparty risk," Journal of Financial Economics, Elsevier, vol. 118(2), pages 336-354.
    17. Giovanni Ferri & Angelo Leogrande, 2015. "Was the Crisis due to a shift from stakeholder to shareholder finance? Surveying the debate," Mo.Fi.R. Working Papers 108, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
    18. Bonfim, D. & Kim, M., 2012. "Liquidity Risk in Banking : Is there Herding?," Other publications TiSEM 6e6df5ea-401b-49a2-b1be-4, Tilburg University, School of Economics and Management.
    19. Jorge, José & Kahn, Charles M., 2020. "Illiquidity as a signal," Journal of Financial Stability, Elsevier, vol. 50(C).
    20. Fiorella De Fiore & Marie Hoerova & Ciaran Rogers & Harald Uhlig, 2018. "Money Markets, Collateral and Monetary Policy," NBER Working Papers 25319, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    bank liquidity; interbank markets; central bank policy; financial fragility; bank runs;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:tiu:tiucen:06dc8c5e-b918-4028-8330-9ed737236d73. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Richard Broekman (email available below). General contact details of provider: http://center.uvt.nl .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.