Imperfect Competition in the Inter-Bank Market for Liquidity as a Rationale for Central Banking

35 Pages Posted: 7 Mar 2008

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Denis Gromb

HEC Paris

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB)

Multiple version iconThere are 2 versions of this paper

Date Written: March 18, 2008

Abstract

We consider liquidity transfers between banks through the inter-bank borrowing and asset sale markets when banks providing liquidity may have market power and assets may be bank-specific. We show that when the outside options of liquidity-affected banks are weak, surplus banks may strategically underprovide lending. Thereby inducing excessive and inefficient sales of bank-specific assets. A regulator such as a Central Bank can ameliorate this inefficiency by standing to lend to affected banks, provided it has greater information about banks (for example, through supervision) compared to the outside markets, or absent such information access, it is prepared to make some loss-making loans. The public provision of liquidity to banks, or its mere credibility, can thus improve the private allocation of liquidity among banks. This rationale for the existence of a Central Bank and has support in historical episodes preceding the modern era of Central Banking and has implications for recent debates concerning the supervisory and lender-of-last-resort roles of Central Banks.

Keywords: Competition, Inter-bank lending, Market power, Asset specificity, Lender of last resort

JEL Classification: G21, G28, G38, E58, D62

Suggested Citation

Acharya, Viral V. and Gromb, Denis and Yorulmazer, Tanju, Imperfect Competition in the Inter-Bank Market for Liquidity as a Rationale for Central Banking (March 18, 2008). EFA 2008 Athens Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1102384 or http://dx.doi.org/10.2139/ssrn.1102384

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Denis Gromb

HEC Paris

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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