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Relationships in the interbank market

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  • Chiu, Jonathan
  • Monnet, Cyril

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 in order 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, the fact that banks sometimes trade above (resp. below) the central bank’s lending (resp. deposit) rate. The model also helps understand 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 limit on relationship lending.

Suggested Citation

  • Chiu, Jonathan & Monnet, Cyril, 2016. "Relationships in the interbank market," Working Paper Series 5210, Victoria University of Wellington, School of Economics and Finance.
  • Handle: RePEc:vuw:vuwecf:5210
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    File URL: http://researcharchive.vuw.ac.nz/handle/10063/5210
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    References listed on IDEAS

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    Cited by:

    1. Chen, Bing & Li, Li & Peng, Fei & Anwar, Sajid, 2020. "Risk contagion in the banking network: New evidence from China," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    2. Jonathan Chiu & Jens Eisenschmidt & Cyril Monnet, 2020. "Relationships in the Interbank Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 35, pages 170-191, January.
    3. Jonathan Chiu & Jens Eisenschmidt & Cyril Monnet, 2020. "Relationships in the Interbank Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 35, pages 170-191, January.
    4. Chukwudi Henry Dike, 2020. "Strategic Interactions in Financial Networks," 2020 Papers pdi579, Job Market Papers.
    5. Sylvia Xiao & Randall Wright & Guillaume Rocheteau, 2017. "Open Market Operations," 2017 Meeting Papers 345, Society for Economic Dynamics.

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    More about this item

    Keywords

    Interbank market; Relationships; Networks; Monetary policy; Corridor system;
    All these keywords.

    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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